Cameron's EU deal is wafer thin, but that's not the point

Britain's real obstacle lies at home
February 18, 2016
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The European Union’s model of shared sovereignty is in a mess. The eurozone needs closer integration, which the bloc’s electorates and politicians don’t want to accept. Schengen is in trouble, in part, because member states won’t allow the EU to control the external border or to distribute refugees. And Britain is flirting with leaving the EU because the right dislikes its power to determine British law, and its people dislike the free movement of workers.

The Prime Minister’s renegotiation was an attempt to sate his party’s demand for powers to be returned to Westminster, and the electorate’s desire for reduced immigration. Remember the context of his January 2013 speech at Bloomberg's headquarters. The Tories were lagging badly in the polls, as the economy flatlined (or so we thought: revisions to the data subsequently showed that the economy grew from 2009 onwards). Ukip was surging, and Cameron’s backbenchers were terrified of losing their seats. There was talk of a leadership challenge. As always happens when a Conservative prime minister is in a weak spot, the right of the party had started to bang on about Europe. Cameron needed to kick the EU issue past the next general election. He then needed to signal his euroscepticism, to satisfy his party, while keeping the option open to campaign to stay in the EU, which he rightly saw as in Britain’s national interest. A re-run of Harold Wilson’s gambit—a “renegotiation” of EU membership and a referendum on the deal—was, he thought, the only way to satisfy everyone.

Cameron surprised everyone by winning the general election outright. So he has been forced to go through with his EU strategy. Donald Tusk, President of the European Council, has delivered the draft reform package to the leaders of the other member states to discuss at a summit on 18th-19th February. The right-wing of the British press has been largely dismissive. They are both right and wrong: right that the negotiations will not give Britain more control over its own affairs, boost the British or European economy, or curb immigration—but wrong that the package is further evidence that Britain should leave the EU.

Three reforms are intended to deal with the sovereignty question directly. The first, a Council declaration that Britain “is not committed to further political integration into the EU,” exempts Britain from the treaty commitment to “ever-closer union among the peoples of Europe” without changing the EU’s treaties. But the phrase had little power in any case: the UK was not forced to join the euro or Schengen.

The second reform proposes that national parliaments should have the right to block legislation. But 55 per cent of the EU’s national parliaments must club together to do so. It seems unlikely that a majority of national parliaments would go against the wishes of their governments, since most governments would have voted for the legislation in the Council in the first place.

A third proposal is intended to prevent new measures on the eurozone from damaging the City of London. George Osborne, who sees this as the most pressing issue, originally hoped that eurozone “outs” would be able to halt eurozone-inspired legislation. But the French and Germans have been hostile, after David Cameron tried to get similar protections appended to the EU’s 2011 fiscal treaty. So the proposed mechanism would only allow one or a group of countries to force EU leaders in the Council to discuss a proposal.

There are some other, more helpful, reforms that establish the rights of the “outs.” The Council would declare that eurozone measures will “respect” the internal market. This would be welcome, since it would clarify that the European Central Bank (ECB), which is an increasingly powerful actor in financial supervision and regulation, may not force financial institutions to move to the eurozone. In 2011, the ECB tried to insist that euro clearing houses had to be based within the eurozone. The UK took the ECB to the European Court of Justice and won in 2015, but this declaration acts as a warning against other encroachments by the eurozone on rights of the “outs.”
"it is doubtful that a “competitiveness” drive will do much to boost the UK economy"
Lastly, the “outs” will not be involved in future eurozone bailouts. An obscure fund—the European Financial Stabilisation Mechanism, to which all 28 member states contribute—was used to bail out Greece last summer. The UK won guarantees that it would not lose any money—perfectly fair, given that the bailout is unlikely to work in the absence of debt relief, which Germany refused to give. This reform establishes the principle that the eurozone should pay for its own mistakes.

Overall, however, the reforms do not give Britain much more power over the EU's future direction, much less the return of powers to Westminster. They do include promises to simplify EU regulation, deepen the single market and push for bilateral free trade deals with countries outside Europe. But it is doubtful that this “competitiveness” drive will do much to boost the UK economy.

There can be no doubt that some EU rules impose more costs than benefits. But there is next to no evidence that EU membership is a significant constraint on the supply-side of the UK economy. For example, according to the Organisation for Economic Co-operation and Development (OECD), Britain’s markets for goods and services are the second least regulated in the world, after the Netherlands, another EU member state.

The same story broadly holds for the labour market. According to the OECD, employment protection legislation is only slightly more restrictive in the UK than in the United States or Canada, and less so than in Australia. It is, of course, much less restrictive than in continental Europe, for example France or Spain.

Moreover, the direction of travel is towards deregulation in the EU. The other member states are steadily liberalising their markets, converging on a loosely regulated model, not the reverse.

The OECD also assesses the quality of countries’ regulatory regimes. It tested the European Commission’s rule-making process alongside those of other countries, and found that it is of better quality than the OECD average—and similar to that of UK and Australia, which the OECD ranks highest. There can be little doubt that some proposals are forced through the EU’s legislative machinery without proper assessment of the potential costs, but it is far from clear, on the basis of the OECD’s index at least, that the EU does this more than the UK itself.

The constraints on Britain’s long-term growth are overwhelmingly at home. The OECD cites Britain’s rigid planning rules and its restrictions on freeing land for development as a significant constraint on labour mobility and productivity. These rules help to explain why, despite rapid growth in the population, housing construction is running at half the level of the 1960s; why office rents are the highest in the EU; and why Britain’s transport infrastructure is so congested and expensive to build.

The OECD also criticises Britain’s education system. The UK has world-class universities, but its rates of literacy and numeracy at age 15 are at best around the EU average, as are its rates of graduation from secondary education. Add to this the longstanding weaknesses in vocational training, and the result is that Britain has a comparatively large number of people with low skills—a failing that constrains the labour supply to a far greater degree than EU employment rules such as the Working Time Directive or the Temporary Agency Workers Directive. In short, Britain’s problems are almost entirely home-grown, and nothing in the renegotiations will have any bearing on those.

Will the package of reforms open the way for a deepening of the EU’s single market? The EU has made slow progress in removing barriers to the trade in services across the EU so the commitment to boost this trade—however rhetorical—is welcome. However, it should be noted that deepening the EU market for services will be impossible without more regulation. Service markets tend to be more highly regulated than markets in goods. Consumers find it more difficult to assess the quality of a lawyer than, say, an apple, so the state intervenes to ensure legal standards are high. Member states would not allow foreign companies, operating under foreign rules, to provide services to their citizens without common standards at the EU level.

Will the proposed package of reforms lead to the EU signing more trade agreements, boosting UK exports? Eurosceptics often criticise the EU for allegedly not doing enough to sign trade agreements with emerging markets, which they argue offer the best opportunity to boost Britain’s trade. But this is simplistic and ignores what drives trade and its economic impact.

Trade is driven by proximity—neighbouring countries trade more than distant ones, because of the cost of shipping goods. Size is a factor too: trade flows between two big economies are larger than between two small ones. Countries like Britain, which exports high value-added goods, are more successful in exporting to countries with high per capita income.

Higher trade and investment with developed economies, as opposed to poorer ones, are more likely to raise productivity. This is because of a reason often lost on politicians and the public alike—that the biggest gains from trade come not from exports but from imports. Imports boost competition, raising incentives for domestic firms to make productivity-enhancing investments.

Imports and inward investment from rich countries can raise the rate of economic growth through a process known as the dynamic gains from trade. Importing from more productive EU firms encourages British companies to raise productivity and spend more on research and development in order to keep a foothold in the market. The constant pressure of competition from more productive overseas companies raises productivity growth—not just productivity levels.

By contrast, trade driven by comparative advantage and the global division of labour between rich and poor countries reduces the cost of imports and encourages labour and capital to shift to more productive sectors of the economy. But this effect is a one-off—once a British steel mill has been closed and its workers and capital have been redeployed, that’s it: there has been a one-time boost to Britain’s total income.

It follows, therefore, that it is much more important for the UK to have unimpeded access to the EU market and to the US, than to China. Fortunately for Britain, the EU is already working on a far-reaching trade agreement with the US, the Transatlantic Trade and Investment Partnership (TTIP), and is working on a free-trade agreement with Japan.

Finally, the package is unlikely to reduce the number of EU migrants moving to Britain in search of work. There is no evidence that people move to the UK in order to benefit from in-work benefits, so the proposal to restrict immigrants’ access to them will do little to lessen the attractiveness of the UK as a place to work. The government continues to claim that benefit tourism is a problem. Philip Hammond, the Foreign Secretary, has argued that the ability of EU migrants to receive benefits and to send money home has encouraged others to come. But the behaviour of EU migrants contradicts this story: very few are on unemployment benefits. And in the first two years of residence, in-work benefit take-up rates are low, but grow over time, as migrants decide to stay in Britain, and many pair up and have children. Since tax credits and housing benefit are more generous for working families, this isn’t surprising.

The proposed “emergency brake” on benefits to allow the UK government to attempt to cap the number of EU workers entering the country—to relieve pressure on its labour market and public services—will be difficult for other member states to accept. It is hard to see how the government could argue that the country’s welfare or employment systems are under pressure: unemployment is at just 5 per cent, and EU immigrants are net contributors to the public purse. The government could argue that immigration was putting unsustainable pressure on public services, such as healthcare and education. But it will have to demonstrate that the problems are down to immigration rather than the underfunding of public services. Given the government itself has conceded that EU immigrants are net contributors to the UK’s public finances, this will be difficult to prove. And, in any case, it will find it difficult to convince the other 27 member states, who must agree to the brake, to tolerate such discrimination against their citizens. Even if they did acquiesce, their citizens could take the UK to the European Court of Justice, unless the UK succeeds in having the emergency brake written into the EU’s treaties, which is highly unlikely.

Cameron’s UK-EU deal is wafer thin. It was always going to be and Tory MPs knew this. Other concerns—career advancement and avoiding the hellish political fallout from leaving the EU—were always going to persuade most Tory MPs to support continued membership whatever Cameron negotiated. It would be good if, in a few weeks, the whole process of renegotiation is largely forgotten and the debate will focus on the real issue: the economic and political risks to the UK of leaving the EU.

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