Analysis: What if Britain left Europe?

A "Brexit" is considered a real possibility for the first time in four decades. But just how economically damaging would UK withdrawal be, asks Ben Chu

The moment of climax is almost upon us. David Cameron is due to deliver his "tantric" speech on Britain's future relations with the European Union in the Netherlands on Friday. The Prime Minister is expected to promise a national referendum on our membership of the club to take place after the next election.

Mr Cameron indicated in a radio interview today that the promise will come with a barrel-full of caveats. Among other things, the Conservatives will have to win a majority in 2015. Plus our European partners will have to be willing to amend the EU's governing treaties. In other words, the promised popular vote may never arrive.

Nevertheless, a sense is growing that a British exit from Europe is now a more real possibility than at any time since Edward Heath took us into the Common Market in 1973.

Business leaders are starting to sound the alarm, warning that a British withdrawal – even a mere vote on withdrawal – represents a serious danger to our fragile economy. Some of the few remaining pro-European Conservatives, including Lord Heseltine, are stirring too.

Are their warnings merited? Just how economically damaging would what some are calling a "Brexit" actually be for us?

Trade

Britain entered the European Union 40 years ago because of the perceived economic advantages of being part of the single market. Back in the 1970s, Europe was growing strongly – more strongly than Britain.

Today much of the bloc is in recession and still suffering from an economic fever brought on by the eurozone debacle. But in raw economic terms those trade advantages have actually grown. The European Union is now a market of some 500 million people, thanks to successive rounds of enlargement taking in first the newly democratic nations of southern Europe and then the former Soviet satellites of Eastern Europe. The EU is the destination for half of our exports. Lose access to those markets and the danger to our exporters is self-evident.

Couldn't we negotiate a free-trade agreement with the EU, like Norway and Switzerland? Perhaps we could. But that cannot be assumed. And what would the terms of a future deal be? Would a departing Britain get a decent settlement from our irked former club partners?

There are plenty of reasons why foreign or even domestic firms might be nervous about investing in Britain while the country pondered whether to stay or leave.

Regulation

Eurosceptics complain loudly about the plethora of business regulations that emanate from Brussels which they claim are throttling innovation and entrepreneurial dynamism. Steve Hilton, the Prime Minister's former adviser, reportedly recently complained that 40 per cent of the Government's time is spent implementing EU red tape. The British Chambers of Commerce has estimated that the annual cost of these regulations is £7.4bn a year.

But the problem with the proposal of withdrawal as a solution is that we would have to implement these regulations in any case to continue selling into the trading bloc, just as Norway and Switzerland do. While in the EU we have a say on setting the rules that govern the single market. We can push for reform from within. It is not clear what advantage Britain would be getting if it withdrew from the rule-setting club.

And it's not only restrictions that emanate from Brussels, but also freedoms. Britons have the right to work and travel anywhere in the European Union. Would they enjoy those same rights if Britain exited?

That might not matter terribly for the aggregate UK economy, but it matters immensely for those British citizens who want to work or retire on the Continent. At the moment some 750,000 Britons have are exercising this freedom.

Investment

Some non-European manufacturing firms regard the UK as a bridgehead to the EU market. Around five out of six cars manufactured here are exported. We have seen in recent days from two diverging decisions by two firms – Japan's Honda and the Indian-owned Jaguar Land Rover – how important the inward investment decisions of multinational corporations are for UK employment. European investment in Britain matters too, with a significant proportion of inward investment in Britain comes from the European Union. How would a British referendum affect all these flows?

Richard Lambert, the former head of the CBI, pointed out that the latest forecasts from George Osborne's Office for Budget Responsibility show 10 per cent rises in business investment in 2015 and 2016. At this time government retrenchment will still be subtracting demand from the economy thanks to the ongoing austerity programme. To put it bluntly, if that investment does not materialise, neither does the elusive UK recovery.

The UK higher education sector could also face a problem if Britain pulled out of the EU. By some estimates up to 20 per cent of British universities' incomes come from European research grants. Would the UK taxpayer be prepared to fill this gap and safeguard Britain's economically crucial science base?

Financial services

As with trade, Britain presently helps to set the rules that govern the way financial markets across Europe are regulated. Some have suggested that, since the countries of the eurozone are moving to closer integration, this advantage is not what it was. Britain is bound to be outvoted sooner or later, we are told.

Some see jealous European eyes fixated on the business of the City of London. And it is true that Christian Noyer, the French central bank governor, recently suggested that London cannot be considered the natural centre for trading euro-denominated securities.

Yet Britain probably has a better chance of fighting for its financial services interests from within the EU negotiating chambers than outside. George Osborne won protection from being outvoted on banking matters in Brussels last year when the eurozone nations were haggling over the establishment of a single currency banking pact. If Britain had not been in the EU, the Chancellor would not have even been in the room.

Agriculture

There would be some unambiguous economic benefits from withdrawal. If Britain left the EU, it would be freed from the wasteful, iniquitous and environmentally harmful Common Agricultural Policy. That would be an economic advantage to the tune of £5.5bn a year (the annual sum sent to Brussels between 2007 and 2013). Ministers could then decide themselves whether to spend that money subsidising large landowners. But given that agriculture accounts for less than 1 per cent of our national output, this change would not be a transformational one.

Upon leaving the EU, ministers would also be free to decide unilaterally how much fish to extract from our own territorial waters, without having to haggle over annual quotas in Brussels. But again, anyone hoping to see Britain making its living in the 21st century powered by a reinvigorated domestic fishing industry is liable to end up cruelly disappointed.

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