Report 04/2016
Where next? A liberal, free-market guide to Brexit
Raoul Ruparel, Stephen Booth, Vincenzo Scarpetta About the Authors
Raoul Ruparel Open Europe is a non-partisan and independent policy Co-Director think tank, committed to crafting and putting into action solutions to the European Union’s most pressing challenges. Open Europe’s Co-Director, Raoul is also a contributing We are committed to European Union reform. Our vision author for Forbes, writing on European economics for a slimmed-down, outward looking and dynamic EU rests and politics, and a member of the British Chamber of on four principles: Commerce Economic Advisory Group. •• Boost jobs and growth. Enable and encourage free trade – internally and globally. Regulate business less, but better. •• Embrace democracy. Be transparent and accountable to citizens, recognising the crucial Stephen Booth role of national parliaments. Cut the cost of Co-Director Brussels. •• Focus on the big questions. Do not interfere in Stephen has led Open Europe research projects on areas that could be equally well handled at the EU regulation, justice and home affairs and the UK’s national or local level. trade with the EU. Stephen also directed Open Europe’s •• Be flexible. Allow powers to flow back to the policy work on EU migration and free movement, which member states, and let some countries integrate featured prominently in the Prime Minister’s recent more than others. immigration speech. Disclaimer
Open Europe will remain neutral in the EU Referendum campaign, confining ourselves to commenting as Vincenzo Scarpetta accurately as we can on the arguments and facts Policy Analyst advanced on both sides of the debate.
Vincenzo specialises in the politics and economics of Southern Europe and is a regular commentator in print Acknowledgements and broadcast media across Europe. He has co-authored policy-changing Open Europe Intelligence on EU free We are also indebted to the hard work of our research movement, employment law, financial regulation and the interns Jayson Probin and Christopher Hughes da Silva in European Neighbourhood Policy. helping to put together this report.
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1 | Open Europe We Drive Change in Europe www.openeurope.org.uk @openeurope Contents
Executive Summary 1 Introduction 5
Literature Review: An emerging economic consensus? 7
1 Trade 9 1.1 Coverage 9 1.2 Scope 15 1.3 Speed 17 1.4 Conclusions and policy implications 21 1.5 Trade Case Study- Agriculture 22 2 Immigration 28 2.1 The political climate 28 2.2 Why a liberal approach to migration is likely to remain important 31 2.3 Managing immigration in the century of globalisation 37 2.4 Conclusions and policy implications 42
3 Deregulation and competitiveness 44 3.1 Business desire for deregulation 44 3.2 What level of politically feasible deregulation? 45 3.3 Competitiveness 50 3.4 Conclusions 51
4 Conclusions: What are the implications for a new UK-EU relationship 53
Annex 1 55 Annex 2 59 Annex 3 60
www.openeurope.org.uk @openeurope Executive summary
The EU referendum is a crucial decision about Britain’s future, but the campaign so far has failed to adequately address how life outside the EU might look. It will not be an apocalypse and it will not be a utopia. The growing economic evidence suggests that there would be a small negative economic result from Brexit, probably in the region of 0.5% - 1.5% of GDP in the long run, presuming a reasonable trade agreement is struck between the UK and the EU. The question then is whether the UK can use its new found freedoms to offset this cost or reverse it to a positive outcome.
We believe it is possible, but the path to prosperity outside the EU lies through: free trade and opening up to low cost competition, maintaining relatively high immigration (albeit with a different mix of skills), and pushing through deregulation and economic reforms in areas where the UK has historically been sub-par compared to international partners. There is no doubt that such an approach would disappoint a number of people on the ‘Leave’ side and whether there is appetite for such changes in the UK is unclear. One thing that is clear is that Brexit cannot be all things to all people.
Below, we outline the key priorities for a UK Government post Brexit:
Trade
The first step would be to try to strike a Free Trade Agreement with the EU and to maintain the FTAs Britain has with other states via the EU. As we outlined in our previous report, this is not an easy task and could take many years. The emerging consensus is that – taken by itself – there would be a small negative economic impact from leaving the customs union and the single market in the long run.
The second step would be to build FTAs with other states to try to offset this effect.
o Contrary to popular belief, countries don’t only strike free trade agreements with large states or economic blocs. Medium-sized economies such as Norway (80%), Australia (77%) and Canada (69%) have managed to strike FTAs covering a significant proportion of their trade – more than the UK at 63%. For Norway and Canada this is reliant on having reached an agreement with their largest trading partner – the EU in the UK’s case. However, Australia and New Zealand have proven a more diversified approach can also work. Striking deals with US and China would bring the UK’s share of trade covered by FTAs to over 81% – slightly higher than Norway’s.
o Evidence suggests this will take some time. Globally, trade deals have usually taken anywhere between four and ten years to negotiate. The EU is not uniquely sluggish.
o There is a trade-off between speed and scope. A more complex agreement addressing services and non-tariff barriers (NTBs) does seem to take longer.
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Basic agreements focusing on goods tend more towards the four year end of the scale while more comprehensive deals tend towards ten years.
o One option for the UK to speed up this process would be to dump the EU’s all or nothing approach. That way, the UK could strike initial agreements on removing tariffs on goods and revisit negotiations on services and NTBs at a later date. This would make sense for emerging market economies where tariffs are relatively high and the majority of UK trade is in goods – China, India and Brazil fit this category.
o Striking a series of FTAs with Asian economies (China, India, Japan and ASEAN) could deliver a boost of up to 0.6% of GDP for the UK, going some way to offsetting the negative impact of leaving the EU customs union and single market. Alternatively, a unilateral free trade approach could deliver a boost of around 0.75% of GDP in the long run.
o A case study of the agricultural sector highlights the tension between opening up to the rest of the world or continuing protectionism and subsidies. There are potential savings for both taxpayers (£1.5bn) and consumers (between £400m and £1.4bn) from liberalisation. However, this would mean creative destruction and would see a number of farms going out of business, not least because 19% of British farms do not currently make any profit. So far, comments from politicians suggest they are not willing to take on the established interests in this sector. How much more widely would this apply post-Brexit?
o Recent controversies, particularly around the steel sector, highlight the potential political challenges to opening up trade with emerging markets and particularly non-market economies such as China. Striking trade agreements with such countries may well face significant grassroots opposition.
The third step could be revisiting and updating older agreements.
o Only eleven of the 33 EU FTAs currently in force cover services. Often the biggest difference between trade agreements does not come from the size of the negotiating parties, but whether it is a first generation agreement (basic, focused on tariffs and goods) or a more comprehensive second generation agreement (dealing with services, NTBs and regulation).
Immigration
While there would be political pressure to reduce immigration following Brexit, there are several reasons why we believe headline net immigration is unlikely to reduce much:
o The business case for maintaining a flexible supply of labour. The evidence suggests that, with a record high employment rate, the UK’s labour market is already tightening;
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o the political and economic challenge of finding policy alternatives to relieve pressure on the public finances caused by ageing demographics, where immigration can help smoothen the path to fiscal sustainability; o the effects of globalisation on migration flows, which the UK is not alone in experiencing; o and the likelihood of some constraints on UK immigration policy under a new arrangement with the EU.
Nevertheless, free from EU rules on free movement, the UK would likely pursue a selective policy more geared towards attracting skilled migration, which could be more politically acceptable.
Open Europe would recommend a system seeking to emulate the points-based systems of Canada and Australia. The system could be weighted strongly towards those with a job offer, but also offer a route for skilled migrants seeking work. Such a system could give priority to UK industries and employers suffering skills shortages but also allow a flexible supply of skilled workers to enter the UK labour force subject to a cap which could be varied depending on economic circumstances. However, there is likely to be a continued need for migrant labour to fill low-skilled jobs. Therefore, the UK would also need a mechanism to fill low-skilled jobs or meet labour shortages where employers have recently relied on EU migrants.
However, there is likely to be a trade-off between the depth of any new economic agreement with the EU and the extent to which the UK will have to accept EU free movement. The evidence from the precedents of Norway and Switzerland suggest that the deeper the agreement, the more likely the UK will need to accept free movement. This might mean building in preferential treatment for EU citizens in the UK’s new points system, which would give EU nationals priority over non-EU nationals, or it could create a separate temporary migration scheme for migrants from the EU.
The UK is far from alone in its migration experience in terms of developed economies. Between 2000 and 2015 the UK received 3.7 migrants for every thousand people, which puts it just above the average but below countries such as Canada, Australia, Norway and Switzerland. If the UK had experienced the same level of immigration as Canada or Australia there would have been an additional 3 million or 4.4 million migrants respectively coming to the UK over the past decade – though of course the UK is a more crowded country.
Regulation and competitiveness
There is certainly scope for deregulation outside the EU, though maybe not as large as assumed. We estimate a politically feasible deregulation agenda could lead to permanent gains of 0.7% of GDP – with savings coming mostly from three areas: social employment law, environment and climate change and financial services. But even such a scenario would involve difficult choices such as scrapping renewable energy targets and deregulating social and employment laws.
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More broadly, the UK remains one of the most competitive developed economies, particularly in areas such as: labour market, business environment and product market regulation. Yet there are of course potential gains, especially in areas such as: education, skills, infrastructure and costs of certain services. There is little evidence that the EU holds us back in these areas, but their reform and the ensuing competitiveness boost will become increasingly crucial in the case of Brexit.
These findings have important implications for the type of relationship the UK should seek with the EU post-Brexit. Realising the potential economic gains we’ve identified – notably via immigration and deregulation – means a relatively high degree of flexibility from the EU. The confines of a Norwegian or Swiss-style arrangement would not deliver this. As such, the best option would be for the UK to pursue a comprehensive bilateral free trade agreement, aimed at maintaining as much of the current market access as possible while also adopting a broader liberalisation agenda over the longer term. Of course, this is easier said than done.
This paper is not an endorsement of Leave or Remain. But an attempt to flesh out some of the policies which we believe the UK may reasonably have to adopt in the event of a Brexit in order to offset the costs and maximise the economic benefits.
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Introduction
In March 2015, Open Europe published the report, ‘What if…? The consequences, challenges and opportunities facing Britain outside the EU’, which concluded that Britain’s economic performance outside the EU would depend on the type of deal the UK secured with the EU, the UK’s approach to global trade and immigration, and domestic policies on regulating the economy.1
Using a CGE economic model and previous work on the cost of regulation,2 we estimated the long-run macro-economic effect of withdrawal from the EU to fall within the range of -2.2% and +1.6% of UK GDP by 2030. Our modelling concluded that leaving the EU’s single market and customs union would result in costs that could not be off-set merely by striking a new trade deal with the EU. Britain would need to be prepared to use its new found independence to make up the ground lost from a dislocation with the EU in other ways.
Britain would therefore face a series of difficult choices in the following areas:
Trade (Beyond the border) Since UK trade policy is currently outsourced to the EU, Brexit would not only necessitate a new economic relationship with the EU, it would also require a new British strategy for boosting trade with the rest of the world. Opening up the UK economy to trade with the rest of the world – including the USA, India, China, Malaysia and Indonesia – would be essential to economic growth post-Brexit. However, this would mean exposing UK firms and workers to new levels of competition from low-cost countries, which could be politically very sensitive.
Migration (On the border) In order to be competitive outside the EU, Britain would need to maintain a liberal policy for labour migration. However, limiting migration would be a major motivation for those voting to leave the EU, meaning the Government would face pressure to move in the opposite direction.
1 Open Europe, ‘What if…? The consequences, challenges and opportunities facing Britain outside the EU’, 2015; http://openeurope.org.uk/intelligence/britain-and-the-eu/what-if-there-were-a-brexit/ 2 See Open Europe, ‘Still out of control? Measuring eleven years of EU regulation’, 2010; http://openeurope.org.uk/intelligence/economic-policy-and-trade/still-control-measuring-eleven-years-eu-regulation/; Open Europe, ‘Top 100 EU rules cost Britain £33.3bn’, March 2015; http://openeurope.org.uk/intelligence/britain-and-the-eu/top-100- eu-rules-cost-britain-33-3bn/
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Regulation (Behind the border) EU rules have largely been incorporated into UK law, and would be the default until Parliament decided to amend or scrap them. Outside the EU, we estimated that a very liberally inclined, free market Government could in theory cut the cost of the most burdensome EU regulations by an amount equivalent to between 0.7% and 1.3% of GDP. However, in some cases, the UK currently regulates beyond the minimum EU requirements and therefore realising these gains would not simply require leaving the EU but gaining political support for a new domestic approach.
This report explores the specific policy challenges in these areas following a Brexit and the steps a future Government should consider to help the UK economy prosper outside the EU.
The transition to a new relationship with the EU and the rest of the world
Irrespective of the long-term impact of Brexit, most analysis acknowledges that withdrawal is likely to result in a short-term shock to the economy.3 While the UK’s trade relationship with the EU and other global partners would not change immediately after a Leave vote in the referendum, the uncertainty resulting from the negotiations over withdrawal and a new relationship with the EU are expected to have a short-term negative economic impact. In addition, realising the economic potential of new trade deals with global partners or deregulation would be a gradual rather than immediate process. However, by definition, it is almost impossible to meaningfully quantify this uncertainty and what it might mean for investment, the value of Sterling and the wider economy.
Broadly, there are three parts to the leaving process, which would most likely take place under Article 50 of the EU treaties.
Transitional arrangement: The first part would be to negotiate a transitional arrangement between the UK and the EU. This is essentially the holding pattern while the next steps take place. This would likely cover issues such as the rights of EU and UK citizens living abroad. New long term trading arrangement: This would be the negotiation of a new trading relationship between the UK and the EU which will replace the current membership of the customs union and single market. Relationship with the rest of the world: This will be partly dependent on the first two but will involve the UK negotiating to maintain its current free trade agreements and then also expanding them to tap into other markets.
The rest of this report will explore what the ‘final destination’ might be outside the EU and as such will focus mostly on the final stage of leaving process outlined above.
Most reports focus on the relationship between the UK and the EU first and foremost and then look further afield – including our previous report. However, in this paper we flip this on its head. Ultimately, a key motivation for leaving the EU would be to look further afield and more widely. As such, taking this first and assessing how the UK would approach the rest of the world as well as its domestic policies and then looking at what this means for our relationship with the EU can be a useful exercise.
3 See Greater London Authority, ‘London: the global powerhouse’, 2016, p44; https://www.london.gov.uk/sites/default/files/gla_the_london_economy_report_full_low_res.pdf
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Literature review: An emerging economic consensus?
There have been a huge number of studies on the impact of Brexit produced over the years, but particularly in the past year since the referendum was confirmed. The studies are based on a wide variety of assumptions and inputs, some more credible than others.
However, there seems to be a broad consensus emerging around the fact there is likely to be a small negative economic impact from the initial step of leaving the EU in the longer run (usually up to 2030). Generally, there seems to be convergence around a long run loss in the region of 0.5% - 1.5% of GDP in a scenario where the UK strikes a free trade agreement with the EU and maintains its free trade agreements with other countries. This fits with the findings of our study as well as those of PwC, Oxford Economics and London School of Economics Centre for Economic Performance.4 The question then is whether the UK can use new found freedom outside the EU to take policy choices which might help offset this negative economic impact. This paper attempts to explore this in more depth looking in detail at the choices facing the UK outside and how politically palatable they are.
Selected estimates of the cost of UK membership/withdrawal from the EU Study Assumptions Benefit/Cost of membership/withdrawal Oxford Economics, Nine scenarios considered Economic impact of Brexit would ‘Assessing the economic from staying in customs be somewhere between -0.1% of implications of Brexit’, union to falling back on GDP to -3.9% of GDP. March 2016 WTO. Each also includes assumptions about liberal or protectionist policy approach (including migration). PwC, ‘Leaving the EU: Examine FTA and WTO Brexit leads to decline in GDP of Implications for the UK scenario as well as varying between -3.1% and -5.5% (-3% economy’, study assumptions of liberal (or and -5.4% in GDP per capita commissioned by the not) immigration system. terms) in the short term (up to Confederation of British No scenario sees services 2020). In the longer term the Industry, March 2016 access. Incorporate some decline falls to between -1.2% gains from FTA with US and -3.5% of GDP (-0.8% and - and deregulation. Negative 2.7% in GDP per capita terms) knock on fiscal effects. by 2030. Capital Economics, ‘The Shift to more tailored Trade and broader impacts seen economic impact of Brexit’, migration policy. Expect as negligible either way. See good study commissioned by UK to strike FTA with EU, prospects for the UK inside or Woodford Investment but if not fall back on WTO outside the EU. Management, February rules. FTA seen as more 2016 important for production than services sectors. Financial services faces short term disruption but remain competitive in long run.
4 For a more detailed analysis of the recent PwC and Oxford Economics reports see, Open Europe blog, ‘Economic debate over Brexit heats up’, 23 March 2016: http://openeurope.org.uk/today/blog/economic-debate-over-brexit-heats-up/
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Dhingra, Ottaviano and Optimistic case assumes UK Brexit impact ranges between a Sampson, ‘Should we stay obtains full access to single fall of 1% (£850) in average or should we go? The market like Norway. household income and a fall of economic consequences of Pessimistic scenario the UK 2.6% (£1700). Other EU states leaving the EU’, The falls back on WTO rules. also lose but by much less. Centre for Economic Costs include tariffs, NTBs Unilateral free trade could reduce Performance, London and opportunity costs. impact by 0.3 percentage points. School of Economics and Including productivity impact Political Science, March significantly increases cost. 2015 Professor Gianmarco Pessimistic case assumes Losses from Brexit range Ottaviano et al, ‘The Costs that the UK and EU will between 1.13% and 3.09% of and Benefits of Leaving the apply MFN tariffs post- GDP. Including dynamic effects EU’, May 2014 withdrawal. In optimistic could more than double such scenario tariffs on goods losses. continue to be zero. Varying increases in non-tariff barriers and further intra- EU liberalisation. Ian Mansfield, ‘A blueprint In both best case and most The total long-term impact of for Britain: openness not likely scenario benefits from withdrawal is estimated to be isolation’, IEA, April 2014 reducing fiscal and between -2.6% and +1.1% of regulatory costs outweigh GDP, with a best estimate of trade and FDI gains of +0.1%. withdrawal. CEPR, ‘Trade and UK falling back on to WTO Withdrawal would cost 1.77% of investment balance of MFN market access to the GDP (£25.8bn) annually, of competence review: a study EU. which £3.8bn tariffs and £22bn for the Department of non-tariff barriers (NTBs). Business, Innovation and A UK-EU FTA similar to Withdrawal would cost 1.24% of Skills’, November 2013 terms envisioned under EU- GDP (£18bn) annually, of which US deal. £2.8bn rules of origin and £15.2bn NTBs. Professor Patrick Minford Outside the EU, UK would 3.2–3.7% of GDP in ongoing et al, ‘Should Britain leave pursue unilateral free trade costs from EU membership. the EU? An economic and enjoy MFN WTO Leaving EU would benefit analysis of a troubled access to EU markets at consumers via lower prices, while relationship’, IEA, 2005 world prices. exposing UK firms to greater competition would increase specialisation and productivity. NIESR, ‘The Costs of withdrawal GDP would decline by 2.25% macroeconomic impact of primarily because of lower permanently after withdrawal. UK withdrawal from the FDI leading in turn to lower EU’, 2004 technical progress. IoD, ‘EU membership – The aggregate impact of the Net cost of EU membership what’s the bottom line?’, EU Budget, CAP, Customs stands at 1.75% of GDP per 2000 Union, Single Market, EU annum. Social Welfare Model and EU related Foreign Direct Investment is negative for the UK economy. Under an alternative scenario, whereby FDI increased because of a lower cost and regulatory burden in the UK, the annual net cost of membership could increase.
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Box 1 – the under discussed impact of leaving the customs union One point which we think continues to be missed by people on both sides of the debate is the impact of leaving the EU’s customs union and imposing a customs border between the UK and the rest of the EU. Some studies noted above do capture this impact but it remains under-discussed. As we noted in our previous Brexit report, this forms the bulk of the costs in all scenarios. These come in the form of the imposition of new time and out-of-pocket costs on cross-border trade, for example time spent at customs and the administrative cost of getting through customs. Importantly, this is a cost which will occur no matter what is negotiated between the UK and the EU and it is a dead weight cost for the economy (not a transfer as with tariffs). This goes someway to explaining why there is always likely to be a small negative cost to leaving the EU in the long run.
1. Trade
This section looks at the challenges and opportunities for the UK trade after Brexit. We have decided to focus our attention on bilateral deals and unilateral free trade, primarily because there currently appears to be little opportunity for new multilateral trade agreements through the WTO. Despite achieving significant success, such as completing eight rounds of negotiations between 1958 and 1994, the most recent attempt to further deepen trade liberalisation within the WTO framework, the so-called ‘Doha round’ launched in 2001, faced years of stalled negotiations before being essentially shelved in December 2015 – when the WTO declined to re-affirm Doha’s mandate.5
In part, multilateral agreements have become a victim of their own success. Successive rounds of deals have substantially lowered tariff barriers leaving limited room for further gains through simple tariff rate reductions. Instead, most impediments to trade now take the form of ‘non-tariff barriers’ – which touch upon more politically sensitive subjects such as environmental standards, consumer protection and health and safety regulations. The failure of the Doha round has therefore led to a proliferation of bilateral Free Trade Agreements (FTAs), which represent the main avenue for further trade liberalisation.
1.1 Coverage
When looking at the future of UK trade after Brexit, the first aspect is coverage – as Britain would need to maximise the share of its global trade that is covered by preferential trade agreements.
1.1.1 Securing existing relationships
The EU is the UK’s largest trading partner – something which would not change after Brexit. Furthermore, the EU currently has 33 preferential trade deals in force covering 62 countries in total.6 Britain is a party to all these agreements via its membership of the EU.
5 Financial Times, ‘Trade talks lead to death of Doha and birth of new WTO’, 20 December 2015: http://www.ft.com/cms/s/0/97e8525e-a740-11e5-9700-2b669a5aeb83.html#axzz44qDDoPBN 6 The total tally includes Kosovo, the Faroe Islands and the Occupied Palestinian Territories. The EU has preferential trade agreements with all of them.
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This means EU membership and the trade deals with third countries the UK is a party to via EU membership currently cover nearly 63% of Britain’s global trade in 2014. This is set to rise to over 65% once the agreements the EU recently concluded with Canada and Singapore enter into force. It would rise further to over 78% if the Transatlantic Trade and Investment Partnership (TTIP) with the US were agreed.7
Therefore, the first priority for the UK after Brexit would be to secure its existing trade relationship with the EU – ideally one that replicates the UK’s current access to the single market as closely as possible. This is itself a huge task, but not the focus of this paper. For a detailed discussion see our previous Brexit report.8 This would also include maintaining the preferential trade agreements with third countries to which Britain is currently a party via its membership of the EU. These two steps could allow Britain to retain many of the benefits it currently enjoys, before moving on to expanding its global network of trade agreements.
Since the UK is a party to these agreements via its EU membership, they would not be automatically inherited by the UK after Brexit and maintaining them would take some negotiation. The other countries would need to decide whether they want to grandfather the existing agreements to the UK outside the EU.
In principle, this could be relatively straightforward to negotiate if the UK were to propose that the terms stayed the same. It would essentially be a matter of replacing the existing agreements to include the UK as a signatory in its own right – a largely technical and therefore potentially relatively quick process.
However, the sequencing could be an issue. In other words, would the UK be able to conduct and conclude these negotiations alongside the talks over its ‘withdrawal agreement’ with the rest of the EU? In a recent paper looking at the process for leaving the EU, the UK Government suggested this would not be the case, arguing that,
“The countries with which we currently have preferential trade agreements through the EU are likely to want to see the terms of our future relationship with the EU before negotiating any new trade agreements with the UK.”9
1.1.2 Expanding the network of trade agreements: size isn’t everything
The next step would be for the UK to further expand its global network of trade deals. As a member of the EU, the UK is currently in a better position than the US, which has only 35% of its global trade covered by preferential trade agreements, but trails medium-sized economies such as Norway (80%), Australia (77%) and Canada (69%).
7 Based on ONS figures 8 Open Europe, ‘What if…? The consequences, challenges and opportunities facing Britain outside the EU’, March 2015 9 UK Government, ‘The process for withdrawing from the European Union’, February 2016, page 9; https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/503908/54538_EU_Series_No2_Accessible.pdf
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The graph below includes, for each of these countries, the single largest trading partner with which they have a preferential trade agreement in place. The figures confirm that countries tend to trade the most with their neighbours. The EU, for instance, accounts for around 49% of Britain’s and 74% of Norway’s total trade. Similarly, about 66% of Canada’s total foreign trade is with either the US (63%) or Mexico (3%) – its partners within the North American Free Trade Agreement (NAFTA). However, Australia and New Zealand’s trade profiles illustrate that it is possible to diversify away from the largest trading partner or bloc through a strategy of bilateral FTAs.
10 Data is from 2014, except for Norway – for which the latest available data refers to 2012. Data for Norway is from the OECD, since the Norwegian statistics office does not provide a country-by-country breakdown of trade in services.
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The experience of Australia and New Zealand clearly challenges the assumption that states only want to strike trade deals with bigger countries or economic blocs – these countries both have a diversified portfolio of FTAs covering a high proportion of their trade. While this begun by striking FTAs with countries in their neighbourhood, both have expanded. Both are parties to the Trans Pacific Partnership (TPP), which has been concluded but is not yet in force. Both have an FTA with Chile, while Australia has one with the US. New Zealand has struck an FTA with the Gulf Cooperation Council (yet to come into force) while Australia is in the process of negotiating one. It is also notable that this significant free trade push has taken place in the past ten to 15 years for both countries.
Of course, trade deals can differ in quality and in many cases size will play a role in the negotiations (see Section 1.2). Nevertheless, these figures also show that, while it is not badly placed at the moment, the UK could certainly use its increased room for manoeuvre after Brexit to pursue a more ambitious trade strategy. In this regard, it is worth bearing in mind that the EU has currently no free trade arrangements in place with a number of large economies such as the US, China, India, Japan and Brazil.
After Brexit, the UK would be able to enter free trade negotiations without the constraint of reservations that may be raised by other EU member states – particularly those with a more protectionist mind-set. There are many examples of where constraints from other EU countries or different interests have held back trade agreements which the UK was keen to conclude:
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Pakistan: For commercial, strategic and cultural reasons, the UK was among the strongest supporters of extending trade concessions based on the EU’s so-called Generalised Scheme of Preferences (GSP) to Pakistan in the wake of the tragic floods that hit the country in the summer of 2010. Pakistan was eventually granted access to the GSP, but only from January 2014.11 However, negotiations with Pakistan were slowed down by opposition from other EU member states – notably Portugal – which raised concerns over the possible negative consequences of cheap Pakistani imports on their domestic textile industries.12
Singapore: While negotiations were concluded in October 2014, the agreement is not yet in force. As a global financial centre, the UK was keen for any agreement with Singapore to make headway on financial services integration and regulatory integration. However, the focus of the majority of other EU states was on geographical indications, rules of origin and tariffs. Therefore, the case of Singapore illustrates how competing interests can affect free trade talks between the EU and third countries. While for the UK financial services liberalisation is key, for other EU member states the protection of geographical indications (e.g. Champagne or Parmigiano Reggiano) is of greater importance.
US: Talks over the Transatlantic Trade and Investment Partnership (TTIP) with the US are moving slower than expected, and it has been long clear that the agreement will not be concluded before the end of US President Barack Obama’s term. Objections have been raised in a number of EU states over agricultural issues, such as allowing the US to sell chlorinated chicken or hormone-boosted beef into the EU. France has also raised cultural concerns, particularly around the liberalisation of audio-visual services – which were eventually excluded from the negotiating mandate adopted by EU member states.13
Canada: While a deal was eventually agreed, it is yet to come into force, the talks were delayed by a number of concerns from other EU states – notably concerns from countries such as Germany around the use of the Investor-to-State Dispute Settlement (ISDS) mechanism.
Mercosur: Negotiations with Mercosur – the regional bloc of which Brazil is a member – were suspended in 2004, then re-launched in 2010 and then brought to a new standstill, with the latest full round of talks taking place in October 2012.14 Contacts then resumed slowly, and the two sides exchanged market access offers at the end of last year. However, the EU judged Mercosur’s proposal insufficient. As of early April 2016, the two sides were looking to agree on the date for a new exchange of market access offers.15 Agriculture has been the main stumbling block so far.
11 European Commission, ‘Trade – Pakistan’, last retrieved on 4 April 2016; ec.europa.eu/trade/policy/countries-and- regions/countries/pakistan/. As a result, more than 78% of Pakistani exports can now enter the EU at preferential tariff rates – including around 80% of textiles and clothing articles. 12 See, for instance, EurActiv, ‘EU-Pakistan trade plan faces fresh criticism’, 10 May 2011; http://www.euractiv.com/section/global- europe/news/eu-pakistan-trade-plan-faces-fresh-criticism/ 13 Embassy of France in London, ‘EU deal on cultural exception a victory for France’, 17 June 2013; http://www.ambafrance- uk.org/EU-deal-on-cultural-exception-a 14 European Commission, ‘Trade – Mercosur’, retrieved on 9 March 2016; http://ec.europa.eu/trade/policy/countries-and- regions/regions/mercosur/index_en.htm 15 MercoPress, ‘Uruguay in Brussels to begin a crucial round of Mercosur/EU negotiations’, 8 April 2016; http://en.mercopress.com/2016/04/08/uruguay-in-brussels-to-begin-a-crucial-round-of-mercosur-eu-negotiations
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When talks came to a halt in 2004, Mercosur countries complained about the EU’s insufficient offer of access to its agricultural markets. The re-launch of negotiations in 2010 was strongly criticised by eight EU member states – led by France – who signed a joint declaration voicing opposition to a deal with Mercosur due to the negative consequences it could potentially have for Europe’s agricultural sector.16
All of this is not to say that the UK itself never objects or raises barriers to agreements being finalised. However, it is clear that many EU states have different concerns and objectives to the UK. It is hard to envisage the UK blocking deals based on concerns over GMO food, ISDS or textiles. It is also clear that the priorities for the UK often lie in different areas, specifically non-tariff barriers, regulatory integration and the services sector. None of this would come easily to the UK on its own, but there are examples due to cultural and historical links where agreements might be possible – India, US, Australia and New Zealand come to mind.
Such an argument cuts both ways in terms of the impact on the length of trade talks after Brexit. In some cases, the UK could indeed find it harder to make headway. One example could be Mercosur, the Latin American trading bloc. Given the often troublesome bilateral relations, Argentina could be more likely to stand in the way of an agreement with the UK alone than one with the whole EU.
Assuming that it secures a comprehensive agreement with the EU and the grandfathering of all the FTAs currently in force to which it is a party via EU membership, the UK would then only need to strike free trade deals with the US and China – worth over 13% and 5% of Britain’s global trade in 2014 respectively – to be in a better position than Norway, as it would then have over 81% of its trade covered by FTAs.17
Ciuriak et al note that “an Australia-like run of FTAs with the major East Asian economies (China, Japan, India and ASEAN), should generate something on the order of a net [boost] of 0.6% of GDP for the UK.”18 This highlights that there are gains to be made and while they may not look huge they would go a significant way to offsetting the negative economic impact of Brexit (once again working on the assumption the UK secures an FTA with the EU and maintains the ones it currently has).19
The final question this raises is whether this would be politically feasible? Opening up to low cost competition from countries such as China, India and other emerging markets would undoubtedly be controversial.
16 See, for instance, Reuters, ‘EU and Mercosur re-launch trade talks, farmers opposed’, 17 May 2010; http://www.reuters.com/article/us-trade-eu-mercosur-idUSTRE64G6G120100517 - It should also be noted that disputes between the UK and Argentina have at times derailed the talks as well. 17 Nearly 84% if we include the EU-Canada and EU-Singapore FTAs, which have been concluded but have yet to enter into force. 18 Ciuriak et al, ‘The trade-related impact of a UK exit from the EU single market’, 23 April 2015; http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2620718 19 The political challenges of such a run of FTAs should not be dismissed lightly. As the recent steel crisis has shown, opening up to tariff free trade with the likes of China and India would be incredibly controversial and could be a significant shock, particularly for the UK’s remaining manufacturing base.
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Box 2: UK steel controversy shows challenges of opening up to free trade with emerging markets The recent controversy over the potential closure of some UK steel plants is a prime example of the potential challenges to striking trade agreements with some of these countries – particularly China.20 While deals with markets such as China potentially offer the largest gains they also offer the potential for the largest disruption. While this may on net prove beneficial for the UK economy (lower costs for consumers and producers) and generate growth, as our figures above suggest, it will come at the expense of vested interests and potentially short term unemployment as industries adjust. Politicians may well balk at such a trade-off, especially if there is significant domestic pressure as with the steel plants. This could manifest itself in a number of ways from torpedoing agreements entirely to reducing their speed or limiting their scope or even limiting the coverage to only more developed market economies.
1.2 Scope
Free trade agreements can be differentiated based on their scope – that is, on how comprehensive they are.
1.2.1 FTAs have become increasingly complex, but none replicates the EU single market
For most of the twentieth century, the central aim of free trade agreements was to eliminate restrictions to the movement of goods across borders. Therefore, so-called ‘first generation’ trade deals are essentially focused on scrapping or reducing tariffs. Over the past couple of decades, average tariffs have come down and there is far greater trade in services. As a result, ‘second generation’ trade deals aim to cover a much wider range of areas – services, investment, public procurement, and so forth.
Based on an extensive analysis of a number of trade deals concluded by the EU and non-EU countries (see Annex 1), including the ‘first generation’ EFTA-Canada deal and the new generation US-Australia and Switzerland-China agreements, we conclude that:21
No matter how comprehensive, no existing free trade agreement reproduces the level of integration of the EU single market.
The scope of a trade deal does not depend solely on the size of signatories but also on when it was negotiated. While specific commitments in terms of market access obviously vary, FTAs negotiated in the 2000s generally cover more ground than those negotiated over the previous decade.
As a large exporter of services, the UK’s key interest when negotiating trade agreements on its own after Brexit would be to get rid of regulatory and non- tariff barriers. Experience shows this is generally tougher to achieve than duty- free trade in goods.
20 For more background on the steel crisis and a discussion of whether UK steel would be better inside or outside the EU see Open Europe blog, ‘Would the UK’s steel industry be better off outside the EU?’, 30 March 2016: http://openeurope.org.uk/today/blog/would-the-uks-steel-industry-be-better-off-outside-the-eu/ 21 According to some scholars, free trade agreements such as CETA already belong to a ‘third generation’. See, for instance, Markus Krajewski (Editor), ‘Services of General Interest Beyond the Single Market’, Asser Press/Springer, 2015, page 246
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According to the OECD’s Services Trade Restrictiveness Index (STRI), for instance, both India and China have above average protections in place for commercial banking and insurance, as well as legal and accounting services – all sectors where the UK would be interested in securing better market access.22
However, there are examples of bilateral trade deals that have achieved genuine progress in terms of services liberalisation beyond the existing WTO commitments (e.g. Australia’s FTAs with China and Japan, or the Canada-South Korea FTA). Still, even the most comprehensive trade deals fail to replicate the degree of liberalisation of the EU’s single market – particularly in financial services.
As shown by the Switzerland-China FTA, sometimes leverage might not be on the UK’s side in trade talks after Brexit – which in turn could have an impact on the scope of future FTAs. For example, questions over whether the UK on its own would be able to gain access to some of China’s protected sectors (e.g. commercial banking and insurance) are legitimate.23
1.2.2 The UK could look to upgrade existing EU FTAs with third countries
Of the 33 preferential trade agreements the EU currently has in place with third countries, only eleven cover services.24 Therefore, after grandfathering all of them (a task in itself as noted above), the UK could look to upgrade those with a more limited scope at some stage. This is something the EU itself is aiming to do – for example with Egypt, Jordan and other members of the so-called Euro-Mediterranean Partnership.25 The EU is also looking to upgrade its trade deal with Mexico – although the existing one already covers services and includes specific chapters on investment and public procurement.26
1.2.3 Could securing continued single market access mean less freedom to negotiate FTAs?
One point to keep in mind is that, the more ground the deal with the EU covers, the more it could restrict the UK’s flexibility when it comes to concluding free trade agreements with the rest of the world – since the UK might have agreed to abide by very detailed regulatory standards in order to retain full access to the single market. At least, this seems to be the lesson from Norway. Ulf Sverdrup, Director of the Norwegian Institute for International Affairs, recently described Norway’s current position as follows,
22 OECD, ‘Services Trade Restrictiveness Index’, updated to December 2015. See here for China: http://www.oecd.org/tad/services-trade/STRI_CHN.pdf; and here for India: http://www.oecd.org/tad/services- trade/STRI_IND.pdf 23 See, for instance, Frederik Erixon, ‘Boris and the Brexiteers are talking nonsense about Britain’s trade policies’, from the Spectator’s Coffee House blog, 1 April 2016; http://blogs.spectator.co.uk/2016/04/boris-and-the-brexiteers-are-talking- nonsense-about-britains-trade-policies/ 24 These are the agreements with: Switzerland, the EEA, Chile, Mexico, Central America, the CARIFORUM, South Korea, Colombia and Peru, Georgia, Ukraine, and Moldova. 25 On 14 December 2011, the EU Council of Ministers adopted negotiating directives for Deep and Comprehensive Free Trade Agreements (DCFTAs) with Egypt, Jordan, Morocco and Tunisia; http://ec.europa.eu/trade/policy/countries-and- regions/countries/jordan/ 26 European Commission, ‘Commissioner will upgrade EU-Mexico Free Trade Agreement’, 11 May 2015; http://trade.ec.europa.eu/doclib/press/index.cfm?id=1305
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“A lot of issues in free trade agreements are about non-tariff barriers like food security, and technical standards are already in the acquis [law] of the EU so we cannot negotiate on these things. So what we in reality can deal with in those free trade agreements is very much constrained.”27
1.3 Speed
Another key element for UK trade after Brexit is how quickly Britain would be able to conclude free trade deals with the rest of the world. As the tables below demonstrate, previous experience shows that negotiating free trade agreements can turn into a painstaking exercise – be they between the EU and third countries or exclusively between non-EU countries. Generally negotiating an FTA takes anywhere between four and ten years. The fastest negotiations the EU has concluded are with Mexico and South Korea, at just over four years. However, nearly a decade went by between the launch of the negotiations over the so-called ‘Bilateral I’ package between the EU and Switzerland in February 1993 and its entry into force in June 2002.
As regards negotiations between non-EU countries, the US-Australia deal was negotiated in less than four years. However, the agreement between Canada and South Korea took over ten years. This suggests the EU is not uniquely sluggish.
EU FTA negotiations with other global economies
FTA Negotiations First round Final round Signed Entry into Total announced of of force (from launch of negotiations negotiations negotiations to entry into force) EU-Mexico May-96 Oct-96 Nov-99 Mar- Jul-00 4 years and 2 00 months EU-Korea Apr-07 May-07 Oct-09 Oct-10 Jul-11 4 years and 3 months EU-Georgia Jul-10 Feb-12 Jul-13 Jun-14 Sep-14 4 years and 3 months EU - Apr-07 Jun-07 Mar-10 Jun-12 Mar-13 (Peru) 5 years, 10 Peru/Colombia Aug-13 months (Peru) (Colombia) 6 years, 3 months (Colombia) EU- Feb-93 Dec-94 Jun-98 Jun-99 Jun-02 9 years and 4 Switzerland months EU-US Jun-13 Jul-13 ? ? ? 2 years, 9 months and counting EU-Canada May-09 Oct-09 Oct-13 Sep-14 ? 6 years, 9 months and counting Source: European Commission, Open Europe analysis
27 Quoted in The Times, ‘Trading links can be kept open at a cost’, 24 February 2016; http://www.thetimes.co.uk/tto/news/politics/article4697933.ece
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FTA negotiations between other global economies Total First round Final round Entry Negotiations (from launch of FTA of of Signed into announced negotiations to entry negotiations negotiations force into force) US-Australia Apr-01 Nov-02 Feb-04 May-04 Jan-05 3 years and 9 months Switzerland- Aug-10 Apr-11 May-13 Jul-13 Jul-14 3 years and 11 months China Mercosur- Dec-05 Feb-06 Nov-06 Dec-07 Mar-10 4 years and 4 months Israel Japan-India Jun-06 Jan-07 Sep-10 Feb-11 Aug-11 5 years and 2 months Iceland- Dec-06 Apr-07 Jan-13 Apr-13 Jul-14 7 years and 7 months China Canada- Nov-04 Jul-05 Mar-14 Mar-14 Jan-15 10 years and 2 months Korea Source: European Commission, Open Europe analysis
1.3.1 The trade-off between scope and speed
Generally speaking, a lot appears to depend on the scope of a trade deal. The more comprehensive and ambitious the agreement, the longer it takes to conclude it. This should come as no surprise. The table below highlights that, while the relationship is not perfect, generally the more comprehensive trade deals – which include liberalisation or mutual recognition of services, investment, public procurement, intellectual property and qualifications as well as tackling non-tariff barriers more widely – tend to take longer to negotiate. The more basic agreements, which tend to involve just negotiating tariff reductions, tend to be relatively quicker and easier to negotiate.28
The table below provides examples of FTAs that we broke down into three broad categories: comprehensive, fairly comprehensive, and basic. For each trade deal, we also indicate how long it took from the official launch of negotiations to its entry into force. Those where it took longer than 10 years are in red, between 7 and 10 years in orange, 4 and 7 years in yellow and less than 4 years in green. See Annex 2 for a detailed explanation of how we categorised the various FTAs.
28 See also Open Europe Blog, ‘Would Brexit lead to up to a decade or more of uncertainty?’, 29 February 2016; http://openeurope.org.uk/today/blog/would-brexit-lead-to-decade-or-more-of-uncertainty/
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Comprehensive FTAs Fairly comprehensive FTAs Basic FTAs
China-Australia Iceland-China Mercosur-Israel (10 years and 8 months) (7 years and 7 months) (4 years and 4 months)
Australia-ASEAN-New Canada-South Korea EU-Mexico Zealand (10 years and 2 months) (4 years and 2 months) (7 years and 4 months)
EU-Peru/Colombia EU-Switzerland (5 years and 10 months for
(9 years and 4 months) Peru; 6 years and 3 months for Colombia)
Japan-Australia Japan-India
(8 years and one month) (5 years and 2 months)
Canada-EU EU-Georgia (6 years and 9 months, but not yet (4 years and 3 months) in force)
EU-South Korea China-Switzerland
(4 years and 3 months) (3 years and 11 months)
US-Australia
(3 years and 9 months)
1.3.2 Move away from the ‘nothing is agreed until everything is agreed’ approach
Outside the EU, however, the UK could adopt a more flexible attitude in trade talks. When negotiating a free trade agreement, the EU’s preferred approach is ‘nothing is agreed until everything is agreed’. The inherent risk with this strategy is that a single issue can potentially hold up an entire deal for months or even years. We have established the sections above that the UK would want to strike FTAs which include liberalisation of services (tackling regulation and non-tariff barriers). But we also established that this takes some time. As such the UK may want to nuance its approach to try to deliver some gains as soon as possible.
After Brexit, the UK could therefore consider multi-stage trade talks. This could allow the UK to secure duty-free trade in goods with a larger number of countries in a shorter period of time – as scrapping tariffs is usually the easiest bit of a trade deal – while more complex areas would be addressed at a later stage.29
29 Of course, separating out negotiations over tariffs on goods and more complex negotiations in services may also alter the balance of power in negotiations. Part of the logic of an all or nothing approach is that it may force countries to open up more in the services sectors in exchange for greater access in the goods sectors. However, evidence suggests the results are mixed at best.
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Simple Simple Simple Share of UK Share of Share of average average MFN average MFN goods total UK total UK MFN applied applied Non- export trade in trade in applied Agriculture Agriculture trade goods goods tariff tariff tariff and services Brazil 13.5% 10.2% 14.1% 0.7% 0.6% 0.6%
United 3.5% 5.1% 3.2% 12.6% 9.2% 13.1% States Australia 2.7% 1.2% 3.0% 1.2% 0.8% 1.2%
China 9.6% 15.2% 8.6% 5.3% 7.4% 5.4%
India 13.5% 33.4% 10.2% 2.2% 2.1% 1.8%
Japan 4.2% 14.3% 2.5% 1.4% 1.6% 1.9%
New 2.0% 1.4% 2.2% 0.2% 0.2% 0.2% Zealand Source: WTO Tariff Profiles 2015, and ONS Pink Book 201530
Of those included in the table, the highest average tariff countries that the UK does not yet have FTAs with are India (13.5% MFN), Brazil (13.5%) and China (9.6%). In terms of the UK share of the export of goods that these highest tariff countries make up, China is the largest (9.4%), then India (2.1%) and then Brazil (0.6%). Striking even basic agreements with China, India and Brazil could deliver gains for the UK, not just in terms of reducing the cost of current trade but opening up new avenues.
Needless to say, the longer-term goal for the UK would still be to conclude agreements that provide for the fullest possible liberalisation of trade in services – and financial services in particular. The obvious example where this is true would be the US. While it accounts for 12.6% of UK goods exports, it accounts for 23% of UK services exports. As such, the largest returns from an FTA with the US would come from integration on services by removing regulatory barriers and duplication.
1.3.3 The option of ‘unilateral’ free trade
A more radical way to pursue quicker trade liberalisation after Brexit would be for the UK to offer ‘unilateral’ free trade. The economic argument in favour of unilateral free trade is well known. If Britain were to scrap all its tariffs on imports from the rest of world, selling into the UK would become cheaper. This would translate into lower costs for consumers but also lower costs of production for UK firms, as they would have to pay less to buy intermediate goods and services from abroad. Therefore, UK exports could eventually also become cheaper and more competitive.31 Ultimately, this could also result in greater choice for consumers.
30 WTO, Tariff Profiles 2015; https://www.wto.org/english/tratop_e/tariffs_e/tariff_data_e.htm and ONS, ‘United Kingdom Balance of Payments - The Pink Book’, 30 October 2015; http://www.ons.gov.uk/economy/nationalaccounts/balanceofpayments/compendium/unitedkingdombalanceofpaymentsthepink book/2015-10-30/unitedkingdombalanceofpaymentsthepinkbook 31 For a broader discussion, see Open Europe, ‘What if…? The consequences, challenges and opportunities facing Britain outside the EU’, March 2015; http://openeurope.org.uk/intelligence/britain-and-the-eu/what-if-there-were-a-brexit/
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In our previous Brexit report we analysed this scenario in detail, finding that unilateral free trade could potentially deliver a permanent boost to GDP of up to 0.75% of GDP.32
However, this approach would raise two problems. First, it would expose UK companies to a sudden wave of low-cost competition – which some may not survive. This would have knock on effects for employment but also political impacts. Second, the UK would essentially forfeit its leverage in trade negotiations – as other countries would have little incentive to reciprocate and open up their markets accordingly.
1.4 Conclusions and policy implications
Coverage
Contrary to popular belief you don’t have to be big to strike free trade agreements. Medium-sized economies such as Norway (80%), Australia (77%), Canada (69%) and New Zealand (60%) have managed to strike FTAs covering a significant proportion of their trade. In the case of Norway and Canada, this is overwhelming due to a comprehensive agreement with their largest trading partner (the EU and US respectively). However, Australia and New Zealand have far a more diversified trade portfolio, which covers a significant proportion of their trade.
The UK does fairly well inside the EU with 63% of its trade covered. If it managed to strike an FTA with the EU and keep existing FTAs in place, it would only need to strike deals with the US and China to reach coverage levels of 81% of its trade – above Norway.
There are a number of examples where other EU states have held up trade agreements which the UK could well have pushed ahead with if it were alone. Of course, this cuts both ways – there are countries where a deal could be harder to reach, e.g. Argentina.
Scope
The scope of a trade agreement seems to have as much to do with when it was struck as who it is between. First-generation agreements focus largely on tariffs and goods, while second-generation agreements look more at regulations and non-tariff barriers.
More generally, the UK would need to assess on a case-by-case basis whether it is worth offering unrestricted access to its market in return for more limited access to significantly larger markets.
Only eleven of the 33 EU FTAs currently in force cover services. Over time, the UK could seek to update older first-generation agreements.
32 This benefit is generated through a number of avenues. The removal of tariffs on any and all trade introduces a huge amount of new competition into the UK economy via low cost imports, particularly from emerging markets. This new competition will spur on efficiencies, drive a better allocation of capital and produce greater specialisation via a distillation of comparative advantages. It will also allow for a significant influx of a broad range of cheap imports which will lower prices for both consumers and businesses (particularly those which import component parts for their own production).
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Speed
Striking trade deals takes time. Rarely are deals done in less than four years. This is true for those the EU negotiates but also for those involving other states.
There is a rough trade-off between speed and scope. A more complex agreement addressing services and NTBs does seem to take longer. Basic agreements focusing on goods lean more towards the four year end of the scale while more comprehensive deals head towards ten years.
What might a post-Brexit UK trade strategy look like? The UK’s first priority would be to secure the 63% of its trade covered by its EU membership and existing EU trade agreements.33
Striking deals with US and China would bring its share of trade covered by FTAs to over 81% – better than Norway (80%). One option for the UK to speed up this process would be to dump the EU’s all or nothing approach. That way the UK could strike initial agreements on removing tariffs on goods and revisit negotiations on services and NTBs at a later date. This would make sense for emerging market economies where tariffs are relatively high and the majority of trade is in goods.
Striking a series of FTAs with Asian economies (China, India, Japan and ASEAN) could deliver a boost of up to 0.6% of GDP for the UK, going some way to offsetting the negative impact of leaving the EU customs union and single market.
The most radical option the UK would have at its disposal after Brexit would be to pursue ‘unilateral’ free trade by scrapping all tariffs on imports from the rest of the world. This could deliver a boost of up to 0.75% of GDP in the long run. However, such an approach would expose British companies to significant low-cost competition and would ultimately amount to the UK forfeiting any leverage it may have vis-à-vis its trading partners.
1.5 Trade case study - Agriculture
As we have outlined in the chapter above, outside the EU there are potential trade gains for the UK but these require some tough choices. Nowhere is this clearer than in the agricultural sector – there is a clear choice between liberalisation and protectionism. Potential long run economic gains are there to be had, but are politicians willing to make such a radical change?
1.5.1 Inside the EU agriculture is heavily protected and subsidised
As has been widely documented, the agricultural sector across the EU is heavily subsidised via the Common Agricultural Policy (CAP). In the 2014 to 2020 long-term EU budget, the CAP accounts for around €362.3bn (£289.4bn), just over one-third of total expenditure. Currently, the CAP supports farmers in two main ways:
33 65% if we include the EU-Canada and the EU-Singapore FTAs, which have been concluded but are yet to enter into force.
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Subsidies: These come in two different forms, referred to formally as the two pillars of the CAP. The first pillar consists of subsidies paid out directly to farmers and landowners via the Basic Payment Scheme (formerly the Single Payment Scheme). This accounts for the vast majority of total CAP spending and is funded entirely from the EU budget. The second pillar is a wider subsidy scheme aimed at developing and diversifying rural economies which is co- financed from national budgets.
External tariffs: The average tariff on agricultural imports from Most Favoured Nation countries (MFN) is 12.2%, although in areas such as dairy products and fruit and vegetables, this can reach as high as 122% and 182% respectively.34 While trade has been liberalised between the EU and some areas such as the Africa/Caribbean/Pacific region, tariffs remain in place for much of the world. The OECD has estimated that EU agricultural tariffs cost EU consumers €12.86bn in 2014.35
1.5.2 How does the EU approach compare to agricultural sectors in Europe and globally?
One important consideration when it comes to deciding agricultural policy post-Brexit will be what other countries are doing and how that will influence competition and potential trade deals. There are two points to note here.
34 National Farmers’ Union, ‘British Agriculture: The Implications of a British exit from the EU’, April 2016, page 5; http://www.nfuonline.com/nfu-online/news/british-agriculture-the-implications-of-a-uk-exit-from-the-eu/ 35 OECD, ‘Monitoring and evaluation, reference tables – Consumer Support Estimate’, retrieved on 8 April 2016: http://stats.oecd.org/viewhtml.aspx?QueryId=66827&vh=0000&vf=0&l&il=&lang=en 23
Firstly, in terms of the CAP, UK farmers actually do quite badly and therefore receive lower direct subsidies than in many other EU states. As the chart above shows, per hectare, the UK ranks among the lowest in terms of support with only the new member states below it. Of course, relative to living standards and prices this means the UK is likely bottom of the pile in terms of real value of such CAP support. The UK also receives less from the rural development pillar of the CAP. This is partly by design since the UK gets a larger rebate on spending under the first pillar, which covers direct subsidies to farmers.
Secondly, the average level of support to EU farmers, in terms of their income, is actually below that of several other advanced economies. As the chart above shows, the likes of Japan and South Korea, but more notably Norway and Switzerland, provide their farmers with much higher subsidies proportionate to their income. These points suggest the UK would not only be facing low cost produce from emerging markets but also heavily subsidised produce from the developed world.
1.5.3 Brexit impact is about choices
If the government decided not to continue with subsidies and/or external tariffs, it would clearly be a significant shock to the system. This would not be uniform across the sector however; as the chart below shows, some industries such as dairy and specialised poultry still bring in significant income.
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However, other parts (such as cereals and grazing) are on average entirely reliant on subsidies for their profits, with actual agricultural activity making a loss. As DEFRA noted in a report towards the end of 2015:
“Over a fifth of pig, poultry, mixed and grazing livestock farms failed to make a profit in 2014/15 compared to less than 10 percent of dairy farms. Moreover, around 70 percent of mixed and grazing livestock farms generated incomes below £25,000.”36
As the distributional income below shows, on average 19% of all farms in the UK are making a loss. It would not be unfair to assume that these farms would struggle to survive under a liberalised scenario. For example, a Dutch study in 2010 found that 15% of UK farms would be unviable under a totally liberalised system, a scenario similar to that which occurred when New Zealand removed all its subsidies.37
36 DEFRA, ‘Farm Business Income by type of farm in England, 2014/15’, 29 October 2015; https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/471952/fbs-businessincome-statsnotice- 29oct15.pdf 37 Vrolijk, H.C.J. et al, ‘Farm viability in the European Union: Assessment of the impact of changes in farm payments, LEI report 2010-11’, April 2010.
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As is often the case with liberalisation, the outcome could be greater specialisation. Types of farming better able to compete will be boosted and draw in capital and labour, while those that are not will fall by the wayside. This of course could have a serious impact on employment and see a number of firms going out of business. As of December 2015, there were 409,000 people employed in the UK’s agricultural sector out of a total workforce of 33.8 million (%).38 Employment in agriculture is not evenly distributed around the UK – in 2014 it accounted for 1.1% of total employment in England, compared to 2.5% in Scotland, 4.2% in Wales, and 5.8% in Northern Ireland.39 Significant job losses from farms unable to function under a liberalised regime would therefore have wider social implications for the regions most affected.
The flipside to such disruption would likely be lower prices. If tariffs were removed, the consumer support of between £400m and £1.4bn for UK farmers would no longer exist and this could be realised, at least partially, by consumers.40 Furthermore, the greater competition and specialisation could drive prices even lower.
Of course, all this is unlikely to happen in one big bang, not least because it would be a significant change. The current approach in terms of tariffs and subsidies would, even in this scenario, be grandfathered and loosened over time to allow farms more scope to adjust and compete.
38 ONS, ‘Labour Market Statistics’ March 2016; https://www.ons.gov.uk/releases/labourmarketstatisticsmarch2016 39 DEFRA et al, ‘Agriculture in the United Kingdom, 2014 annual report’, May 2015; https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/430411/auk-2014-28may15a.pdf 40 The OECD does not produce CSE figures for individual EU states. Equally the EU no longer publishes breakdowns of each countries income from agricultural duties. As such the UK’s share is backed out in a number of ways. Firstly, looking at historical UK income from agricultural duties. From 2000 – 2008, the last period for which the figures are published, the UK’s income averaged €530m. However, the overall OECD CSE figure suggests support goes beyond this. A rough estimate of the UK’s share of this overall CSE is based off of the UK’s share of food, drink and tobacco imports from non-EU countries in 2014 (14%). This suggests a share of €1.8bn. These figures are converted to pound sterling using the average exchange rate of €/£ for the year 0.806.
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Alternatively of course, the government could decide to continue subsidising the sector permanently. As the UK is a large net contributor to the EU budget, there would be more than enough money available to do this post-Brexit. In 2014, the UK received €3.9bn (£3.1bn) in CAP subsidies while its share of total spending came to €5.2bn (£4.2bn) – a net contribution of €1.4bn (£1.1bn).41
Retaining farm subsidies would also limit the scope for reallocating the money saved on our EU budget contributions, money which has in some cases already been pledged many times over to the NHS, defence, scientific research and tax cuts, to name but a few. But the real issue here is that, by keeping the same system in place, it removes another sector which could potentially be reformed, thereby reducing the scope for gains both in economic terms but also in terms of sovereignty and independence from Brexit.
Beyond just the potential economic costs in terms of benefits of consumers or impact on employment and viability of firms, there are other aspects to consider such as self- sufficiency in agricultural terms and food security.
1.5.4 Trade agreements both with the EU and beyond will be important
As usual, much of the outcome will hinge on the nature of the post-Brexit UK-EU relationship. The oft cited Norwegian and Swiss models do not include agriculture, meaning that these states are outside of the CAP and outside of the EU’s common external tariffs. But as the chart above shows, both heavily subsidise their domestic agricultural sectors. In fact, one of the reasons public opinion in these countries has been less keen on EU membership is the desire to retain the ability to protect agriculture to a greater extent than the EU does.
A more specific negotiated free trade deal could offer a reduction in tariffs. For example CETA will see the EU eliminate 93.8% of its agricultural tariffs for Canadian produce. But whatever agreement was struck would also affect other trade agreements which the UK might try to strike. For example, if a deal was agreed to keep tariffs low and agricultural markets open, this might limit the scope the UK has to open up to other markets, at least in terms of strict rules of origin principles. The EU would obviously not want cheap agricultural goods passing through the UK or being used as inputs in UK production before being exported to the EU.
1.5.5 Lessons from this case study
This case study highlights that, while economic gains are possible in Brexit, they are not easy to reach and may well involve significant disruption – savings for taxpayers and consumers could come at the cost of employment and the established farming sector set up. This raises the question of whether politicians will be able and willing to take more radical decisions or stick more closely to the status quo. The initial evidence is of the latter, with many on the Leave side already promising to maintain subsidies. As Minister of State at the Department for Environment, Food and Rural Affairs and Leave advocate George Eustice recently said,
“Let's get one thing straight. The UK government will continue to give farmers and the environment as much support - or perhaps even more - as they get now.”42
41 There may be some efficiency savings and improvements which the UK could achieve by administering farm subsidies from Westminster rather than recycling them through Brussels, however, this is likely to only amount to a few percent of the overall spend. 42 Vote Leave, ‘George Eustice: UK government will continue to support farmers after we Vote Leave’, 23 March 2106; http://www.voteleavetakecontrol.org/george_eustice_uk_government_will_continue_to_support_farmers_after_we_vote_leave
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2. Immigration
They said it…
“I can see many advantages in Britain quitting the EU. But that alone would not crack the immigration problem. Even if we were to leave, it is inconceivable that the UK could negotiate a trade deal with the EU that did not involve some agreement on freedom of movement…
…Managing immigration is a question of balance. We cannot afford to bring down the shutters and cut ourselves off from the rest of the world – many of our industries need skilled immigrants to keep our economy growing. Remember, too, that enterprising migrants have started nearly half a million businesses, employing over eight million people. A managed immigration policy should recognise this.”
- Owen Paterson MP43
“Britain needs a points-based immigration system, similar to that in Australia. An eVisitor visa scheme would make it easy for legitimate visitors and tourists to enter the UK. Parliament would annually agree on a quota of those who would be allowed to permanently settle — and in time acquire citizenship. Places would be allocated on the basis of the skills that these people would bring with them.
Because we want to attract the brightest and the best, we would exclude university students from the annual quota total. If there was, say, a shortage of doctors or fruit pickers one year, there would be a rational debate about the need to raise the quota accordingly.”
- Douglas Carswell MP44
2.1. The political climate
Throughout the 2000s, with looser policies on non-EU migration and EU enlargement to Eastern Europe taking effect, net immigration to the UK increased from the tens of thousands to well over 200,000 a year. There was little public discussion about these policies and the impact on numbers was widely underestimated. According to Ipsos- Mori’s issues tracker, in the late 1990s, immigration was considered to be the most important issue facing the country by just 10% of the British electorate. By the mid- 2000s, the share of people saying it was the most important issue steadily increased to 40%, and by May 2015 it reached 50%.45
43 Writing on Conservative Home, ‘Why UKIP is wrong about immigration’, 5 January 2015; http://www.conservativehome.com/platform/2015/01/owen-paterson-mp-why-ukip-is-wrong-about-immigration.html 44 Writing in The Times, ‘Enoch Powell was wrong about immigration’, 24 February 2015; http://www.thetimes.co.uk/tto/opinion/columnists/article4363351.ece 45 For a wider discussion see Ipsos-Mori Social Research Unit, ‘Perceptions and reality: 10 things we should know about attitudes to immigration in the UK’, January 2014; https://www.ipsos-mori.com/Assets/Docs/Publications/sri-perceptions-and-reality- immigration-report-summary-2013.pdf
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Of the roughly 5 million net immigrants to the UK between 1990 and 2014, over three- quarters came from outside Europe. However, the composition has changed and immigration from the EU now makes up nearly half of the UK’s net inflow. EU migration to the UK has not been homogenous. Migrants from the ‘older’ member states have tended to fill higher skilled jobs, while more recent migration from the ‘newer’ member states has tended to fill jobs at the lower-skilled end of the labour market.46
46 This does not necessarily reflect the skills of migrants from the new member states, of which a higher proportion are degree educated than the native population, but reflects that these people tend to ‘trade down’ when they first enter the UK labour market before often moving up the ladder.
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16% of those working in low skilled jobs are migrants and almost 60% of the total stock of migrants in lower-skilled jobs comes from outside the EU but, as noted above, the pattern of migration has changed dramatically over the last decade. Migrants from A10 EU countries now account for 50% of all new migrants in low skilled work, whilst migrants from outside the EU account for less than half.
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If the referendum results in a vote for Brexit, a public desire to reduce immigration is likely to be among the primary motivations of the electorate. Therefore, following withdrawal from the EU, it seems inconceivable that the UK Government would not be under immense political pressure to alter its immigration policies.
On the other hand, post-Brexit immigration policy will have to balance the needs of business, the impact of migration on UK demographics and the public finances and work within the constraints all governments face in an era of increased global mobility. The UK could also be constrained by the nature of the new UK-EU relationship. The Norwegian and Swiss models of EU association (which are the most advanced trade arrangements the EU has with any non-members) illustrate that accepting the principle of EU free movement of people may be the ‘price’ the UK has to pay in order to gain something close to the levels of access to the single market that British exporters are used to.
2.2. Why a liberal approach to migration is likely to remain important
The impacts of immigration are complex and wide-ranging, encompassing economic, social and cultural aspects. Conventional economic theory suggests that the impact of migration is likely to depend on a number of factors: the skills mix of the immigrant inflows compared with that of the native population; and the characteristics of the host country – including the flexibility of both labour and capital and the ability of the labour and product markets to adjust in the short and longer term. There are potential economic benefits associated with migration, especially to fill gaps in the labour market – where there are shortages of workers, whether high- or low-skilled. However, immigration also throws up a number of challenges, such as increased competition and downward pressure on wages in low-skilled sectors of the labour market, and increased demand for public services and infrastructure.
Not all immigration is directly work-related, for example student or family migration, but all types of migration are affected by immigration policies. This report is primarily interested in the economic effects of immigration policy and its impact on labour supply following a Brexit and will therefore focus on the policy implications for work-related immigration. This also reflects that immigration to the UK from the EU is primarily for work rather than for study or family.47
2.2.1 The UK is not unique in experiencing recent high levels of net immigration
In an era of increased global mobility, the fastest growing developed countries across the globe are all experiencing relatively high levels of immigration. The total foreign- born population in OECD countries stood at 117 million people in 2013, which is 35 million (40%) more than in 2000.48
47 In 2014, 58% of EU migrants came to the UK for work, 16% to study, 10% for family and 16% for other reasons. On the other hand, 25% of non-EU migrants came to the UK to work, 51% to study, 19% for family and 5% for other reasons. The UK can impose some restrictions on non-EU family migration. For example in 2012 the government introduced a requirement that UK citizens wanting to sponsor non-EU spouses had to be earning at least £18,600 a year. This rises to £22,400 if a non-British child is to be admitted too, with an additional £2,400 required for each child thereafter. The government justified this on the ground that it ensures migrants won’t be a burden on taxpayers. This has been challenged in the courts on the basis that the rules were discriminatory and interfered with Article 8 of the Human Rights Act, the right to a private and family life. The courts have so far said that the rules are legal. 48 OECD, ‘International migration outlook 2015’, 2015
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When net migration flows are measured as a ratio of total populations, between 2000 and 2015, OECD countries received on average 3.1 net migrants for every thousand inhabitants. The UK received 3.7 for every thousand, which puts it just above the average but below countries such as Canada, Australia, Norway and Switzerland – countries cited as potential models for the UK to emulate outside the EU. For example, if the UK had the same migration rate as Norway, which is outside the EU but has to adhere to similar free movement rules as a member of the European Economic Area, there would have been an additional 2.6 million net migrants to the UK between 2000 and 2015. Even countries that are not subject to the EU’s free movement rules have had much higher levels of migration than the UK. If the UK had Canada’s migration rate there would have been an additional 3 million net migrants in the UK, and under Australia’s rate it would have more than doubled with an additional 4.4 million net migrants.
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The experience of comparable economies – whether they are subject to the EU’s free movement rules or not – illustrates that immigration is a fact of life for relatively prosperous and open economies in the 21st Century and is likely to remain so.
2.2.2 The business case to maintain a flexible supply of labour
Immigration has both direct and indirect effects on economic growth. Where migration expands the workforce, aggregate GDP will grow. From a trade and business perspective, placing restrictions on the movement of labour is likely to be negative since restricting the potential labour supply would mean that the UK economy would react differently to growth opportunities. If UK-based businesses no longer had access to the flexibility that has recently been provided by EU free movement, tighter labour market conditions are likely to put upward pressure on both wages and prices. This could mean that the gains from future trade liberalisation with the rest of the world would be translated primarily into higher wages and prices rather than output, which could have adverse knock-on effects for the UK’s productivity and competitiveness, as well as being negative for consumers.
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In the three months to January 2016, the UK’s employment rate (the proportion of people aged from 16 to 64 who were in work) was 74.1%, the highest rate since comparable records began in 1971. Unemployment is historically low and the inactivity rate (the proportion of people aged from 16 to 64 who were economically inactive) was only slightly higher than the record low of 21.7% last recorded for July to September 1990.49
Meanwhile, the UK Commission for Employment and Skills’ 2015 Employer Skills Survey concluded that:
“Overall, vacancies and skill shortage vacancies have increased significantly over the last two years, with some sectors in particular facing heightened difficulties in recruiting staff, such as in Construction and Finance.”50
Greater investment in training and development of existing staff and the UK workforce is clearly part of the answer but business groups such as the British Chambers of Commerce and the Institute of Directors have also made clear that migration is needed to fill certain skills gaps.51
49 ONS, ‘UK labour market: March 2016’, 16 March 2016; https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/employmentandemployeetypes/bulletins/uklabourmarket /march2016#economic-inactivity 50 UKCES, ‘Employer skills survey 2015: skills in the labour market’, 28 January 2016; https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/499047/UKESS_Summary_report_-_for_web.pdf 51 See the IoD's response to the Migration Advisory Committee's consultation on “Tier 2 route”, 17 August 2015; http://www.iod.com/influencing/policy-papers/education-and-skills/iod-response-tier-2-route
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The House of Commons’ Home Affairs Committee recently concluded in an inquiry that:
“The motivation to recruit from abroad seemed to be more a desire to get the best person for the job, and the need to respond flexibly to the needs of the economy within the appropriate timescale.”52
The inability to meet skill shortages, despite the ability to recruit freely from the rest of the EU, could also be an argument for a more ‘balanced’ immigration regime that is not so restrictive on non-EU migration.
2.2.3 Demography and the UK’s fiscal position
Immigration to the UK (and particularly from the EU) has typically been concentrated among people of working age. The Office for Budget Responsibility (OBR) notes that this means net migration has led to a higher employment rate and a lower dependency ratio than would otherwise have been the case.53 Lowering the dependency rate can contribute to improving the UK’s long-term fiscal position, although it should be noted that long-term migrants will also require pensions and long-term care in their old age.54
Nevertheless, the effect of migration on the UK’s demographic profile is likely to be significant due to the effects of an ageing native population of post-war baby-boomers. Under the OBR’s central projection of an annual net migration level of 165,000, debt to GDP is expected to initially shrink before gradually increasing to reach 81% of GDP by the financial year 2060-61. Higher levels of migration could significantly ease this burden with a higher annual net migration rate of 225,000 resulting in debt to GDP being 15% points lower at just 66% of GDP. Conversely, restricting net migration to 105,000 a year and would result in debt levels of 98% of GDP in the absence of any other policy changes.
52 House of Commons Home Affairs Committee, ‘Immigration: skill shortages’, Fifth report of session 2015-16, 9 December 2015, p31; http://www.publications.parliament.uk/pa/cm201516/cmselect/cmhaff/429/429.pdf 53 OBR, ‘Economic and fiscal outlook’, 2016, p204; http://cdn.budgetresponsibility.org.uk/March2016EFO.pdf 54 Ideally, this would buy time for a more comprehensive overhaul of the pension and social security system. If this were done, then it is less likely that similar problems would arise when the migrants themselves began reaching old age.
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This is not to say that migration is the only way to improve the public finances, it simply illustrates that in the absence of offsetting policies such as significant tax increases or spending cuts, reducing migration could have a substantial cost in terms of its impact on the public finances. It also highlights that reducing immigration and balancing the books might require either politically unpopular tax increases or spending cuts, or drastic improvements to existing workers’ productivity, all of which is proving difficult for the current government. In other words, while immigration is not the solution to the UK’s demographic challenge, it buys time to make difficult reforms to spending, taxation and/or pension policies.
2.2.4 Immigration also comes with political and economic challenges
Immigration, like trade liberalisation, produces winners and losers and the impact of immigration on GDP per capita is not clear cut. For example, a reduction in the rate of population increase could reduce demand and the pressure on public services. The bulk of the economic analysis suggests that migration is unlikely to bring large gains, or significant losses, in terms of productivity and GDP per capita.55
A recent OECD study on the fiscal impact of migration for all European OECD countries, as well as Australia, Canada and the United States, suggests the impact of the cumulative waves of migration that arrived over the past 50 years in OECD countries is
55 See Migration Advisory Committee, ‘Migrants in low-skilled work’, July 2014; https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/333084/MAC-_Migrants_in_low- skilled_work_Summary_2014.pdf; and Boubtane, Ekrame and Dumont, Jean-Christophe and Rault, Christophe, ‘Immigration and Economic Growth in the OECD Countries 1986-2006’, 23 June 2015, CESifo Working Paper Series No. 5392; http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2622005
36 on average close to zero, rarely exceeding 0.5% of GDP in either positive or negative terms.56 Immigrants are thus “neither a burden to the public purse nor are they a panacea for addressing fiscal challenges.”57
Immigration can also have distributional effects. A recent Bank of England study noted that immigration’s “biggest effect is in the semi/unskilled services sector, where a 10 percentage point rise in the proportion of immigrants is associated with a 2 percent reduction in pay.”58
2.3. Managing immigration in the century of globalisation
Looking at opinion polling in individual countries59 and cross-country surveys,60 the UK public appears to be the most hostile to immigration and the least convinced of its benefits compared with Australia, Canada and even the US. However, how much this has to do with the ability of these countries’ governments to be more selective in their immigration policies than the UK is unclear. Just as important is likely to be their long histories as countries founded on immigration.
56 Liebig, T. and J. Mo, ‘The Fiscal Impact of Immigration in OECD Countries’, International Migration Outlook 2013, OECD, http://dx.doi.org/10.1787/migr_outlook-2013-6-en 57 OECD, ‘Is migration good for the economy?’, May 2014; http://www.oecd.org/els/mig/OECD%20Migration%20Policy%20Debates%20Numero%202.pdf 58 Bank of England, ‘Staff working paper 574: the impact of immigration on occupational wages: evidence from Britain’, December 2015; http://www.bankofengland.co.uk/research/Documents/workingpapers/2015/swp574.pdf 59 UK: NatCen, ‘British social attitudes 2013: attitudes to immigration’, 2013; http://www.bsa.natcen.ac.uk/media/38108/immigration-bsa31.pdf; Canada: Citizenship and Immigration Canada, ‘A literature review of public opinion research on Canadian attitudes towards multiculturalism and immigration 2006-2009’, March 2010; http://www.snsoroka.com/files/2012Soroka&Roberton.pdf; Australia: Monash University, ‘Inventory of Australian public opinion surveys’; https://www.monash.edu/mapping-population/public-opinion/surveys/inventory-of-surveys/immigration; United States: Gallup; http://www.gallup.com/poll/1660/immigration.aspx 60 Ipsos, ‘2015 Global attitudes survey, Global @dvisor Wave 71’, 2015
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Nevertheless, as the box below shows, governments have increasingly turned to ‘points based’ migration systems as a means of managing immigration and many advocates of Brexit suggest that, outside the EU, the UK should emulate the policies employed in Canada and Australia. However, there is no single template for a points based system and they can differ substantially. There are essentially two approaches to immigration policies: the ‘supply led’ approach, under which the government defines selection criteria for immigration applications, and the ‘demand led’ approach, under which employers select economic migrants or migrants are selected on the basis of skills that match national shortages.
The UK already operates a points-based system for non-EU migration, which is based on five ‘Tiers’:
Tier 1: for ‘high-value migrants’ and covers entry of entrepreneurs, investors, and those very few people who come under the ‘exceptional talent’ visa. Tier 2: for ‘skilled workers’ with a job offer in the UK. It includes skilled workers who are transferred to the UK by an international company, skilled workers where there is a proven shortage in the UK, ministers of religion and sportspeople. Tier 3: this category was designed for low-skilled workers filling specific temporary labour shortages but the Government has so far never allocated any visas under this scheme as it views the demand is supplied under EU free movement rules. Tier 4: for students aged over 16 who wish to study in the UK. Applicants must have a place at a registered UK educational establishment before they can apply.
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Tier 5: contains six sub-tiers of temporary worker including creative and sporting, charity, religious workers, and the youth mobility scheme which enables about 55,000 young people every year to work in the UK on working holidays. The visas are awarded to young people from countries that have reciprocal arrangements with the UK.
Coupled with EU free movement, the UK operates a hybrid system, albeit one that is unbalanced: too loose on the one hand and too tight on the other. EU free movement offers a huge source of labour supply, while the UK’s points based system for non-EU migration offers a demand-led source of migration, which tends to be top-down and restrictive.61
Increasingly, governments in other countries are adopting a ‘hybrid’ system, mixing the supply and demand led approaches. For example, Canada adopted a points-based system in the late 1960s which attempted to balance the aim of boosting the population with a steady supply of those with a ‘talent for citizenship’.62 In the 2000s, however, it moved towards a new ‘Express Entry system’, which greatly increases the weight given to offers of employment (i.e. a system led by the demand of employers).63
61 The number of Tier 1 visas issued in 2014 was just 2,700. The majority of work-related migrants therefore arrive in the UK via Tier 2 (52,500) and Tier 5 (42,200). The need for all applicants in Tiers 2 to 5 to submit a certificate of sponsorship when they apply to come to the UK means the vast majority of non-EU immigration to the UK is demand-driven. Oxford Migration Observatory, ‘Non- European labour migration to the UK’, 22 March 2016; http://www.migrationobservatory.ox.ac.uk/briefings/non-european- labour-migration-uk 62 Czaika, M. and Parsons, C., ‘The gravity of high-skilled migration policies’, Oxford International Migration Institute, 2015 63 The new system ranks economic migrants on a 1,200-point scale, with half the points awarded to those with a job offer or a nomination under one of Canada’s provincial immigration plans, which are closely aligned with job vacancies. Those with the highest scores will be quickly invited to apply for permanent residency under one of three economic entry programmes. The rest remain in a pool from which the government and employers can pick. See The Economist, ‘No country for old men’, 10 January 2015; http://www.economist.com/news/americas/21638191-canada-used-prize-immigrants-who-would-make-good-citizens- now-people-job-offers-have
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Characteristics of selected countries’ economic immigration policies UK Migration from within the EU/EEA is subject to the free movement of labour. Operates a ‘points based system’ for non-EEA migrants modelled on the Australian system. No opportunity to work for low-skilled migrants from outside the EEA. 5 ‘tiers’ for non-EEA visas. Tier 1- High Value Migrants. Tier 2- Skilled workers. Tier 4- Students. Tier 5- Temporary workers. Tier 3- Low-skilled migrants is closed. Within each tier points are awarded for: skills; education; age and for meeting a specifically identified skill shortage. You need to have sponsorship from a UK company to gain a work visa. Whilst there is no overall cap there is a cap for some tiers. Tier 1 of 1,000 per year. Tier 2 of 20,700 per year.
Australia Operates a hybrid system incorporating a points based system and work sponsorship system. The work sponsorship component has increasingly become the dominant part with only 15% of migration now taking place under the points based system. Points are based on: age; English language capability; years in employment; education qualifications. In addition, migrants must: be under 50; have at least competent English and meet the health and character requirements. Workers can also apply if they meet specific skill shortages that have been identified by the Australian government. This lowers the amount of points they need to enter. Sets a cap for economic migrants. For 2014-15 this was set at 190,000. Canada Operates a hybrid system incorporating a points based system and work sponsorship system. Points are based on: education qualifications; language ability; age; experience in Canada; adaptability; employment experience and whether they have arranged employment in Canada. Extra points awarded to those migrating to provinces with a particular need for migrant labour. Migrants must meet a minimum in each category in addition to achieving a minimum total overall. Must also meet minimum health requirements but these are less strict than in Australia. Has an ‘express’ entry system for workers who have specific skills identified as being in demand and favours those with a job offer. Operates a total cap on migrants and caps by sector. Total cap for 2014-2015 is 250,000 per year. USA Operates a system with 60 different types of visas. In general it tends to favour low skilled migration and family reunification over high skill migration. Permanent employment based migration is fixed at 140,000 a year which is sub divided into 5 categories. There is also a limit per country such that no country can receive more than 7% of work visas (regardless of population). New Operates a hybrid system incorporating a points based system and work Zealand sponsorship system. Points awarded for: skills; education qualifications; work experience; age and providing skills that are in shortage or migrating to areas experiencing low population growth. Can also for work in one of the industries identified by the national ‘skills shortage’ list. Operates a cap for certain, highly in demand sectors but not overall cap. Process for moving from temporary migration to permanent residency is relatively quick and easy.
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2.3.1 A points system is not a magic bullet for dealing with labour market needs
However, the history of immigration in Canada and Australia illustrates that a points system alone is not necessarily sufficient to meet the labour market’s needs. Points based systems tend to lead to long-term residency but there is an increasing demand for flexible, temporary labour. This type of migration can also seem more acceptable to electorates that find permanent immigration “threatening”.
For example, successive Australian governments have granted temporary migrants – including both skilled temporary migrants and ‘working holidaymakers’ – access to the Australian labour market, which provides a source of labour for lower or unskilled jobs.64 Those entering via the temporary migration route consistently outnumber those entering via the points based or employer sponsored routes.65 This so-called ‘backdoor’ immigration route has provoked arguments – similar to those in the UK prompted by EU migration – about the impact on native youth unemployment and the exploitation of migrants.66
64 Australia also operates a ‘free movement’ route for migration with New Zealand. While temporary skilled migration under so- called ‘457 visas’ is demand led and tied to particular employment, far greater numbers of working holidaymakers provide a supply-led source of labour. See Ryan Batchelor, a senior adviser to the Australian Prime Minister, writing in The Daily Telegraph, ‘What should Britain copy from Australia's 'points-based' immigration system?’, 4 May 2015; http://www.telegraph.co.uk/news/general-election-2015/politics-blog/11577295/What-should-Britain-copy-from-Australias- points-based-immigration-system.html 65 Australian Government Productivity Commission, ‘Migrant intake into Australia: issues paper’, May 2015, p14; http://www.pc.gov.au/inquiries/current/migrant-intake/issues/migrant-intake-issues.pdf 66 See Prof J. Howe writing for ABC, ‘”Backdoor” working visas are leaving migrants at risk, and the Government's response is discouraging’, 6 May 2015; http://www.abc.net.au/news/2015-05-06/howe-backdoor-working-visas-are-leaving-migrants-at- risk/6448272 and B. Birrell writing for The Age, ‘Lax immigration policy hurting Australian jobseekers’, 7 August 2014; http://www.theage.com.au/comment/lax-immigration-policy-hurting-australian-job-seekers-20140806-1019tr.html
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Canada also has a temporary worker immigration route. Unlike the Australian system of temporary migration which is predominantly driven by a supply of young, working holidaymakers, the Canadian temporary scheme is employer-led and temporary migrants are usually tied to a particular job.
In the US, which has a quota rather than a points based system, the economy’s demand for foreign labour is largely filled by migrants that nominally arrive for non-economic family reasons or illegally via the southern border.67 Some estimates suggest that there were 8.1 million undocumented immigrants either working or looking for work in 2012.68
2.4. Conclusions and policy implications
Despite the likely political pressure to reduce immigration following a Brexit, there are three strong reasons that suggest net migration to the UK is likely to remain high. These are:
the business case for maintaining a flexible supply of labour; the political and economic challenge of finding policy alternatives to relieve pressure on the public finances caused by ageing demographics, where immigration can help smoothen the path to fiscal sustainability; and the effects of globalisation on migration flows, which the UK is not alone in experiencing.
Nevertheless, if the UK were not subject to the obligations of EU membership or its rules on the free movement of people, it would likely have designed a very different immigration system. Compared with the – largely successful – systems in Canada and Australia, the current UK policy is unbalanced: too loose from the EU and too tight from outside the EU.
If the UK were no longer subject to the EU’s free movement rules, the UK could pursue selective policies more geared towards attracting skilled migration, which all things being equal should be more economically beneficial and therefore more politically acceptable. However, the Canadian and Australian, and to some extent the US, experience all illustrate that points based or quota systems are not a magic bullet. These countries all offer alternative migration routes, which also contribute to providing a flexible supply of labour for the economy, particularly for lower-skilled jobs. Temporary migration plays an important role in filling lower skilled or seasonal jobs. This type of migration is the most politically contentious and, in the UK, this role has recently largely been filled by EU free movement. Outside of the EU, the UK would likely need to find a new mechanism to attract temporary or low-skilled labour.
67 Centre Forum, ‘Britain’s points based migration system’, 2011, p24; http://www.centreforum.org/assets/pubs/points-based- system.pdf 68 Pew Research, ‘5 facts about illegal immigration in the US’, 19 November 2015; http://www.pewresearch.org/fact- tank/2015/11/19/5-facts-about-illegal-immigration-in-the-u-s/
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Box 3: What might an alternative, liberal UK immigration system look like? Firstly, the Government would need to decide on the status of EU migrants already in the UK. It is highly likely that, for political and legal reasons, the UK would allow these people to continue to live and work legally in the UK, with continued access to social security and public services.69 This would also ease any reciprocal arrangements for the approximately 1.2 million British citizens currently living and working elsewhere across the EU. Therefore, the policy choice would be with regards to future immigration policy.
If the UK were no longer subject to the EU’s free movement rules, the UK could seek to emulate the points based systems of Australia and Canada by extending and adapting the exiting UK points system for non-EU migration to all migration to the UK:
This would mean significantly easing the cap on skilled routes in to the UK under the existing Tier 1 and 2 programmes. These routes are still quite restrictive and therefore mirroring the Canadian ‘express’ entry system, which is weighted strongly towards those with a job offer, but also offers a route for skilled migrants seeking work, would seem like a sensible approach. Such a system could give priority to UK industries and employers suffering skills shortages but also allow a flexible supply of skilled workers to enter the UK labour force that could be subject to a cap which could be varied depending on economic circumstances. As noted above, there is likely to be a continued need for migrant labour to fill low-skilled jobs. Therefore, the UK could open a new route – such as the currently unused Tier 3 programme – to fill low-skilled jobs or meet labour shortages where employers have recently relied on EU migrants.
Such a system could give a greater degree of political control over migration from the EU to the UK, yet retain responsiveness to the needs of UK businesses and the wider labour market.
Potential constraints of a new EU relationship However, as noted at the outset of this section, future UK migration policies could also be constrained by its new relationship with the EU. There is likely to be a trade-off between the depth of any new economic agreement with the EU and the extent to which the UK will have to accept EU free movement. The evidence from the precedents of Norway and Switzerland suggest that the deeper the agreement, the more likely the UK will need to accept free movement.
For example, Norway’s membership of the European Economic Area means accepting largely the same rules on the free movement of people as other EU member states. There are ‘safeguard measures’ that theoretically enable Norway to temporarily suspend parts of the EEA agreement, including the free movement of people. However, this is somewhat of a ‘nuclear option’, since if they are triggered, the agreement also allows the EU to take retaliatory “proportionate rebalancing measures”, which would lead to a political negotiation and potentially suspension of other parts of the agreement.70
69 International law, and specifically the Vienna Convention on Law of Treaties, demands that so-called ‘acquired rights’ be respected. 70 The outcome of any such negotiations would ultimately be determined politically. Norway has never used the safeguard measures for this purpose but, in the late 1990s, Liechtenstein applied safeguard measures to restrict free movement while it negotiated the ability to apply restrictions on foreign EEA nationals’ residence and employment which it has applied since 2000. See Open Europe, ‘What if? The consequences, challenges and opportunities facing Britain outside the EU’, 2015, page 55.
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Alternatively, the UK might try to negotiate different arrangements governing EU migration as part of a new relationship – though this will ultimately be up to the EU. Even a looser relationship might still require building in preferential treatment for EU citizens in the UK’s new points system, which would give EU nationals priority over non-EU nationals. Another option could be for the UK to create a separate temporary migration scheme for migrants from the EU. This would all, however, be subject to the wider UK-EU negotiations post-Brexit.
3. Deregulation and competitiveness
The third area which needs to be addressed is ‘behind the border’ – i.e. what domestic action can the UK take to boost its economic competitiveness post-Brexit. This mostly takes the form of deregulation. We addressed this to some extent in our previous report, looking at the politically feasible levels of deregulation, and will restate some of our findings here. However, they will also be supplemented by a broader assessment of where the UK stands in global terms when it comes to regulation and competitiveness – how much low-hanging fruit is there and what sectors is it concentrated in?
As we demonstrated in the previous report there is undoubtedly scope to deregulate post Brexit but in many cases this will involve politically challenging decisions and may also mean shifting the trend of domestic policy – nothing comes easy. It will also likely mean limiting integration with the EU, since the deeper the UK ties itself back into an agreement with the EU, the less flexibility it will have when it comes to regulation.
3.1 Business desire for deregulation
Before getting into the detail of a deregulatory drive it is worth noting that there is broad desire and support for deregulation amongst businesses. In business surveys regulation often ranks high in terms of businesses’ main concerns.
For example in the recent PwC Global CEO Survey, 79% of respondents cited ‘over regulation’ as a concern.71 A reduction in red tape has also consistently ranked highly when it comes to the reforms businesses wish to see to the EU. A survey of its members by the Institute of Directors found that 60% wanted to “reduce the volume of unnecessary red tape” as the chief aim of the UK’s reform drive.72
The story is also true for specific areas. For example, the IoD also found that 51% of its members saw EU regulation on employment and social affairs as quite or very unhelpful. The 2016 CBI/Accenture Employment Trends Survey found that 50% of businesses ranked the burden of employment regulation as the biggest threat to the UK’s labour market competitiveness.73
71 PwC, 19th Annual Global CEO Survey’, January 2016; https://www.pwc.com/gx/en/ceo-survey/2016/landing-page/pwc-19th- annual-global-ceo-survey.pdf 72 IoD, ‘IoD calls on all parties to accept need for EU reform’, 28 September 2015; http://www.iod.com/influencing/press- office/press-releases/iod-calls-on-all-parties-to-accept-need-for-eu-reform 73 CBI, ‘The path ahead: CBI/Accenture Employment Trends survey 2015’, December 2015; http://news.cbi.org.uk/news/job- creation-up-but-skills-shortages-rising-labour-costs-start-to-bite-cbi-accenture-survey/the-path-ahead/
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This desire for deregulation is not necessarily enough for these businesses to support Brexit, but more that, if it were to occur, it may be seen as an opportunity to push for deregulation and there could well be a number of vocal supporters for such an approach in the business community.
3.2 What level of politically feasible deregulation?
Based on our regulatory database – covering over 2,300 EU and domestic regulations – we examined nine broad areas below. We estimate, based on the Government’s own Impact Assessments (IAs), that the 100 most expensive EU-derived regulations currently cost the UK economy £33.3bn a year (2014 prices). For a range of reasons, this is not the total cost of EU rules to the UK economy. Many regulations are not subject to IAs in the first place and not all the costs associated with regulation such as indirect effects – are captured by the IAs’ methodology.
Our calculations also only include the annual recurring costs, but some regulations also come with substantial one-off costs. The annual recurring benefit of these regulations is estimated by the IAs to be £58.6bn. However, we believe this is somewhat overstated – for example, due to the fact that many of the benefits of the climate change regulations have not materialised as they were premised on securing a global climate deal before 2010 to reduce emissions significantly. In 26 out of the 100 regulations the net cost actually exceeds the benefits, while in a further 31, the costs and benefits have not been fully quantified.
Current Feasible Sector annual annual cost (£bn) saving (£bn) EEA FTA Social, Employment, Health & Safety laws 9 5.6 Yes No Environment and Climate Change laws 11.9 5.8 Yes No Energy 1.6 0 Yes No Consumer protection 1.2 0 Yes No Competition and public procurement N/A N/A Yes No Financial Services 7 1.4 Yes No Product Standards 1.9 0 Yes No Life Sciences 0.4 0 Yes No Total Regulation 33 12.8
As the table above shows there are three key areas which we believe can deliver real savings in a broadly politically feasible way – social employment, health and safety laws, environment and climate change and financial services.
It is also worth noting that achieving this level of deregulation is not possible from inside the EEA – ultimately Norway still adopts 93 of the top 100 costliest EU regulations, taking on 94% of the cost. This suggests a looser relationship with the EU would be needed to achieve these gains.
Our scenario envisages an ambitious yet politically feasible deregulatory drive including the scrapping of several regulations and targeted amendments to others.
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This would deliver a saving of £12.8bn (0.7% of GDP).74 Since these are annual recurring costs this should be a permanent saving.
3.2.1 EU Social, Employment, Health & Safety laws
Annual recurring cost £9bn Contenders for de-regulation On-call time rules, compensatory rest, agency workers rules, holiday roll-over, redundancy, works councils Politically sensitive/unfeasible Holiday entitlements, some anti- discrimination, asbestos rules Annual savings under politically £5.6bn feasible scenario Conclusion Substantial scope for deregulation but would trigger domestic battles
EU social and employment laws come with a significant cost to the UK economy – 22 of the 100 costliest EU derived regulations fall into this category – and they are particularly burdensome for small business. We envisage that under our deregulatory scenario the UK government would seek to cut costs in this area by scrapping the Agency Workers Directive entirely (saving £2.1bn) and reining in the costs imposed by the Working Time Directive (WTD). Collectively, three UK regulations implementing the WTD come with an annual recurring cost of £5.1bn, and we envisage that post- Brexit the UK could cut this by £3bn while still keeping in place some restrictions on working hours and the 20 day minimum holiday entitlement. The remaining savings would come from scrapping rules on equal treatment rights for fixed-term workers (saving £345m) and a handful of other regulations such as rules on the mandatory information and consultation of employees (collectively saving £118m).
The domestic politics
Significant de-regulation will require a major change in mentality and it would also mean taking on a series of domestic interests, including the trade unions and a Labour Party which under Jeremy Corbyn’s leadership has abandoned the relatively pro- business policies and outlook it had in government between 1997 and 2010. Areas where even the most liberal UK government would be reluctant to de-regulate include:
The entitlement to 20 days paid holiday (on top of bank holidays) enshrined in the WTD. Most of the non-discrimination laws such as the right to equal pay would certainly stay, although the UK government could reverse some EU rules and European Court of Justice (ECJ) rulings such as the requirement for insurance firms to charge men and women the same premium. Health and safety regulations protecting workers from exposure to asbestos and excessive noise would likely remain, although they could be adapted to better suit UK circumstances and adjusted to factor in the size and nature of individual businesses.
74 In our previous Brexit report, we also examined a more extreme scenario. The second scenario envisaged an extremely ambitious deregulatory drive pursued by a very economically liberal government including the outright scrapping of a substantial number of politically sensitive regulations. This would deliver a saving of £24.4bn (1.3% of GDP).
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It should be noted that the UK has at times driven the legislative agenda in Europe and has sometimes gold-plated EU-derived legislation, for example rules restricting vibration and noise levels at work.75
It is also worth keeping in mind that, by most measures, the UK continues to have one of the most flexible and deregulated labour markets in the world. According to the World Economic Forum’s Competitiveness Index, the UK ranks 5th in terms of labour market efficiency and, more specifically, 9th for labour market flexibility. In both cases it is the highest ranked EU member.76
3.2.2 EU Environment and Climate Change laws
Annual recurring cost £11.9bn (£3.47bn + £8.47bn) Contenders for de-regulation Renewables target, electrical waste standards, EU ETS Politically sensitive/unfeasible Air pollution, water quality Annual savings under politically £5.8bn feasible scenario Conclusion Where the UK could gain the most competitiveness outside the EU but would take major change of heart for any UK government to deregulate
The EU’s environmental and climate change laws come with a substantial cost to the UK economy and this is arguably the area in which a post-Brexit UK government could make the greatest savings for both consumers and businesses, whilst boosting the country’s overall competitiveness:.
The EU’s Climate Change rules are meant to deliver a net benefit of over €200bn to the UK economy by 2020, but without a global deal on emissions this falls to a net cost of between €11.4bn and €20.6bn up to 2020 based on Open Europe estimates. In 2013, the average household’s dual gas and electricity bill was £59 (5%) higher due to EU regulations or the UK’s implementation of EU defined targets. By 2020, EU-related regulations or targets are set to increase annual household bills by £149 (11%).77 In 2013, the average medium sized business’ bill was 9% (£130,000) higher due to EU regulations or the UK’s implementation of EU defined targets. By 2020, EU-related regulations or targets will increase medium sized firms’ bills by 23% (£350,000).78
75 For a more detailed discussion see Open Europe, ‘Repatriating EU social law: the best choice for jobs and growth?’, November 2011; http://openeurope.org.uk/intelligence/economic-policy-and-trade/eu-social-law/ 76 World Economic Forum, ‘Competitiveness Rankings’, retrieved on 8 April 2016; http://reports.weforum.org/global- competitiveness-report-2015-2016/competitiveness-rankings/ 77 This is not to say bills will automatically fall if the UK leaves the EU. But clearly there are potential savings but it would require a change of approach which breaks with the current UK and EU approach. 78 For a more detailed discussion of the costs associated with current EU climate change policy see Open Europe, Rotten Foundations: Time to reassess the EU’s Environment and Climate Change policies’, September 2014; http://openeurope.org.uk/intelligence/energy-and-environment/europe-2020/
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We envisage that, under the politically feasible scenario, the UK would keep the bulk of climate change legislation in place and retain its ambition to cut emissions, but it would be free to pursue an alternative strategy and abandon the EU mandated renewables targets saving up to £5.7bn.79
In terms of the broader environmental measures, we envisage the costs associated with laws on preventing air and water pollution will remain unchanged. However, a few less significant EU-derived environmental regulations could be scrapped delivering a cumulative saving of £80m, just over half of which would come from scrapping mandatory systematic environmental assessments from planning applications under the EU’s Strategic Environmental Assessment Directive.
The domestic politics
Deregulation would mean some tough choices for the UK, particularly as this is one of the areas where the UK has gone further than EU standards and continues to do so. The current UK government has proposed to reduce emissions by 80% of 1990 levels by 2050 via legally enforced carbon budgets. It has also committed to pursue a Carbon Price Floor at £16 per tonne of CO2, well above the EU’s carbon price of around €5 per tonne under the Emissions Trading System. This suggests that it would take a major change of a heart for any UK government to pursue far-reaching de-regulation in this area. The potential benefits to consumers and businesses could however be a major political incentive, but are not automatically guaranteed by leaving the EU; there does need to be a clear policy shift.
It would also be very hard for any government to significantly roll back rules on air and water quality, hence why the costs associated with these rules remain fixed under our scenarios.
3.2.3 Financial Services
Annual recurring cost £7bn Contenders for de-regulation AIFMD, bankers’ bonus cap, insurance capital rules, short selling regulation Politically sensitive/unfeasible Capital requirements, money laundering, payments systems Annual savings under politically £1.4bn feasible scenario Conclusion Some scope for de-regulation but much will depend on market access deals
79 This comprises the £4.67bn cost of the EU’s Renewable Energy Directive, the £245m cost of the Greenhouse Gas Emissions Trading Scheme, and the £757m Fuel Quality Directive (which includes provisions on biofuels, part of the renewables target). However, this needs to be caveated with the fact that there has been a change in government policy since the May 2015 election. There is now far less direct subsidy support for renewable energy. As such these sorts of savings only hold if the government is actually fully implementing and meeting its renewables target. Doubt has been thrown on this fact by recent leaks, see Open Europe blog, ‘UK on course to miss EU 2020 renewables target’, 13 November 2015: http://openeurope.org.uk/today/blog/uk-on- course-to-miss-eu-2020-renewables-target/
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Given the importance of financial services to the UK economy, this will be a crucial area for de-regulation and there are a number of provisions the UK would seek to scrap or amend. The top contenders for deregulation in this sector include:
The bankers’ bonus cap – the UK was the only EU country to oppose this measure. Emergency bans on short selling administered by European Securities Markets Authority. Solvency II capital rules for insurance companies and pension funds. Excessive reporting and disclosure requirements for fund managers.
However, the scope for de-regulation is constrained both by domestic politics and the need to maintain market access, particularly for the single market.
As such we envisage that savings under the politically feasible scenario would be relatively limited. The UK would likely scrap Solvency II (saving £200m) as well as the domestic application of EU rules such as the Alternative Investment Fund Managers Directive (AIFMD) and the Markets in Financial Instruments Directive (MiFID), applying them only to businesses exporting to the EU. On the basis that 41% of the sector’s exports to the EU, we apply a 59% regulatory saving which amounts to £1.2bn.80 However, we envisage that the entire £4.6bn cost associated with CRD IV would remain in place.
The domestic politics
Given the political climate in the UK in the wake of the financial crisis and a number of scandals involving the industry, any government proposing substantial deregulation will face stiff opposition.
Britain would also have some international commitments that it needed to take into account. For example, CRD IV remains the most costly of EU financial regulations with an annual recurring cost of £4.6bn. Since, this is based on the internationally agreed Basel III rules, it seems likely the UK would choose to keep some version of these in place, although it could gain greater flexibility over their implementation including over the bankers’ bonus cap.
Single market considerations
This area more than the previous two is clearly tied in with the single market and as such might be linked to the terms of the UK’s continued access to the EU market. This would depend heavily on what type of deal is negotiated, but ultimately as we have pointed out many times there is a trade-off between control/freedom over regulation and market access. The two extremes here are that that the UK is either able to continue to use the single market passport in financial services or that it is treated as a third country. In either case, access will be predicated upon implementing EU financial services regulation or similar measures.
80 It has been argued by PwC that the cost of having a dual rulebook would outweigh the benefit. This risk does exist though moving from the higher level to the lower level should not be overly onerous. There is also a distributional point here, the deregulation will aid the smaller and medium sized firms who gain far less from EU access and have far less capacity to stomach regulatory costs. PwC also believe that partially removing certain regulations might be difficult since they apply across firms rather than to specific products, meaning it is hard to apply them only to products marketed in the EU. This is a valid concern, but in plenty of cases, particularly asset managers, firms do not market any products in the EU. See PwC, ‘Leaving the EU: Implications for the UK economy’, study commissioned by the Confederation of British Industry (CBI), March 2016, Annex E; http://news.cbi.org.uk/news/leaving-eu-would-cause-a-serious-shock-to-uk-economy-new-pwc-analysis/leaving-the-eu- implications-for-the-uk-economy/
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In the former because it is tied in with the passport or in the latter because to gain access the UK would have to be judged ‘equivalent’ to the EU in terms of regulation and risk management. These considerations could also weigh on decisions to deregulate in this sector.81
3.3 Competitiveness
Looking beyond deregulation and more broadly at the issue of competitiveness might also provide an indication of areas for low hanging fruit which can be grasped post Brexit in order to offset any negative economic shock.
The picture we find is that, while the UK remains a very competitive economy in global terms, there are certainly potential changes which could yield benefit – although it is not immediately clear these are in sectors where EU membership is acting as a constraint. This section is a summary of a longer, more detailed assessment which can be found in Annex 3.
3.3.1 International comparisons of competitiveness
The World Bank’s Ease of Doing Business report ranks the UK 6th overall. The UK’s highest rankings come in areas such as starting a business, resolving insolvency and protecting minority investors. The UK also ranks well on infrastructure related indicators (such as getting electricity to new businesses). Its lowest rankings come in: registering property, enforcing contracts and trading across borders. Improvements in registering property could be delivered by reducing the number of procedures involved, but hint at broader issues in this space – namely restrictions from UK planning rules and the low level of housebuilding. The World Economic Forum’s Competitiveness index shows the UK’s worst performing areas to be: macroeconomic climate, health and primary education and tertiary education. Again these are areas largely unaffected by the EU and which have been longstanding challenges for the UK. Reforming and improving these areas is far from a simple challenge and is inevitably politically controversial. The OECD’s Product Market Regulation index again highlights the UK as one of, if not the, most competitive economies on this front. Only the Netherlands beats it out in terms of ranking for the most favourable product market regulation.82 London came top in the 2015 Global Financial Centres Index. Frankfurt, Paris, Amsterdam and Dublin ranked at 14, 37, 36 and 46 respectively. This highlights the continuing competitiveness of London relative to its EU and global peers. The EU does not seem to be holding back the City significantly, while it also seems unlikely Brexit would erode its competitiveness quickly, especially relative to other EU cities.
81 The point is often made that an increasing number of regulations are set at the global level. While there is some truth in this, they are still enforced via the EU and therefore access will be determined by the EU interpretation of the global rules. 82 OECD, ‘Indicators of Product Market Regulation Homepage’ http://www.oecd.org/eco/growth/indicatorsofproductmarketregulationhomepage.htm#indicators
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3.3.2 Underlying drivers of competitiveness
There are also a number of economic indicators which are traditionally seen as ‘drivers’ of competitiveness.
Trade performance: In 2014 globally the UK ranked 10th in merchandise exports and 5th in imports and 2nd in services exports and 5th in imports. However, the UK ranks 30th in the ICC’s Open Markets Index, but this is largely down to the measurement of ‘trade openness’ which favours smaller states with larger merchandise trade. Germany, Canada, Australia and the United Kingdom are the only four G20 countries that record an above average openness in the ICC index. Productivity: Historically, the UK’s labour productivity has underperformed relative to Germany, France and the US. While the gap to France and Germany closed in the ‘90s and ‘00s it has risen since the financial crisis. Skills: UK does fairly well in terms of tertiary education but less well at lower levels and on basic metrics of literacy. A recent survey of its members by the IoD also found that 42% ranked access to skilled employees as the issue which most negatively impact their business, making it the highest rated concern.83 As noted in Section 2, skills shortages are at record highs. Innovation: The UK ranks as one of the lowest spenders on R&D in the EU as a share of GDP, at 1.7% in 2014. Infrastructure: The UK’s infrastructure is generally well regarded, though road and airport congestion hold it back. Digital infrastructure, particularly for workers, rates well. Investment: In terms of overall investment the UK does poorly, which links back to some of its infrastructure and other problems. UK ranks last in terms of average spend on capital investment between 2006 and 2015 in the EU. It does better in terms of FDI attracting record highs and often the most in the EU. However, even here it ranks below the OCED average in its index on FDI Regulatory Restrictiveness.
3.4 Conclusions
This remains a broad assessment but the metrics suggest that in a number of areas – labour market, business environment and product market regulation – the UK is a competitive economy, especially in terms of the developed world. Areas where there is evidence of the UK underperforming are broadly certain parts of education, certain skills, costs of some services and some aspects of its infrastructure (notably road and air). When it comes to trade performance the evidence is mixed – it is generally an open country and does particularly well in services trade but some parts of trade administration, for example border administration, could do with updating and improvement.
That said, Brexit does potentially present an opportunity in terms of deregulation and competitiveness improvements. However, these are not without challenges. There is less low hanging fruit than some may think and the political opposition to some changes could be significant.
83 IoD, ‘Skills shortage and access to finance top concerns for UK entrepreneurs’, 14 December 2015; http://www.iod.com/influencing/press-office/press-releases/skills-shortage-and-access-to-finance-top-concerns-for-uk- entrepreneurs
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Nevertheless, we assess a politically realistic deregulation could deliver gains of 0.7% of GDP permanently.
This could be topped up with other reforms though they are less in areas where the EU interferes and as such it is no obvious that these could not also be done inside the EU. Outside the EU they would, however, become more urgent and form a more important part of readying the UK for wider competition with the rest of the world, similar to the need for a modern immigration and trade policy outlined in sections one and two. As with those approaches, such reforms will likely require greater dislocation from the EU in order to gain the flexibility needed, particularly when it comes to deregulation.
Box 4: How might a deregulation and competitiveness strategy outside the EU look?
The policies and priorities we would recommend include:
Deregulation Scrap the Agency Workers Directive Scale back the Working Time Directive significantly Scrap certain other social and employment rules such as equal treatment for fixed-term workers and consultation of employees. Drop the Renewables Directive and accompanying renewables target. Scrap mandatory environmental assessments from planning applications. Scrap Solvency II rules. Limit AIMFD and MiFID rules so that only those exporting to the EU need apply them.
Competitiveness Invest in state of the art border controls and customs procedures to reduce cost of trading for businesses. Improve procedures for registering property and ease planning restrictions. Cut legal costs for businesses to access court system, consider methods to promote greater competition in legal industry. Renewed push to improve primary education and basic standards of literacy. Promote greater investment in R&D to further innovation. Encourage greater capital investment, including on infrastructure such as roads and airports.
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4. Conclusions: what are the implications for a new UK-EU relationship?
EU membership involves difficult trade-offs and so do the alternatives. The existing precedents are fairly well rehearsed and highlight the challenge in striking a balance between market access and control over regulation and immigration:
Seeking to remain within the EU’s single market (the ‘Norwegian’ option): This would involve remaining a member of European Economic Area. While this model scores highly in terms of maintaining market access, it falls short in terms of guaranteeing the UK a say over the rules (Norway has no veto at the European Council, no votes in the Council of Ministers and no representation in the European Parliament). It also falls short in terms of independence, given that most EU policy areas would continue to apply post Brexit. Crucially, this includes the free movement of people. The UK would gain the ability to negotiate its own trade deals. Seeking a bilateral deal (the ‘Swiss’option): This model provides a mixed level of market access – it is relatively comprehensive in terms of goods but falls short in terms of services access, particularly for financial services. It also fares poorly in terms of having a say over the rules with Switzerland essentially having to mirror EU legislation in key areas where it wants to secure single market access. It does score more highly than the EEA option in terms of gains in independence with several policy areas including social and employment law returning into the remit of the UK government. However, it still involves keeping free movement of people. Going it alone (the ‘WTO’ option): This model understandably scores low in terms of continued EU market access as it entails no preferential agreement with the EU. Some key goods exports would face high tariffs and accessing EU services markets would become much harder, particularly in financial services. Likewise it offers the UK no say over the rules but offers maximum scope for gains in independence and would not involve as complex negotiations with the EU.
Therefore the likelihood is that the UK would need to negotiate some form of bespoke arrangement. However, the fundamental trade-off is unavoidable: the fullest EU market access means accepting greater ‘obligations’ (be they on regulation, some form of contribution to the EU budget, or accepting the free movement of people). The trade- offs are political as much as economic and are not all black and white. Would an UK-EU exit deal prioritise market access over reducing immigration or vice versa? Will the UK seek to remain inside the single market (à la Norway) to ensure continuity of EU market access (avoiding initial disruption) and accept this entails continued adherence to much of the regulation that is seen as a hindrance? Or would it prioritise a greater deal of independence (and what would it do with it?) at the cost of reduced access to the EU market for crucial UK industries, such as financial services?
Our analysis, which is shared by much of the other economic research, is that leaving the EU means a degree of economic dislocation with the UK’s largest trade partner and therefore an economic cost, likely to be in the range of 0.5% to 1.5% of GDP over the long-term, depending on the exact terms of the post-exit deal with the EU.
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However, the EU now accounts for less than half of the UK’s trade and we believe that it is possible for the UK to get back into positive economic territory over the long-term if it takes a liberal approach to trade, immigration and deregulation, as outlined in the conclusions and policy proposals outlined above.
In all the areas we have looked at – trade, immigration and deregulation – the optimal policy response requires a relatively high degree of flexibility vis-à-vis the EU. In particular, a points based system for immigration is unlikely to compatible with EEA- style access to the single market and the deregulation of social and employment law and climate policies would require greater freedom to deviate from EU rules.
The argument that Brexit will benefit Britain economically is also a bet on the future: it presumes that the EU is of declining economic importance and that freedom from the EU offers better potential to take advantage of future global opportunities.
In conclusion, the most rational option would be for the UK to seek a modern bilateral agreement, outside the confines of the single market and European Economic Area, for its new economic relationship with the EU as this would give the UK greater freedom to adopt a liberal economic agenda that would better enable it to offset the costs of withdrawal and prosper outside the EU over the long-term.
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ANNEX 1
EFTA-Canada
Free trade talks between EFTA countries (Iceland, Norway, Switzerland and Liechtenstein) and Canada were officially launched in October 1998. Negotiations ended nearly nine years later, in June 2007, and the agreement was signed in Davos on 26 January 2008.84 It then entered into force on 1 July 2009.85
The agreement scraps nearly 100% of tariff lines on industrial goods.86 Basic agricultural products are covered by separate bilateral agreements between Canada and EFTA countries.87 These all entered into force simultaneously with the main FTA.
As a first-generation trade agreement, however, the EFTA-Canada deal is essentially about tariff reduction and therefore does not really change anything substantive in areas such as services, investment, recognition of professional qualifications or intellectual property – although it does give signatories flexibility to expand its scope at a later stage.88 Similarly, on public procurement, the EFTA-Canada deal simply refers to the existing WTO rules – while leaving the door open for further liberalisation at a later date.89
Overall, as the table below shows, the EFTA-Canada deal is therefore less comprehensive than the recently concluded Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada – despite it taking nearly two years longer than CETA to conclude it.
However, this should not necessarily be seen as a consequence of the ‘clout gap’ between EFTA and the EU. EFTA entered negotiations with Canada over ten years before the EU – when second generation free trade agreements had not yet become the new normal. As of the 2000s, EFTA also shifted to concluding second generation deals – for instance with Mexico, Singapore and South Korea. Of course, the fact that EFTA was able to strike an FTA with Canada, albeit a less comprehensive one, long before the EU is also telling.
84 Government of Canada, ‘New trade agreement eliminates barriers and opens doors to European markets’, 2 July 2009; http://www.international.gc.ca/media_commerce/comm/news-communiques/2009/387354.aspx?lang=eng 85 EFTA, ‘Free Trade Agreements – Canada’; http://www.efta.int/free-trade/free-trade-agreements/canada 86 A transitional period of up to 15 years is envisaged for Canadian imports of sensitive shipbuilding products, while a limited number of industrial products (such as casein and certain albumins) are excluded. See Annex F to the EFTA-Canada FTA; http://www.efta.int/media/documents/legal-texts/free-trade-relations/canada/annexes-rou/EN/Annex%20F%20- %20Products%20not%20covered%20by%20article%2010.pdf 87 Switzerland also represents Liechtenstein for the purpose of these bilateral agreements, see the EFTA website; http://www.efta.int/free-trade/free-trade-agreements/canada 88 Article 12(1) of the Canada-EFTA agreement reads, “The Parties recognise the increasing importance of trade in services and investment in their economies. In their efforts to gradually develop and broaden their co-operation, they will work together with the aim of creating the most favourable conditions for expanding investment between them and achieving further liberalisation and additional mutual opening of markets for trade in services, taking into account on-going work under the auspices of the WTO.” 89 Article 20 of the EFTA-Canada deal establishes that, “The rights and obligations of the Parties in respect of public procurement shall be governed by the WTO Agreement on Government Procurement.”
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EU-Canada (CETA) EFTA-Canada Length of Six years and nine months90 Eight years and eight months91 negotiations Entry into 2017 (estimated) 1 July 2009 force Agricultural EU scraps 93.8% of tariff lines; Covered by separate bilateral deals goods Canada scraps 91.7% of tariff lines between Canada and EFTA countries
Industrial Both sides scrap 100% of tariff Both sides scrap nearly 100% of tariff goods lines lines92 Rules of Based on standard EU rules. Looser Hybrid of EFTA and NAFTA approach Origin rules apply to limited quantities of (i.e. less stringent than EU rules) certain Canadian exports (e.g. cars and textiles) and EU textiles exports Services and New openings, but liberalisation No immediate change. investment not full. ‘Negative listing’ approach, Leaves door open for follow-up meaning only restrictions explicitly negotiations to extend scope of deal at a listed apply later date Professional No immediate change. Sets out No immediate change. qualifications framework for negotiation of Encourages cooperation with a view to profession-specific Mutual achieving mutual recognition at a later Recognition Agreements (MRAs) date Public Canada opens its public markets at Refers to WTO Agreement on procurement all levels of government;93 Government Procurement EU guarantees reciprocal access
Arbitration State-to-state disputes are settled by State-to-state disputes are settled by ad ad hoc panels of independent hoc arbitral tribunals. Disputes arising experts. Investor-to-state disputes under both this FTA and the WTO are settled by a permanent court Agreement can be settled in either forum
US-Australia
Negotiations on a free trade agreement between Australia and the US were announced in April 2001, although the first round of talks did not take place until November 2002. The deal was finalised in in February 2004, signed in May 2004, and then came into force on 1 January 2005.
As a result of the agreement, Australia and the US both scrapped all tariff lines on non- agricultural goods as of 2015 – while 75% of tariff lines on agricultural goods were abolished as of 2008.94
90 Counting from the official launch of negotiations (May 2009) to the end of the follow-up talks over ISDS (February 2016). See European Commission, ‘CETA: EU and Canada agree on new approach on investment in trade agreement’, 29 February 2016; http://europa.eu/rapid/press-release_IP-16-399_en.htm 91 Counting from the official launch of negotiations (October 1998) to the official announcement of the end of the negotiations (June 2007). 92 A limited number of industrial products (such as casein and certain albumins) are excluded. See Annex F to the EFTA-Canada FTA; http://www.efta.int/media/documents/legal-texts/free-trade-relations/canada/annexes-rou/EN/Annex%20F%20- %20Products%20not%20covered%20by%20article%2010.pdf 93 Except for some restrictions in Ontario and Québec, see European Commission, ‘CETA – Summary of the final negotiating results’, December 2014; http://trade.ec.europa.eu/doclib/docs/2014/december/tradoc_152982.pdf 94 Australian Department of Foreign Affairs and Trade, ‘Manufactured Goods: Australia-United States FTA’; http://dfat.gov.au/trade/agreements/ausfta/fact-sheets/Pages/understanding-the-agreement.aspx. See also, Australian Department of Foreign Affairs and Trade, ‘Agriculture: Australia-United States FTA’: http://dfat.gov.au/trade/agreements/ausfta/fact-sheets/Pages/agriculture.aspx
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As regards services, the agreement goes further than WTO commitments in areas such as financial, education, and professional services. On financial services, for instance, both countries committed to allowing each other to provide investment advice or portfolio management to collective investment schemes.95
The agreement also goes further than WTO rules in the area of intellectual property rights – with Australian laws being harmonised with US ones.96 In addition, given that Australia is one of very few developed countries that have not yet signed up to the WTO Agreement on Government Procurement,97 the US-Australia free trade deal is of particular significance in this area – as it opens up the public procurement markets of all Australian states and territories, and of 31 US states.98 The investment section, however, fails to significantly go any further from anything that had previously been agreed.
Nonetheless, the beneficial effects of the US-Australia trade deal have been put into question. In a paper published in January 2015, Dr Shiro Armstrong of the Australia- Japan Research Centre estimated that, by 2012, the agreement had ‘diverted’ $53.1bn of total trade with the rest of the world for both the US and Australia. Imports to Australia and the US from the rest of the world had fallen by a total $37.5bn over the period – while exports to the rest of the world from both countries had shrunk by a total $15.6bn. In other words, the study suggests that the US-Australia trade deal had failed to generate new trade. The author argues that his findings “add to the evidence about whether or not preferential trade agreements increase net trade – with the body of evidence currently suggesting that they do not and if anything lead to a contraction.”99
Switzerland-China
Switzerland and China agreed to launch talks over a free trade deal in January 2011. The negotiations were concluded over two years later, in May 2013. The agreement was then signed in July 2013 and entered into force on 1 July 2014.100
The deal established that tariffs on goods would eventually be scrapped on 99.7% of Chinese exports and 84.2% of Swiss exports – meaning that Switzerland comparatively opened its market more.101
95 Australian Department of Foreign Affairs and Trade, ‘Financial Services: Australia-United States FTA’: http://dfat.gov.au/about- us/publications/trade-investment/australia-united-states-free-trade-agreement-guide-to-the-agreement/Pages/13-financial- services.aspx 96 Australian Department of Foreign Affairs and Trade, ‘Intellectual Property: Australia-United States FTA’: http://dfat.gov.au/trade/agreements/ausfta/fact-sheets/Pages/intellectual-property.aspx 97 See WTO, ‘Agreement on Government Procurement – Parties, observers and accessions’, retrieved on 18 March 2016: https://www.wto.org/english/tratop_e/gproc_e/memobs_e.htm 98 Strategic defence procurement is not covered, see Australian Department of Foreign Affairs and Trade, ‘Government Procurement: Australia-United States FTA’: http://dfat.gov.au/trade/agreements/ausfta/fact-sheets/Pages/government-procurement.aspx 99 Dr Shiro Armstrong, ‘The economic impact of the Australia-United States free trade agreement’, AJRC Working Paper 01/2015, January 2015, page 14; https://crawford.anu.edu.au/pdf/ajrc/wpapers/2015/201501.pdf 100 Swiss State Secretariat for Economic Affairs, ‘Factsheet: Free Trade Agreement between Switzerland and China’, April 2014; http://www.seco.admin.ch/themen/00513/02655/02731/04118/index.html?lang=en 101 Once products on which tariffs are reduced but not fully eliminated are included, the share of goods covered by the FTA rises to 99.99% for Chinese exports and 96.5% for Swiss exports. For further details, see Marc Lanteigne, ‘The Sino-Swiss Free Trade Agreement’, Centre of Security Studies No 147, February 2014; http://www.css.ethz.ch/content/dam/ethz/special- interest/gess/cis/center-for-securities-studies/pdfs/CSSAnalyses147-EN.pdf
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In addition, Switzerland agreed to scrap its tariffs on Chinese imports upon entry into force of the agreement – while China would eliminate its own tariffs more gradually after transition periods ranging from five to 15 years, depending on the product.102 The more generous concessions made by Switzerland can be seen as a result of China having substantially larger bargaining power – not least given the size of the Chinese market compared to the Swiss one. China also argued that the transition periods were a necessity, given that its average tariff across all products was 8.7%, compared to Switzerland’s 2.4%.103
As regards services, the Switzerland-China deal incorporated the existing WTO rules but also went further in a number of areas. Both countries agreed to improve their commitments for certain services. For example, Switzerland committed to improving market access for China in private sector training services, such as foreign language services, while China agreed to grant Switzerland greater market access to its environmental services, such as emission and noise control services.
The agreement also improves on some of the existing WTO commitments on financial services. As a result of the deal, for instance, Swiss securities firms operating in China are now able to establish joint ventures, with foreign ownership capped at 49%, but they are also free to engage in underwriting shares and handling domestic bond offerings. If a joint venture meets the domestic regulatory demands, it would then be able to gradually engage in securities brokerage, asset management or proprietary trading.104
Perhaps the main lesson the UK could draw from the Switzerland-China agreement is that leverage will not always be on its side in future trade talks. However, this needs to be put on balance with the size of the market to which the UK would be boosting its access by concluding a new trade deal. Britain would have to decide on a case-by-case basis whether it is worth offering unrestricted access to its market in return for more limited access to a significantly larger market (e.g. China, India or the US).
102 Ministry of Commerce of the People’s Republic of China, ‘Minister Gao Hucheng signed the China-Swiss Free Trade Agreement with Johann Schneider-Ammann’, 10 July 2013; http://english.mofcom.gov.cn/article/newsrelease/significantnews/201307/20130700192882.shtml 103 André Bruschweiler and Alexander Troller, ‘Insight into the Swiss-Sino Free Trade Agreement- a path to new business opportunities’, Jusletter 16, June 2014; http://www.lalive.ch/data/publications/Swiss-Sino_Free_Trade_Agreement.pdf 104 For further details, see Wenfei Law, ‘A Practical Guide to the new Free Trade Agreement between Switzerland and China’, December 2013; http://www.wenfei.com/fileadmin/pdfs/China_Publications/Wenfei_FTA_Publication_December_2013.p
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ANNEX 2
The methodology categorising each FTA is based on what has been included in the deal, and how far different sections of the deal have been liberalised. Apart from including a deal on goods and removing tariffs, how far does the agreement liberalise and improve upon WTO commitments in the areas of services, procurement, investment, and intellectual property. We have judged each deal in relation to what the deal includes, and then as they become more comprehensive, by how far they liberalise in each of these areas.
Those that have been placed in the column as ‘Basic’ are agreements that cover a deal in goods, but fail to include services or go beyond WTO commitments in the area of services.
Those that have been deemed as ‘Fairly Comprehensive’ go slightly beyond WTO commitments in services, and a few other areas, whether it be in investment or intellectual property, but still fails to liberalise past WTO commitments in a significant number of areas. For example, the EU-Peru/Colombia deal includes services, government procurement, and intellectual property rights, but it only goes beyond WTO commitments in services. The EU-Georgia and Japan-India deals are also very similar and the FTAs that China has struck with both Switzerland and Iceland improve upon commitments in services and property rights, and are the first European countries to strike an FTA deal with China, but they fail to liberalise in other areas such as investment. The Australia-ASEAN deal is the most comprehensive deal ASEAN has ever done, and goes beyond WTO commitments in goods, services, investments and intellectual property but they only bring about modest improvements on their existing GATS and WTO commitments.
FTAs that have been referred to as ‘Comprehensive’ include liberalisation in all or in nearly all areas, and often substantial liberalisation. For example, the EU-Korea agreement includes and goes beyond WTO commitments in goods, services, investment, public procurement and intellectual property. The Canada-EU and US- Australia FTAs also cover a range of areas, and while the China-Australia deal is very comprehensive in terms of services, and investment, offering China its best service commitments apart from Hong Kong and Macau, it still lacks improvement on WTO commitments for procurement, and property rights. The Canada-Korea deal puts Canada on the same footing as the EU and the US in terms of what Korea agreed with them, but goes even further than these deals in some areas, such as the temporary entry for business persons, and the speed of tariff elimination for certain goods. The Japan- Australia FTA is the most liberalising bilateral trade deal Japan has agreed, substantially liberalising services, investment, intellectual property and government procurement, while Switzerland being a member of the EEA enjoys access to the single market.
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ANNEX 3
Broad international indexes of competitiveness
If we look at the World Bank’s Ease of Doing Business report the UK ranks 6th overall. The UK’s highest rankings come in areas such as starting a business, resolving insolvency and protecting minority investors. The UK also ranks well on infrastructure related indicators (such as getting electricity to new businesses). It lowest rankings come in: registering property, enforcing contracts and trading across borders. Improvements in registering property could be delivered by reducing the number of procedures involved but hint at broader issues in this space – namely restrictions from UK planning rules and the low level of housebuilding.
The other two areas where the UK lags are somewhat of a surprise. Firstly, enforcing contracts – an area where you might expect the UK to excel given its well-regarded legal system. This becomes clearer with deeper examination and is largely down to the cost. Legal fees have been increasing in the UK for some time and, given that the professions remains quite heavily protected, the scope for promoting further competition is there. Though again opening up would not be without controversy.
The border issue raises an interesting challenge for the UK. The suggestion is that the cost of dealing with customs both in terms of time at the border and documentation is quite high for the UK – though presumably this only applies to trade with non-EU countries at the moment. There is certainly scope for improving and instituting new, higher tech border procedures.105 This does raise some concerns for the potential impact of imposing a border with EU trade post Brexit – which we found in our previous paper would likely form the chunk of trade costs in Brexit.106
The World Bank’s analysis is supported by some of the other indexes in this area. The World Economic Forum’s Competitiveness index shows the UK’s worst performing areas to be: macroeconomic climate, health and primary education and tertiary education. Again these are areas largely unaffected by the EU and which have been longstanding challenges for the UK. Reforming and improving these areas is far from a simple challenge and is inevitably politically controversial.
The OECD’s Product Market Regulation index again highlights the UK as one of, if not the, most competitive economies on this front. Only the Netherlands beats it out in terms of ranking for the most favourable product market regulation.107
105 This should be caveated with the fact that it is unclear exactly why the UK border costs are so much higher than some other smaller land locked countries. There could be distortion in terms of waiting time and customs due to the fact that the UK has to do most of its trade via sea/ports. 106 See Open Europe, ‘What if? The consequences, challenges and opportunities facing Britain outside the EU’, 2015, page 80. 107 OECD, ‘Indicators of Product Market Regulation Homepage’; http://www.oecd.org/eco/growth/indicatorsofproductmarketregulationhomepage.htm#indicators
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Sectoral rankings
There are not many sector specific international indexes/ranking but one obvious one is the Global Financial Centres Index. London topped this list in 2015, highlighting that it remains incredibly competitive both relative to global cities and EU peers.108 One implication of this is therefore that there is unlikely to be a huge number of easy changes which will make the City of London even more competitive given it is already top of the pile. This fits with our analysis above of the potential gains from deregulation. However, it also suggests that the attractiveness of the City as a place to do business runs deep. Furthermore, Frankfurt, Paris, Amsterdam and Dublin are currently ranked at 14, 37, 36 and 46 respectively. Clearly EU access alone does not make a financial centre and the idea that these cities would be able to quickly steal market share off London also seems questionable.109
Underlying drivers of competitiveness
There are also a number of economic indicators which are traditionally seen as ‘drivers’ of competitiveness. These may also provide some insight as to how the UK performs relative to its peers.
108 Qatar Financial Centre, ‘Global Financial Centres Index 18’, September 2015; http://www.longfinance.net/images/GFCI18_23Sep2015.pdf 109 See Open Europe, ‘EU Wargames: The challenges facing UK negotiators inside and outside the EU’, 17 February 2016, p11; https://docs.google.com/viewerng/viewer?url=http://openeurope.org.uk/wp-content/uploads/2016/02/A4_Report- EU_War_Games-Digital-Ve1-FINAL.pdf
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Trade performance: In terms of trade performance, in 2014 globally the UK ranked 10th in merchandise exports and 5th in imports and 2nd in services exports and 5th in imports.110 Further indicators, such as the total or average of imports and exports as a share of GDP also suggest that the UK performs relatively well in terms of trade openness compared to other developed economies.
However, the ICC’s open markets index ranks the UK lower down than expected at 30th, with a number of EU states coming in higher. This suggests the UK has some more work to do on open markets. However, looking deeper it is clear that this is more complicated. The UK performs well on a number of fronts but falls down on trade openness, but this is largely down to the lower level of trade as a share of GDP and the lower level of merchandise trade. As such, this metric tends to favour smaller economies, while it also favours those focused more on goods than services. This also goes someway to explaining why the EU 28 average imports and exports is high in the chart above.
Boosting the share of trade as GDP is not easy and is fundamentally different for larger economies driven by domestic demand. This becomes clear when the UK is compared to other similar countries. For example, Germany, Canada, Australia and the United Kingdom are the only four G20 countries that record an above average openness in the ICC index.
110 WTO, ‘International Trade Statistics 2014’; https://www.wto.org/english/res_e/statis_e/its2014_e/its2014_e.pdf
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Productivity: the UK travails when it comes to labour productivity – both over the long term compared to the likes of the US, Germany and France as well as during the post crisis period – are well documented. A number of explanations have been presented from underinvestment to measurement problems, however, there is yet to be a consensus how to tackle this issue.
Skills: We have documented some of the skills shortages facing the UK in the previous section and how these may or may not be addressed by changed in immigration policies. Looking beyond this, we can see that broadly the UK has been improving its skills base at least when measured in terms of the number of people gaining qualifications. Educational attainment has improved, with the younger generation having notably higher levels of attainment than older generations. On the whole in this area the UK does not do badly and generally ranks above the OECD average, though there is plenty of work to be done to reach the top of the pile. The story is similar in terms of education spending – which is better for tertiary compared to primary and secondary education. However, international comparisons also show UK students perform below the OECD average in terms of reading performance, suggesting basic levels of literacy are not as good as they should be. A recent survey of its members by the IoD also found that 42% ranked access to skilled employees as the issue which most negatively impact their business, making it the highest rated concern.111
111 IoD, ‘Skills shortage and access to finance top concerns for UK entrepreneurs’, 14 December 2015; http://www.iod.com/influencing/press-office/press-releases/skills-shortage-and-access-to-finance-top-concerns-for-uk- entrepreneurs
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Innovation: One area where the UK has seemingly lagged is spending on R&D – it has not only been low relative to other EU countries but also compared to developed countries across the world. This does not fully capture the state of innovation in the UK but it is supported by other indicators such as low levels of patent applications from the UK (though this is also a broader problem in the EU).112 Brexit would give the UK scope to pursue a more liberal regulatory regime in areas like Life Sciences - the EU tends to err on the side of precaution as opposed to risk management – but again, domestic opposition on issues like GMO cultivation is significant; it has been banned by both the Welsh and Scottish governments for example.
112 See for example World Intellectual Property Organisation, ‘World Intellectual Property Indicators’, 2015; http://www.wipo.int/edocs/pubdocs/en/wipo_pub_941_2015.pdf
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Infrastructure: In terms of the broad indexes the UK ranks fairly well here, however, this is held back somewhat by the congested road network and the overburdened airports. In terms of digital infrastructure the UK does reasonably well. The UK ranked 6th in 2015 in the EU in terms of employees who have access to broadband.
Investment: This covers both domestic investment and foreign direct investment (FDI). While the UK has a good performance in the latter, its performance in the former has been quite poor.
As the chart below shows the UK performs relatively well in the OECD’s FDI Regulatory Restrictiveness index showing it is fairly open to FDI. However, it still ranks just below the OECD average and while it performs well relative to other EU states it lags behind other developed economies such as Canada, Norway and the USA. This suggests that there could yet be more to be done to open the UK up to FDI outside the EU. In terms of FDI flows, recently the UK has been attracting record levels of inflows and is consistently the best performing EU state, highlighting the UK’s attractiveness as a destination for FDI but also that the EU isn’t obviously holding the UK back on this front.
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113
The picture in terms of broader investment is more mixed. As the data below highlight, over the past decade the UK has, on average, spent the lowest amount in terms of a proportion of GDP on capital investment in the EU. This crude average does miss the fact that investment has been growing in the past few years and is dragged down by especially low levels during 2009 – 2013 when UK government spending cuts were steepest. Nevertheless, the UK has generally lagged other countries in this area. As such, outside the EU, particularly if FDI flows face some disruption, there will be pressure for increasing spending on capital investment.114
113 OECD, ‘FDI Regulatory Restrictiveness Index’; http://www.oecd.org/investment/fdiindex.htm 114 There is a broader discussion to be had here about whether FDI crowds out or crowds in domestic investment – i.e. does it replace domestic investment or does it encourage it. The evidence isn’t clear cut but given high levels of FDI and low domestic investment, it could be a crowding out story. If that were true, than one would expect domestic investment to pick up and fill in any disruption to FDI. There would still be some cost given that this investment is likely less efficient, effective and more costly but it won’t necessarily mean a large drop in overall investment levels.
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