How now for a British exit?

The economic rationale for Britain to leave the EU appears to stack up, but the terms on which it would leave are all-important.

FT.com

In discussing the pros and cons of Britain’s membership of the EU, the most important point to remember is this: the terms of an exit are freely negotiable. This means that the economic consequences will depend to a large extent on those exit terms.

In his article in The Times last week, Lord Lawson, a former UK chancellor, argued that the regulatory costs of the single market for the British economy exceed the economic costs of an exit. As a consequence he favours an exit. Is the analysis correct? Does the conclusion logically follow?

I do agree with most of his analysis, especially his point that, for the UK, the single market carries higher costs than benefits. For the EU as a whole, the single market has been a macroeconomic non-event. Its impact on aggregate gross domestic product is statistically imperceptible. If you really wanted to defend it on macroeconomic grounds, you would need to argue that trend growth would otherwise have declined – and would have done so at exactly the time when the single market was introduced. Good luck with that.

The single market brought some benefits to the EU’s many small open economies, especially those with a relatively large industrial base. The UK is a large economy with a small industrial base. For a country such as the UK, the regulatory burden of the single market outweighs the benefits.

But can one conclude from this observation that the UK would be economically better off outside? To do so, one would have to make two assumptions.

The first one is that, upon exit, the UK does not immediately seek membership of the European Economic Area. The club currently comprises Norway, Iceland, and Liechtenstein. The whole purpose of the EEA is to give those countries access to the single market, albeit with virtually no influence over the rules. So if you feel that the single market is a regulatory monster, you certainly do not want to join a club that forces you back into it.

The second big assumption is that even without EEA membership, the UK would still enjoy access to free trade with the EU. Is that a reasonable assumption?

I think it is. Germany or the Netherlands will almost certainly not oppose a free-trade agreement with the UK, and can probably persuade the others to accept a liberal post-membership arrangement with Britain, too. It would be in nobody’s interest for the UK to suffer a negative trade shock.

David Cameron, Britain’s prime minister, may also find it easier to negotiate favourable exit terms than a treaty change. The latter would be needed if he wanted to put substance to his goal of a fundamental change in Britain’s relationship with the EU. It would have to be agreed by all members, their parliaments, and it would need to pass in several referendums.

The legal basis for an exit clause is softer than for a treaty change. Article 50 of the Treaty on European Union, one of the two treaties known together as the Lisbon Treaty, provides the option of an exit. There would have to be negotiations between the British government and the various European institutions. Everything would be up for grabs. Britain can negotiate a favourable or a non-favourable deal. My best guess is that an exit would put Britain in a similar situation as Switzerland, which would not exactly be an economic disaster. Any exit deal would thus have to include, or come along with, a bilateral trade agreement. Without it, it would be folly to leave the EU.

Lord Lawson’s strongest argument relates to the changing nature of the EU. If Britain decided to remain a member, it would find itself pushed to the outside as the eurozone integrates. The financial transactions tax and banking union are two early examples of an integration that occurs without Britain’s participation. There will be many more. The euro is what splits the EU – or rather the British decision not to join it. The rest is an inevitable denouement. Where I disagree with Lord Lawson is his ambitions for the City of London as Europe’s financial centre. In any case, I believe the UK would be better off in the long run if it reduced its reliance on finance. But even if one disagrees with that statement, the goal to secure the City’s position as Europe’s financial centre, is unrealistic – no matter whether the UK is inside or outside the EU.

The EU’s incipient banking union may be too slow to resolve the eurozone crisis, but potent enough to drive a wedge between the eurozone and the UK. A banking union means that the eurozone will ultimately end up with its own financial centre. I can think of nothing that can safeguard the role of the City in the long run, except a decision to join the euro. This, of course, is not going to happen. And Lord Lawson is certainly not demanding it.

My overall conclusions, however, concur with his. There may be reasons why the UK may wish to remain a member of the EU. But whatever they are, they are not economic.

Copyright The Financial Times Limited 2013.