Thursday 19 June 2014

The Cost and Benefits of EU Membership

A lot that has been said about the recent elections to the European Parliament.  (Full disclosure: I am an EU national living in the UK.)  For me, part of the debate in the UK represents a useful reminder of the challenge of cost-benefit analysis.  Not surprisingly, there isn’t an accepted view about the balance between costs and benefits of EU membership.  Here is an illustration of the range of estimates (as of 2013) from a research paper of the UK Parliament:

I reviewed some of what has been written and have also read with interest Hugo Dixon's recent book - 'The in / out question'.  I thought that rather than develop another cost-benefit analysis, I would set out the main considerations to take into account if you choose to read one of them to form your own views.

It seems uncontroversial – I think – that the economic benefit from EU membership is the access to supply products and services to a market of 510 million consumers and an economy the size of the US.  Hugh Dixon quotes an estimated benefit of the order of 4% to 5% of UK GDP.  If you accept this, then the key questions are whether: 
  •  the costs to the UK of achieving that benefit offset it; and  
  •  the benefit can be achieved through an alternative arrangement. 
To consider this, a cost-benefit analysis must set out the ‘counterfactual’, i.e. what would happen in the absence of EU membership, and identify what is incremental as a result.  However, there are a number of options.  The ‘do nothing’ option means trading with the EU based on the UK membership of the World Trade Organisation (WT0).  This does not mean free-trade; it will entail custom duties for certain products such as cars.  There are also other options as represented by the cases of Norway, Switzerland and Turkey.  The bottom line is that you cannot seriously consider the costs and benefits of EU membership without taking an explicit view on an alternative from the very beginning.

If so, here are a number of questions and answers to identify what is incremental (including the benchmark of EU membership).  A "smiley" indicates that the change (or lack of it) is a positive development from a cost-benefit perspective.

A couple of points to note about the table.

Firstly, UK manufacturers exporting to the EU will need to comply with EU product regulations.  They are likely to end up manufacturing to UK and EU product regulation standards so (at best) cost savings would be limited. 

Secondly, the distinction between goods and services in the table is the reality of “free trade”, which does not usually apply to services, such as financial, business and legal services.  They represent 78% of the UK GDP. 

The table suggests that being outside the EU could be cheaper on a ‘cash’ basis.  However, none of the options would appear to replicate the benefits of a single market.  Norway replicates many of the benefits at a reduced cost.  However, note that they are bound to follow EU legislation without having a saying on it – an interesting view about sovereignty! 

Overall, I struggle to see how the UK would be able to replicate the economic benefit of the single market in products and services outside the EU. 

However, the real value of cost-benefit analysis is the impetus to focus on increasing benefits and reducing costs.  This means considering how to reform the EU and get the best from a single market of 510 millions of consumers and a GDP that is as large as the US.  Dixon suggestions include cutting red-tape, negotiating trade deals with US, Japan and China.  For me, one of the more interesting suggestions is the potential gains from banking disintermediation and providing long-term finance to industry through capital markets.  As he puts it, the crisis was a banking crisis not a financial crisis.  Something for another post …  

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