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UK industry asks the EU - ‘What have you done for me lately?’

A banana

The context of the BREXIT debate so far has been like a playground spat – both sides calling each other names and fixing on particular points to alarm or calm in equal measure. Every time objective analysis leads to an estimate of the financial impact of leaving or staying, it is immediately seized upon by the other side and is framed in a negative way.

Well, let’s step outside the politics of all this and look at the more micro level impacts of the EU and how it has affected UK. Time to move away from the posturing and point scoring, let’s review and discuss some of the various estimates of the effect of the EU on UK industry.

Drowning in a sea of bureaucracy?

A seemingly common perception is that membership of the EU has substantially added to the degree of regulation applying to UK business. This additional regulation has in turn increased costs for business.

Analysing the detail, extent and impact of this heightened level of ‘red tape’ is difficult, but there is no shortage of people trying:

Business for Britain reported that, “between 15 October 2013 and 30 September 2014, a total of 1,139 new EU business regulations and directives were introduced by the EU, amounting to over 6.3 million words”.1

That’s a significant number and in just one year too. What might be the impact of this regulation?

Well, according to Open Europe, it might be substantial:

The cost of regulation keeps on going up

Indeed, they go further...

“since 1998, regulation introduced in the UK has cost the economy £176bn. Of this, £124bn, or 71%, had its origin in the EU. This means that EU regulation in the past 11 years has cost every UK household an average of £4,912.”2

 

Ouch! That’s a big cost attached to all that red tape. It goes on to estimate the impact of the top 100 EU regulations on UK firms as costing £33.3 billion per annum (March 2015).

The implication seems clear: leave the EU, remove the restrictions imposed by EU legislation and save costs into the process. What’s not to like?

As ever, these figures must be treated with care. However, there is no denying that there has been increased regulation arriving from membership of the EU. Who could fail to remember the ‘bendy bananas’ issue?

As Commission Regulation (EC) 2257/94 puts it, “bananas must be ‘free from malformation or abnormal curvature’. In the case of "extra class" bananas, there is no wiggle room, but Class 1 bananas can have ‘slight defects of shape’, and Class 2 bananas can have full-on ‘defects of shape’.3

While this was all rather amusing, the legislation was not actually saying bananas had to be straight. But was reported in such a way to demonstrate the reach of the EU legislation and why it caused such an issue.

Does all this regulation represent such a burden? According to the Department for Business Innovation and Skills there were a record 5.4 million private sector businesses at the start of 2015. Of these, 99.9% were small or medium-sized (SMEs), and they accounted for 60% of all private sector employment.

The greater proportion of these is likely domestically focussed and have little to do with trade. However, they will be subject to the various EU regulations which will, therefore, impose some implementation costs.

Trade: the lifeblood of the nation

But we must not forget that EU membership has led to an increase in trade by making it easier for UK companies to trade with other EU member states in three key ways:

‘At the border’ effects

The most obvious effect on these is the removal of import quotas and tariffs (a levy usually imposed on a per unit basis as a % of the sales price). This is estimated at an average of 9% for countries with no preferential trade agreement.

The second element has been the creation of a customs union; this has allowed removal of customs duty; a UK good exported to the EU can avoid imposition of a charge to reflect differences in duty levels, meaning no customs costs on trade within the EU.

The UK Treasury cites analysis suggesting that crossing the border, documentation and other delays can increase the transaction costs of trade by up to 24% of the value of traded goods. Yet, the World Bank estimate that between 1999 and 2008 UK’s average trade costs with the EU fell by 10%.

‘Beyond the border’

Regulations and directives on product and service standards have levelled the playing field across the EU as goods can be sold across numerous jurisdictions, providing they meet EU standards. This has boosted consumer choice in the UK and increased the potential market size for British goods and services.

An excellent example is the ‘passporting’ seen in financial markets, which allows financial products from one EU country be marketed and sold in another country. In financial services, this has benefited the UK; financial services exports have increased from 1.6% of GDP in 1991 to 3.5% of GDP in 2015.

In the absence of these standards it is possible to restrict competition by slow examination of imported goods and the insistence of retro fitted equipment or changes.

What has been the effect of this liberalisation the UK’s trade with the EU? The share of trade (exports and imports) as a percentage of GDP has grown dramatically for the UK; trade as a share of national income has risen to over 60% in the past decade, compared to under 30% in the years before the UK joined the EU.

Interestingly, the effect of the three changes above are best seen via supply chains of more complex items, such as aircraft or car manufacture. These involve export and import of intermediate (i.e. semi-completed goods) across numerous borders. The UK has a very large aerospace sector with turnover of nearly £30 billion and the Treasury estimates that 3,000 companies operate in the supply chain.4 Imagine that trade taking place in the context of tariffs and customs duty!

BREXIT might not remove all of these relationships or barriers – but it would make creating similar linkages in the future that much more difficult, not to mention, expensive.

But what is also apparent is that EU membership and liberalisation of trade has led to increased competition in the UK, with EU firms entering UK markets and vice versa. A simple example of this is the popular Spanish fashion retailer Zara trading in the UK.

Going in the other direction, fashion design house Paul Smith now has 11 shops in the EU and Church’s, the up-market shoe maker, also has an extensive range of shops across the EU. So, for UK companies, it represents a real opportunity to expand business too.

…And finally, what of the cost of capital? Well, we don’t know for sure, but the consensus in financial markets seems to be that in the event of BREXIT the UK would look a riskier investment, at least in the short term. This would probably have two effects: reduction in Gilt prices and an upward shift in the yield curve, increasing the risk free rate and thus feeding through to required rates of return generally.

The second effect would be a possible upward shift in the equity risk premium. The combination of the two effects (at least in the short term) would cause a rise in the cost of finance for companies, but no-one knows by how much.

In summary, there is no doubt that there has been a great deal of regulation originating from the EU and this will have increased firms’ costs as they sought to comply with those regulations. But it is also beyond doubt that removing at the border restrictions has dramatically lowered the cost of trade. This effect, coupled with standardising product and service regulation, has greatly increased UK trade volumes and values with the EU and subsequently increased UK GDP. In fact, the Treasury estimates that UK GDP is between 4.6% and 7.8% greater through EU membership.4

Sources:

  1. Business for Britain, Cutting red tape: is the EU listening?, 26 October 2014
  2. Still out of control? Measuring eleven years of EU regulation, Open Europe, June 2010
  3. BBC.co.uk, Friday, 23 March 2007)
  4. HM Treasury analysis: the long-term economic impact of EU membership …April 2016

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Roy Daintith, Senior Consultant of Macroeconomics, Leadership and Professional Development at Kaplan, believes that economics is fundamentally relevant to business performance and is passionate that decision makers should understand the bigger forces shaping and driving their industry.

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