1

FROM PROJECT FEAR TO PROJECT PROSPERITY

Economists for Free Trade

September 2017

2

FROM PROJECT FEAR TO PROJECT PROSPERITY

Contents

Introduction: Patrick Minford Page 4

Fundamental Benefits of Leaving Page 13

Roger Bootle - The Dangerous Myth of EU Economic Success Michael Burrage - Trading with the EU under WTO Rules is not the Worst Possible Option, and Single Market Membership is Not the Best Tim Congdon - Too Much Regulation David Paton – Labour Economic Policy under Brexit Swati Virmani and Veda Balasubramanyan – Post-Brexit Trade Prospects for the UK Economy

Why Free Trade Page 28

John Greenwood – The UK and Asia-Lessons for Brexit Tim Congdon – Free Trade in the Modern World Graeme Leach - Where There is No Vision, the People Perish

Post-Brexit Spending Page 35

Warwick Lightfoot – The UK’s EU Expenditure Kent Matthews – Dividing the Post-Brexit Dividend

Migration Page 42

Neil MacKinnon - Immigration Paul Ashton, Patrick Minford and Neil MacKinnon – The Economics of Unskilled Immigration

Impact on Sectors Page 48

3

David Blake – Brexit Can Herald a New ‘Golden Era’ for the City of London as a Global Financial Powerhouse Patrick Minford and Edgar Miller – Implications of the WTO Option for Manufacturers Patrick Minford and Edgar Miller – A Brief on the City after Brexit]

Trade Negotiations Page 63 Kevin Dowd – When Bargaining with the EU, the UK Should Call the EU’s Bluff Graeme Leach – Forget Trade Deals: Unilaterally Tearing down Our Trade Tariffs Would Be Britain’s Berlin Wall Moment Martin Howe – Why a ‘Soft Brexit’ is Anything but Soft Liam Halligan – Clean Brexit Can Avoid the Cliff Edge Chaos John Whittaker – Brexit Negotiations

Response to Critics Page 75

Patrick Minford – The Gravity View of Trade is Seriously Wrong

Post-Brexit Forecasts for the UK Economy Page 78

Patrick Minford, Vo Phuong Mai Le, David Meenagh, Yongdeng Xu and Liverpool Macroeconomic Research

Economists for Free Trade Members, Co-Authors and Advisory Group Page 82

4

INTRODUCTION

Patrick Minford Chair, Economists for Free Trade

In March 2016, Economists for Brexit was formed to present what we saw as the economics of the EU, our membership of it and the economics of leaving. At the time, the referendum was raging and soon Project Fear would be launched by the Treasury, with its warnings of economic doom if we chose Brexit. On the Leave side, not much at all was said about the economics and the only response to Project Fear was to damn ‘experts’. We felt then that - instead of economics - we were witnessing propaganda with little or no economics behind it. We hoped to present economic analysis in a form that would readily be understood by non-economists and would place all this propaganda into context. We are now almost a year and a half further on; Brexit won in the referendum and following a long period of policy development by the May government towards what we felt was the right strategy of free trade outside the Single Market and the Customs Union, we had the snap election. In this election, Mrs May lost her absolute majority but the Commons amendments calling for the UK to stay in the Customs Union and the Single Market were resoundingly defeated. So the UK is embarking on negotiations with a determined stance. In this Introduction to our forthcoming report, From Project Fear to Project Prosperity, Economists for Free Trade - as we are now renamed - is setting out the key arguments for free trade, properly understood as global free trade and not simply free trade with the rest of the EU. The Fallacy of ‘Soft’ Brexit We have noticed that, like Humpty Dumpty, some politicians have used words in what we consider to be highly misleading ways. Some say they want a ‘soft’ Brexit, implying that this is better economically than a ‘hard’ Brexit. Yet what they mean by ‘soft’ is a Brexit that changes the status quo minimally: in it, we retain the customs union and the single market and consequently also the EU’s freedom of migration. This status quo agreement would promote the interests of existing producers who obtain protection from the EU through its high trade barriers on food and manufacturing, who benefit from EU regulation that supports the aims of large lobbying businesses against smaller competitors and who gain from taxpayer-subsidised cheap unskilled EU labour. By contrast ‘hard’ Brexit would eliminate this protection and regulation in favour of free trade and full competition and would remove taxpayer subsidy from unskilled migration. These moves benefit UK consumers, lowering the cost of living by 8% on our estimates and by so introducing competition raising productivity across the economy - with a total gain in UK welfare and GDP of around 4% from free trade and another 2% from improved regulation, a total

5

gain to GDP of 6%. On top of this there are gains from regaining our net EU budget contribution (0.6% of GDP) and removing the taxpayer subsidy to unskilled Immigration (0.2% of GDP). There will also be longer term gains to growth through enhanced innovation and entrepreneurial activity. 1 So the correct conclusion is, ‘hard’ Brexit is good for the UK economically while ‘soft’ Brexit leaves us as badly off as before. But you would hardly guess from these labels that ‘hard’ is economically much superior to ‘soft’. The proponents of ‘soft’ Brexit support this notion by saying it would ‘preserve jobs’; yet what they mean is it would preserve existing jobs by stopping competition from home and abroad. As every schoolboy knows and every politician ought to know, this aborting of competition reduces jobs in the long run. We never would justify stopping competition in order to keep existing jobs because we know the dynamics of a modern economy require that existing jobs go if they cannot compete with better ones. Competition increases productivity and so employment because higher wages paid for by higher productivity make work more attractive; competition also increases our general welfare because we produce more. Why is Global Free Trade Good? What exactly is global free trade? Some people think it means that foreign trade barriers must come down against our exported goods and services while we also eliminate trade barriers against our imports of others’ goods and services. However, it is obvious that this is an idealistic vision as we cannot realistically expect all other countries to eliminate their trade barriers, excellent as that would be for the world economy. There have been efforts for the last twenty years to obtain such general reductions in trade barriers under the ‘Doha Round’ of talks within the WTO and they have come to nothing. What many people do not realise is that the biggest gains from free trade come from a country eliminating its own trade barriers against imports from the rest of this world. Indeed, most people think the opposite: that the big gains come from other countries lowering their trade barriers against our exports. But this is quite wrong for a country like the UK, which though the fifth biggest in the world, is still rather small relative to the world economy – about 3% of it. Why is this? World trade is clearly highly competitive in most markets - think of the vicious competition to get into those ubiquitous global supply chains, or the cutting down of big brands like Nokia and Blackberry. We sell cars like Jaguar and Land Rover into world markets where other luxury brands like Mercedes Benz and Lexus compete head to head. Our City services compete with New York, Singapore and Hong Kong. What all this means is there is a going competitive price for the goods and services we sell around the world that we must match. If we do so, we can sell everywhere at this price. This price effectively is the price at the border - or for the home producer, the ex-factory price. From that point in every country, there are particular distribution and other costs (including that country’s trade barriers) that raise the price to the consumer.

6

The implications of this are stark. If another country gives us a special preferential tariff deal, then yes, we will sell more there because we are cheaper than the competition. But this does not mean in the end we will sell more overall! How can we? We have limited land and labour, even if we can get more capital easily from the world market. Our output, as a country, is limited by our resources. Therefore, when this preference is given, we sell more into that market and less into others; vice-versa, other countries sell less into that market and more into others. It is true that, in the short term, we might possibly make some gains by selling more into that preferential market - perhaps we could get a higher price for a time - but these gains are simply short term and trivial when compared with the permanent long term gains we can make from trade policies that promote competition. Now, think about what happens if we reduce our trade barriers on imports. We reduce the prices of imports to consumers, and this creates both a gain to them and more competition with our home producers, forcing them to raise productivity. This is a most definite and permanent gain to our economy - a rise in consumer welfare and in GDP. A natural by-product of this is, as we produce more, we export more to pay for our higher imports. In the short run, this comes about by a fall in sterling to stimulate these sales; in the long run, once our new markets are established, sterling recovers to its old level, its job done. We are quite familiar in the UK with this sterling movement; the pound regularly falls when we need to stimulate output in export industries, as it has done after Black Wednesday when we left the ERM, also after the financial crisis, and latterly after Brexit. So when we talk about global free trade we mean getting rid of our own trade barriers against all of the rest of the world. Of course, we would also be delighted if the rest of the world got rid of its trade barriers too because this would make the whole world more prosperous, but that is not where the big gains come from for us. And the critical point to understand is, we get these gains even if other countries do not reduce their trade barriers against us. All they achieve by maintaining import trade barriers is to cause injury to their own economy and reduce their citizens’ welfare. There are two ways to achieve global free trade. One is the apparently easy path of negotiating free trade agreements with first, the EU and then, the rest of the world. Unfortunately, this path can turn out to be difficult and treacherous because each agreement involves a cooperating partner. In the case of the EU, cooperation cannot be taken for granted, as is obvious from the many aggressive statements by EU politicians. Nor can it be taken for granted that the rest of the world will agree to trade terms we can accept, as they may make excessive demands, for example, for migration access or for rights under our laws. In addition, such agreements take time to complete and it is unlikely that 100% coverage of the world will ever be achieved. Thus, this potential lack of cooperation from other countries could hold up or even entirely derail the free trade agreements needed to achieve global free trade. Unilateral Free Trade - the Threat that will Force the EU to do a Trade Deal

7

It is fortunate, therefore, that there is another route to free trade that depends solely upon our own actions. This is unilateral free trade (UFT) whereby we simply abolish our trade barriers without asking for others to do the same. This approach – entirely under our own control –allows us to realise the gains to our economy and consumer welfare outlined earlier. The most famous example of this was in 1846 when Sir Robert Peel abolished the Corn Laws greatly reducing the price of food and helping to stimulate the industrial revolution. Some people are concerned that, if we do this, we would undermine the incentives for other countries like the EU or the US or Australia to conclude a free trade agreement with us. After all, if we unilaterally abolish our trade barriers why would these other countries want to offer us agreements to reduce their own trade barriers against us? Here we need to distinguish between the EU and the rest of the world. With respect to the EU, our adoption of UFT would cause immense damage to EU interests. Imagine that we invoke UFT following a failure by the EU to offer reasonable terms in a general agreement on trade. EU exporters to the UK would immediately face a UK market in food and manufactures where prices were much lower (both by around 20% on our calculations) with imports able to enter the UK from all over the world without any tariffs or other trade impediments. These EU exporters would therefore lose substantial profits and/or volumes on their UK sales. By contrast, in a trade agreement, they would seek to negotiate at least some transition period in which their markets would remain unchanged and possibly also some further deferment of free trade in particular sectors, so keeping these markets protected for even longer. If we enact UFT, none of this would be possible. Some argue that, instead of adopting UFT, we should retaliate by levying tariffs on the EU in the event of no trade agreement. But this makes less sense for the simple reason that, by levying such tariffs, we damage ourselves! While some politicians believe this would deter the EU from failing to agree a trade deal, threats to damage oneself are less credible and therefore may deter less effectively. So the threat of UFT provides a strong incentive to the EU to do a trade deal with us - which politically is what we want. This is the origin of the political sound bite, ’No deal is better than a bad deal’. In fact, no deal is better than the arrangement we have today if we do not raise tariffs against the EU. Such a ‘tit-for-tat’ scenario is, in fact, the scenario analysed by Remain in order to discredit the notion of trading under WTO rules.2 Nevertheless, even if we did go for tit-for-tat on general political grounds, it can be a viable strategy - provided we achieve FTAs with key rest of the world exporters quickly (see next section). Now consider the rest of the world. It is true, if the rest of the world thought we would do UFT in the absence of a trade deal with them, their incentive to do one on food and manufactures where trade barriers prevail might be reduced. But, actually, we do not really care about this. The gains for us from trade deals with them come from ourselves dropping our trade barriers. Once these have gone, we can still benefit from doing trade deals on broader issues where there are subtle barriers and general issues of competition in all markets - such as removal of other trade distortions on goods, facilitating trade in services, enabling competitive public procurement, guaranteeing full legal protection for foreign direct investment, improving protection of intellectual and other property rights, and so on.

8

So trade negotiations with the rest of the world would continue but on a much broader canvas - with the hope of wider, if smaller, gains by reducing the less visible barriers in other areas of trade. Thus, in order to pursue global free trade, we need to have a definite strategy if trade agreements prove difficult to attain, especially with the EU. UFT – or FTAs with the rest of the world- acts as ‘the club in the closet’ to bring the EU to a proper trade agreement with us. As far as the rest of the world is concerned, we can invoke UFT if negotiation progress is slow; then the slowness will not matter as the talks switch to areas of less urgency. The Case of ‘Tit-For-Tat’ Some say that UFT is not ‘politically practicable’ and so irrelevant to our situation: therefore, we must get to free trade via FTAs, keeping intact the external tariffs we ‘inherit’ from the EU. The FTA approach enables politicians to ‘buy off’ business opposition to the reduction of barriers against imports by obtaining reduced barriers in foreign markets. If our government chooses to go down this route for such political reasons, it can offer quite good results - although not as good as UFT. The vital proviso is that we definitely abolish the CAP elements and are, in fact, successful in quickly signing FTAs with key world suppliers of food and manufactures, such as the US, Australia and New Zealand, all of whom have expressed eagerness to do so. Again, it does not matter hugely whether the EU signs a deal or not; if not we will trade together under tariffs of some 3-5%. Such tariffs are de minimis and would be easily absorbable on both sides. Because of our existing mutual conformity with regard to non-tariff barriers, any attempt by the EU to re-create such barriers would be illegal under WTO rules. Thus, we can think this FTA approach to free trade as only different in detail and timing to UFT and with a similar endpoint. It too would strongly incentivise the EU to agree an FTA. Practical Worries about Unilateral Free Trade - the ‘WTO Option’ UFT is often referred to as the ‘WTO Option’ or the ‘No Deal Option’. An aspect of Project Fear has been the unrelenting claim by Remoaners that, if we ‘crash out’ of the EU without a deal and are forced to trade under WTO rules, we will be faced with various disasters ranging from airline flights being cancelled to queues of lorries piling up at Dover to our manufacturers being unable to export to the EU. To understand why such fears are not, in fact, great concerns, it is first necessary to understand how WTO rules work. Upon leaving the single market/customs union under WTO rules, we would immediately adopt the Most Favoured Nation (MRN) tariffs that initially would be the same as we operate now. So, no immediate change. However, what generally is not understood is that these MFN rules do not dictate the level of our tariffs – only the maximum tariffs we

9

can levy. We are free to reduce or even eliminate tariffs (as long as we treat all countries the same) thereby allowing us to adopt UFT and avoid raising tariffs against the EU – as discussed above. WTO rules also prevent the EU making a special case of the UK – ie, they are prohibited from ‘penalising’ us out of spite. In addition, negotiations on trade arrangements must be separated from negotiations on the myriad of arrangements that govern the day-to-day lives of UK and EU citizens – eg, airline arrangements. While such areas are detailed and tedious, they are separate from the subjects of trade arrangements and there are powerful incentives for all sides to find solutions. Customs Clearing. A concern some express about the WTO Option is that it could lead to customs ‘hold-ups’. People envisage queues at customs points around the world and particularly at the EU border. But modern customs bear no relation to what is in most people’s minds – ie, border queues as ‘paperwork is checked’. Modern customs procedures are almost entirely computerised and so ‘virtual’. If a consignment’s (electronic) paperwork is out of order this will be known well before arrival at port and will either have been fixed by arrival or if not, unusually, that particular cargo will be stopped. A recent survey of customs clearing in all developed countries showed that 97% to 99% of all goods were immediately cleared electronically and the vast majority of the remaining 1% to 3% were cleared within a day – most likely a few hours.3 Another related worry is, if the EU were to levy tariffs on our exports where currently none exist, then many of our industrial inputs would be subject to tariffs and, because they ‘cross borders many times’, they would face tariffs multiple times. First, tariffs on inputs are levied in a ‘virtual warehouse’ manner. If any input is re-exported, it is not subject to duty as an input; hence, duties are not payable unless the end product is consumed inside the border. So, inputs crossing borders multiple times simply does not matter - duties will be paid only if they finally do not leave the country. Note that this applies crucially to Irish-Northern Ireland trade; if inputs are crossing this border many times they will pay no duty at all if the final product is for export to the rest of the world. Furthermore, in spite of Project Fear stories to the contrary, the majority of inputs do not cross the EU-UK border multiple times. For example, most auto components come from the EU to the UK and remain unless the finished car is exported to the EU (when, as above, no tariffs would be levied on the inputs). And, the EU has agreed that tariffs are not payable at all on inputs in sectors, such as aerospace, where inputs do cross borders multiple times. The above illustrates another powerful argument for not levying tariffs against the EU - even if they insist on doing so to us – as this would add complication and costs to manufacturing supply chains. EU Import Tariffs. As for tariffs the EU levies on our manufacturing exports, these are rather low on average, at around 3.5% on our manufactures – far less than half of our current net annual budget payment to the EU. In fact, the large fall in sterling has more than compensated for any potential EU tariffs on manufacturing exports and we believe sterling is likely remain low for many years. Even if this does not prove to be the case, analysis shows that the lower cost of inputs from the rest of the world coupled with enhanced productivity opportunities once out of the EU, mostly compensates for any EU tariffs4. And, our manufacturers could always decide to raise their prices in the EU and lose some market share, diverting this product to the rest of the world where they already on average sell half their output.

10

Farmers. Global free trade means lower, world prices for farmers - an end to EU protection. This is inevitable and important for the UK and our consumers if we are to reap the full gains of leaving the EU. EU tariffs on food are high, at nearly 20% on average. But under global free trade, we would cease to levy these food tariffs and our farmers’ prices would fall to world levels. They would export their food to the world market at these lower prices. If they export to the EU, they would get these same lower prices, on top of which EU tariffs would be paid bringing the total price up to the EU price level for EU consumers. If we were to levy tit-for-tat tariffs against the EU on food (not advised), then our farmers would get the same home prices as received today until we sign trade agreements with world producers like the US, Australia and New Zealand. At this point, their prices again would fall to world levels assuming genuine zero tariff deals were agreed. However, our farmers still can be supported as required; but they will need to raise productivity and switch crops to gain the greatest efficiencies. The UK taxpayer could support farmers directly in both the short term (as they adjust to new competition) and in the long term (as we protect our environment), thereby providing the country with a huge gain relative to the current regime of EU protection and the Common Agricultural Policy. Competing With the EU. Another concern is that the EU ‘will not like’ our independent settings of trade, regulation, tax and immigration policy; some politicians have ‘assured’ the French we will continue to play by EU rules, even after we have left. Why so? To do that would risk simply throwing away our hard-won freedom from EU rules that reduce our competitiveness as a nation; we would be throwing away the very gains from Brexit that we enumerate above. If the EU does not like competing against our new UK rules, then it is free to adjust to them as it likes: it could follow free trade, more liberal regulation and more sensible immigration policies itself. Indeed, it might well have to because of the new competition it would face on its own doorstep. This is an entirely healthy reaction, beneficial to the world economy. It is argued by some that the EU would instead become yet more protectionist, especially against us. But, as we have seen already, this would harm them not us. Border Controls. A final worry concerns the movement of people across the border. This particularly is invoked for the Irish-Northern Ireland border. Yet, today everyone has to show identification at these borders since the UK is not in the Schengen agreement. It is a matter of detail what identification is needed and how it is controlled – eg, at the Northern Ireland border where currently it is light and, in practice, may even be largely suspended on particular roads. In practice, this could continue - it is a matter for the UK and Irish governments how to manage their borders. It is worth remembering that there is no EU border agency: EU governments each provide the border service on its behalf. The WTO Option and the Welfare of UK Manufacturing Industry Plainly the end of EU protection of manufacturing must mean greater competition for UK manufacturing. However, much of UK manufacturing is high-tech, high value-added in nature, much of it competes successfully in world markets and the trends continue in this direction. This sector is one that increasingly resembles services where the UK has a strong comparative advantage because it is intensive in skilled labour.

11

Inefficient low-tech manufacturing will struggle. Judging how much of manufacturing (currently 10% of GDP and 8% of employment) falls into the high-tech category is difficult. However, we know that productivity growth in manufacturing has been strong for decades. Over the last 30 years it has averaged around 3 per annum. To offset the long run effect of losing EU protection, manufacturing productivity needs to be raised, compared with no Brexit, by only about 1% a year for a decade, which looks entirely feasible. Another important element is the fall in the exchange rate post-Brexit. At 15%, this has greatly boosted manufacturing profits and provided a cushion, which we believe could well last five or ten years, during which productivity adjustment can take place. Our analysis shows, for example, that auto manufacturers will improve profitability post-Brexit. If sterling regains pre-Brexit parity, only a modicum of incremental productivity improvement and re-sourcing of supply chains (both facilitated by Brexit) will be required to compensate for the increased strength of sterling. The effect on jobs of this adjustment will be positive, as indeed it has been overall during the contraction of manufacturing from 35% of employment in 1970 to the 8% of today. Because jobs have been created in services to replace jobs displaced from manufacturing; we have full employment in the UK and also a record level of employment at 75% of the population of working age. Time and again, some short-sighted politicians have proclaimed their intention to ‘revive manufacturing’ to ‘create jobs’; in this they have failed but jobs have certainly been created in the economy as a whole as manufacturing has necessarily contracted in response to the changing nature of society and competition from the world economy. Note however, because of growth in the economy and population, a decline in the share of manufacturing does not necessarily equate to an absolute decline. Economic Prospects In spite of the continuing dire forecasts from Remoaners, we believe the economy will continue with business as normal while also gradually benefiting from the Brexit gains we have identified above. As we have argued repeatedly in our publications, the devaluation brought on by Brexit is acting as a powerful stimulus to the economy, switching demand away from consumers to net exports and business investment, and boosting corporate profits. This is a normal exchange rate response to a large regime change like Brexit. As capacity gets used up, business investment will strengthen further. As labour availability gets used up, wages will start to rise faster. Once immigration controls bite on unskilled EU immigration, this situation will get tighter; so far, the labour market still seems to be somewhat slack, with many workers working less hours than they would like. With the economy still not tight on either plant or labour capacity, we have some leeway on monetary tightening. However, the zero interest economy underpinned by massive printing of money and combined with draconian regulation of banks, is causing widespread problems; government, large and inefficient corporations and so-called ‘safe’ borrowing like mortgages and car loans, are artificially subsidised while savers get negative real returns and small businesses get poor access to credit and on tough terms. It is time to withdraw slowly from this distorted situation, by raising interest rates in a studied gradual way, slowly withdrawing with it the vast pool of printed money and also loosening the excessively tight regulations on bank lending. In doing this it will be joining the US Fed and probably quite soon also the ECB.

12

Against this background, Brexit will lead to a strengthening of competition and growth, while also slowing inflation. The full gains will take around five to ten years to come through but we envisage growth reaching the 2- 4% range by 2020 as against the current 2-3%. Besides the one-off gains from Brexit that push up this growth rate in the medium term, we have identified a further longer term gain in growth due to the boost to innovation and entrepreneurship created by the more competitive environment. This should keep growth in this higher range for a prolonged period of time. References: 1 Minford, Patrick, with Sakshi Gupta, Vo Phuong Mai Le, Vidya Mahambare and Yongdeng Xu (2015) Should Britain leave the EU? An economic analysis of a troubled relationship, second edition, December 2015, pp. 200, Edward Elgar. 2 Patrick Minford and Edgar Miller (2017) ‘What shall we do if the EU will not play ball?’ downloadable from www.economistsforfreetrade.com 3 World Bank Logistics Performance Index, 2016 for Canada, US, UK, Germany, Sweden, Belgium, Netherlands, France, Italy, Spain, Norway, South Korea, Japan, Australia, and New Zealand, downloadable from https://lpi.worldbank.org/ 4 Op cit, Minford et al (2015)

13

FUNDAMENTAL BENEFITS OF LEAVING

Roger Bootle - The Dangerous Myth of EU Economic Success Page 14

Highlights that the EU's poor recent economic performance looks set to continue and largely reflects the poor decisions it continues to make

Michael Burrage - Trading with the EU under WTO Rules is not the Worst Possible Option, and Single Market Membership is Not the Best Page 17

Reviews empirical evidence from past trends in trade showing that countries outside the Single Market have increased their trade with the EU much faster than trade inside the Single Market has increased suggesting we can still trade vigorously with the EU from outside the Single Market. Moreover, our trade with other countries is likely to increase faster because their growth rates are higher.

Tim Congdon - Too Much Regulation Page 20

Stresses that the EU has led to a sharp increase in regulation, which in turn has been a major contributor to the region's poor economic growth

David Paton – Labour Economic Policy under Brexit Page 23

Explains that the Labour Party now supports a Brexit outside the Single Market and the Customs Union - a ‘Hard Brexit’ in other words - and that this is greatly in the interests of poor households because of the sharp fall in the cost of living this will bring

Swati Virmani and Veda Balasubramanyan – Post-Brexit Trade Prospects for the UK Economy Page 25

A study of India’s trade shows that the gravity model fails to allow for key supply-side factors as well as the pull of middle class Indians on the pattern

of trade. They show that UK trade prospects in India and other Asian countries are good, following rapid recent growth.

14

THE DANGEROUS MYTH OF EU ECONOMIC SUCCESS

Roger Bootle

There have been umpteen studies of the immediate net cost or benefit of staying in the EU. Important though such calculations are, we also need to look at how such a balance of costs and benefits is likely to evolve over future decades, including in relation to opportunities and threats that we cannot, at present, clearly foresee. Is the EU likely to make good decisions about these threats and opportunities? This issue turns on the quality of governance in the EU. And the conclusion is not favourable. It is not widely recognised among the public that the EU is a comparative economic failure. Not in its initial years, of course, when its members grew strongly, thanks to recovery from the war and the transfer of large numbers of people from agriculture to industry. And not so much during 2017, when the EU’s relative performance compared to the US, for instance, picked up. But this is likely to be a flash in the pan. Over the last two decades, its record has been poor, not only against the emerging markets – which is a misleading comparison – but also against other developed countries such as the US, Australia and Canada. Moreover, over this period, most members of the EU have decidedly under-performed against the UK. (See Bootle, 2016.) Why is this? Over the last decade and a half, the answer is mostly “the euro”, which has been an unmitigated disaster. But poor relative performance predates the euro. I think that the reason for this earlier under-performance, which has carried through to the euro era, is a series of bad decisions which have reduced efficiency. The widely acknowledged misuse of the EU’s funds has not helped. But more important than this has been the EU’s excessive regulatory zeal which has placed countless, unnecessary, burdens on business. And probably more important still has been the absorption of the time and attention of politicians, officials and business leaders with barmy plans for the harmonisation, integration and Europeanization of something or other. While the leaders of the rapidly growing countries of Asia were busying themselves with the fundamentals of economic growth, in Europe their equivalents were obsessed with unnecessary and damaging integrations. The most serious of these was undoubtedly the formation of the euro, which was an unforced error. But it was not a one-off. It followed a host of other bad decisions. The most serious of these is the Common Agricultural Policy, which has caused a massive waste of from which we all lose. In addition, the EU

15

continues to operate a protectionist trade policy which has brought about a huge misallocation of resources with a consequent loss of real incomes for European consumers. Why does the EU make such bad decisions? Because its institutions are badly structured and don’t work well, and because its essential ethos – the drive towards “ever closer union” - is misguided. The EU operates through an unelected Commission, supported by an army of bureaucrats, and the European Council, where the horse-trading of individual country interests dominates. In practice, things used to be run by the dominant pair, France and Germany. More recently, France has faded and Germany now dominates. Meanwhile, the European Parliament is a weak institution with little democratic legitimacy and limited powers. I do not know what the predominant issues of the next few decades are going to be. But I do know this: on the basis of its record, the EU is likely to make cack-handed decisions about them, whatever they are. Two candidates for disastrous policy decisions readily suggest themselves: a move to “harmonise” pension arrangements across the Union; and the restriction, including possible taxation, of robots and the employment of advances in Artificial Intelligence. Yet aren’t the EU’s cack-handed decisions likely to be outweighed by the benefits of the “Single Market”? The short answer is no. These benefits have been greatly oversold. (See Burrage, 2016 and 2017.) People talk about Britain “having access” to the Single Market, as though it were some sort of room, with a door through which you may or may not be admitted, depending upon your membership. But this is nonsense. All countries in the world have access to the Single Market. It is simply that in order to sell goods into it they have to agree to meet its standards. Yet that is true wherever you try to sell goods. As it happens, plenty of countries around the world have had great success selling into the Single Market without themselves being members of it. The United States is the largest exporter to the EU, followed by China. As for the importance of being able to influence its rules, which has supposedly been a strong argument for the UK to remain a member of the EU, exporters from these other countries have not been able to influence them either. Nor do these countries have a single MEP or representative at any European meeting. By contrast, the downside to the Single Market is that you have to apply all its rules and regulations throughout the whole economy. In the UK’s case, about 12% of our GDP is directly accounted for by exports to the EU. This means that some 88% is not. Yet that 88% must also obey all the EU’s rules. Moreover, whatever advantages there are from Single Market membership are set to fade as the EU is falling rapidly in relative importance as it is outgrown by the rest of the world. For the same reason, the costs of having to impose its regulations on the whole economy are set to rise. This is a club of which we should not want to be a member. Unshackled from the EU and its destructive policies, there is every chance that the UK will enjoy a faster rate of economic growth – faster than it enjoyed in the past while a member, and faster than the remaining members in the future.

16

References Bootle, R, 2016. The Trouble with Europe. 3rd ed. London: Nicholas Brealey Publishing Burrage, M, 2016. Myth and Paradox: How the trade benefits of EU membership have been mis-sold. London: Civitas Burrage, M, 2017. It’s Quite ok to Walk Away: A Review of the UK’s Brexit Options with the Help of Seven International Databases. London: Civitas.

17

TRADING WITH THE EU UNDER WTO RULES ISN´T THE WORST POSSIBLE OPTION, AND SINGLE MARKET MEMBERSHIP ISN´T THE BEST

Michael Burrage

Being ready and willing to leave without a deal, and trade, for a period, under WTO rules, is the essential prerequisite for a successful outcome to the Brexit negotiations. It may well be the only way for the UK to avoid the unacceptable costs, and unacceptable restrictions on the UK´s future freedom of action, that the EU might seek in reply to the UK proposal for continued free trade. Paradoxically, it may be the only way the UK can go on to become, as the Prime Minister hopes, a global leader in free trade. Other EU members apparently do not believe that the UK will be willing to walk away without a deal.i And they are no doubt heartened by the stream of Remainers in the UK who have, since the election, urged the UK cling to some form of continued single market membership, via EEA or Customs Union membership, and portray trading under WTO terms as the worst possible option.ii The polar contrast between the two options has never been grounded in empirical reality. International trade databases show that in terms of export growth, of both goods and services, the Single Market has been a dismal 23 years for the UK.iii The belief that UK productivity has improved during membership, and that its exports have benefited significantly from the 60-odd trade agreements the EU has negotiated around the world, are woefully wide of the mark.iv But none of the available evidence on its costs and disappointments is ever mentioned by the Lib Dems, the SNP, and now the trade unions, who want the UK remain in the Single Market.v Those who argue against trading under WTO rules are similarly indifferent to evidence. In an open letter to the Prime Minister after the referendum, the heads of the CBI along with three other employer federations declared that

Every credible study that has been conducted has shown that this WTO option would do serious and lasting damage to the UK economy and those of our trading partners. The Government should give certainty to business by immediately ruling this option out under any circumstances.

They declined, when asked, to name any studies.vi Since the election, they have again urged that the UK seek a soft Brexit to avoid the possibility of no deal and the WTO option.vii They saw no reason to refer to the UK´s current exports to 111 countries under WTO rules, which presumably involves some of their own members, and which has over the life of the Single Market grown nearly three times faster than UK exports to the EU.viii If they had had the national interest in mind, they would have asked their members who export to both about their comparative costs and convenience, and then explained how the ´serious and lasting damage´ they predict if the UK takes the WTO option was combined with growth nearly three times faster. And they might have added evidence about a supposed ´cliff edge´ when the 27 EU countries have to be treated like the 111. International trade databases provide numerous examples to show that trading under WTO rules does not prevent rapid increases rates of growth of exports of goods to the EU. Australia,

18

China, India, and the US were among the 22 of these countries whose exports of goods to the 12 founding members of the SM over the years 1993-2015 grew at a more rapid rate than those of the UK.ix Moreover, if we look only at the larger value exporters to the EU, with exports of more than $10b in 2015, the exports of fifteen of the countries trading under WTO rules grew significantly more (135%) over the years 1993-2015 than the six neighbouring countries that have been trading with the EU under some kind of bilateral agreement (107%). Still more striking perhaps, the fifteen WTO exporters have also grown much faster that the exports of 11 founder members to each other (70%).x By the simple measure of goods export growth, trading under WTO rules emerges as a better option than membership. In services, there is no exact equivalent to trading under WTO rules, though many countries that have no trade agreements including services with the EU have grown faster than those with agreements, and faster also than the UK and the mean rate of all member countries exporting to each other.xi A comparison of the exports of 27 of these countries with 27 member countries to each other from 2004 to 2012, (the only years for which comparable data is available), found that the non-members had grown slightly (0.5 per cent) faster than members to each other. Hence leaving the EU, and trading with no deal, or the equivalent WTO rules again emerged as a better option than membership.xii By the EC preferred index, the ratios of intra to extra exports as a percentage of EU GDP, a single market in services barely exists, so there can hardly be much grief or loss when leaving the largely imaginary services half of the Single Market.xiii The much-lamented ´passporting´ is an exception, but then it itself illustrates that there is no single market in services. Trading with the EU without an agreement, and under WTO rules has manifestly been a very good option for many countries. The UK should therefore be ready and willing to join them. There may, to be sure, be some inconvenience for exporters, but apart from terminating the unacceptable costs of the Single Market, it may be the only way to open the UK economy to free trade, and to the many trade opportunities that Brexit offers. References I Sir Ivan Rogers, former UK Representative to the EU, to the European Scrutiny Committee 1 February 2017: ii And perhaps also by https://www.thetimes.co.uk/edition/news/just-65-tories-are-prepared-to-leave-eu-without-a-deal-5mtf5hld6 iii Michael Burrage, Why negotiate to remain in the Single Market? Its benefits for the UK have yet to be identified, Brexit Central, XX June 2017 iv Data from OECD, WorldBank, UN Comtrade and WTO pp75-87 It´s Quite OK to Walk Away: A review of the UK’s Brexit options with the help of seven international databases http://www.civitas.org.uk/content/files/itsquiteoktowalkaway.pdf v https://www.thetimes.co.uk/article/unions-urge-corbyn-to-fight-for-single-market-membership-9p2n20rw9 vi https://www.cbi.org.uk/news/cbi-signs-open-letter-to-government-on-brexit-negotiations/ vii https://www.thetimes.co.uk/past-six-days/2017-06-18/business/bosses-join-forces-to-push-for-softer-brexit-cjz9mcs0j viii IMF Direction of Trade statistics at data.imf.org p-40, It´s Quite OK

19

ix IMF DOTS, data.imf.org, p.19, It´s OK x IMF DOTS, data.imf.org, p.26, It´s OK xi OECD Dataset: OECD EBOPS 2010 p.58, It´s Quite OK to walk away xii OECD Dataset: EBOPS 2002 - Trade in Services by Partner Country European Union pp.60-62 It´s Quite OK to walk away xiii http://ec.europa.eu/economy_finance/publications/pages/publication784_en.pdf

20

TOO MUCH REGULATION

Tim Congdon

Over the last 60 years Europe’s politicians have promoted greater political and economic integration between their nations, in line with the “ever closer union” commitment in the 1957 Treaty of Rome. But they have been markedly reluctant to pool control over taxation or public expenditure. The power of the purse remains very much at the national level. As a result, the practical meaning of integration has been a sharp increase in regulation, which takes the form predominantly of Directives and Regulations initiated by the European Commission. These Directives and Regulations constitute the so-called acquis communautaire, a body of law or quasi-law that is now approaching 200,000 pages in length. The enforcement of this vast number of injunctions and prohibitions is costly for European business, particularly in small- and medium-sized companies. In Britain, as elsewhere in the EU, much regulation is deeply resented. With the Brexit process now under way, the UK has a chance to move towards lighter, more efficient and more appropriate systems of regulation. Four areas of regulation can be highlighted. First, European governments have been more emphatic than the global average about the dangers of global warming.xiv The EU has therefore adopted the renewables agenda with greater zeal than most of the world’s nations and forced member states to replace low-cost by high-cost energy sources. Coal-fired power stations have been closed down, offshore wind farms built and so on. In an article in the Financial Times in January 2014, Lakshi Mittal, the Indian entrepreneur with interests in steel and heavy industry in many countries, warned that the EU’s energy policies had undermined the competitiveness of its manufacturing industries. Second, the EU has pressed for social legislation (such as the 2003 Working Time Directive and the 2004 Gender Equality Directive) that adds to companies’ costs and reduces employment. Open Europe, a think tank that regards itself as neutral in the debate on EU membership, estimated in 2011 that EU social legislation by itself made the UK worse off by £15 billion, about 1 per cent of national output.xv Third, control over financial regulation passed from UK authorities to EU bodies connected to the Commission as a result of the 2009 Lisbon Treaty. Since then several new interferences – including the cap on bankers’ bonuses and an outright attack on financial derivatives business – have damaged the City of London and stopped its growth. For 40 years to 2008 the City had been the most dynamic and successful part of the UK economy. Another example is that the EU competition authorities have required RBS to sell a significant number of branches, as a penalty for taking a loan from the Bank of England in the 2008 financial crisis. This is blatantly unfair and discriminatory, in that much more generous credit facilities were offered by the European Central Bank to Eurozone banks not just during the crisis period, but subsequently. Indeed, even today many Italian and Spanish banks have loans outstanding to their national central banks that have been in place for almost a decade. Yet banks benefiting from these facilities have not been forced to divest operations or subsidiaries.

21

Finally, literally thousands of regulations to ban substances and manage processes have emanated from EU institutions since 1973 and particularly since the drive for “the single market” began in 1992. They have affected activities that range from fine art auctions to herbal medicines, and in every case have disturbed established and profitable businesses. Often the only aim has been to impose on the UK an existing standard in France or Germany, even though the UK had previously been happy with its own arrangements.xvi The burden of regulation has been so severe that it has reduced productivity (output per person employed) as well as the number of people with jobs. With the acquis communautaire adding thousands of pages every year, the damage to productivity has increased over time. As productivity growth is the key ultimate driver of higher living standards, all Europeans – including of course the British – are worse off than they would have been if they had kept regulation at a national level. The table below shows the rate of change in real GDP in high-income societies in the five years to 2016, according to the International Monetary Fund. It is obvious that the economies of EU member states are falling behind those of other high-income societies, and falling behind consistently and by a significant amount. Too much regulation must be the main explanation.

References 1 Colin Robinson Climate Change Policy: Challenging the Activists (London: Institute of Economic Affairs, 2008). 1 Stephen Booth, Mats Persson and Vincenzo Scarpetta Repatriating EU Social Policy (London: Open Europe, 2011). 1 Tim Congdon How much does the European Union cost Britain?, report for the UK Independence Party, 2013 issue in an annual series, pp. 23 – 6. The reports are available from www.timcongdon4ukip.com.

The EU's economic decline, relative to other high-income societies

Table shows % rate of change in constant-price GDP, according to the IMF

2012 2013 2014 2015 2016

Cumulatively, over

five years to 2016

USA 2.2 1.5 2.4 2.6 2.8 12.0

Japan 1.7 1.6 -0.1 0.6 1.0 4.9

Canada 1.9 2.0 2.4 1.0 1.7 9.3

Australia 3.6 2.1 2.7 2.4 2.9 14.5

Hong Kong 1.7 3.1 2.5 2.5 2.7 13.1

Singapore 3.4 4.4 2.9 2.2 2.9 16.9

Euro area -0.8 -0.3 0.9 1.5 1.6 2.9

European Union -0.4 0.2 1.5 1.9 1.9 5.2

22

23

LABOUR ECONOMIC POLICY UNDER BREXIT

David Paton

During the recent Election, the Labour Party Manifesto pledged to put the economy, living standards and jobs at the heart of Brexit. Notably, there was no commitment to stay in the Single Market or Customs Union, only a plea for negotiations to focus on “retaining [their] benefits” (p. 24). Indeed, the Manifesto promise to end free movement, the call for reducing trade tariffs and the discussion of future trade deals would all be incompatible with membership of the Single Market and Customs Union. Despite this, some 50 Labour MPs voted for an amendment to the Queen’s Speech which would renege on those promises. Given that over 85% of the electorate backed MPs from parties committed to leaving the single market and customs union, it is surely now time to focus on how best to leverage economic benefits from a ‘clean’ Brexit. Predictions of immediate economic gloom after the referendum have not come to pass: foreign direct investment has shown no signs of slowing down (OECD, 2017), unemployment is at record low rates whilst the economy has exceeded growth predictions. Disappointingly some economists from the Project Fear school of thought are now hard at work emphasising the risks of a clean Brexit whilst ignoring the ways in which leaving the Single Market and Customs Union have the potential to help the economy, living standards and jobs. Most obviously, moving out of the protectionist EU Customs Union provides the UK with the easiest and perhaps only way of “minimising tariff and non-tariff barriers to trade with the rest of the world” (Labour Party Manifesto, p.30). Lowering and, where possible, completely eliminating tariffs on imports will reduce consumer prices, providing an immediate boost to people struggling on low incomes. Just as importantly, it will reduce prices of many inputs providing a boost to our manufacturing industry. Many people are understandably concerned about both the risks of the EU imposing barriers to our exporters as well as the human costs which may affect particular areas and sectors in adjusting to a new free-trade economic environment. However, the EU already trades successfully with many countries under WTO rules, whilst the depreciation of the pound has provided a one-off competitiveness boost to UK companies which can help to cushion the blow should the EU foolishly seek to impose new export tariffs on the UK. Crucially, leaving the Single Market means the UK Government will be able, if it so wishes, to provide short run support for particular sectors and communities in ways which are impossible under current EU rules. Finally, continued membership of the single market, even in some modified form, would almost certainly mean UK taxpayers continuing to transfer large sums of money to the EU, resources that we would otherwise be free to decide how to spend, be it on the NHS, providing support to UK businesses or regionally-based infrastructure investment. In the longer term, a further benefit of a clean Brexit will be the increased freedom of UK Governments to take independent decisions on a series of economic policy areas. Obvious examples include flexibility over VAT rates, decisive action in response to export ‘dumping’ by other countries and the ability to re-focus regional development initiatives to suit the priorities of the UK electorate as opposed to those of EU bureaucrats. Of course there will be keen debate

24

about the strategic direction economic policy should take. Indeed, a new era of vigorous debate over economic policy choices which are only available to Governments outside the EU is likely to be a notable and (for democrats at least) welcome side-effect of Brexit. Even if there are disagreements over areas such as labour market and environmental regulation, there are cases where being outside EU regulations can unambiguously benefit UK industry, an obvious example being the forthcoming EU Ports Directive which would have severely penalised efficient and successful UK ports. On the 25th June it was announced that the EU Commission has agreed to yet another bailout of Eurozone banks, this time in Italy. As usual, wealthy bondholders are being protected with the burden falling largely on taxpayer, in direct contradiction of EU rules. Politicians arguing that putting jobs at the centre of Brexit means we must keep ourselves as close as possible to EU institutions, might want to note the irony that youth unemployment in Italy remains around 40% compared to just 12% in the UK. If we really want to achieve a Brexit for the many not the few, it is essential that we release ourselves from the constraints of EU institutions and embrace the ability to trade freely and develop our own industrial strategy. The sooner the UK can achieve this, the better it will be for UK workers, consumers and industry.

References The Labour Party (2017), For the many not the few: The Labour Party Manifesto 2017. Financial Times (2017), Italy sets aside €17bn to wind down failing lenders’, The Financial Times, June 25, www.ft.com/content/83ad52a8-59a5-11e7-9bc8-

8055f264aa8b?mhq5j=e2 OECD (2017), FDI in figures, April, www.oecd.org/daf/inv/investment-policy/FDI-in-Figures-April-2017.pdf

25

POST–BREXIT TRADE PROSPECTS FOR THE UK ECONOMY

Swati Virmani and V N Balasubramanyan One of the arguments the Remainers have produced to warn the Brexiteers that post Brexit the UK would find it hard to locate trading partners outside of the draws upon the so called gravity model of trade. The model suggests that similarity of economic size attracts countries to trade with each other while high geographical distance between prospective trading partners weakens the attraction. Brexit, the Remainers argue, would compel the UK to trade with countries, mostly the emerging economies that in general do not satisfy the conditions stipulated by the so called gravity model. Although India and China figure as the seventh and second largest countries in the world measured by their GNP at market prices with $2.25 trillion and $11.22 trillion respectively, they are not counted as large prospective trading partners of the UK because of their low per capita incomes. China and India, however, rank high on the league table of income inequalities with estimated Gini coefficient at 35.1 and 42.2 respectively. The taste patterns of the high income groups in the low income countries may generate both a demand for and supply of differentiated products. The low income countries may trade raw materials and standardized labour intensive consumer goods with the high income countries in exchange for high priced differentiated products demanded by their upper income groups. Statistical tests of the gravity model, incorporating income inequalities as an explanatory variable, with India as a case study, lends support to our hypothesis that income inequalities do influence trade. We analyse cross section data for trade between India and its 68 trading partners for the year 2015. The number of countries included in the analysis are the ones for which income distribution data are available (see our working paper for details). Briefly put, our statistical results suggest that it is not just income levels, but more importantly income distribution plays a significant role in India’s external trade. Income distribution measured by the Gini coefficient has a positive and relatively high impact on India’s exports and total trade. Besides income distribution India’s trade is also influenced by its ties with countries that were colonies of Britain in the past. This finding is of significance for it suggests that countries including India that were mostly colonies of Britain in the past share a common business culture. There is also a variety of supply side factors that influence trade not only between India and the UK but also between UK and the emerging economies in Asia and Africa. Apart from endowments of natural resource based raw materials possessed by several of the African countries, there are countries, such as Singapore, Malaysia and Taiwan that are well endowed with trained labour. In several of these countries, principally India, the age dependency ratio is low and training of labour is a factor of significance. Yet another supply side factor of significance is the language of business, essentially English, in which most of the business communities in these countries are well versed. The language of business and other institutions, such as financial institutions and the media, do contribute to trade between countries that share these features.

26

Another supply side factor that promotes trade between many of the emerging economies and the UK and the USA is the presence of a sizeable diaspora of these countries in the UK and the USA. Members of the diaspora, not only transfer substantial sums of money back home but also invest in manufacturing and services of various sorts in their countries of origin. These business connections between the diaspora and the emerging economies are a factor of significance in promoting trade between the emerging economies and the USA and the UK. Apart from trade in goods, trade in services has assumed prominence in the case of several emerging economies, especially India, and the UK for the most part is a service economy. Transport costs, or distance, are of little significance for trade in services. Most services, especially software and related services are transmitted across national borders via the satellite or delivered in person by temporary migration of software experts. Trade in services of not only software but also finance, insurance and R & D services are likely to increase post Brexit between the UK and the emerging economies, principally India. It is also noteworthy that the rate of growth of trade between the UK and the commonwealth countries is much higher than UK’s trade with the EU. UK’s goods exports to the Commonwealth countries doubled from £13 billion in the year 1996 to £25 billion in the year 2010. UK’s service exports to the Commonwealth tripled from £8.5 billion in the year 1999 to £22 billion in the year 2015. The Remainers, though, would point out that this growth in the UK- Commonwealth trade is from a low base. They also talk about the large number of trade agreements that the EU has entered into with several developing countries including the Commonwealth countries. In all this they suggest that post Brexit, trade with the Commonwealth countries is unlikely to compensate for the loss of trade with UK’s EU trade partners. These are just debating points. Post Brexit, shorn of all the EU rules and regulations, the high growth rate of trade between the UK and the Commonwealth countries is likely to increase further. The UK would be free to enter into trade agreements with non- EU countries within the WTO framework. There may be a large number of EU trade agreements with the commonwealth countries. But it is not known how many of these agreements are operational. Negotiations relating to several of these agreements are long drawn-out. It is reported that negotiations between India and the EU on a free trade deal have been continuing for the last seven years. It looks as if the well- known Indian bureaucracy has met its match. Admittedly at the present, only 9% of UK’s exports are to the Commonwealth countries and imports from the Commonwealth account for only 8% of UK’s total imports. These shares though are likely to increase significantly post Brexit. It is not just that the UK will be compelled to rebuild its ties with its Commonwealth partners but also UK’s trade deals with the Commonwealth countries, shorn of the EU rules and regulations, are likely to come to fruition swiftly. Besides the Commonwealth countries and other emerging economies, such as Taiwan and Thailand, there are two other major trading partners for the UK- the United States and China. They accounted for a total of 21% of UK’s exports and 17% of UK’s total imports in the year 2015. China’s recent policy initiative of turning the exports based economy into a domestic market based one is likely to provide UK with a substantial market for the exports of both goods and services. The USA with more than a 15% share in UK’s total exports of £304 billion and an 8% share in the country’s total imports of £412 billion is likely to

27

continue as a major trading partner, although the two trading partners may have to cope with the EU’s tariffs on UK’s exports that may have an impact on US exports to the EU produced by the US firms investing in the UK. In sum, post Brexit the Commonwealth countries, headed by India and the African countries such as Nigeria and South Africa, along with China and the USA, two of the World’s largest economies, are likely to compensate UK for the loss of its EU markets. It should be added that the changes in volume, direction and pattern of trade will be a gradual process with existing patterns yielding place to new ones over time.

28

WHY FREE TRADE

John Greenwood – The UK and Asia-Lessons for Brexit Page 29

Explains the context of East Asia and how its free trade policies have succeeded. Prominent examples have been Singapore and New Zealand. The UK increasingly trades outside the EU, its EU trade share having greatly fallen since 2007. East Asia will be a key future partner.

Tim Congdon – Free Trade in the Modern World Page 31

Reviews the merits of free trade and draws parallels between recent unilateral actions by nation states and Peel’s Corn Law repeal

Graeme Leach - Where There is No Vision, the People Perish Page 33

Explains how producer interests are opposing Brexit and arguing for continued protection, whereas the interests of consumers and the national interest demand a Brexit with unilateral free trade. This will lower consumer prices, enhance competition and bring long term prosperity.

29

THE UK AND ASIA – LESSONS FOR BREXIT

John Greenwood

A key problem in the Brexit debate is that it has been led by interested parties who feel that they will be losing out as a result of the UK’s withdrawal from the EU. These vested interests are generally either businesses that have enjoyed EU protection (such as motor manufacturers and farmers), or organisations that have benefited from EU funds (science researchers, universities), or individuals –diplomats or British residents on the continent - who tend to think about the subject in personal and emotional rather than in economic terms. They all represent the status quo. For an economy to be successful over the long run it needs to be able to adjust to changes in global supply and demand conditions. This requires flexibility not just of prices, wages, and the exchange rate, but also adaptability in the composition of economic activity and employment. Economic policy should prioritise consumers rather than be protective of producers. It is not necessary to have either large supplies of natural resources, or to be a member of a regional trade bloc. How do we know this? Because this is how small economies such as Hong Kong and Singapore, reliant upon free trade and shunning protectionism, have grown over the past eighty years, taking their per capita income levels from far below the UK to average incomes some 40% ahead of the UK today. Although neither China nor India are paragons of openness or free trade, both are growing at three or four times the growth rates of the UK and the EU, and – assuming just a few more decades of rapid growth -- will come to dominate global trade. China overtook the US as the largest exporter in the world as recently as 2006-07, and today it already exports 40% more than the US. On the import side China still trails the US, but the gap between US and Chinese imports has halved since 2001. Similarly the total exports of the smaller economies of the ASEAN region (Singapore, Malaysia, Thailand, Vietnam, Indonesia, and the Philippines) together with those of Korea, Taiwan and Hong Kong in 2016 have exceeded US exports since 2006. These economies are much more open than either China or India, but eliminating our tariffs on imports from East Asia would mean much greater choice at lower prices for British consumers, while the growth of the East Asian economies spells big opportunities for British business, especially for our specialist manufacturers and service providers across a range of industries. Commentators sometimes bemoan the reduction in British manufacturing employment or the decline in manufacturing as a share of GDP by value added that the free trade model implies, but this is a secular trend in all advanced economies -- seen in the US, Japan, Germany, France and Italy, as well as the UK. Substantial foreign direct investments in the UK steel and car industries notwithstanding, it is a decline that has not been prevented by our membership of the protectionist EEC/EU. Furthermore, productivity growth in UK manufacturing has averaged over 3.2% p.a. since 1985 compared with just 1.6% p.a. for

30

the economy as a whole, so it would be hard to argue that UK manufacturing has been underperforming. Conversely our services have grown from 68% of GDP in 1990 to 79% in 2016. If instead of protecting the status quo the UK were to focus on its areas of comparative advantage, this would give the UK the best possible outcomes in terms of both trade and living standards. As an example of the perils of continuing to bias our trade towards the slow-growing, protectionist EU – an unfortunate but unavoidable result of the trade-diverting tariffs and subsidies operating in the EU -- consider the growth of the UK’s exports to markets around the world over the past three decades. Between 1992 and 2007 the EU’s share of UK exports remained essentially unchanged at 61%, but since then it has plunged to 47% in 2016. By contrast, the growth of UK exports to the rest of the world has surged from 39% in 2007 to 53% in 2016. In short, trade with rapidly growing Asia and other regions can easily compensate for the slow growth of trade with the EU. On the other side, consider the case of New Zealand, an economy that adopted protectionism to offset the hit from the decision of the UK to join the EEC in 1973. At that time half of New Zealand’s dairy exports and one third of all its exports went to the UK. With some exceptions for dairy and meat quotas, the country was locked out of any future growth in the UK market, and could not gain access to other tariff-protected markets such as Japan and the US. Unfortunately New Zealand chose to impose tariffs to protect domestic producers and/or charge for import licences, and ended up with a very high cost structure, reduced responsiveness to the global market, misallocated resources, and weak productivity growth. Britain faces exactly that risk if, through negotiations with the EU, we decide to remain in the customs union and impose EU-equivalent tariffs and non-tariff barriers on imports from all non-EU markets. By the early 1980s, according to Sir Lockwood Smith, former New Zealand High Commissioner in the UK, the economy was “going down the plughole.” The sheep industry (meat and wool) received subsidies as high as 90%. Protected sheep-meat could not be sold and was turned into fertilizer, and the wine industry, protected by a 40% tariff, produced “battery acid. You could not export the stuff—no self-respecting person would drink it.” Then in 1985 under Roger Douglas’s reforms protectionism and subsidies for the wine and sheep industries were eliminated. The results have been spectacular. Today New Zealand wine is world class, and the country produces a similar weight of lamb from less than half the number of sheep, requiring 23% less land. A lamb carcass is converted to 42 different cuts plus by-products and marketed across 100 different countries around the world. Productivity is up by 107%. On our departure from the EU Britain, too, should adopt free trade across major sectors, announcing immediate or phased programmes of tariff removal. To conclude, the economic case for Brexit – leaving the EU, not being a member of a protected market and leaving the customs union -- is a strong one. The small, open economies of East Asia illustrate the gains in living standards that can be achieved from free trade over the long term, while even the mistakes – subsequently rectified – in trade policy by economies like New Zealand also demonstrate the benefits of the free trade model. The UK has much to gain outside the protectionist, over-regulated, slow-moving EU.

31

FREE TRADE IN THE MODERN WORLD*

Tim Congdon Free trade is good for you. Nations that adopt it as the central principle of their international economic policy-making develop and prosper; they outperform nations that restrict imports and limit contact with the rest of the world. That is one of the plainest lessons of the almost two and a half centuries that have followed the publication in 1776 of Adam Smith’s Wealth of Nations, the book usually regarded as the beginning of modern economics and still unequalled as a critique of inward-looking mercantilism.

Such city states as Hong Kong and Singapore, which began as colonial free ports and retain free trade to this day, have incomes per head which are a multiple of their neighbours. At the other end of the spectrum, the two remaining self-styled communist polities – North Korea and Cuba – pursue autarky, and are marginalised, backward and poor. Hong Kong and Singapore may be small and exceptional, but they are not unique. Crucially, their success has been an example to others, sometimes much larger and with huge geopolitical significance.

However unattractive the style of government in the United Arab Emirates may be in other ways, it cannot be overlooked that since independence from Britain in 1971 the UAE has been a startling economic success story. From the start the Maktoum family determined that Dubai (and specifically the Jebel Ali Port and Free Zone) should adopt free trade, and commercial policy for the UAE as a whole has also been relatively free and open. The Emirates too have incomes per head that are a multiple of their neighbours.

After the death of Chairman Mao in 1976 China’s political leaders rethought from scratch the management of their economy, which had been closed to the rest of the world for 30 years. At that time the international trade of Hong Kong, which with the New Territories had about the same size as the Outer Hebrides, was greater in value than that of mainland China, the world’s most populous country and the fourth largest in terms of land area. The creation of free-trade Special Economic Zones – mini-Hong Kongs in effect – was Deng Xiaoping’s pragmatic and understandable response.

Deng thereby inaugurated the most far-reaching strategy of unilateral trade liberalization ever seen, so that China nowadays has low import tariffs by international standards. The value of its total trade (exports and imports of goods combined) is roughly the same as that of the United States of America at about $4,000 billion, and it is by far the largest exporter of goods in the world. According to data published by the International Monetary Fund, this trade opening – pursued voluntarily and on their own initiative by the Chinese authorities – has been associated with an almost twenty-fold increase in real incomes per head since 1980.

32

The message of China’s trade liberalization, and of other trade liberalizations over the last 40 years (notably in Latin America, where Chile and Mexico have had major trade reforms), is of huge relevance to the Brexit debate. Not only is free trade good for you, but also – very logically – self-chosen action to open the home market to imports, to move closer to free trade, is beneficial. The ideal trade regime for all nations is to have no tariff or other barriers on imports whatsoever. To recall the phrase and the sentiment that determined last year’s Conservative leadership contest, free trade means free trade.

The point for the Brexit negotiations is simple and fundamental. No hard bargaining between the British government and the European Union on trade is necessary at all. The best policy is to have no tariff or non-tariff restrictions for imports from the EU, just as that is the best policy for imports from any country. The Brexit negotiations have now started, and risk being arduous and complex, but the optimum approach would be for Theresa May to declare a policy of unilateral free trade and to move on. We just don’t care what restrictions the EU wants to impose on our exports to it. That would return Britain to the status of global free trade champion that it maintained from 1846 to 1932, when its living standards were among the highest in the world and well above those in the rest of Europe.

These issues are not new. Sir Robert Peel, when announcing the repeal of the Corn Laws in the House of Commons in 1846, remarked that the government should not “resume the policy which…we have found most inconvenient, namely the haggling with foreign countries about reciprocal concessions, instead of taking that independent course which we believe to be conducive to our own interests…[L]et us trust that our example, with the proof of practical benefits we derive from it, will at no remote period insure the adoption of the principles on which we have acted… Let, therefore, our commerce be as free as our institutions. Let us proclaim commerce free, and nation after nation will follow our example.”

*reprinted by kind permission of Standpoint

33

WHERE THERE IS NO VISION, THE PEOPLE PERISH

Graeme Leach

There is enormous confusion in the minds of the public about the economic consequences of Brexit, because the debate is dominated by producer interests. Producers say that leaving the EU customs union and the single market will mean higher tariff and non-tariff barriers on UK exports - with reduced exports, profit margins and jobs as a consequence. With regard to imports from the EU, the CBI and others argue that without a deal agreeing to tariff free-trade, the UK would be obliged to impose the same tariffs on its imports from the EU, as from other WTO members (due to WTO rules), disrupting supply chains and adding to costs. Various business groups have trotted into 10 and 11 Downing Street to repeat this message to the Prime Minister and Chancellor, and then to the media outside. The media lap it up because it all seems to make sense, and public opinion is shaped as a result. But this is a very limited view of the potential impact of Brexit. Brexit might mean this but it is entirely within our sovereign power to ensure that it doesn’t. It assumes we would engage in tit-for-tat retaliation on tariffs with the EU, and then have to impose those same tariffs on the rest of the world. However, if we chose not to do this, and implemented unilateral free trade with zero tariff and non-tariff barriers on the EU and the RoW instead (which would be entirely under our control once outside the customs union), the economic consequences of Brexit would change dramatically. We need a consumer and producer vision of the benefits of unilateral free trade, but that is obscured at present by the protectionist rhetoric of business leaders who can’t (possibly because of a protectionist mentality after 40+ years of the common external tariff) or won’t see it (due to their rent seeking behaviour). The unilateral free trade vision should include:

The wide economic benefits from domestic producers facing more intensified competition at lower world prices. Trading at world prices could benefit consumers by 7 times the cost to producers (as discussed elsewhere in this paper).

The long-term dynamic impact of competition raising productivity and incomes across the whole economy.

The opportunity to sign free trade agreements as wide and as deep as we wish, with as many countries who are willing, once outside the customs union.

34

Real repeal in the wake of the Great Repeal Bill, providing the opportunity to create a more flexible, lighter regulated, enterprise driven economy.

The opportunity to shine as a beacon to the world as to the merits of genuine free trade. This is surely the positive vision business should be championing, instead of narrow interests. The Brexit vision must embrace global leadership, lower prices, higher incomes, wider and deeper free trade and the flexible regulatory environment required to maximize growth in the 21st century. The current debate is so dominated by producer interests that consumers are unaware of the potential Brexit dividend they could receive if the UK introduced unilateral free trade and traded at lower world prices. Such is the confusion, most consumers probably associate Brexit with higher prices, due to the weaker pound and higher import costs. This is a fundamental misunderstanding, if Brexit means Brexit means unilateral free trade. The producer mind-set is short-term, worrying about the impact on export demand, prices and margins. Without realising it, consumers are effectively standing up for the opposite, a long-term supply side view orientated towards maximising productivity and incomes. At the heart of this debate are 2 fundamental truths from the economic history of the world:

The counter intuitive truth that removing trade barriers benefits an economy.

That competition works and drives up productivity and incomes. The current debate also revives other insights from economic history. Firstly, Adam Smith’s warning that business interest may not always be in the public interest. Secondly, that many of the big businesses of today are behaving the same as the big landowners of the 19th century, in opposing a trade policy liberalisation which would benefit consumers. It’s no longer about the Corn Laws, but it is about the same principle. If we want to drive up productivity and incomes in the UK, then we need to intensify competition. In the 1980s the intensification of competition at home was mainly based on domestic reforms such as privatization. In the 2020s Brexit provides the opportunity to raise productivity with the most important trade policy reform of all - unilateral free trade.

35

POST-BREXIT SPENDING Warwick Lightfoot – The UK’s EU Expenditure Page 36

The UK is a large net contributor to the EU Budget and would benefit from being able to spend better its large budget contribution were we to leave

the EU.

Kent Matthews – Dividing the Post-Brexit Dividend Page 39

Discusses how the Brexit Dividend will be divided up. Initially the government is committed to keeping flows to existing recipients. However, in the

long run, the Dividend will need to be allocated efficiently on the basis of need.

36

THE UK’S EU EXPENDITURE

Warwick Lightfoot The UK is the third largest net contributor (gross contribution less the “Thatcher rebate” less receipts from the EU) to the EU budget behind Germany and France. Of the 28 EU members, nine, including the UK are net contributors to the EU budget, and nineteen are net recipients. Contributions to the EU budget vary slightly from year to year, depending upon economic performance and currency movements. The gross UK contribution is around £17.8 billion to £20 billion and the net contribution is between £8 billion to £10 billion. The UK’s real (that is taking out the impact of inflation) net contribution to the EU budget, in 2014 prices, has risen from under £4 billion in 1978 to around £8 billion in 2015. The peak was closer to £10 billion in 2014. In the context of Total Managed Expenditure of £772 billion and UK money GDP of around £1,943 billion, the net contribution is modest but would represent 2 p on the basic rate of income tax. Some argue that we should look at the gross figure because, were the UK to leave, the government would then be able to decide how to allocate all of this money. It is not clear that the EU allocates this money in an efficient way. However, most economists would tend to look at the net contribution, after the UK receives back some of its own money. Even though the UK is a net contributor to the EU, there are areas and sectors of the UK that receive funds and, consequently, may be nervous of the potential loss of them if the UK were to leave the EU. However, such concerns overlook the fact that we give the EU the money in the first place. Therefore, some of the money we save from the EU can be redirected to these areas, if the government so chooses. Thus, in a Brexit scenario, much of the spending the UK receives back from farm policy, social funds and grants to science would have to be maintained. In which case, these areas would suffer no loss in income, and would have nothing to fear. But, there undoubtedly would be opportunities for conventional efficiency savings, improved auditing and scope to tailor spending programmes specifically to the particular circumstances of UK economic and social policy. The UK contribution to the EU budget and the receipts that are returned to it represent spending that is expensive, poorly directed, defectively audited and allocated through a process of fiscal churning. The Fontainebleau Rebate The UK’s contribution would be much greater, if it was not partially mitigated by the Fontainebleau Rebate, which was negotiated by Mrs Thatcher in 1984. It is calculated according to a formula which used to mean that the UK’s net contribution was reduced by 66 per cent, relative to what it would be without

37

the abatement. The latest edition of HM Treasury’s European Union Finances, published December 2015, Cm 9167 estimated The Fontainebleau Rebate will reduce the UK’s gross budget contribution in 2015 by £4,861 million from £17,779 million, to a net contribution of £8,473 million after £4,445 receipts from the EU (the portion of our own money being returned). The value of the rebate varies from year to year. It was worth between £3 billion and £5 billion to the UK between 2009 and 2015. Because of the manner in which the Fontainebleau Abatement operates, marginal spending on EU programmes that benefit the UK comes at a net high cost to the UK taxpayer. For example, based on the figures for 2015 above, the UK taxpayer must commit £17.8 billion (gross) or £8.5 billion (net) in order to receive £4.4 billion of receipts from the EU – a benefit/cost ratio of either 0.25 or 0.52, depending on whether the EU receipts are compared to the gross or net expenditure. The UK’s Fontainebleau Rebate arrangement has reduced the UK’s very high net contribution to the EU budget. It is a source of undiminished irritation to other member state governments, led by France, and to the EU Commission; and is periodically challenged by them. Any change to the rebate requires unanimity in the Council, which means that the UK must agree to any changes. At each major budget renegotiation and treaty change there is intense pressure for the rebate to be reviewed, reduced or eliminated. Mr Blair agreed to a significant reduction in the value of the rebate. As a result certain elements from the EU Budget are excluded from the deduction. These include EU overseas aid, and from 2009 non-agricultural expenditure in new Member States. The effect of these changes was phased in up to 2011, and largely accounts for the sharp increase in the UK’s recent net contribution. Common Agricultural Policy The inefficiency of EU spending is highlighted by the Common Agricultural Policy (CAP). Although agriculture accounts for only around 3% of the EU economy, the CAP still continues to represent almost 40% of the EU budget. It is a poorly focused mechanism for achieving UK policy objectives. In 2015, receipts relating to CAP were £2,544 million. They accounted for half of the estimated £4,445 million that the UK received back from the EU in exchange for a net contribution of £8,473 million. The rest was spent on structural and social funds. Of total EU CAP spending, 75% is spent on directly helping farms and farm businesses, and 80% of that money is paid to the top 10% of farming households by income. Within the UK, this means that the great aristocratic estates and large agricultural businesses receive the largest share (60%) of the subsidy rather than smaller traditional farming households that might be considered to merit non-market support for wider reason of social policy, supporting rural communities and helping households with low incomes. The UK has, over many years and without notable success, sought cuts in the overall EU budget supporting the CAP and tried to promote reforms that make it a more market and competition-orientated policy to help farmers prepare for a future without income support. The EU CAP subsidies (paid under Pillar 2) relate to payments for rural development programmes that benefit the wider rural economy. Across the UK, a large component of these programmes is directed at agri-environment schemes where farmers receive additional payments to enhance the environment. Outside

38

a CAP regime, these programmes would continue in some form across the UK as there are well-established mechanisms to promote environmental policy objectives. The Rural Development Policy programmes in the UK support the wider rural economy with priorities relating to tourism, rural broadband and SMEs. If the UK were outside of the constraints of the CAP, it would be able to redistribute farm spending to increase help given to lower income farming households; ensure that more money went towards correcting market failures in agriculture rather than aggravating them; and would provide scope for overall savings in spending. In summary, the message is the UK is a net contributor to the EU. Were the UK to vote for Brexit, there would be an immediate windfall gain in spite of maintaining existing support programmes, as the UK Government, not the EU, decided how to spend taxpayers' money.

39

DIVIDING THE POST-BREXIT DIVIDEND

Kent Matthews In a letter to David Davis, Secretary of State for Exiting the EU, dated 12 August 2016, David Gauke, the then Chief Secretary to HM Treasury confirmed that in the short-term all EU funded projects administered by the government will be fully funded by the Treasury including all other projects initiated while the UK is still a member of the EU. Also UK institutions participating in Horizon 2020 projects will have them fully underwritten by the Treasury and Agriculture receiving support under Pillar 1 of the Common Agricultural Policy will continue receiving this until 2020. It is important for recipients of so called ‘EU funds’ to realise is that these funds are not from the EU but from the UK taxpayer via the EU and as the same letter states that once the UK has left the EU the future of all EU funded projects will be reviewed according to the objectives of the programme and the priorities of the government. The future of resources beyond 2020 to fund projects currently funded by the UK taxpayer via the EU will depend on two important factors. First, the Divorce bill (including contributions during the transitional period), which defines the budget constraint, and therefore what is available for re-deployment. Second, the persuasiveness of the arguments forwarded by the current recipients for continued support in terms of the economic and political imperatives. The estimated UK gross contribution to the EU in 2016 is £17.0 billion. Subtracting rebates and public sector receipts the expected net contribution is £8.6 billion, double that of the contribution in 2009 and an increase of 84 per cent in real terms over the space of seven years. The expected net contribution for 2017 is £7.9 billion and the expected net contribution in 2018 and 2019 is £10.6 and £10.4 billion (Keep, 2017b). The UK, along with Germany and France were the three largest net contributors to EU funds in 2011-15 (Ayres, 2016). In 2015 the UK was the second largest net contributor and the third in terms of per head of population The estimate of the Divorce bill is very much a matter for negotiation and at this stage it is hard to put a figure on it with any precision. The EU’s Chief Negotiator, Michel Barnier, puts it at around £60 billion1 but an independent estimate by the Institute of Chartered Accountants in England and Wales puts it in the range £6-36 billion2. Given that we now know there will be a transitional period of about two years, then if we allow for both transitional contributions

1 House of Lords European Union Committee, ‘Brexit and the EU Budget, 4 March 2017, HL Paper 125 2 ICAEW, ‘Analysing the EU Exit Charge’, May 2017

40

and good-will politics, the total figure will probably be a little above £36 billion but certainly a lot less than £60 billion3. Treasury forecasts of the net contribution in 2020-21 in the absence of Brexit is an average of £10.6 billion a year, hence the UK could be contributing at the current net commitment for up to four years after formally exiting. So what does this mean for the division of the Brexit dividend? First, it means that the full dividend will be delayed – perhaps a small price to pay for a smooth transition and a tidy Brexit. Second, it means that current recipients can continue to receive some funding as part of the transitional settlement. Who are these recipients? The two main beneficiaries come under the European Structural and Investment Programme for regional, rural and social development (€16.8 billon in the 2014-20 allocation, approximately £2.1 billion a year) and farming and fisheries under the European Agricultural Guarantee Programme (€22.5 billion 2014-20 allocation, roughly £2.9 billion a year). The latter receives funds in the form of agricultural development subsidies, block grants and price support. The Commission also directly funds a number of other projects under Horizon 2020 and Erasmus+ schemes that have 3937 participants from UK universities (£877 million in 2016) through to Rolls Royce for research in energy saving aero-engines, and £234 million for various education and training projects. The Institute for Fiscal Studies estimates that receipts from the EU to non-governmental bodies is in the order of £1-£1.5 billion a year, but some of this is for joint projects with other EU institutions. It should be noted that like other non-EU countries (Norway, Turkey, Israel) the UK can have associated status in Horizon 2020 (Hubble, 2016). One of the reasons the UK gets the lion’s share of research funding is that it has more universities in the world top 100 than the rest of the EU put together. So under the most generous assumptions, the UK receives about £6 billion to support various special interest groups. Quite clearly the UK can compensate the Brexit losers from the Brexit dividend if it chose to. The important question is, does it want to and if so how should that compensation take place? Firstly, it is unclear that such funds are used in an efficient or economically productive way. Research using the European Commission’s QUEST model has shown the effectiveness of structural and regional funds on GDP is negative in eight EU countries, of which the UK is one (HM Government, 2014, p.47, Table 3). As Open Europe has pointed out, if one looks at EU cohesion funds, "Most of the money the UK received went back to the same region from which it came" (ibid, p. 60). The UK Government's competency report on cohesion and region funding stated, "The House of Commons Communities and Local Government Select Committee was concerned that it had been so difficult to assess the value for money of European Development Regional Funds (EDRF)" (ibid). Two further questions remain. First, what is the least distortionary way for the "gainers" from Brexit - the UK public at large - to compensate the "losers" – the current interest group recipients - namely Universities, scientists, and farmers, among others? Second, can the UK government credibly commit to compensate the "losers"?

3 Julian Jessop, Chief Economist and Head of the Institute of Economic Affairs reckons a figure of £26 billion is appropriate. ‘Should the UK pay an EU divorce bill?’ BREXIT Unit Institute of Economic Affairs, 26 June 2017

41

On the first question, the least distortionary method of compensation is to provide a lump-sum subsidy that will leave production decisions unaffected by interventions. This would simply be a means of cushioning the financial impact on those recipients who have grown dependent on funds disbursed by the EU. As stated in HM Government 2017, “leaving the EU offers the UK a significant opportunity to design new, better and more efficient policies for delivering sustainable and productive farming, land management and rural communities” p41. One other benefit of removing distortionary subsidies is that as the margin of cultivation recedes, the UK agricultural sector’s reliance on 75,000 seasonal harvest workers (McGuiness and Garton-Grimwood, 2017) from the EU will recede. The second question is harder. There is no credible way a future government can pre-commit to spend the Brexit-dividend in the way the EU currently does. This is particularly so as research suggests that many of the EU projects are inefficient and not allocated in the right areas or for the right reasons. It may be politically defensible to promise the losers in the short term that they will be protected but in the longer term this will have to be balanced against how the resources may be better used. In a democracy each lobby group would make their case to government, which will be balanced against the greater good. After all, that is how a democracy works. References Ayres S (2016), ‘UK Funding from the EU’, House of Commons Library, Briefing Paper 7847, 29 December 2016 HM Government, (2017), ‘The United Kongdom’s Exit from and New Partnership with the European Union’, Cm9417, February 2017 HM Government, (2014), ‘Review of the Balance of Competences between the United Kingdom and the European Union Cohesion Policy’, summer 2014. Hubble S (2016), 'The Impact of Leaving the EU on Higher Education', House of Commons Library, Briefing Paper 7483, 13 December. Keep M (2017a), ‘A Guide to the EU Budget’, House of Commons Library, Briefing Paper 06455, 30 January 2017 Keep M (2017b), ‘The UK’s Contribution to the EU Budget’, House of Commons Library, Briefing Paper 7886, 12 June 2017 McGuiness T and Garton-Grimwood G (2017), ‘Migrant Workers in Agriculture’, House of Commons Library, Briefing Paper 7987, 4 July 2017

42

MIGRATION

Paul Ashton, Patrick Minford and Neil MacKinnon – The Economics of Unskilled Immigration Page 43

Show calculations for the cost of unskilled EU immigrants to existing citizens and the taxpayer

Neil MacKinnon – Immigration Page 45

The EU's freedom of movement rules prevent the UK from controlling immigration from the EU, much of it of unskilled workers. To control total

migration, the UK must restrict non-EU immigration unreasonably. Only outside the EU will the UK be able to obtain the mix of immigrants with the

skills it needs within a reasonable total.

43

THE ECONOMICS OF UNSKILLED IMMIGRATION

Paul Ashton, Neil MacKinnon and Patrick Minford No one is arguing, from Leave or anywhere else, that we should restrict skilled immigration: the Leave proposal of introducing a ‘green card’ or skill-based points system would deliberately leave overall skilled immigration untouched, while tightening up on uncontrolled unskilled immigration from the EU, treating it as we now do unskilled immigration from the non-EU. Thus the net benefits from skilled immigration would remain the same and it would be unskilled EU immigration that would fall. Hence the key question about immigration is what are the costs of unskilled immigration, which would be the target of the green card system. This has been widely neglected in the referendum debate. We show in a recent paper (Ashton et al, 2016) that under the UK’s welfare system an unskilled migrant worker on the minimum wage costs the taxpayer in the region of between £57 (for a single person) and £29000 a year (for a worker with a family). Estimates on the data available suggest that with the current population of 3 million EU migrants the cost to the average UK worker of supporting EU unskilled migrants could be around £2 a week; each adult unskilled EU immigrant costs the UK taxpayer on average £3500 per annum. For workers in an area with a dense migrant population such as Leicester the cost to local taxpayers could rise to £6 a week. There is no mechanism for spreading the cost burden evenly across the country because welfare resources are mainly provided locally. However the key point is that within the EU there is no upper limit to the inflow of unskilled migrant workers from the rest of the EU. This cost could escalate without limit therefore. Every million extra unskilled adult immigrants we admit in the future adds these costs over again. Everyone understands the politics of this problem. However, Economists for Free Trade believe that the economic losses involved have not yet been properly appreciated. The basic point is that modern developed economies with advanced and costly welfare states provide benefits well in excess of the low tax take from unskilled workers; indeed these workers may receive more in tax credits than they pay in taxes and thus contribute negatively to the welfare benefits in kind that the state provides to them. What is required is a system of migration control that meets the skill needs of the economy while properly limiting the drain on the economy from unskilled immigration. Essentially this should be the same for EU citizens as the one already applied by the UK to non-EU citizens. Reference

44

Paul Ashton, Neil MacKinnon and Patrick Minford (2016), ‘The economics of unskilled immigration’, September 2016, downloadable from www.economistsforfreetrade.com

45

IMMIGRATION

Neil MacKinnon The contentious issue of immigration has its roots in the decision of Prime Minister Tony Blair to allow uncontrolled immigration into the UK in the early years of the Labour government (2004). Recently, immigration has become a more contentious and controversial topic throughout the EU in the light of the migrant crisis. German Chancellor Angela Merkel’s “open-door” policy on migrants has proved contentious with many. As far as voters are concerned, it is shaping attitudes towards the EU in an unfavourable way. The rise of anti-euro, anti-austerity parties throughout the EU in recent years has been well-documented and highlights a growing gap between the EU’s creditors and debtors and between “north” and “south”. Now the migrant crisis, perhaps the greatest challenge facing the EU in its history, adds to those political uncertainties and threatens an upheaval of the political status quo in the EU, especially ahead of the French and German national elections in 2017. The EU deal with Turkey is controversial and can only add fuel to the debate which, at its heart, is the ability of a country to control its own borders. The Schengen agreement, which had dismantled internal border controls between 26 of the 28 EU countries, and was a symbol of the EU’s ambition to become a super-state, is now under serious threat. The migrant crisis has exposed this vulnerability and not surprisingly resulted in some EU countries closing their borders. The distinction between migrants and refugees has become blurred through the EU’s mishandling of the situation. Immigrants can be seen as people moving from another EU state or those coming from outside the EU. Immigration data also includes nationals returning home. The latest comparable EU wide data relates to the start of 2014. Then, the largest number of immigrants were found in Germany (7.0 million), U.K. (5.1 million) and Italy (4.9 million). The largest number of non-EU immigrants were found in Germany, Italy, France, Spain and the UK (2.4 million). The highest number of immigrants from another EU state were in Germany, followed by the UK (2.6 million), followed by Spain. In terms of actual numbers, it is these countries that see the biggest inflows. In relation to the size of the overall population, the highest recipient is Luxembourg, at 45%. In the larger economies, immigration is 8.7% of the total population in Germany and 7.8% in the UK. Migration Watch estimates that net migration plus births to foreign born parents has accounted for 85% of UK population growth since 2000. If net migration continues at recent levels, the UK’s population is expected to rise by 8 million over the next 15 years (see the latest migration statistics here). In mid-2015, the UK population was estimated at around 65 million with net migration averaging 242 thousand over the previous 10 years. In the period 1995-2011, it is estimated the cost of immigration to the Exchequer amounted to over £100 billion (see other updates on fiscal costs here).

46

Drawing clear-cut conclusions on the economics of migration can sometimes be difficult, but most economists would argue that free mobility of labour - like free trade - is a positive for the economy. Indeed, controlled immigration can have net economic benefits. But uncontrolled and unrestricted waves of immigration may have adverse political, social and economic consequences. It goes without saying that this creates the potential for social division, as well as pressure on the UK’s infrastructure and ability of public services to handle fiscal provision for migrants. Not all migrants will be skilled or professional labour and indeed some unskilled migrants may be “unemployable”. The assumption in many studies on the economic effects of migration is (wrongly) that migrants have the same economic characteristics as UK nationals in terms of productivity, employment, earnings etc. A Bank of England report published in December 2015 found that increasing migration put downward pressure on wages, particularly in sectors already experiencing low wages (there was little difference in the impact on wages between migrants that were from the EU or non-EU). In the semi/unskilled services sector, the study found that a 10% point rise in the proportion of immigrants was associated with a 2% reduction in pay levels. The counter-argument is that a restriction in labour supply through a restriction of immigration will force wages up though so far the evidence to support this is thin. The G20, in its recent Staff Analysis, observed that the impact of “refugees” on medium to long-term growth and on the public finances depends on “how effectively they can be integrated into national labour markets”. A “slow integration” scenario using the IMF’s EUROMOD model showed increasing government debt-to-GDP levels at a time when there are many Eurozone economies that already have debt-GDP ratios above 100%. The House of Lords Select Committee on Economic Affairs found that the net impact of immigration on the UK economy was minimal, in terms of GDP per head. Professor Rowthorn highlighted this in his December 2015 study with unskilled workers “likely to have suffered some reduction in their wages due to competition from immigrants." The Committee made the point that “the issue is not whether immigration is needed but what level and type of immigration is desirable”. In this context, net immigration from the EU - which we expect to remain positive - cannot be controlled. As a member of the EU, the UK cannot prevent anyone from another member state deciding to move to the UK and live here. If the UK government tries to limit the number of overseas citizens coming to live and work in the UK, it can only attempt to do so by limiting inflows from non-EU countries. For instance, non-EU students who study in the UK find it hard to get a visa to work upon completion of their studies. The migrant crisis has exposed the EU’s dysfunctionality in terms of its inability to respond with a coherent policy on immigration. The Schengen system of passport free travel is now effectively dead. Therefore, as far as the Brexit debate is concerned, our thesis is that we must take back control of our own borders for political, economic and security reasons and take back responsibility for setting UK immigration policy. The recent negotiations between PM David Cameron and the EU focused on the payment and eligibility for migrant benefits. Proposed curbs still have to be agreed by the European Parliament but the so-called “emergency brake” might actually have little effect. Unfortunately, the debate over immigration as a

47

key public policy issue has not been helped by a lack of transparency and honesty that has plagued government attitudes to immigration in recent years. Brexit campaigners are not talking about stopping migration altogether but rather about bringing back control from the EU on migration policy (and having the ability to impose selection criteria rather retain existing work and residency rights for EU citizens) and taking control of its own borders, consistently with its economic interests in the longer term. References

The Refugee Surge in Europe: Economic Challenges, IMF Staff Discussion Note, January 2016 Group of Twenty Global Prospects and Policy Challenges, 26-27 February 2016 The House of Lords Select Committee on Economic Affairs The Economic Impact of Immigration, April 2008 The Costs and Benefits of Large-Scale Immigration, Professor Robert Rowthorne, Civitas, December 2015 The impact of immigration on occupational wages: evidence from Britain, Stephen Nickell and Jumana Saleheen, Bank of England Staff Working Paper No 574, December 2015. The impact of in-work benefit restrictions on EU migrants to the UK, MigrationWatch UK, 23 February 2016 Project unclear: Uncertainty, Brexit and migration, www.migration observatory.ox.ac.uk, 10 March 2016 http://ec.europa.eu/eurostat/statistics-explained/index.php/File:Non-national_population_by_group_of_citizenship,_1_January_2014_(¹)_YB15.png

48

IMPACT ON SECTORS David Blake – Brexit Can Herald a New ‘Golden Era’ for the City of London as a Global Financial Powerhouse Page 50

Reviews the position of the City in world markets noting that the EU’s best interests are served by continuing to use its services. Meanwhile, by creating its own regulatory order the City, will expand its markets worldwide

Patrick Minford and Edgar Miller – WTO Option Implications for Manufacturers Page 53

Reviews the post-Brexit situation of manufacturing and the car industry in particular. Shows, when the Brexit devaluation is taken into account, these industries will have increased profits that will cushion their efforts to raise productivity in the long run as EU protection is ended and the exchange rate returns to normal.

Patrick Minford and Edgar Miller – A Brief on the City after Brexit (written Submission to House of Commons International Trade Committee)

Page 57

Analyses the relatively minor impact the potential loss of passporting will have on the City, the practical impact potentially hostile EU actions might have, post-Brexit economics for the City, and the City’s future role as a World Financial Centre. Concludes the City has little to fear from Brexit

49

50

BREXIT CAN HERALD A NEW ‘GOLDEN ERA’ FOR THE CITY OF LONDON AS A GLOBAL FINANCIAL POWERHOUSE

David Blake The City Of London Is Very Important The banking, asset management and insurance sectors contribute 8% to the UK’s Gross Value Added and 75% of the UK’s trade surplus in services. The UK has the world’s fourth largest banking sector – with 17% of all international bank lending, more than any other centre – the third largest insurance sector and is second for assets under management at £6.2trn. The UK’s financial services industry is of great importance to the EU with around 40% of UK net financial services exports going to the EU: 60% of the EU’s capital markets business is conducted through London and UK banks are the biggest source of cross-border lending to EU banks and corporates with more than £1.1tn of loans outstanding. What Does The City Want And Why What It Wants Won’t Work And Is Also Unnecessary? One of the City’s two key demands for the Brexit negotiations is access to the single market – via passporting. The other is access to Europe’s best labour talent. However, the City’s wish to preserve passporting is ‘completely unexecutable’, according to Barney Reynolds (2016). This is because it would require the UK to stay in the Single Market and accept the EU’s burdensome regulations which have become overly prescriptive since the financial crisis. The UK would also have to sign up to the authority of EU supranational bodies such as the European Banking Association and the European Securities and Markets Authority,

and be subject to interpretations issued by the European Court of Justice. It would also have to accept free movement and make financial contributions to the European Budget. What Are The Alternatives To What The City Wants? There are two main alternatives. The first is the enhanced equivalence model under MiFID II from January 2018. This covers the entirety of investment businesses, including banks doing their investment business, but does not import the ‘four freedoms’ or other concessions on sovereignty. It involves the UK (while maintaining equivalence): removing the most unnecessarily onerous requirements; moving away from the EU's process-focused approach to one based on outcomes; re-drafting laws in common law style, which would bring far greater certainty and clarity compared with the ‘purposive’ method of interpretation in the EU; moving away

51

from poor ECJ decision-making in the financial services context, which is insufficiently focused on fact-based analysis; and removing laws designed to provide for the EU Single Market. However, the enhanced equivalence model might not be achievable because plugging any gaps in the existing equivalence regimes may not be politically acceptable to the EU and the equivalence-based approach may be unattractive for certain areas – such as the regulation of alternative investment funds – due to the high degree of conformity with EU laws. In this case, Reynolds argues that the UK should adopt the go-it-alone Global Financial Hub model. This gives the UK freedom to design a more attractive regulatory framework, freed of the EU’s restrictive policy and process-driven approach, based on global standards. Not only would such a model attract business and liquidity to the UK, it would liberate financial services from the burden and increasing uncertainty of EU regulation The UK would reconsider its entire regulatory framework. This would involve: removing the particularly burdensome rules that could not be removed under the enhanced equivalence model; a complete shift from the EU's process-focused approach to a more tailored approach based on outcomes; a comprehensive scrutiny and re-draft of laws in common-law style; and a complete shift from poor ECJ decision-making in the financial services context with reasoning that operates sometimes by omission, and is insufficiently focused on fact-based analysis to provide the clarity that the common law brings with it. The issue of skills can be dealt with through a visa system for skilled labour. Conclusion Brexit is a golden opportunity for Britain*. It is also a golden opportunity for the City of London to escape the clutches of the EU as a global financial hub and take the lead in the new digital revolution of fintech and blockchain. Let us not forget, we have been here before, as Stephen Alford (2017) reminds us. In 1553, London merchants funded a naval expedition to China via the North East passage. It got trapped in the ice in Russia’s White Sea and was forced to travel overland to Moscow where Ivan the Terrible granted it exclusive trading rights. The group returned to London to set up the Muscovy Company. This became the model for future trading ventures in Africa, the Levant, Canada, the East Indies, Virginia and the Caribbean. In less than 100 years, the UK became the most outward trading nation in the world. London was transformed from a small European trading centre into a global financial hub. This same will happen again after Brexit. *For a more in-depth analysis of the City after Brexit, see David Blake (2017)

52

References Alford, Stephen (2017) London’s Triumph, Allen Lane Blake, David (2017) Brexit and the City, Economists for Free Trade; https://static1.squarespace.com/static/58a0b77fe58c624794f29287/t/58ca91f8e58c62741806e682/1489670684557/Brexit-and-the-City.pdf Reynolds, Barnabas (2016) A Blueprint for Brexit: The Future of Global Financial Services and Markets in the UK, Politeia; http://www.politeia.co.uk/wp-content/uploads/2016/11/Barnabas-Reynolds-A-Blueprint-for-Brexit-2.pdf

53

IMPLICATIONS OF THE WTO OPTION FOR MANUFACTURERS

Patrick Minford and Edgar Miller From a national macroeconomic perspective, as argued elsewhere in this pamphlet , it is clear that the optimal strategy from the country’s economic perspective and that of consumers is to embrace unilateral-free-trade and, if an attractive FTA with the EU is not forthcoming and the EU raises import tariffs against us, we should not raise imports tariffs against them. But, what about the perspective from producers? Is this a zero-sum-game in which, if the country prospers, producers cannot? In the sections below, we evaluate the post-Brexit prospects of two sectors that are often cited as post-Brexit victims – manufacturing and financial services. Allowing High-Value-Added Manufacturing to Thrive During our membership of the Single Market, manufacturing as a share of UK employment has fallen from around 35% to 8%. It is a dangerous fallacy to believe either that the EU has been good for UK manufacturing or that today’s diminished manufacturing status quo would somehow be preserved in aspic were we to stay in the EU. It is furthermore worth noting that this is not a “British problem” relating to free market economics. France, which has had mainly interventionist and socialist policies for the last thirty years, has had an almost identical re-balancing of its economy away from traditional manufacturing. Looking to the future, analysis at both the macroeconomic and sectoral levels confronts the myth that manufacturing cannot deal with the elimination of EU protection. The manufacturing sector will benefit massively in the short to medium-term from the post-Brexit fall in Sterling, giving it a useful transition period in which to raise its productivity to the degree needed to offset a more competitive home market and the impact of any EU import tariffs. This would continue the long term trend of going up the value-added chain to a more hi-tech industry as already demonstrated by JLR, Dyson, and JCB. Macroeconomic Perspective. The WTO Option in our World Trade Model assumes that initially, following the loss of EU protection, UK manufacturing prices will fall by 20% in the home market compared with current EU prices but eventually over, say 10 years will settle to 10% lower than prices within the EU. This is because the EU is assumed to follow a slow trend towards reduced protectionism. It also assumes that our exports to the EU face the current EU MFN tariff but that a general pro-business industrial strategy support package is put in place by the government to allow industry to absorb this without putting up EU prices. The Sterling exchange rate has fallen about 15% post-Brexit: Cardiff-macro-models suggest this could continue for around five years but Sterling is likely to revert to its pre-referendum value within a decade. Under these assumptions, we can assess the effects on the manufacturing sector’s profits as shown in detail in Appendix B.

54

The total manufacturing home market is around £100 billion; total manufacturing exports to the EU are around £110 billion and to the ROW about the same at £115 billion. So, for five years, as shown below, manufacturing makes profit gains of £25 billion, on total gross value added of about £160 billion equating to 16% extra gross margin on value added.

55

Home Market EU Market ROW Market

(£100 bn) (£110 bn) (£115 bn) TOTAL

Price Impact -20% 0 0

EU Tariff Impact 0 -3.5% 0

Sterling Impact +15% +15% +15%

TOTAL -£5 bn +£12.6 bn £17.2 bn +£25 bn

After a decade, assuming the exchange rate reverts to the pre-Brexit level, manufacturing profit declines by £14 billion, or a 9% reduced gross margin.

Home Market EU Market ROW Market

(£100 bn) (£110 bn) (£115 bn) TOTAL

Price Impact -10% 0 0

EU Tariff Impact 0 -3.5% 0

Sterling Impact 0 0 0

TOTAL -£10 bn -3.8 bn 0 -£14 bn

Thus, for five years, manufacturing will enjoy a transition period with higher than pre-Brexit profits due to the exchange rate. During this time, it can focus on raising productivity so that it can, at least, maintain pre-Brexit profitability when the beneficial effects of lower Sterling run out. This would require a once-off labour productivity increase of only around 9% - or an annual productivity improvement on the order of 0.9% a year. This compares with average manufacturing labour productivity growth since 1970 of 2.9% per annum. This seems to be something the industry can easily take in its stride, continuing its march ‘up the value-added chain’ towards a hi-tech manufacturing sector. Some may say that it is not correct to include this 0.9% productivity increase since manufacturers would have achieved it in any case. However, we believe this required productivity increase is a small portion of the productivity gains normally achieved and is likely to be subsumed by extra productivity gains enabled by leaving the EU. Furthermore, the above analysis does not explicitly account for lower input prices resulting from the elimination of import tariffs

56

or opportunities for UK manufacturers to source less expensive components from ROW suppliers (the auto manufacturing analysis below does take these factors into account). Sectoral Perspective. How does the national macroeconomic scenario work out at the level of a specific industrial sector – for example, auto manufacturing? This industry is often cited as being a major victim of Brexit given that it exports over half of its product to the EU and imports more than a third of its purchased goods from the EU. In Minford and Miller (2017) Appendix D, we show a detailed calculation for a prototypical auto manufacturing company illustrating how it will fare under the WTO ‘tit-for-tat’ option, as well as under the WTO Zero Tariff option in the short, medium, and long-term. This analysis strongly confirms the conclusions of the macroeconomic analysis above and, in fact, demonstrates that the UK automobile manufacturing industry has nothing to fear from Brexit. Indeed, under post-Brexit WTO rules, it can prosper, even without any government support to offset EU import tariffs:

In the short-term, under the ‘WTO ‘tit-for-tat’ option, the industry would increase its profits because it would be partially protected from import competition. However, this analysis does not account for potentially disruptive effects on supply chains.

With WTO Zero Tariffs, the industry would suffer a marginal decrease in short-term profitability as the effects of increased import competition slightly overwhelm the beneficial effect of Sterling’s devaluation. However, profitability improves markedly over the medium and longer term - even if Sterling regains its pre-Brexit parity - due to (easily achievable) labour productivity improvements and the opportunity to source components outside of the EU at better value.

Note that both of the above analyses are “static” – ie, they implicitly assume there is no volume growth, no new products, no changes in technology (eg, no electric or driverless cars), no regulatory improvements, and so on. Because of this, we believe the conclusions understate the positive opportunities available to UK manufacturing outside the EU. We believe UK manufacturing can thrive. Reference Patrick Minford and Edgar Miller (2017) ‘What shall we do if the EU will not play ball?’ downloadable from www.economistsforfreetrade.com

57

A BRIEF ON THE CITY AFTER BREXIT

Written Submission to House of Commons International Trade Committee 21 December 2016

Economists for Brexit

This submission provides additional support to our oral answers on November 29th to the question, “Why do you think there are not great risks on losing

passporting rights outside of the Single Market?”.

There is much misunderstanding of the City’s prospects after Brexit. Some Remainers suggest that the City (ie, the UK’s financial services sector) could be hit

by large-scale relocation of banks and other financial houses to the Continent as large amounts of EU business are lost. This is quite wrong. These concerns

- principally obsessing about the potential loss of Passporting - have neglected to take into account the degree to which Passporting matters, fail to see the

nature of potential EU protectionism in perspective, do not appreciate the City’s strong position in the global financial services market, and have dismissed

the advantages of the City’s enhanced freedoms outside the EU.

We conclude that the City - rather than concentrating on maintaining a relatively unimportant regulatory feature (Passporting) - should instead embrace a

post-Brexit future as a World Financial Centre establishing its own financial regulatory regime attuned to the requirement of global financial markets.

This submission should be read in conjunction with The Economy after Brexit 1 published by Economists for Brexit in April this year.

The Importance of Passporting

It is essential to understand that only a start has been made in regulating trade in services within the EU – known somewhat misleadingly as the ‘Single Market

in Services’. In reality - essentially - there is no single market in services to leave. The vast bulk of service regulation hitherto has been done by national

governments; EU actions so far have been mainly limited to financial services. The main achievement in terms of trade protection has occurred in financial

services with ‘Passporting’ – ie, reducing national barriers so as to reduce the existing level of protection exerted by nation states.

Passporting – a series of rules and regulations within the Single Market provided via such regulations as MIFID I & II, CRD IV, and AIFMD - provides sector

specific relief from some, but not all, of the national barriers erected over the years by EU countries. The assertion that the success of the City is based on

full and complete “access” to the EU’s financial services markets because of Passporting is not true. In some sectors, the Passport is important to doing

business and others it has much less importance or none. Even equipped with Passports, national regulations must often still be met by financial services

58

firms wishing to do business across EU county borders. In sectors where Passporting provides little value (eg, insurance), City firms have long since developed

ways of working around the problems.

Importantly, because UK national protection of services is minimal, Passporting has had no observable effect on the demand for UK financial services or

prices; but has enabled more penetration of EU markets by UK suppliers. In terms of product regulation, more has been done, but as we argue below much

of it is potentially damaging to the interests of the City as the world’s leading financial centre not always to good effect [can we make a more emphatic

comment about this?] - see Congdon, 2014.

Critically, analysis of reports published by Oliver Wyman and Open Europe and discussions with City practitioners suggest the amount of City business that

might be lost as a consequence of losing Passporting rights is relatively small. The insurance and asset management sectors have little business at risk because

insurance companies – given there is no EU single market in insurance – already conduct most of their EU business through subsidiaries and most EU asset

management business is already managed in the UK via the international norm of “delegation of managed assets”. Lloyds of London has stated publicly that

only 4% of their business is EU-related and we understand from Lloyds’ practitioners that this business has low profitability. Only Businesses Business?

Banking and some parts of Investment Banking have any significant revenue [too much use of ‘business’ here…] at risk.

Thus, we estimate –based on discussions with City practitioners and analysis of figures from the Oliver Wyman and Open Europe reports - that only about 9%

of total City revenues is potentially at risk from loss of Passporting rights (see Table A). In practice, the true “at risk” figure is likely to be even lower because

the 9% figure implicitly assumes that Passporting provides comprehensive coverage of all Banking business, which is not the case.

For this “at risk” business to be lost, one would have to assume post-Brexit that (a) all Passporting rights would be lost, (b) none of the “passported” rights

lost would be compensated by the continuation or evolution of “Equivalence” schemes, and (c) that centuries of City creativity and innovation would not be

able to discover “work-arounds”. If even half of this “at risk” business were to be lost, the potential impact on City revenues would be only about £8 bn

confusing you mean 41/2%!! . Experienced City practitioners find it very difficult to imagine losing half of these “at risk” revenues.. Losing a quarter of these

revenues amounts to about £2 bn of revenue. To put this into perspective, UK auto manufacturing industry revenue in 2015 was £ 72 bn and 44% of UK

manufactured cars were exported to the EU.

This result contrasts sharply with garish headlines claiming that more than £50 bn of City business could be lost – stemming largely from the Oliver Wyman

report produced for City UK. This report assumed an unlikely scenario they called, “Low Access”, in which the City would lose essentially all its access to EU

markets and this impact would be almost tripled by the loss of supporting jobs – primarily in IT and data provision services. We have not met any City

practitioners who believe this.

59

Oliver Wyman also produced a more realistic access scenario but did not publish the result. We understand, on good authority, that this was because the

result was “not bad enough”. The full report has not been made public and circulation of it has been so severely restricted that even individuals in CityUK

who worked on the report have not been allowed to see it.

Potential EU Hostility in Perspective

A key concern by those who worry about the loss of Passporting is the threat that, post-Brexit, the EU will resort to hostile behaviour toward the City; for

example, taking an unreasonably aggressive line with regard to granting Equivalence to City firms that, in principle, should alleviate the loss of Passporting

rights. Such equivalence schemes have already been granted to third countries.

But how threatening is the possibility that the EU will act in such a protectionist way towards the City after Brexit? There are, at least, two major factors to

consider:

Maastricht and Free Capital Mobility. First, the EU has traditionally sought to act in a non-discriminatory way towards capital markets around the

world. It awards ‘equivalence’ to other countries – ie, many EU financial services laws allow financial institutions in third countries to access the single

market if the third-country's laws are deemed "equivalent" to the EU's in a relevant area. Institutions from a number of other countries enjoy this

status under various pieces of existing EU legislation, including companies incorporated in the US, Japan, Singapore, Switzerland, Canada, Mexico and

others (see Reynolds, page 5 and Annex C). The reason for this approach is that under the Maastricht Treaty the EU has aimed for free movement

of capital and it also participates in the Bank for International Settlements, which aims similarly to ensure that financial markets remain open and

non-discriminatory.

London as Europe’s Investment Banker. It is a well-known fact that there are significantly more “Inbound” Passports awarded to EU financial services

firms’ desiring to do business in the UK than “Outbound” Passports to UK firms. This reflects the importance of the City as the financial centre of

Europe, and the world. If Passporting were to be eliminated and no “equivalent” regime substituted, it is difficult to see how EU corporate and

sovereign capital demands could be met. It is virtually impossible to imagine that the minor financial centres of Frankfort (19th in the world just

between Dubai and Vancouver), Paris (29th in the world just behind the Cayman Islands), or Amsterdam (33rd in the world tied with Calgary) could

ever fulfil Europe’s financial needs.

Thus, in addition to the potential loss of Passporting not being material to either the City’s or the country’s interest, there is some reason to believe that

ultimately the EU will not adopt a hostile posture toward the City that would go against some of its fundamental principles and would be self-harming.

60

The Fundamental Economics of the City Outside of the EU

An important omission by those obsessed with Passporting and all the technical details of it, is failure to understand the underlying economics that will drive

the City’s future success.

The City’s Future Size. After Brexit, the City is likely to expand as EU protection is removed and UK resources move towards the UK’s central area of

comparative advantage - traded services, with the City as the prime element of these. Our research, based on a long-proven world trade model, suggests

that the City is likely to expand on the order of 10% over a decade or so purely on the basis of economic fundamentals. It is mistaken to think that the size of

the City depends on demand for its services; it depends instead on the availability of UK resources, especially of skilled labour (it uses relatively little unskilled

labour) and available office sites, as capital can flow in from around the world. Think how the City expanded after Big Bang; this happened because new

powerful banks and other operators moved into London, boosting available supply and lowering its cost base. Brexit will redirect resource supply to the City.

Regulation Pre and Post-Brexit. A key element in the City’s ability to supply the right services at low cost is the regulative system it faces. What often is

missing in the discussion about Passporting and attendant suggestions that the City should attempt to maintain its Single Market status in one form or other,

is the negative impact that future EU regulatory actions are likely to have on its ability to prosper and compete with its real competitors – New York, Singapore,

and Hong Kong. EU regulations brought in over the past ten years or so have been of uneven quality to say the least The EU, in fact, is currently threatening

the City with a variety of hostile actions such as the Financial Transactions Tax, which is still alive and kicking. Its bonus caps have also been a nuisance, while

in general it has a fussy and over-prescriptive approach. Now that the traditional regulative authority over the City - the Bank of England - has been restored,

much better regulation than the EU is likely to be forthcoming. Brexit will therefore strengthen the quality of regulation, an essential element in the

expansion we predict for the City.

Potential Trade Diversion by the City. Last and by no means least, there is the position of the City in world markets to be considered. As mentioned earlier,

the size of the City depends on its available supplies, not on its potential demands. The latter are virtually infinite compared with the City’s size, remembering

that the UK, while one of the world’s larger economies, has only around 3% of world GDP. No UK business sector, including the City, can as a whole supply a

lot more than this fraction of the world’s markets for their products. Because of the UK’s comparative advantage in financial services, the City might supply

somewhat more – say, 6% overall. If the EU employs protection to reduce UK financial services sales in its countries, all this does is divert demand from UK

to EU suppliers without affecting overall EU demand for financial services in total; thus world prices, which depend on the overall balance of demand and

supply across all world markets, will remain unchanged. UK financial services output will also therefore be the same in total; and so output not sold in the

EU will be diverted in the long term to other world markets - a process known as ‘trade diversion’. While there are some adjustment costs involved, these

61

are short term and are relatively trivial when set against the massive long term, permanent gains to the City from Brexit (see Reynolds (2016) and Minford

(2016)).

The City’s Future Role as a World Financial Centre

For all the reasons explained above, the City will thrive after Brexit, continuing as the world’s leading financial centre and expanding further. The Bank of

England should have the confidence to grasp the regulative challenge and simply ignore EU protectionist threats; these have little credibility and, in any case,

if carried out would lead only to losses within the rest of the EU. Such actions would reduce their ability to access the most competitive financial services.

This notion of serving as a World Financial Centre establishing its own regulatory regime compatible and competitive with global financial services markets

has been carefully argued and set out by Barnabas Reynolds in a Politeia paper, A Blueprint for Brexit. We believe it merits careful consideration.

References:

1. The Economy after Brexit, Economists for Brexit (2016). Downloadable from www.economistsforbrexit.co.uk

2. The City of London in Retreat, Congdon, Tim (2014). The Bruges Group, www.brugesgroup.com

3. The Impact of the UK's Exit From the EU on the UK-Based Financial Services Sector - Oliver Wyman

4. How the UK Financial Services Sector Can Thrive After Brexit - Open Europe

5. A Blueprint for Brexit: The Future of Global Financial Services and Markets in the UK, Reynolds, Barnabas (2016). Downloadable at

www.politeia.co.uk

6. Trading Places- Consumers versus Producers in the New Brexit Economy, Minford, Patrick (2016). Downloadable at www.politeia.co.uk.

Table A: The Impact of Passporting on Financial Services Revenu

TABLE A: THE IMPACT OF PASSPORTING ON FINANCIAL SERVICES REVENUE

REVENUE 3 EU-RELATED REVENUE

Passport Coverage

EU-RELATED REVENUE AT RISK DUE TO LOSS OF PASSPORTING

£ bn % Oliver Wyman 4 EfB

Assumption* £ bn Per

Cent Of Comment

62

SECTOR £ bn % £ bn %

Total Industry Revenu

e

Banking 109 64% 25 23% 13.8 13% 14

(Max) 7.6% Represents the maximum

amount at risk because Passporting does not

comprehensively cover all sub-sectors of banking

Sales/Trading 30 4.5 15% Yes

Investment Banking 11 2.8 25% Yes

Retail & Business Banking 62

Retail (Say, 50%) * 31 0 Nil No Virtually no EU-related business

Business (Say, 50%) * 31 6.2 20% Yes

Private Banking & Wealth Management 6 0.3 5% Partial

Insurance 40 23% 4 10% 4.0 10% 0.5 0.3% Only 13% of EU business is potentially vulnerable because

87% of EU business is conducted via European

subsidiaries as a consequence of no Single Market existing for insurance services 4. (Possibly

none is vulnerable as passporting generally is not

employed)

Domestic Retail & Commercial 28 No

Corporate & Speciality 9 No

Reinsurance 3 No

Asset Management 22 13% 6 25% 3.3 15% Partial 1.1 0.6% Two-thirds of EU assets

managed in the UK are done so

via delegation, in line with

international norms, and

therefore not directly reliant on

the passport 4

TOTAL 171 100% 35 20% 21 12% 15 9%

1 * EfB assumption based on discussions with City practitioners

63

TRADE NEGOTIATIONS

Kevin Dowd – When Bargaining with the EU, the UK Should Call the EU’s Bluff Page 64 Examines why, using simple game theory, it is necessary for the UK to be willing to walk away if it is to negotiate a satisfactory trade deal with the EU.

Graeme Leach – Forget Trade Deals: Unilaterally Tearing down Our Trade Tariffs Would Be Britain’s Berlin Wall Moment Page 66

Sets out the moral case for unilateral free trade

Martin Howe – Why a ‘Soft Brexit’ is Anything but Soft Page 68 Explains why a ‘soft Brexit’ is not a possible route for Brexit

Liam Halligan – Clean Brexit Can Avoid the Cliff Edge Chaos Page 70 Notes the logic of a ‘clean Brexit’

John Whittaker – Brexit Negotiations Page 73

Looks at the motives of the players in the Brexit negotiations and reasons that, despite all the media noise and political posturing, a successful Brexit will happen because this is in everyone’s interest.

64

WHEN BARGAINING WITH THE EU, THE UK SHOULD CALL THE EU’S BLUFF

Kevin Dowd The EU’s bargaining position on Brexit is a case study in blackmail, and the UK should have no truck with it. They have demanded that the UK agree to a budgetary deal before discussions on trade matters can even start. If the UK does not resist this demand, then the EU wins the negotiating game and the outcome is guaranteed to be a bad one for the UK. Their EU’s reasoning goes as follows. They assume that the UK needs a trade deal, which would take time to negotiate. Since the UK wants a trade deal, the ticking clock would pressure the UK to accept a hard bargain on the budgetary issue. Once the EU has the budget deal it wants, it would be a strong position on the trade deal too, because the British would have fewer cards left to play. The intent is to maximise the price that Britain pays to leave: the UK must not benefit from Brexit, they say. I say that the UK should stand firm and call their bluff. The EU’s strategy is based on a flawed assumption: it assumes that the UK has to make a trade deal, and that the EU’s bargaining power comes from its ability to withhold any such deal to bring the UK into line. The reality is that the UK can always walk away: no deal is better than a bad deal. With no trade deal, the UK would be free to establish free trade with the rest of the world, and there are big gains to be had from the UK ending EU protection of food and manufactures: consumer prices would fall by maybe 8% and GDP would rise by maybe 4%. A trade deal would be nice to have, but the UK doesn’t need it and definitely don’t want a bad one. The EU’s strategy then unravels, as there is no reason for the UK even to come to the bargaining table in the first place and the EU has no means of forcing it to. Given however that the UK government has (unwisely) already agreed to talk about the budget before trade, then they should take a hard line: they should insist that nothing is agreed until everything is agreed, they should restrict budgetary discussions to methodology only and not discuss numbers until and unless there is progress on trade and other issues. They should also make it clear that UK contributions to the EU budget and the jurisdiction of the European Court of Justice over the UK will end on March 30th 2019 when the UK leaves the EU. Above all, they should insist that the UK will leave on that date regardless of whether there is any agreement or not.

65

For their part, MPs who support Brexit should hold the government to account and give it no room to backslide. They should make it clear that holding the government to account includes being willing to vote against it on confidence issues if the government caves in. Fiat iustitia, pereat mundus. They should make it clear that the UK is in a much stronger position than Greece when it comes to dealing with unreasonable demands from the EU. They should make it clear that for the government to give in to such demands would be political suicide. Nor should the EU be worried about future trade arrangements with the EU. The UK will always have access to European markets. Access to the Single Market does not require membership of it, and the UK will benefit enormously by freeing itself of the onerous regulations that membership of the Single Market entails. As for tariffs, the EU is welcome to impose them on the UK if wishes to. UK exporters could fairly easily absorb EU tariffs which average under 4%, especially as they are making large profits due to the fall in sterling. It is also worth pointing out that for the EU to impose tariffs on the UK would be a major act of self-harm. Their importers would have to pay more on their imports from Britain and they would disrupt their own supply chains, which are very sensitive to tariffs. But if the EU wish to hurt their own importers and risk their supply chains shifting in favour the UK, then that is up to them.

66

FORGET TRADE DEALS: UNILATERALLY TEARING DOWN OUR TARIFFS WOULD BE BRITAIN’S BERLIN WALL MOMENT

Graeme Leach

The Aussies are itching for a free trade deal and the Prime Minister is said to want to lead the world against protectionism. For most people such issues are economic, pure and simple. Unfortunately, what is missing is the moral dimension, which needs to be far better understood. Adam Smith argued that “all commerce that is carried on betwixt any two countries must necessarily be advantageous to both” and therefore “all duties, customs and excise on imports should be abolished … and liberty of exchange should be allowed with all nations.” The key word here is liberty. Freedom is not simply something political. There needs to be a much deeper concept of economic liberty. Why should the state be allowed to alter the price of the goods I wish to buy from overseas? The EU Customs Union is a deprivation of liberty, but so too would be membership of the World Trade Organisation with a tariff regime. Genuine economic freedom is only provided by zero tariffs, and unilateral free trade on the part of the UK, so that we trade at world prices. There are other considerations too. Protectionist policies such as the EU Customs Union have a much greater negative impact on consumers (higher prices paid) than a positive impact on producers (prices received). The protectionist ranting from Bernie Sanders and Donald Trump, and their claims that they’re on the side of the workers, suggests otherwise, but it ain’t so. Workers are consumers. Protectionist politics are a gross distortion of the truth. So where does this leave us with regard to free trade deals and leading the world against protectionism? There is a real risk at present that the UK will chase free trade deals all over the world and Liam Fox will accumulate more air miles than any man in history. But while the secretary of state is at 35,000 feet, consumers and businesses in the UK will continue to be deprived of their liberty due to a continuing tariff wall. Unilateral free trade makes economic and moral sense. The risk in chasing free trade deals is that we become too focused on the back door of the factory (the cost of what goes out), and stop thinking about what happens at the front (the cost of what comes in). If the Prime Minister wants to lead the world against protectionism, Britain needs to lead by example. Leaving the EU customs union and replacing it with tariff-lite is not leading by example. Leadership is displayed in sacrifice. Unilateral free trade is not cost free, as there would be a negative impact on previously protected sectors. But that sacrifice would reap a reward in the form of higher productivity. Political populism is exploding around the globe. Protectionism flourishes in such an environment. This is a defining moment for Britain in the twenty-first century, just as the abolition of the Corn Laws was a defining moment in the nineteenth century. We did the right thing then, and we can do the same now.

67

I seem to remember President Reagan shouting over the Berlin Wall that, “if you seek liberalisation, come here to this gate. Mr Gorbachev, open this gate. Mr Gorbachev, tear down this wall.” Tearing down this wall (tariffs) should be the post-Brexit mantra.

68

WHY A ‘SOFT BREXIT’ IS ANYTHING BUT SOFT

Martin Howe

There was a rational argument for staying in the EU, and accepting its rules and its common customs tariffs while being able to vote on them and exercise some degree of influence. The British people rejected that argument. There is a rational argument for leaving the EU, and then taking advantage of our new freedom from the EU’s rules and regulations and customs tariffs.

There is no rational argument for leaving the EU, thereby giving up all rights to take part in its decision making, and then still being bound by its laws and rules across our entire domestic economy, and, if we were to stay inside the Customs Union, across the whole of our trade with the world as well. Yet this is what is misleadingly called a “soft” Brexit which somehow will be “better for jobs” or “better for the economy” than a so-called “hard” Brexit.

Yet there is no evidence at all for these widely repeated assertions about jobs and the economy. What is surprising is the sheer scale of the ignorance which prevails among business leaders who should know better and many media commentators about the actual legal mechanics involved and the consequences if the UK were to stay inside these EU constructs without being an EU member.

This ignorance has allowed a total myth to be propagated. That myth is that it would be economically better for the UK to stay inside the customs union and/or the single market, and that it is only pointless ideology or an obsession with curbing immigration at all costs which accounts for the Government's rejection of these options.

This myth does not withstand a moment's serious scrutiny and analysis. Post-exit membership of the EU internal market and of the customs union would put us in a limbo-land where we would be rule-takers, bound by huge restrictions on our economic and political freedom of action according to rules on which we would no longer have a vote, and which are likely to be altered seriously to our disadvantage as time goes on.

Since we would no longer have a vote on the internal market rules on financial services, we would be powerless to prevent them being changed even further to the detriment of the City and our other major financial centres such as Edinburgh. There would be no barrier against the EU adopting protectionist rules designed to hamper the City in furtherance of a misguided protectionist desire to bolster financial services within the Eurozone. And as a non-voting member of the internal market, we would be obliged to implement those rules whether we liked it or not.

More widely, we would be totally prevented from undertaking supply-side reforms of the regulatory burdens imposed on our domestic economy and international trade by the EU internal market rules. We would be required to submit to our laws to being automatically overturned by rulings of the EFTA

69

court which simply shadows the ECJ.

Customs union membership would oblige us to continue to charge high tariffs on types of goods where we have no UK industry to protect, for the sole advantage of producers in EU states. British consumers would pay the cost of the tariffs through higher prices, but we would have to continue to hand over to Brussels 80% of the tariffs borne by our consumers. Even more catastrophically, customs union membership would totally prevent us from entering into trade agreements with non-EU countries who now represent an over 55% (and growing) share of our export markets.

On the other side of the ledger, the supposed economic advantages of customs union and internal market membership are grossly oversold. Tariff-free trade between the UK and the EU can continue after Brexit under a free trade agreement which preserves our ability to decide on our own levels of external tariffs and to reach trade agreements with non-EU countries. Modern "friction-free" and "virtual border" customs arrangements can ease the flow of goods at the Channel ports and avoid the need for physical customs posts on the Northern Ireland land border. And mutual recognition of standards based on a starting point where we are in line with the EU internal market rules can ease the flow of goods and services between us and the EU after Brexit.

The idea that single market membership would somehow be easier to negotiate than a free trade agreement is another total myth. If the UK wanted to belong to the single market after EU exit, we would need to apply to join the European Economic Area Agreement as a non-EC member. In order to join the EEA we would need the consent of 30 states (the EU members plus Norway, Iceland and Liechtenstein), all of whom would need to ratify the necessary treaty changes in accordance with their respective national constitutional requirements. This is actually a bigger barrier than what is needed to secure agreement to a free trade agreement with the EU.

The reality is that there is no "soft Brexit". It does not exist as a serious or credible option. Half-way house arrangements in which we are subject to EU rules but have no say in setting them are the worst of all worlds, which would continue to subject us to all the disadvantages of EU membership but not give us the freedom and opportunities of leaving the EU in shaping our laws, controlling our borders and taking advantage of global trading opportunities. The only softness is in the heads of the people who advocate such half-baked and ill-thought out notions.

When fully examined, the overwhelming economic and constitutional drawbacks of the limbo-lands of post-Brexit customs-union and internal market membership are glaringly apparent. It is vital that the real consequences of these choices should be fully understood.

70

CLEAN BREXIT CAN AVOID THE CLIFF-EDGE CHAOS

Liam Halligan I voted to leave the EU. I also think the UK should come out of both the so-called Single Market and the EU’s Customs Union. Some say that makes me an extremist “Hard-Brexit” nutter – wishing for an isolated, poorer UK. I’d say that’s nonsense – and here’s why. Leaving the EU, as we heard before the referendum, means leaving the Single Market. As “members”, our laws stay under European Court of Justice jurisdiction and the multi-billion-pound annual payments to Brussels continue. We’d also remain unable to control numbers of EU migrants living and working in the UK – which, after our referendum, makes the Single Market a non-starter. The economic advantages of being “in” the Single Market are, anyway, wildly exaggerated. We can trade freely with the EU, yes, but it is the slowest-growing economic bloc in the world. Since 1999, the share of UK exports sold in the EU has fallen from 61pc to 44pc. The real number is probably below 40pc given the “Rotterdam effect” – with UK goods bound for that port often going on to global markets. Even on official numbers, then, 56pc of UK exports go to the non-EU – outside the Single Market. We chalk up a surplus on our fast-growing non-EU trade, but shoulder an even bigger deficit on our EU trade – not least as the SM barely covers the service export in which the UK excels. The US, China and Japan trade happily enough with the EU – from “outside” the Single Market. American EU exports totalled a huge $247bn (£203bn) last year – with US firms gaining “access” by meeting EU regulatory standards and, where necessary, paying low, single-digit tariffs. Ours can do the same, without subjecting the UK to endless laws our government cannot control, not least “freedom of movement”. Then there is the Customs Union, which imposes a Common External Tariff on EU imports. That pushes up consumer prices, not least on food. Free of the Customs Union, food in Britain could be some 15pc cheaper. That would help UK households, not least those struggling on lower incomes. Ah, but “being in the Customs Union means the UK benefits from dozens of EU free trade agreements with the rest of the world,” I often hear. Really? The EU is ghastly at cutting joint trade deals – given the conflicting interests of big member states.

71

Talks with both the US and China have failed, despite years of trying – hindering UK trade with the world’s two biggest economies. EU deals that do exist, mostly with tiny countries, account for under a 10th of the global economy. They do few favours for service-sector exporters like Britain, either, being driven by French and German interests – the same old EU story. Outside the Customs Union, Britain can strike its own trade deals, designed to help our exporters, boosting our trade with the 88pc of the world economy outside the EU once we leave. It is vital we forge deeper trade links not just with the US, but also the fast-growing emerging markets that increasingly dominate global commerce. This is impossible inside the EU’s protectionist Customs Union. Big businesses like the Single Market, of course. By tying up all UK firms in EU red-tape, including the 90pc-plus that don’t even export, it helps keep smaller rivals in check. The Customs Union, also, helps big incumbent exporters, while making imports more expensive for us all. Many hope a “bespoke deal” can be struck during the Article 50 “negotiation window”, the UK achieving a trade-off between free trade and the open borders that are integral to Single Market “membership”. To my mind, the chances of that are remote. If the EU bends the rules, with discontent rising over the continent’s lack of border controls, any flexibility shown to the UK would see electorates across the EU demanding their own exit referendums. The “European project” could implode. Consider, also, that a Treaty-busting UK-EU deal needs to be ratified by 27 EU parliaments and a bunch of regional assemblies – and even then, it could be vetoed by an increasingly hostile European Parliament. All that within two years? At the very least, it is extremely risky. An inevitably bitter negotiation over the EU’s core principles would, at best, seriously harm UK-EU relations, undermining future cooperation on a range of issues. It could also spark a systemic EU-wide crisis, traumatising pan-European politics for a generation. The chances of a stalemate, or any deal being blocked, are anyway very high. As the Article 50 period expires, the UK would face a “cliff-edge”, amidst a frenzy of closed-door, last-minute bargaining – what Gerard Lyons and I call a “Messy Brexit” in our recent paper for Policy Exchange. In the UK, and across Europe, voters would despair at the chaos and nationalistic finger-pointing that goes with a Messy Brexit. Prolonged uncertainty would damage business sentiment too. “Clean Brexit” works – avoiding “cliff-edge” chaos. So we should now continue to negotiate our own trade deals with the wider world, while preparing for a knowable Brexit. Better that than tearing UK-EU relations to pieces, for extremely dubious economic gains. Reference

72

Liam Halligan and Gerard Lyons, ‘Clean Brexit’, Policy Exchange, 2017

73

BREXIT NEGOTIATIONS

John Whittaker We must pay an exit bill of €60bn or more, says Jean Claude Juncker, president of the European Commission. The European Court of Justice must retain jurisdiction over EU nationals resident in Britain, says Michel Barnier, the Commission’s appointed Brexit negotiator. Britain must be worse off outside the EU, says Guy Verhofstadt, the European Parliament’s Brexit representative, otherwise other countries might be tempted to leave. And they all say negotiations will be long and hard. At the same time, the various EU officials make conciliatory noises: they will negotiate co-operatively and constructively. But they set the agenda: they say they will not talk about our future EU trade relations until we have agreed to pay them money and settled the position of EU nationals in Britain. Whether these attitudes are opening gambits intended to put us on the back foot or just grandstanding, their negativity seems to be echoed here in Britain. Goaded by the media, we worry that there is so much detail in what needs to be agreed that it can never be done by the deadline, i.e. the expiry of the Article 50 process on March 29, 2019. And the reconsideration of the large accumulated body of EU law will take many more years. There is also a tendency to talk down our economic prospects. The Confederation of British Industry (CBI) emphasises the dangers of a ‘bad’ deal – which seems to mean any deal which changes existing trading relationships – in fact any deal which means leaving the EU. At the Bank of England, Governor Mark Carney continues to exude comments about the negative effect of Brexit on the UK economy, citing this as a reason why Britain still needs his Bank’s ultra-stimulatory policy. Even Mrs May keeps telling us that negotiations will be tough, which does not inspire confidence. So what will be the outcome? Among all the rhetorical mess and media noise, perhaps what matters is who has the final say in approving the UK’s exit deal (or deals). Formally, the final deal must be approved by the Council of the EU and in the European Parliament. The Council consists of relevant government ministers from the various countries and it votes by Qualified Majority Voting, meaning that 55% of countries containing 65% of the EU population must agree. (The Council of the EU should not be confused with the European Council which is a discussion body for heads of state, or the Council of Europe which is not an EU institution.) Importantly, no individual country has a veto, despite an opinion in December 2016 from an EU judge that parts of trade deals must be agreed by all member state parliaments. The judge was actually referring to a proposed deal with Singapore and was no doubt mindful of how the regional government of Wallonia in Belgium had held up the EU-Canada trade deal. But in May this year, the European Court of Justice ruled that nearly all components of an agreement are ‘an EU competence’ that may be ratified by a vote in the Council.

74

It is hard to avoid the feeling that they are making it up as they go along. The EU is very good at making rules that they sidestep when the rules become inconvenient. An example is the Stability Pact limit on Eurozone government budget deficits which has been regularly breached by nearly all countries, yet no country has ever suffered the punishment of a fine. In the end, these formal rules and procedures may not matter much, as national interests and expediency will prevail. It is the main heads of government, Emmanuel Macron and Angela Merkel, whose say will matter the most, not the functionaries in the European Commission. These leaders are aware of their own business lobbies, and they have every incentive to co-operate with an independent UK over trade and other areas of common interest. And while members of the European Parliament want to feel relevant and will have plenty to say, they are unlikely to be obstructive. Whatever the course of negotiations, the UK will leave the EU. And in spite of the wishes of ‘soft Brexiteers and Remainers, the UK will leave the single market and the customs union (in case there is still doubt, this is not a statement that the UK will cease to trade with our European neighbours). UK law-making will return to Westminster and we shall be able to make our own trade arrangements with the rest of the world. Trade patterns will change and, while multinational companies may lose some of their existing business, there will be plenty of new opportunities. Meanwhile, our minister for exit, David Davis, seems resolute and in control of his brief. Best foot forward, David. We know you can do it. And thank goodness we never joined the euro. Getting out of that would be much more troublesome. References Institute for Government, 2017, The EU’s role in Brexit negotiations

75

RESPONSE TO CRITICS

Patrick Minford – The Gravity View of Trade is Seriously Wrong Page 76 Explains why the gravity models used by most trade economists do not represent a realistic picture of how trade will change post-Brexit

76

THE GRAVITY VIEW OF TRADE IS SERIOUSLY WRONG

Patrick Minford We are conscious that there are economists who do not share our views. Indeed during the referendum there was a very large body of opinion, at home and abroad, lined up by the Treasury to create the impression of an overwhelming consensus in favour of staying inside the EU. Since the referendum, opinion among economists has become more diverse, especially since the gloomy consensus predictions for the economy have been seen to be badly wrong. Now the opposition to our promotion of the free trade policy approach now adopted by the government has boiled down to those embracing a neo-protectionist ‘gravity model’ approach to trade. Under this model trade is determined largely by the forces of demand, from neighbours wanting imports and from others modified by the factor of distance- due to transport costs and border costs; competition is rather limited, highly ‘imperfect’, and prices are set by producers as a mark-up on costs, so they move rather little. Once demand has determined trade and the production to meet it, foreign direct investment and associated innovation follow it, boosting productivity. Workers and capital come from all over the world to supply the necessary inputs. In short, while supply is important in this gravity approach it is essentially determined by the forces of demand. Because it is hard to break into new and distant markets it makes sense in this approach to support existing markets. Hence leaving the EU will damage existing markets’ demand, so reducing trade and so reducing supply and productivity via falling FDI and innovation. Reducing trade barriers with the rest of the world will only weakly substitute for this loss of demand by stimulating more demand there? Even though the EU protects its markets via trade barriers, this on the gravity view is good for the UK because it raises demand for our exports within the EU. Hence this school of thought is in favour of EU protectionism- it is what I have called ‘neo-protectionist’. In general free trade according to the gravity approach is something that must be evaluated case by case on the basis of its effects on demand for UK products and so the supply side of the economy. Proponents of this gravity approach claim that it is supported by the ‘facts’- consisting of many estimated relationships between exports and the GDP of the demanding countries, adjusted for distance. However this claim is disingenuous: the gravity ‘model’ has simply been rigged to replicate these relationships, it is neither supported nor denied by them. Empirically, the problem for the gravity models comes in their denial of obviously high competition in world trade, such as the rigorous grinding out of supply chains or the destruction of brands such as Nokia and Blackberry; and in terms of facts their failure to come up with any explanation of comparative advantage- such as has occurred in the UK with the rise and rise of traded service industries, like the City, health and education provision. In the gravity model the only reason for the rise of an industry is contiguity to a market where it is demanded. Yet the City of London is not at all contiguous to its world markets!

77

To date no ways have been found to test trade models in the manner now becoming more routine with macroeconomic models of the economy. However, work is under way and we hope that some proper empirical testing of the gravity model versus its traditional trade theory rival can soon be undertaken and generally studied. Meanwhile we think that the world revealed by numerous obvious facts favours a model of high competition in world markets and one where supply-side factors such as the availability of skilled and educated labour, plus good domestic policies, are dominant in determining which industries thrive under world competition. This model of trade is the classical one developed by the great trade theorists of the past two centuries- Ricardo, Heckscher, Ohlin, Samuelson- and pursued in much empirical work based on it. While some gravity modellers have sniffed at this tradition as ‘old’, implying that they are the purveyors of fresh modern thought, in economics such sniffings should be treated with scepticism: we have been privy to another major reversal of classical thought, the Keynesian Revolution, which later, after causing massive inflationary and supply-side damage, had to be ditched in favour of a return to classical principles. So we think it will also be the case with trade ideas. Thus in this pamphlet we base our position on the principles of free trade and competition and we reject the protectionism of the gravity modellers. For us the key to future UK success lies in adopting policies that support our industries with good laws and regulations in their search for higher productivity and wider markets, and that expose all parts of our economy to the competition of world markets. Meanwhile we reject as absurd the idea that a major and successful economy like the UK should freely admit unskilled workers from much poorer economies who are able to get access to the generous UK welfare state; this has long been well-known among economists and it underpins the idea that admission of unskilled workers should be controlled.

78

POST-BREXIT FORECASTS FOR THE UK ECONOMY

Patrick Minford and Liverpool Macroeconomic Research

After their disastrous efforts at forecasting doom and gloom from Brexit, the forecasting community has at last come to its senses and begun to forecast normally. The outlook among the key forecasters has moved to a growth forecast of 2% for 2017 for the UK, against an outturn for 2016 that has been revised down to 1.8% overall on the basis of a very weak (revised) first quarter. This is a surprising revision which may change yet again. But the basic point about it is that 2016 came in as a lamb and went out as a lion- so turning the ‘Brexit Disaster scenario’ on its head.

What to make of all this? Time and again the forecasters forgot the power of the exchange rate. For them it is all about the effect on the consumer price index, and not at all about the profitability of exports and import-substitutes. Yet go back to basic open economy macroeconomics and remind yourself that a large devaluation is like a large monetary stimulus that works by raising home producer prices relative to wages, with an impact on industrial profitability in selling to foreigners at the same dollar prices and in selling at home at prices that can rise to match much more expensively home-priced foreign products. No wonder that we have been hearing nothing but good news from industry, on sales, investment and output.

This devaluation has powered up an economy that was doing perfectly well already. On top of this world growth is strengthening, with even the euro-zone perking up and Trump’s America straining at the leash and slavering over the prospect of an Obama-free world of deregulation and tax cuts. Interest rates are rising in the US; QE will continue for a time in the euro-zone but with inflation there over 2% this will not go on for long now. Here it can only be a matter of time before the Bank moves to tighten monetary conditions, if only modestly in 2017. Inflation here is already over 2% and likely to rise further over the next year as price rises filter through from the devaluation and also push up wages. The Liverpool Macro Research forecast is for growth over 2% in 2017; it could well get up to 3% p.a. or more by the year-end depending on just how much wages respond. So far it looks as if the response will be fairly muted, and that money and credit have also not responded as strongly as they would have in a less regulated world. Rather like in the post-ERM period from 1992, when also there was a large devaluation, there may be enough cooling sentiment around, due to fear of the unknown, to prevent a precipitate boom.

Meanwhile it is salutary to look at a table of post-Brexit manufacturing profitability.

Table 1: UK forecast summary 2014 2015 2016 2017 2018 2019 2020 GDP Growth1 2.9 2.2 2.3 2.1 2.6 2.9 3.5 Inflation CPI 1.7 0.2 1.2 2.6 2.6 3.0 3.0 Wage Growth 1.2 2.4 2.9 2.6 3.6 4.7 4.5 Unemployment (Mill.)2 1.1 0.8 0.7 0.8 0.8 0.7 0.7 Exchange Rate3 87.1 91.6 80.4 76.4 75.1 74.6 74.4 3 Month Interest Rate 0.6 0.6 0.4 0.9 1.5 2.5 3.0 5 Year Interest Rate 1.8 1.3 0.9 1.1 2.0 2.9 3.0

Current Balance (£bn) 99.9 103.7 44.9 14.4 PSBR (£bn) 83.3 71.2 69.0 53.4 44.8 37.2 12.8 1Expenditure estimate at factor cost 2U.K. Wholly unemployed excluding school leavers (new basis) 3Sterling effective exchange rate, Bank of England Index (2005 = 100)

79

Table 2: Post-Brexit manufacturing profits

Home Market (£100 bn)

EU Market (£110 bn)

ROW Market (£115 bn)

TOTAL

Price Impact -20% 0 0

EU Tariff Impact

0 -3.5% +15%

Sterling Impact +15% +15% +15% TOTAL -£5 bn +£12.6

bn £17.2 bn

+£25 bn

Source: Patrick Minford and Edgar Miller, 2017, What shall we do if the EU will not play ball? UK WTO strategy in a non-cooperative continent, downloadable from www.economistsforfree trade.com.

Notes on Table: The WTO Option in our World Trade Model assumes that initially, following the loss of EU protection, UK manufacturing prices will fall by 20% in the home market compared with current EU prices but eventually over, say 10 years will settle to 10% lower than prices within the EU. This is because the EU is assumed to follow a slow trend towards reduced protectionism. It also assumes that our exports to the EU face the current EU MFN tariff but that a general pro-business industrial strategy support package is put in place by the government to allow industry to absorb this without putting up EU prices. The Sterling exchange rate has fallen about 15% post-Brexit. The total manufacturing home market is around £100 billion; total manufacturing exports to the EU are around £110 billion and to the ROW about the same at £115 billion. So while the exchange rate stays down, manufacturing makes profit gains of £25 billion, on total gross value added of about £160 billion equating to 16% extra gross margin on value added.

Manufacturing gets an immediate uplift once Brexit occurs of no less than 16% on its £160 billion value added, a huge rise in its margins. This is after assuming that the EU levies a tariff on UK exports, while the UK negotiates free trade agreements with the Rest of the World implying that manufactures from the ROW enter here at world prices, 20% lower than current. It is no wonder that UK manufacturing is in high spirits.

The Economy after the Brexit Devaluation

The sharp devaluation that followed Brexit was a response in some degree to uncertainty but mainly to the need to penetrate new markets in order to sell more goods.

80

The uncertainty concerns policy on many aspects of the economy which after Brexit will be determined by the relatively unknown preferences of the UK government instead of the well-known ones of the EU. Nevertheless Mrs. May’s government has been clear in saying that it will pursue free trade abroad and be rather sensitive to worker needs at home- a mixture that is easy for markets to appreciate. The uncertainty now arises most from what exactly the EU is up to. Until negotiations get under way we will remain in the dark on this. Even so, as we have argued before, the UK is in a strong position to have no agreement with the EU and still pursue free trade. This policy will boost consumer welfare, competition and growth. Most indicators now suggest that companies, workers and markets are all rather calm about any remaining uncertainty.

The main reason for devaluation was the need to penetrate new markets in the medium term for various reasons. First, productivity will rise and more goods and services produced; these must be sold. Second, there may well be some protectionist action from the EU which will reduce EU demand for UK product; this will need to be diverted to new markets. Third, there is the existing current account deficit which needs correcting and since this is on top of the first two factors, it has swum into focus after some years of neglect. Fourth, this deficit will worsen in the short run as free trade policies lower import barriers and so encourage imports.

All four factors point to the need to make UK products more attractive worldwide to generate bigger export sales. In our long-term trade model we forecast this as happening without any need for export prices to fall in the long run, because world markets are highly competitive and in principle will easily absorb the extra UK supply of exports; so in the long run we expect the exchange rate to revert to its previous level. Nevertheless in the short and medium term there has to be a factor pushing open this door; this is the exchange rate. It is playing its necessary role in the UK economy as vigorously as ever.

All the evidence from recent indicators tells us that the devaluation has indeed stimulated the economy substantially. A 15% devaluation is the external equivalent of a 15% surge in the money supply: indeed the two things should accompany each other over time. It is a strong monetary stimulus which works through the external channel in the first instance: whereas a monetary stimulus in the form of lower interest rates and more money printing works through the domestic spending channel.

We are seeing strong CBI export survey returns and also strong Purchasing Managers Index reports in all sectors. Thus demand is coming from exports and from import substitution, and the domestic consumption component that was strong in 2016 is weaker in 2017, again a result of devaluation which transfers income from consumer pockets into corporate profits. Given that we wish to divert output into export markets and away from imports we should expect this pattern of demand and supply. Output growth remains strong; even if the first quarter may have slowed a bit. The latest surveys suggest the second quarter will be stronger and also we expect some upward revision of the first quarter as more data comes in on net exports.

Some ink has been spilt on the sluggishness of investment. But this is not surprising as capacity is under used; until capacity is used up, there will be little pressure to invest. Since the financial crisis the labour market has picked up fast, with people pushing to get jobs and forcing employment upwards. We have a flexible labour market and this has shown itself in the form of real wages falling during the crisis and staying low since. This in turn has produced poor productivity figures: but these need to be seen as the other side of the labour flexibility coin. As is now well known, productivity is in any case poorly measured

81

in an economy dominated by services and new goods such as smart phones; price measures simply do not allow properly for quality from the new consumption possibilities.

In our forecast for the UK we see continued steady growth, with demand shifting more towards net exports. Investment growth will wait until current capacity is absorbed. Monetary policy will remain relatively easy but we have long argued that interest rates need to be raised to allow money markets to work properly, without the discrimination against savers that we have been seeing since the crisis.

Fortunately in the US growth continues to be steady, with the first quarter’s sluggishness a regular feature suggesting something is wrong with the seasonal adjustment. A tax-cut package is likely in due course as the Republicans reach some consensus on its shape and on the repeal of Obamacare. Meanwhile President Trump is busy repealing a large swathe of regulations passed under President Obama. Among them are the Dodd-Frank regulations of banking which continues to cramp bank lending and money growth.

The Fed is continuing to raise interest rates which suggests that we will be seeing some normalisation of money markets over the next two years.

As we have argued before the continued excess capacity in raw material supply will keep raw material prices down and this bids fair to maintain a good growth climate for the next decade.

82

ECONOMISTS FOR FREE TRADE MEMBERS

Economists for Free Trade comprises 16 leading economists and is the largest of its kind in the UK, bringing together experts in trade,

macroeconomics, and forecasting, together with extensive experience advising Governments on economic policy. The group includes six

former economic advisers to government and eight university professors

Professor Vudayagi Balasubramanyam - Professor of Development Economics at Lancaster University, specialising in international trade, investment and economic development. He is a member of the Editorial Board of The World Economy and has acted as academic consultant to the OECD.

Professor David Blake - Professor of economics in the Finance Faculty of Cass Business School and Director of the Pensions Institute. He has built many different types of models over the last 40 years in fields as diverse as economics, finance and demography.

Roger Bootle – Chairman of Capital Economics, Europe’s largest macroeconomics consultancy. He is a specialist adviser to the House of Commons

Treasury Select Committee and the author of several award winning books on the economy. Michael Burrage - Director of Cimigo, former lecturer at the London School of Economics and research fellow at Harvard, Uppsala, Free University of

Berlin, and at the University of California, Berkeley. Professor Tim Congdon – Previously a member of the Treasury Panel of Independent Forecasters and one of the “Wise Men” between 1992 and 1997,

which advised the Chancellor on economic policy. Professor Kevin Dowd - Professor of Finance and Economics at Durham University Business School and a partner in Cobden Partners based in London.

His research interests include monetary and macroeconomics, financial risk measurement and management, risk disclosure, political economy and policy analysis.

John Greenwood – Chief Economist at Invesco, with over 40 years’ experience as an economist for leading financial institutions. He has been an

economic adviser to the Hong Kong Government and is currently a member of the Shadow Monetary Policy Committee in England. Liam Halligan – Economist, broadcaster and award winning columnist at the Sunday Telegraph. He is best known for his weekly “Economics Agenda”

column which he has written since 2003, and has been recognized with a highly-coveted British Press Award. He also writes for The Spectator.

83

Martin Howe QC – Leading expert on EU constitution and barrister at 8 New Square specialising in Intellectual Property and EU law. He was a member of the coalition government’s Commission on a Bill of Rights for the UK, and is currently chair of Lawyers for Britain.

Professor Graeme Leach - CEO & Chief Economist of Macronomics, a macroeconomic, geopolitical and future megatrends consultancy. Formerly

Director of Economics at the Legatum Institute, and Chief Economist & Director of Policy at the Institute of Directors (IOD). Warwick Lightfoot – Head of research at Policy Exchange, former economics editor of The European and special adviser to the Chancellor of the

Exchequer between 1989 and 1992. He writes for leading publications on area including monetary economics and public finance. Neil MacKinnon– Global macro-strategist at VTB Capital. He has spent 20 years as an economist and strategic adviser to leading financial institutions in

The City. Professor Kent Matthews – Professor of banking and finance at Cardiff University. He has held teaching positions at many of the leading universities

across the world and is the author of six books and 75 published papers on areas including macro-economic modelling and forecasting. Professor Patrick Minford – Professor of Economics at Cardiff University, formerly director and founder of Liverpool Research Group which built the

‘Liverpool Model’ Of the UK economy, which was hugely influential in forecasting and policy analysis in the 1980s. Chair of Economists for Free Trade Professor David Paton - Professor of Industrial Economics at Nottingham University Business School. He has acted as an adviser to several Government

departments including HM Revenue and Customs, DCMS and the DTI. Dr John Whittaker – Senior teaching fellow at Lancaster University specialising in monetary policy and macroeconomics. He is a former Member of the

European Parliament for the North West England region for the UK Independence Party.

84

ASSOCIATED CO-AUTHORS

Paul Ashton- long standing research associate of Liverpool Macroeconomic Research, with particular knowledge of the UK welfare state and housing market. Vo Phuong Mai Le- lectures on macroeconomics and trade at Cardiff Business School; forecast associate, Liverpool Macroeconomic Research. David Meenagh- lectures at Cardiff Business School on macroeconomics and econometrics; forecast associate, Liverpool Macroeconomic Research. Swati Virmani- lectures on trade, development and econometrics at Huddersfield University Business School. Yongdeng Xu- researcher, Julian Hodge Institute of Applied Macroeconomics, Cardiff Business School.

85

ADVISERS

Businessmen

Sir James Dyson Founder Dyson Ltd Mr John Longworth Former Director British Chambers of Commerce, Vice Chair Leave Means Leave Sir David Ord Co-Owner of Bristol Ports, Vice Chair Open Europe

Financial Services

Sir John Craven Former Board Member Deutsche Bank, Chairman/CEO Morgan Grenfell, CEO Credit Suisse First Boston, Founder Phoenix Securities

Mr Barnabas Reynolds Head of the Global Financial Institutions Advisory & Financial Regulatory Group at Sherman & Sterling

Parliamentarians

Lord Flight Delegated Powers and Regulatory Reform Committee (House of Lords), Chairman Flight & Partners, Chairman EIS

Association Rt Hon Owen Paterson MP Former Secretary of State Environment, Food, and Rural Affairs, former Secretary of State Northern Ireland Mr Jacob Rees-Mogg MP Member Treasury Select Committee, Director Somerset Capital

Media

Viscount Ridley Science and Technology Committee (House of Lords), Columnist The Times, author of some half dozen books on science, the environment, and economics

86