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John Greenwood
Chief Economist, Invesco Ltd.
Nature of costs
% of GDP
Rationale
1.25%
Costs of regulation
5.2%
Costs of resource
misallocation
3.25%
Unforeseen commitments
0.25%
Total
11%
Source: Tim Congdon, How Much Does the European Union Cost Britain? Sept 2013.
Direct costs: In 2013 the British governments net contribution to the EU budget was
estimated to be 8.624 bn, according to HM Treasury.3 This figure is net of the UKs
rebate and UK public sector receipts. The UKs contribution amounted to 12% of the
overall EU budget. Proponents of Brexit estimate the direct cost of EU membership to
the average British household in 2014 was 759 p.a., assuming there are 27 million
households and based on the 2011 UK census figures. The direct fiscal cost was an
estimated 20.5bn in 2014.2
Indirect costs: Besides the direct costs of EU membership, politicians and pressure
groups supporting British exit from the EU emphasise the financial cost of red tape
and regulation imposed by Brussels. The London-based think tank Open Europe,
estimated that the cost of all regulation, including domestic regulation, to UK subjects
was 32.8bn (in 2009), with 59% or 19.3bn of that figure being EU-imposed. The
three areas of EU legislation that are highlighted as extremely costly and invasive are
renewables, employment, and financial regulation.
Financial regulation: A particularly sensitive area of regulation, for Britain, is financial
regulation. Opponents of EU regulation in this area cite the red tape, ill-informed tax
initiatives, protectionist policies, and high costs of the EUs regulation of financial markets.
There is a general perception - rightly or wrongly - among many commentators, that
Germany and France are anti-finance and envious of the Londons position as Europes
de facto financial capital. Therefore there is a perception that financial regulations
enforced from Brussels are either indifferent to their impact on the UKs most crucial
industry or else wilfully targeted at damaging the UKs dominance of the financial
industry in Europe. The EU has proposed taxes of 0.1% on financial transactions
and 0.01% on derivatives in the aftermath of the financial crisis although the
implementation has been postponed until January 2016. In a highly competitive, low
margin industry these transaction taxes are widely viewed as an onerous imposition on
the trading activities of the City. The EU has also sought to regulate the compensation
structure in finance, by imposing caps on bonuses.
Such regulation and perceived interference has led to calls for the UK to leave the
EU, so that the UK financial authorities and Westminster can formulate a regulatory
framework that is more accommodating to the needs of the City and ensure its
continued financial dominance. If Brexit could be combined with a free trade agreement
(to include financial services) between the UK and the EU this would enable Britain to
continue to enjoy access to Europes markets.
Non-financial regulation: In the non-financial sector of the economy there are other
regulatory hindrances to business. EU regulations designed to prohibit dangerous
substances and processes are considered to be extremely costly for business as they have
put some suppliers out of business, or at least forced them to introduce costly changes to
their business operations or products. These regulations have also raised the prices for
consumer goods. In total, EU regulations are estimated to cost 5%-6% of UK GDP per year.2
The Common Agricultural Policy (CAP) has long been a bugbear for people opposed to
British membership of the EU, seen by many as hugely wasteful and costly, and leading to
an uncompetitive domestic agricultural sector dependent on subsidies to survive.
Supporters of the free market are also critical of the EUs protectionist trade policies,
such as anti-dumping policies. These are imposed when the EU believes prices of
imported goods are suspiciously cheap, compared to their EU-made equivalents. The
EU in these cases is suspicious of unfair subsidies, so in response they impose antidumping measures. The total cost of these trade distorting polices, including the CAP
and trade protectionism, is estimated to be 3% of GDP.2
Immigration and benefit tourism: One of the most emotive issues for Britain is that
of immigration. Due to the EUs founding principle of the free movement of people
(along with the free movement of goods, services and capital), the UK has no control
over immigration from other EU member states. Since the membership accession in
2004 of eight Baltic and Eastern European states (Czech, Estonia, Hungary, Latvia,
Lithuania, Poland, Slovakia and Slovenia - the EUA8), there has been a noticeable
wave of migrants from these countries. With income levels in Poland, for instance,
one fifth of those in the UK, this was hardly a surprising development. By 2011 EUA8born residents accounted for nearly 1.7%2 of total employment in the country. There
has been evidence that these migrants, who primarily secure employment in the lowskilled sectors, have suppressed wage growth in the low-skilled sectors, and increased
unemployment levels among the UK-born population. During the global financial crisis
and the years immediately following, employment amongst the UK-born population fell
sharply, whereas amongst the EUA8-born population in the UK, employment grew.2
David Cameron is making Benefit Tourism one of the key issues he wants addressed
in his negotiations with the EU. Figures from January 2012 show that of a total of
5.5 million welfare recipients, 371, 000 were foreign born, and 118,000 were from
the European Economic Area.2 There is also concern that citizens of other EU states
with poorer health services will travel to the UK to take advantage of the free services
available through the NHS.
More detail on benefits of continued EU membership
The benefits for Britain of staying in the EU are primarily - one could argue - economic;
the EU is a large market, accounting for 25% of world GDP. The EU is the biggest trading
partner of the UK; 45% of UK exports are to the EU and 50% of imports are from the
EU. The attractiveness of the UK as a destination for foreign direct investment (FDI) is
enhanced by the countrys membership of the EU, and access to its markets. In 2012
the UK was a recipient of FDI to the tune of 937bn. Investment abroad by UK firms
was 1,088bn. Nearly 50% of UK FDI, both inward and outward is EU related.1
The UK, being a service-based economy, enjoys huge potential gains from membership
of the Common Market. Services account for 75% of world GDP, but only 20% of
world trade. The EU has taken major steps to liberalise the trade in financial services
in particular, launching the Financial Services Action Plan in 1999.4 Beneficial results
have been spread across a range of financial services. For example, there has been
a reduction in cross-border payment costs for a typical 100 payment from 24 in
2001 to 2.50 in 2005. In addition, there was a 50% increase in the number of passported prospectuses between the second half of 2005 and the first half of 2008 (i.e.
share offers - including unit trusts - that could be distributed across the EU), and there
also has been strong growth in the use of cross-border funds since 1999.1 These
developments show that fund managers and associated investment professionals have
been able to take advantage of the EU to expand their business.
Under the Financial Services Market Act 2000 (FSMA), firms authorised in any
European Economic Area (EEA) member state are entitled to carry on permitted
activities in any other EEA member state by either exercising the right of establishment
(of a branch and/or agents) or providing cross-border services.
When one looks at the Brexit question, the importance of the financial services sector to the
UKs economy and the impact that an exit would have on it, is central. Financial services and
related professional services accounted for 11.8% of UK GDP in 2013 and employed over
2.1million people. Financial services accounted for 11.5% of total tax receipts for 2013/14.
In terms of trade, the financial sector generated a trade surplus of 67bn in 2013, more
than all other net exporting industries. FDI in the industry was 100bn. A major reason why
the City has been able to grow and maintain its prominence, and become the main financial
centre in Europe, has been its ability to operate and sell its services throughout the EU.
London is home to more than 250 foreign banks. Many of these use the City as a
base for their main European subsidiaries to take advantage of the automatic Passporting rights to sell their products and operate across the other 27 countries in the
single market. The proponents of Brexit argue if Britain joined the EEA and the EFTA
(European Free Trade Area) the country would still be able to enjoy the same access to
the European markets, but this is not a certainty.
Counter-arguments on immigration: Regarding the principle of the free movement
of people, proponents of continued membership point out those immigrants to the UK
from the EU are better educated than UK nationals with 32% having a degree compared
to 21% of UK subjects. They are also less likely to be in the lower education category.1
They also tend to be younger than the native population: 32.3 years in 2011 compared
to an average of 40.8 years amongst natives, which is a benefit when many countries are
struggling with rapidly ageing population. Immigrants from the EEA arriving since 2000
have contributed 34% more in fiscal terms than they have received, which equates to a
net contribution 22.1bn in 2011 terms. This compares to the native population only
contributing 92.6% of the amounts they received in transfers and benefits.1
Alternatives to full EU membership
What would the alternatives be if Britain voted in the referendum to leave the EU?
The EU has entered into three main types of agreements with non-EU countries:
1. allowing membership of the Single Market (EEA),
2. membership of the EUs Customs Union, and
3. Free Trade Agreement (FTA).
While it would naturally be in their interest to establish a preferential trade arrangement
with the UK, it would also not be surprising if the EU member countries sought to
penalise the UK for leaving the union. The motivation might be to ensure that other
member states see there is a cost to exiting the union. Such a punishment could take
the form of restricting access of certain sectors; the financial sector would be the
obvious candidate. The agreement between the EU and Switzerland excludes financial
services, and it is thought to have limited the size of Swiss financial sector growth. Any
negotiations over an agreement between the UK and EU post-Brexit would be bound to
cause risk and uncertainty and could drag on for years.
Membership of the single market (EEA) would simply mean the UK would still abide by
the same the same Brussels-imposed regulation domestically that currently applies and
still have access to the common market. However Britain would not be able to influence
negotiations on the formulation of regulations as it would have lost its seat at the table. It
would be likely that the UK would still be expected to make a contribution to the EU budget,
albeit at a reduced rate. This is similar to the relationship that Norway, Liechtenstein and
Iceland have with the EU.
Customs Union - this is the relationship that exists between the EU and Turkey. The UK
would remain outside the Common Market, but would retain some of the trade benefits
of membership, in particular for the trade in goods. The UK would lose the benefits of
freedom of movement and the freedom of establishment.5 The service sector would
be likely be severely hampered by this outcome, with its business activities in the EU
curtailed. This would clearly make the UK a less attractive location for FDI investment.
A Free Trade Agreement is another possibility. The EU has a large number of FTAs with
various countries. These are similar to Customs Unions, but are generally agreed on a
product by product basis, and would not interfere with the UKs existing FTAs with other
non-EU countries. However there is serious risk that the EU would not include goods and
services that the UK wanted. The EU has not been happy with the FTA between the EU and
Switzerland, in particular with the issue of dispute resolution. Therefore it may be hard to
achieve a similar deal.
The most drastic alternative would be not to agree a bi-lateral agreement with the EU and
instead to rely on Most Favoured Nation status under World Trade Organization rules.
The City UK, Analysing The Case for EU Membership, How Does The Evidence Stack
Up? April 2014.
2
Tim Congdon, How Much Does the European Union Cost Britain? September 2013
3
HM Treasury, European Union Finances 2013, statement on the 2013 EU Budget
and Measures to Counter Fraud and Financial Mismanagement, November 2013
4
The European Commission, Financial Services : Implementing the framework for
financial markets: Action Plan, May 1999
5
The freedom of establishment, set out in Article 49 (ex Article 43 TEC) of the Treaty
and the freedom to provide cross border services, set out in Article 56 (ex Article
49 TEC), are two of the fundamental freedoms which are central to the effective
functioning of the EU Internal Market. Source : The European Commission
6
The Telegraph, When is the EU Referendum? June 28th 2015.
1
Important information
This document is for Professional Clients only in Dubai, Jersey, Guernsey, Isle of Man
and the UK and is not for consumer use
The value of investments and any income from them will fluctuate (this may partly be the
result of exchange rate fluctuations) and investors may not get back the full amount invested.
While great care has been taken to ensure that the information contained herein is
accurate, no responsibility can be accepted for any errors, mistakes omissions or for
any action taken in reliance thereon.
Where John Greenwood has expressed opinions, they are based on current market
conditions and are subject to change without notice. These opinions may differ from
those of other Invesco professionals.
All data provided by Invesco unless otherwise stated.
Data as at 24 July 2015, unless otherwise stated.
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