Forget the dodgy numbers: Leaving the EU makes economic sense

 
Graeme Leach
Leaving Europe has long made economic sense

UKIP’S recent electoral triumph has reignited debate about the cost of Britain’s place in the EU. But what do we know about the economics of our membership? Let’s start from the beginning: we’ll find that Brexit has long made economic sense.

Prior to joining the then Common Market in 1973, two government white papers and three academic studies predicted that the net economic costs of Britain’s accession would be negative, owing to the combined impact of direct transfers to Brussels and the Common Agricultural Policy (CAP) driving up food prices. During the 1980s, the incoming tide of legislation from Brussels was turning into a tidal wave, but nobody quantified the economic impact until the Institute of Economic Affairs (IEA) published a report in 1996.

Its key conclusion was that the effect of exit on the UK economy would be small (with a net impact of +/- 1 per cent of GDP per annum). The IEA showed there would be a sure gain from leaving the CAP, a loss from the imposition of tariffs on UK exports, a partial offset from reduced distortions from EU tariffs on imports into the UK, and a possible loss from a reduction in foreign direct investment (FDI). My interpretation at the time was that, if you argued the EU wouldn’t shoot itself in the foot – that we would retain open markets and a free trade agreement – exit would almost certainly be positive.

Then, in 2000, I wrote a report for the Institute of Directors, which estimated the net cost of membership at around 1.75 per cent of GDP per annum. So the numbers were edging up, driven by the regulatory burden from the EU and one-size-fits-all Single Market harmonisation, with EU regulations applied to the entire economy. A Civitas report in 2004 raised the bar higher, with an estimate of the net cost of membership at around 4 per cent of GDP per annum.

The next year, a IEA report showed the net cost of membership at between 3.2 and 3.7 per cent of GDP per annum, due to direct transfers (payments to Brussels), regulation (red tape and employment law), and resource misallocation (e.g. CAP and manufacturing prices above world levels). And in 2011, the Civitas estimate was revised upwards to show a net cost of 4-11 per cent of GDP. Finally, an annual cost-benefit study from Ukip began to be published, looking at direct transfers, regulation, and resource misallocation, suggesting the net cost was around 9-10 per cent of GDP over the 2012-13 period.

So the history of cost-benefit studies has showed a positive case for exit, and that case has grown stronger over time. But there are serious questions over the accuracy of the numbers, particularly estimates of regulatory impact and resource misallocation. Even the direct transfer estimates are less than transparent, with a difference between ONS and HM Treasury figures, and debate over whether gross or net figures are appropriate.

But what about those who want to stay in the EU? In 2000, the National Institute of Economic and Social Research produced a study suggesting the level of UK GDP would be 1.5 per cent lower 20 years after EU exit. The key driver was a reduction in FDI. Remove that assumption and the negative impact of withdrawal went away.

A Centre for Economic Policy Research literature review in 2008 suggested that the level of EU output was roughly 5 per cent higher than it otherwise would have been in the absence of European integration since the 1950s. Finally, a CBI literature review suggested in 2013 that most studies showed a 2-3 per cent of GDP per annum net benefit of EU membership. The study then asserted that the dynamic gains of membership are difficult to quantify and so the real net benefit of membership is probably in the region of 4-5 per cent of GDP per annum. This study (like many others) has received withering criticism: the 2-3 per cent claim is not really backed up by the evidence shown, and the 4-5 per cent number is plucked out of the air.

The Brexit camp have real challenges in firming up the numbers on regulation and resource misallocation. Their opponents have a different set of challenges. First, they tend to focus on level effects, because it shows their arguments in a better light. Secondly, they tend to focus on ex-ante model simulations as opposed to ex-post analysis, with the former showing stronger effects than the latter.

But both groups face “morning after” Brexit questions. Will the EU negotiate a free trade agreement or will it shoot itself in the foot? Shooting itself in the foot could mean a double-digit tariff on car exports! Presumably, the UK would still have employment law after leaving the EU, but just how much?

The direct transfer, regulatory impact and resource misallocation effects are undoubtedly net negative and so Single Market and FDI effects would need to be very powerful to make membership a net benefit. But they’re not. Brexit makes economic sense.

Graeme Leach is director of economics and prosperity studies at the Legatum Institute in London.