• Matthew Smylie

Would it be a mistake for Britain to leave the Single Market and Customs Union?

Brexit has been one of the most prominent political sagas in British history. This post looks into whether Britain would be making a mistake by leaving the European Single Market and Customs Union.

Photo Credit: https://ukandeu.ac.uk/the-european-single-market/


Following the ‘Brexit’ referendum, uncertainty surrounds which deals Britain will negotiate; especially in terms of Single Market (SM) access and Customs Union (CU) membership (Belke et al, 2018: 3). This post will investigate what the European SM has achieved in terms of economic integration before analysing the effects of a ‘Hard Brexit’, which would see Britain leave both the SM and CU. The first section addresses the achievements of the SM, arguing that it has been successful in terms of trade in goods and capital flows whilst a lot of work remains to be done in terms of integrating services and labour markets. The second section argues that a ‘Hard Brexit’ will be disastrous for Britain due to its negative effects on trade, financial services and labour flows.


What has the Single Market achieved?


Following on from the work of the CU which eliminated tariffs between member states and established a common external tariff for imports from non-members, the SM was created in 1993 with the aim to further the economic integration between European states. This was to be achieved by removing technical, physical and fiscal barriers to ensure the free movement of goods, services, capital and persons (Van Oudenaren, 2005: 122).


The major achievements of the SM have been in the areas of capital flows (Dahlberg, 2015: 26) as well as the integration of goods markets, where intra-EU trade has increased significantly (Stráský, 2016: 5). Here, the SM has facilitated greater trade links between member countries, reflected by the fact that ‘Intra-EU exports have risen from 9 to 21% of EU GDP’ since its inception in 1993 (Dahlberg, 2015: 11). Similarly, the SM has improved FDI flows by an estimated 85% between members and 45% between members and non-members- reflecting the fact that the SM has made Europe more competitive and attractive for investors (Flam & Nordström, 2007). These triumphs are reflected by Fournier (2016) who shows that for the six nations that joined the EU in 2004, exports and inward FDI have grown much faster than other OECD countries such as Chile and Mexico. Much of this success is due to reductions in trade costs/barriers such as the removal of quotas and the harmonisation of regulations between member states (Fournier, 2015: 21).


Despite the success of the SM in integrating European goods markets, barriers still remain. Most importantly, there still exists a home bias within the EU whereby domestic goods are consumed at a higher rate than foreign goods. This shows that national borders are still important within the SM, with Nitsch (2000) finding that EU countries export roughly 7 to 10 times more to themselves than to partner countries. Therefore, whilst the SM has helped to integrate European goods markets, there is still much work to be done to improve these trade links; this could involve improving transportation infrastructure between nations to allow goods to flow more easily (Braconier & Pisu, 2014). Similarly, there is still sizeable heterogeneity in national regulations (Fournier, 2016) which the EU will be keen to reduce moving forward.


Further, there are many aspects of economic integration where the SM has made little or no impact. Labour mobility between EU member states remains modest, with an annual cross-border mobility rate of approximately 0.2 %- over ten times lower than that of the US (European Commission, 2014). With such low rates of mobility, the benefits of the SM for labour cannot be achieved. The European project must therefore increase mobility, for example by increasing recognition of education qualifications over borders, before it can be said to have achieved labour market integration (Krause et al, 2017).


Trade in services has lagged behind trade in goods and a lot remains to be done in terms of integrating European services markets (European Central Bank, 2007). This underachievement in facilitating trade in services is highlighted by the fact that ‘services make up 70% of Europe’s economies… but account for only 20% of intra-EU trade’ (Department for Business Skills and Innovation, 2015: 3). There exist many barriers that are yet to be dismantled by the SM; these include legal barriers such as territorial restrictions, as well as the inability of foreign firms to demonstrate their capabilities in providing services to consumers in other nations (Limpurg, 2010).


Therefore, while the SM has achieved greater trade links and capital flows between EU members, there is still a lot of work to be done in areas such as labour mobility and trade in services. This demonstrates that the SM still remains largely fragmented, with separate national markets for key services such as finance (Veron & Wolff, 2016: 135) as well as the tendency for member nations to roll back the SM and revert to economic nationalism when times are hard (Monti, 2010: 3). However, the SM is an evolving structure, with many routes being explored to increase economic integration such as deepening pan-European financial markets (European Commission, 2018).

Britain’s Mistake


Following the referendum, it appears that the UK government will follow a ‘Hard Brexit’ path which will see the UK leaving both the SM and the CU (Financial Times, 2017). This is a result of the government wanting to have control over the movement of persons as well as having the ability to negotiate its own trade deals (LSE, 2017). It is my argument that Britain exiting the SM and CU is a mistake.


Under a situation where Britain reverts to being a WTO member, operating outside both the SM and CU, there will be substantial losses relating to trade. On the most basic level, Britain would lose free access to its largest trading partner- with 45% of the UK’s exports and 53% of UK imports taking place with the EU (Dhingra et al, 2016). Further, British exports would be subject to the EU’s WTO tariff rates, imposing an average tariff of 5.5% across all goods (Chang, 2017); this is likely to impact heavily upon car manufacturing which will face import tariffs of 10% (Springford & Tilford, 2014: 9). Trade would also be impacted by ‘rules of origin’ which ‘could add 3-15% extra cost to normal trade costs’ (Nicolaides & Roy, 2017: 101).


After reverting to WTO membership, Dhingra et al (2017: 674) predict that British exports will fall by 14% just 1 year after Brexit, reducing welfare by 2.66% and GDP by £49.8 billion. Such a pessimistic outlook is supported by the HM Treasury pre-referendum study which shows that after 15 years of operating outside the CU and SM; GDP will fall by 7.5%, productivity could fall by up to 7.7% and households will be £5,200 worse off each year (HM Treasury, 2016b). Barriers to trade will also make Britain a less attractive destination for FDI, where it benefits from being an export platform to the rest of the EU (Dhingra et al, 2015). Here, HM Treasury (2016a) suggest that Britain could lose up to £200 billion in overseas investment within fifteen years of leaving the SM.


Britain will also suffer in terms of new trade deals. Firstly, the EU is closing in on new trade deals with both Japan and USA which could ‘lower UK prices by 0.6% and save UK consumers £6.3 billion per year’; leaving the SM will mean that Britain will not obtain these benefits (Dhingra et al, 2015: 6). Secondly, by leaving the CU and operating outside the world’s most powerful trading bloc, it is argued that Britain will have the opportunity to negotiate its own trade deals. However, the UK will have significantly less bargaining power to negotiate future trade agreements (Dhingra et al, 2016). These two factors suggest that the British economy will suffer in terms of trade in goods.


In terms of services, Britain faces huge issues if leaving the SM results in the removal of passporting rights; which allow UK banks to conduct business across the EU (Oltermann, 2016). Britain acts as a financial hub for Europe and financial services are crucial for the economy, contributing 11% of national tax revenue, 8% of UK gross value added (McMahon, 2017) and a large share of the surplus in services that can be seen in figure 1. The loss of passporting rights would restrict access and increase trading costs between EU members and the UK, making British financial services less attractive. This weakening of the financial services sector would likely worsen the current account deficit (Miethe & Pothier, 2016: 368) whilst also having negative impacts upon jobs (MacAskill et al, 2017) financial stability (Armstrong, 2016: 37) and FDI flows (Kierzenkowski, et al, 2016: 25).


Figure 1: The Current Account of the UK in % of GDP

Source: Miethe & Pothier (2016: 368)


Further, the British economy suffers from long run skill shortages, especially in low-wage industries (Coulter, 2018: 209). A major benefit to the UK from SM membership has been the inflow of workers from low-wage EU countries; notably in the area of healthcare where 10% of NHS doctors and over 20,000 nurses are from other EU countries (Iacobucci, 2016). Therefore, by leaving the SM, Britain will deny itself access to a workforce that shares the same standards and agreed rules on education (Mossialos et al, 2016: 3); this poses significant threats to key public services such as healthcare where Britain faces an ageing population and lacks qualified professionals.


Conclusion


In conclusion, the SM has made significant progress in integrating European economies by reducing regulatory heterogeneity and facilitating more free movement of capital and goods. However, the SM is yet to have integrated European services and labour markets successfully, showing that a lot of work is still to be done. This essay has also showed that in the case of a ‘Hard Brexit’ where Britain leaves both the CU and SM, the economy will suffer from lower levels of trade, a weakening of its financial services sector and a reduction in its access to European workers. Such a route poses significant threats to the health of the British economy as well as its citizens and would be a mistake to pursue.


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