EU Transactions - Forward Thinking, Progressive for all

Last updated: 7th September 2016

Aldous Huxley: “Facts do not cease to exist because they are ignored”.

Why EU Transaction Spending Matters

The UK has now voted to withdraw from the EU, but the re-allocation of the existing payments is now highly contentious. In 2015 the official data shows spending was £3.7 billion, equivalent to 0.5% of total Government spending.

Each year, the UK government pays towards the EU budget. Now, this mainly reflects the size of the UK’s economy relative to other EU Member States, and contributions based on tax and levies income. In 2014-15 the EU charged the UK a further levy of £1.7 billion supposedly because the economy had performed better than expected in recent years. That payment followed new calculations by the EU that decides how much each member state should contribute. This involved a re calibration of the economy to include the black market such as prostitution and drugs. The UK has therefore been paying the EU on items that by definition do not contribute to tax income.

EU Transactions Spending, 2010-11 to 2014-15 (£ Million)

EU expenditure by the UK

Source:  HM Treasury

The UK spending on the EU is now subject to potential adjustment, depending on the deal negotiated following the exit result of the referendum.

EU membership was a complex issue about both real and implied benefits and costs which are far- reaching. In 2014 the UK exported £230 billion of goods and services to the rest of the EU. That was £59 billion less than the EU exported to the UK. Some suggest that this implies the EU needs the UK more than the other way round. The EU made up 44.8% of all UK exports in that year.

Other claims suggest the EU increases the cost of food, through EU farm subsidies, by £3 billion. This needs to be balanced with the economic position of UK farmers as well as the food security of supply it affords. Immigration from the EU is a further issue widely reported by politicians and the media, but UK residents also have the right to work in other EU countries from EU membership.

Other figures quoted on EU membership include the number of jobs associated with EU Trade. This is variously quoted at 3-3.5 million. This is not the same as saying that more than 3 million jobs are dependent on the UK’s EU membership. Trade with EU countries will take place even after the UK withdraws from the EU. The number of jobs created by direct investment from EU-based companies in 2014/15 was 28,250 with a further 6,686 safeguarded by the investments according to the UKTI projects database. Again the referendum vote to exit the EU does not necessarily jeapodise these roles.

In 2014, EU countries accounted for 48% of foreign direct investments in the UK (£496 billion out of a total of £1,034 billion). This compares with 24% from the US and 28% from other countries. The share accounted for by the EU has varied between 47% and 53% over the last decade. The EU accounted for 40% of UK foreign direct investment stock abroad in 2014.

The issues of EU membership depend on two major issues. The first is the deal Britain would get following the exit. Officially, British exports to the EU would face an average tariff of 2% if the UK exited the EU, though the charge on food would be much higher. However, this will be totally offset by the devaluation of the pound that took place immediately after the UK voted to exit the EU.

Against this if the UK could negotiate access via a free trade agreement, as Norway and Switzerland have done, the tariff would be waived, but there are costs associated with this and depending on the outcome of negotiations the cost could again involve free movement of labour. The second variable is the future of the economy and currently the UK is outperforming the EU (as indeed is virtually every other region).

In June 2016, the UK had the opportunity to vote in a referendum to exit the EU. Claims on both sides of the debate became increasingly exaggerated with the remain campaign concentrating on the economic issues and the leave campaign emphasising sovereignty and democracy. The leave campaign also rather sadly allowed the argument in connection with immigration to be about just that, rather than the actual issue of the ability to control it.

The turnout for the vote was encouraging at 72.2%. Far higher than the turnout for a general election. The result was a narrow majority voted to leave, and this has encouraged widespread analysis of the result. Analysis has been done by geography, (and the well publicised majority vote to remain in Scotland, Northern Ireland and London which comprised three of the four lowest turnout areas); by age group (evidence suggests the older elements of the population were keener to exit than the younger generation); urban/rural divides (again urban areas had lower turnouts); and ‘class’ (the higher the number of so called working class, again the lower the turnout). While this analysis is of great significance to politicians, it does not change the majority verdict in what was a vote where each vote had precisely the same significance as every other vote.

As an EU member the UK and companies based in the UK have the ability to sell their goods and services to customers in other EU countries without having to pay additional taxes to import those products. Conversely, UK-based consumers and companies can import those products and services from within the EU without tariffs. The EU also has agreements allowing free trade with other countries such as Norway, Switzerland, South Africa and South Korea.

Outside of the EU, the UK will need to develop new deals in order to have free trade with those countries or the remaining EU members. Prior to the referendum the vote leave campaign argued that the government would have informal talks with EU leaders before invoking article 50 of the Lisbon treaty in order to enhance a new free trade relationship with the EU. Subsequent to the referendum the EU have immediately rejected any such informal talks.

In practice the ability to develop new agreements with the EU is highly unlikely within a two-year time frame. Article 50 of the Treaty allows a member state to notify the EU of its withdrawal and obliges the EU to try to negotiate a ‘withdrawal agreement’ with that state. It involves five points:

  • Any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements
  • A Member State which decides to withdraw shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union. That agreement shall be negotiated in accordance with Article 218(3) of the Treaty on the Functioning of the European Union. It shall be concluded on behalf of the Union by the Council, acting by a qualified majority, after obtaining the consent of the European Parliament
  • The Treaties shall cease to apply to the State in question from the date of entry into force of the withdrawal agreement or, failing that, two years after the notification referred to in paragraph 2, unless the European Council, in agreement with the Member State concerned, unanimously decides to extend this period
  • For the purposes of paragraphs 2 and 3, the member of the European Council or of the Council representing the withdrawing Member State shall not participate in the discussions of the European Council or Council or in decisions concerning it. A qualified majority shall be defined in accordance with Article 238(3)(b) of the Treaty on the Functioning of the European Union
  • If a State which has withdrawn from the Union asks to rejoin, its request shall be subject to the procedure referred to in Article 49.”

The form of any withdrawal agreement would depend on the negotiations and there is therefore no guarantee the UK will find the terms acceptable. The EU Treaties will cease to apply to the UK on the entry into force of a withdrawal agreement or, if no new agreement is concluded, after two years, unless there is unanimous agreement to extend the negotiating period.

During the two-year negotiation period, EU laws will still apply to the UK. The UK will continue to participate in other EU business as normal, but it will not participate in internal EU discussions or decisions on its own withdrawal. On the EU side, the agreement will be negotiated by the European Commission following a mandate from EU ministers and concluded by EU governments “acting by a qualified majority, after obtaining the consent of the European Parliament.” This means that the European Parliament will be an additional unpredictable factor in striking a deal.

However, if the final agreement cuts across policy areas within the preserve of the member states, such as certain elements of services, transport and investment protection, as many recent EU FTAs have done (for example with Peru and with Columbia), it will be classed as a ‘mixed agreement’ and require additional ratification by every national parliament in the EU. The EU Treaties will also need to be amended to reflect the UK’s departure. In effect, this means that the final deal at the end of a negotiated UK exit from the EU will need to be ratified by EU leaders via a qualified majority vote, a majority in the European Parliament and by the remaining 27 national parliaments across the EU.

Forward Thinking Policies on EU Transactions

There is now a moral obligation on the Government to deliver on the referendum vote. The business community is concerned about the uncertainty that is created by the decision. The act of Parliament to give effect to the UK leaving the EU need only contain two key clauses. One will relieve the UK of all the obligations of EU membership. The other will carry over all the EU law that currently applies to the UK into domestic law, so that at the outset, nothing changes at all.

The rest will be all about transitional arrangements. There is concern that the UK needs to have a deal in place with the EU before the transition to leave is started. This is not necessary. There are clearly some non-trade issues where agreement is needed, such as giving assurances to EU nationals resident in the UK and UK nationals resident in the EU, and replacing EU security policies such as the European Arrest Warrant and passenger data sharing with bilateral arrangements.

With regard to the trade negotiations, prior to the referendum, Open Europe undertook a detailed study of the various alternatives open to the UK on exit. It concluded that:

  • In a worst case scenario, where the UK fails to strike a trade deal with the rest of the EU and does not pursue a free trade agenda, GDP would be 2.2% lower than if the UK had remained inside the EU
  • In a best case scenario, where the UK strikes a Free Trade Agreement (FTA) with the EU, pursues very ambitious deregulation of its economy and opens up almost fully to trade with the rest of the world, UK GDP would be 1.6% higher than if it had stayed within the EU

It identified that these were the two extremes, and that “the more realistic range is between a 0.8% permanent loss to GDP in 2030, where the UK strikes a comprehensive trade deal with the EU but does nothing else; and a 0.6% permanent gain in GDP in 2030, where it pursues free trade with the rest of the world and deregulation, in addition to an EU FTA.

Importantly the study identified that in none of its scenarios would the cost of leaving the single market and the EU customs union be off-set by merely striking a new trade deal with the EU. Britain will only prosper outside the EU if it is prepared to use its new found freedom to undertake active steps towards international trade liberalisation and deregulation. This has to be the fundamental objective going forward. It will also be attractive to other countries as a growth force and there is nothing to prevent the UK pioneering a new economic community, more akin to the early aims of the EEC. This would then potentially significantly increase the negotiation power of the organisation, and the attractiveness to other companies to undertake such talks.

It must be expected that the EU negotiators will drive a hard bargain with the UK, because they will be fearful that if the UK gains a preferable deal to when it was a member then other countries will similarly defect. The deals will primarily revolve around the financial institution position, trade tariffs and free movement of labour. It will be up to the UK negotiators to decide which areas are non-negotiable and which they deem to be less important. This may or may not reflect public opinion, since the public will be less concerned over individual trade issues but closer to the issue of control of immigration. In the immediate aftermath of the referendum calls have been made to hold a further referendum on the terms when these have been agreed.

Trade negotiations of this complexity are extremely complicated and highly unlikely to be resolved within the two-year timescale allocated under article 50 of the Lisbon treaty. To extend these terms requires all EU member countries to agree, and this provides the EU with a significant negotiating position.

In the debates prior to the referendum various statistics were quoted identifying the size of imports and exports between the UK and the EU. In the first three months of 2016 the trade gap between exports and imports with the EU widened by £0.7 billion to a deficit of almost £24 billion. Proponents of the leave campaign identify this deficit as being a significant impetus for the EU to come to a sensible trade agreement. The pressure on the EU is furthered by the underperforming economies within Europe and the high levels of unemployment within the Eurozone. However, the imbalance in the argument is that UK exports to the EU are equivalent to 45% of total UK exports, and even though there is a trade deficit with Europe and the UK only accounts for 16% of EU exports of goods (this excludes services).

While 16% may not sound like a strong bargaining point, it does make the UK the EU’s single largest trading partner for trade in goods. However, this is probably not the case for trade overall. Including services would reduce the UK’s share somewhat (the EU ex UK exports something over €600 billion in services, while the UK imports only about €40-45 billion in services from the rest of the EU). This will be the concentration of the negotiators because trade in goods can be covered by the global rules set out by the World Trade Organisation. This could form the starting point of UK trade deals, though considerably greater FTA’s need to be targeted.

It is clear that the UK is still far less important to the EU than the EU is to the UK in terms of overseas trade, and this will impact the ability of the negotiators irrespective of the considerable added complication of the number of countries with interests within the EU.

The UK will now be powerless to push for liberalisation of EU services markets. It might find that in some areas, inward investors will switch their money to countries inside the EU. The UK will initially find it very difficult to negotiate trade agreements with non-EU countries that are as comprehensive as those the EU agrees, but they can be developed over time. Seeking other FTA’s (outside of Europe) would also send a clear message to the EU, that the UK is firm on the issue.

In the short-term leaving the UK may hinder inward investment to the UK from non-EU countries, but opportunities abound in the wider international market. Change in Corporation Tax can be used to continue to attract inward investment. The UK partly attracts investment currently because of its access to the EU as a market. All of these are difficult to quantify. However, the UK gains strongly from inward investment:

Major European Locations for New Inward Investment Projects with HQ Operations, 2012 (%)

New inward investment sources

Source:  Financial Times fDI Markets database

The basis of inward investment decisions is partly a financial calculation. Tax is important in that decision. Removing Corporation Tax would be a major attraction to companies, and could more than offset any tariffs imposed on the UK even within Europe, particularly given the readjustment of the value of the pound in the immediate aftermath of the referendum.

Each deal beyond Europe needs to be carefully considered for its implications on UK agriculture and industry, though the liberalisation of trading agreements and the removal of tariffs generally more closely follows practices undertaken in Hong Kong, New Zealand and Singapore. Such a policy, potentially contributes far more significantly to assisting developing countries than any overseas aid contribution that could be made from the UK.

The exit vote is bound up in the principal of regaining control over immigration. This is a very different issue to the immigration debate that was held prior to the referendum. It allows the UK to enter into a non-discriminatory immigration policy, extending opportunities for talented individuals from anywhere in the world to ply their trade in the UK. Furthermore, by reducing the economic and social implications of uncontrolled numbers of migrants entering the UK, not only is the planning of the economy and public services more straight forward, the country has a greater capacity to absorb genuine refugees.

By adopting what has been widely called ‘an Australian’ type points system, the UK has the ability to define its own factors for migrants to work in the UK. In Canada, where similar controls are in place, there is a much more positive attitude towards migrants as a result of that knowledge of control. The UK must look to establish similar respect of migrants who contribute to the furthering of the UK economy and society.

The principle of free movement was established when the EU was a much smaller group of countries with similar levels of wealth. Currently the EU is a Union of 28 hugely different countries with a significant wealth disparity between the richest and poorest countries. In 2013 the UK had a GDP for each person of €29,600 (around £23,700) compared with Bulgaria which had a GDP for each person of €5,500 (around £4,400). This creates a huge incentive to migrate from poorer countries to wealthier countries. This is an incentive that did not exist when the Treaty of Rome was signed and it encouraged immigration to the UK.

If the UK educated and trained the right level and type of skills among UK residents there would be a natural downward pressure on immigration in total. This is however, currently overrun by the disparity of the minimum wages. The UK has a high minimum wage compared with most other countries in Europe.

Minimum Wages in the EU, 2015 (€ per Hour)

EU minimum wage levels

Source:  Eurostat

Identifying quotas for immigration was ineffectual without control over a potentially large part of that immigration. To reduce incentives to live in the UK is the only limitation that can be imposed under EU rules. If negotiations with the UK force a continued agreement on free movement the only way to change benefit incentives is to change the benefit rules for everyone. This will have a small impact on immigration.

In 2014, some 4.9 million (92.6%) of working age benefit claimants were British while 131,000 (2.5%) were EU nationals. The number of recipients from outside the UK, but not from the EU, was 264,000 (5%). Similarly, in the latest data from 2013 for tax credits, 3.9 million (84.8%) of families receiving the benefits were British citizens. A further 302,000 (6.4%) were EU citizens and 413,000 (8.8%) were from outside the UK. The data also shows that among single families receiving either working family tax credit or children’s tax credit, most non-UK claimants are from the EU: 157,600 single families from the EU receive one or both of the benefits while 146,000 of those from outside the EU do.

The benefits that EU migrants can claim in another EU country vary across the 28-nation bloc, but certain basic rules are enshrined in EU law. An EU citizen can stay for three months. To stay longer they have to:

  • be in work
  • actively seeking work with a genuine chance of being hired
  • be able to show they have enough money not to be a burden on public services.

Apart from that, evidence of benefit abuse or fraud is grounds to exclude or expel a person. Even if an EU migrant has permission to stay in the UK, a migrant still has to pass a “habitual residence test” under EU law.

The test covers areas such as the duration of the migrant’s stay; their activity, including their source of income if they are students; their family status; and their housing situation. The migrant has to show enough degree of attachment to the host country. The time already spent in the country is not enough qualification in itself. If a job seeker satisfies the test in the UK then that person can claim Jobseekers Allowance. An EU migrant who is in work in the UK, or self-employed, and who passes the test, can claim housing benefit and council tax benefit. The amounts vary, depending on the local authority.

Under EU law the UK has to provide similar benefits to all EU citizens that arrive in the UK as UK citizens. This is part of a Treaty arrangement so the UK cannot change it. However, It is possible to change the rules of benefit claims for all people. Forward Thinking suggests giving a right to a benefit after a residency period (say 10 years). UK nationals would earn this status while at school.

A negotiated withdrawal form the EU may not fully eliminate the UK contribution, and even if it does, elements of the current benefits will need to be maintained at least in the short term, such as the EU subsidies to agriculture that run at some £3.1 billion.

UK Gross Contributions, Receipts and Net Contributions to the EU, 1970-2015 (£ Billion)

UK net EU contributions

Source:  HM Treasury

There is a major issue with the replacement of the EU’s CAP. Initially the UK would need to honour CAP payments to farmers on exit, but the entire payment structure needs to be thoroughly reviewed in consultation with the farming representatives and the retail industry. EU policies have effectively forced farmers to become dependent on subsidies, and British farmers receive £3.1 billion per annum (equivalent to £235 per hectare) from CAP. This is paid on the basis of the area of land farmed, and efforts farmers make to improve the environment. Many farmers argue that the benefit from the EU’s subsidy rarely reaches them and supermarkets factor in the expected income in their calculations of what to pay their suppliers. Farmers also benefit from access to the EU market, which accounts for more than half of all British food and farming exports, amounting to more than £11 billion a year. It is a very important area that needs positive policies and needs to take consideration of the situation after final tariff negotiations with the EU are concluded.

© Forward Thinking 2017, Progressive for all.