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Mind your Business - 26 April 2004

The EU - A case for exit?

The News

The decision by the Prime Minister to hold a referendum in the UK on the new EU constitution has opened up the debate about the relationship between the UK and our European partners and our membership of the Union. The referendum date has not been announced - don't expect it before the next election - but Mr Blair has effectively widened the issue into a major statement on the UK's membership of the EU. Image: Architect of the EU Constitution, Valéry Giscard d'Estaing. Source: Europa - The European Convention Work on the new EU constitution - basically a document outlining how the EU will be governed in the future - began back in 2001. It is seen as being necessary because of the imminent enlargement of the EU from 15 members to 25 from May 2004. For the most part, whatever constitution is eventually agreed is unlikely to have significant effects on our daily lives but there may well be subtle changes that could well have a long lasting structural impact in the future. Part of the problem for the Prime Minister in the weeks and months to come is in getting the public to focus on the issues in the constitution; the dangers are that the public will see this as an opportunity to express their views about our very membership of the EU and also the issue of the euro. If a vote, when it does happen, goes against Mr Blair it could seriously weaken his position as Prime Minister - assuming that he still occupies that position at the time of the referendum. Is the UK media anti-internationalist? © Photolibrary Group One point that has been raised by a number of commentators is that the British public do not know enough about the constitution to be able to make an informed decision; indeed some have gone as far as to suggest that it is irresponsible to give people whose knowledge is informed by newspapers like 'The Sun' a vote on such an important issue. It is felt that most of the British press is at best Euro-Sceptic and at worst positively anti-European and that the message that Mr Blair wants to get across about the constitution will be lost amongst the headlines highlighting yet another absurd EU regulation about straight cucumbers and bananas or prawn cocktail crisps. There is however a serious economic argument involved in this issue and an argument that impacts on not only the economy but also individual businesses and the welfare of the country as a whole. To arrive at an informed decision on the future of the UK's relationship with Europe, we need to look at the costs and benefits gained from UK membership of the EU. Put simply, if the value of the benefits outweighs the costs then it would be worth the UK remaining in the EU and attempting to influence the debate on the future of Europe from within. There are those however, who believe that there are fundamental weaknesses with the EU and that the UK is getting a raw deal from our membership - that the costs of membership outweigh the benefits. These people are not necessarily 'anti-European' but do feel that the direction of the EU is becoming overtly political. One critic of the direction in which the EU is headed is Professor Patrick Minford of Cardiff Business School. Professor Minford has not merely offered generalised arguments against the UK's membership of the EU but has used appropriate theory and quantitative analysis to highlight the costs to the UK of our continued membership. Professor Minford believes that the EU is putting too many restrictions on member states' economies by limiting the role of the free market in allocating resources efficiently. He believes that the UK has journeyed on a long and often painful road since the late seventies in terms of economic reforms and that the move towards the increased role of free markets in our economy has improved economic performance and overall welfare for UK citizens. The developments in Europe, according to Professor Minford, could put in jeopardy the hard won freedoms in the UK economy. His conclusion, Europe needs to become more like the UK (in economic terms), or the UK might need to get out to preserve the benefits we have worked so hard to acquire in the past 25 years.

Theory

Professor Minford's arguments rest on a number of key points.

1. The euro:
   1. Minford argues that the benefits claimed for membership of the euro are not as great as touted by supporters of the single currency. The key benefits are said to be price transparency and the reduction in transaction costs. Minford suggests that these transaction costs - the cost of changing sterling into euro - might amount to around £1 billion per year. He then points to the fact that to join the euro would involve UK businesses in all manner of changes to accommodate the new currency - tills, vending machines and the like. This amounts to an annualised figure of around £1.2 billion - it appears from his argument here that the cost of membership of the euro outweighs - albeit only marginally - the benefits.
   2. Secondly, joining the euro would, it is argued help expand trade as it would reduce the risk involved in trading in different currencies subject to market fluctuations. Minford points out that the UK trades with two main currency areas - the euro and the dollar and that the proportions are roughly half and half. He points to the relative volatility of the dollar against the euro since 1980. You may have spotted a weakness in the argument here - the euro was not around in 1980!
      
      Minford uses the deutschmark as a reasonable substitute for the euro up until 1999 given the dominance of that currency in world markets prior to the euro. His argument suggests that sterling remained relatively stable between the dollar and the euro during that time and as such highlights the potential danger to the UK of exchange rate volatility, assuming we had been part of the euro since its inception. Since half our trade is with the dollar area, the UK would have suffered from such volatility. He estimates the cost of joining the euro could impact on the average volatility of the UK exchange rate.
   3. Thirdly, the idea of transparency of prices. Minford uses the car industry as an example and argues that it is not exchange rates that can be blamed for higher car prices in the UK than elsewhere in Europe but rather structural differences in the car industry and in the behaviour of car manufacturers and dealers. Joining the euro therefore would not lead to prices of cars in the UK falling to European levels. This effectively destroys the argument over transparency per se!
2. Monetary Policy:
   Minford argues strongly that the necessity of the UK retaining its control over its monetary policy and its interest rate is vital if the country is to set a rate that suits its own economic needs rather than having to put up with a rate that is a 'one size fits all'. There might be considerable costs in terms of economic growth, unemployment and inflation as a result of giving up the UK's control of monetary policy to the European Central Bank, particularly since the economic cycle of the UK is more closely related to the US than Europe. Minford estimates that the likelihood of getting dragged into a 'boom and bust' cycle would increase by around 75%!
3. The Labour Market:
   Minford suggests that measures taken by the EU to regulate the labour market - through such things as increased trade union powers, the minimum wage, and employer costs - could have effects on employment and output. If reversals were made to the legislation on trade union power as implied by the new Constitution, the effect on output could be anything between -3% and -5.8% depending on the degree to which the legislation was reversed with unemployment rising by between 400,000 and 1.3 million. Combinations of policies such as those highlighted above could reduce output by between 9% and 20%!
4. The Pensions Crisis:
   Minford points to the problems facing France, Italy and Germany in meeting their pensions responsibilities in the years to come. The problem is basically raising enough revenue in taxes to meet pension payments for a growing elderly population. Minford points to OECD estimates of a deficit of 8%, 11% and 10% of GDP respectively! Minford suggests that part of the burden of meeting this pensions crisis could fall on the UK taxpayer. Minford suggests that the deficit is as much as one-third of the UK GDP and as such even a small burden on the UK taxpayer would be a substantial cost to the UK as a whole.
5. Trade distortions:
   Over the years the importance of manufacturing in the UK has declined; we now have a far greater proportion of our exports in the form of services and import a greater proportion of manufactured goods. The regime of subsidies and protection given to EU manufacturers effectively means that the UK, as a net importer of manufacturers, pays a higher price for its manufactured products from the EU. Professor Minford suggests that figures indicate consumer prices for some foodstuffs could be as high as 50% above the world price, whilst prices for business equipment and consumer manufactures could be 60% above world prices. This could be counterbalanced by the benefits from being able to sell our services to Europe but they are not subject to the same level of protection and as such the UK loses out. Minford estimates the cost to be approximately 2% of GDP. The diagram below demonstrates the problem.
   
   
   If the UK bought its manufactured goods from outside the EU it would pay the world price. However, in buying its manufactured goods from the EU it pays the protected price, supply of manufactures from the EU will rise whereas demand will fall at the higher protected price. The reductions in producer and consumer surplus (regions a and b respectively) along with the tax revenue collected by the European government which may not find its way back to the UK (area c) represents 2% of GDP.

When you take into account all these factors, Minford believes that the UK suffers from its membership of the EU. If the EU were to change and adopt a greater degree of free market policies then he believes that there could be benefits for the UK and for all other members. While EU policy making is dominated by those who are seeking to place more restrictions on markets rather than encouraging a greater degree of free-market activity and competition within the EU the problems facing the UK will get worse.

Is the EU likely to take on board the lessons learned by the UK economy or will they expect the UK to become more in tune with the philosophy of the current EU? Minford does not hold out much hope for the former and as such, Mr Blair might well have triggered the first steps in a movement that sees the UK moving away from Europe. In a curious twist of fate, the constitution might well deliver the outcome that Minford and others who support free markets are seeking!

Tasks

1. Discuss the issues raised by this resource in your class. Some of these issues might include the methodology by which economists research such issues; is Minford scare mongering or should we be right to be concerned at the issues he highlights?
2. The costs to the UK of membership of the EU as highlighted by Minford are primarily economic costs. Assuming that Minford's methods of analysing and quantifying these costs are accurate, what counter arguments would you put to Professor Minford to justify continued UK membership of the EU?

Related Web sites for research

• Copy of the draft constitution (http://european-convention.eu.int/docs/Treaty/cv00850.en03.pdf)
• Summary of the EU constitution from the BBC (http://news.bbc.co.uk/1/hi/world/europe/2950276.stm)
• Section on the EU constitution from the Europa Web site (http://european-convention.eu.int/enjeux.asp?lang=EN)
• Professor Patrick Minford's Web site (http://www.btinternet.com/~patrick.minford)

Biz/ed would like to thank Professor Minford for his help with this Mind your Business.