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Friday, August 09, 2013

What would leaving the EU mean for the UK's services sector?

Our Director Mats Persson writes on his Telegraph blog,
The UK’s services sector accounts for around 75 per cent of the country’s GDP. Britain’s 0.6 per cent growth in the second quarter of this year was largely thanks to this sector, which grew at its fastest rate in over two years.

Whether we like it or not, the UK will remain a services-based economy for a very long time. So it goes without saying that as David Cameron looks to negotiate a new settlement with Europe, getting a good deal for the UK’s services sector should feature highly.

By far the most common argument from Better Off Outers is: “We sell more to them than they sell to us”, implying that the UK’s trade deficit would give London leverage to secure a favourable Free Trade Agreement in place of EU membership. It’s a persuasive argument. It is also simplistic. As the graph below shows (click to enlarge), the UK’s trade deficit with the EU is the result of a large goods deficit, while it is a net exporter of services.

This is critical for several reasons.

First, UK services firms clearly use their comparative advantage to do business in Europe, boosting UK growth.

Secondly, if you buy into the “trade deficit” argument, it follows that while Germany and others would have an interest in maintaining open markets for selling manufactured goods in the UK, this logic does not apply for services, where they are net importers from the UK.

Therefore, the UK would be vulnerable to tit-for-tat trade games in its key economic sector. Perhaps Germany would be so keen to continue selling tariff-free cars that it would happily offer market access for UK services firms as part of a new deal. However, it’s far easier to remove tariffs for goods than it is to eliminate the myriad of barriers that exist to market access in services. Despite 40 years of negotiations, the Swiss still have patchy EU market access for services, while the EU and US have spent decades trying but failing to agree reciprocal market access for certain types of funds.

Critically, there’s only one off-the-peg model offering full market access for services outside the EU – the Norwegian model (EEA) – which for a range of other reasons would be a bad deal for the UK. The other potential models – the Swiss, Turkish and WTO options – would restrict access for the UK services industry absent separate agreements for specific sectors. This also spells problems for the City of London, currently used by a range of firms as an entry point to the single market, often via a so-called passport (involving a firm being allowed to sell its services across the EU as long as it’s authorised to do so in one member state).

Again, given that the City is also a gateway to global markets for European firms, a deal might be struck. However, since “Anglo-Saxon” bankers and fund managers aren't exactly universally loved on the continent, it’s also easy to see France et al blocking passport-style provisions for UK financial firms in perpetuity.

So, there’s a strong argument for the UK to remain a full member, not only of the single market in goods, but also in services. Now, this cost-benefit analysis could of course change. For example, if the many non-trade costs of EU membership aren't reduced through fundamental reform; if the single market in services – which is under-developed – continues to be held up by protectionist interests; if the EU prevents the UK from taking advantage of growth opportunities from around the world; if Brussels continues to be more interested in restricting financial services activity rather than facilitating trade – then the case for fully remaining in the single market could weaken significantly.

Which is why another round of serious liberalisation of the EU services market is long overdue. Over to you, Berlin.


jon livesey said...

Behind the article is the usual fallacy that trade is a winner/loser proposition with the exporter winning and the importer losing.

That's a popular view, and so widespread that I expect someone will rush to "correct" what I write here.

However, if trade was a zero-sum game there would be no reason for it to growing so strongly.

In fact, trade exists because the exporter and importer both win.

The exporter wins because he can exploit existing production infrastructure more intensively and make more profit. But the import also wins because he doesn't have to create his own infrastructure.

To take a concrete example, when Rolls Royce exports jet engines to China, Rolls makes better use of its skill and R&D and production facilities. But China also wins because it doesn't have to replicate the vast infrastructure that Rolls has built up over many decades, and because it can devote its capital and skills to other projects.

Of course, the Germans can perfectly well be irrational and apply a mercantilist approach, trying to keep the UK an open market for German cars while excluding UK financial services. Any country can behave against its own self-interest - and Germany has a long record of doing exactly that - but Germany has been trying to ppomote Frankfurt as a financial centre in competition with London since at least 1850 and they haven't had much luck yet.

Rik said...

From a strategic pov it is therefor important that the new service 'directive' stuff is dealt with asap. Hard to see how to arrange that outside the EU. As it is unlikley an official directive.
And anyway the longer you wait the less it will work for this crisis.
Plus getting the Souths in is illusional and likely not of much practical use for the UK (main markets are the Norths).

Hard to see from the negotiation side that you will get away without putting the exit option hard on the table. Which is much easier when services are being dealt with first. Simply looks much easier to take it with in a freemarket/but exit scenario than negotiate with some EU-countries as a non EU-member while other EU countries stay out of it.

Also for the model that will be used. The UK is the biggest market for the remainder EU it is very likley that a more bespoke arrangement can be negotiated either in or out. And for both sides beneficial. Benelux could otherwise lose a lot of harbour activity and importduty revenue for instance. Makes importing other stuff from low costs producers much easier. With as result that high cost UK producers compete with high cost EU producers on the EU market. While outside low cost producers can compete in the UK. Kicking highcost EU producers likely largely out of that market.

Rik said...

As an importer of services you benefit mainly if your workforce that is put out of a job can do something else. Preferably something the country is better at (more competitive).
The latter is however a huge problem with the EUs South in the top and middle part of the services industry they are very poor (next to mass unemployment). Their bankers, lawyers, accountants, creative people are usually rubbish compared to those in in say the UK, Germany, Benelux.
Probably the reason why they are not very enthousiastic about the idea. While in reality they need the competition if the Indias and Chinas start to compete with them on these kind of things the will have their backsides whipped (like now with manufacturing).

Anyway the above figures show that the UK is strong/competitive with services and uncompetitive with manyfacturings/goods. And as a strong/competitive player you benifit from a market that is as large as possible.
Same will apply for say Benelux countries. But the picture for the rest is mixed.
Germany will benifit as their service sector is strong (allthough they focus more on manufacturing).
France has a language problem, but quality of the workers is ok and it is not the first you think off. Plus it has relatively few international organisations compared to say the UK which could form a basis.
The South is all disadvantages. Poor languageskills, poor quality workforce, no organisations etc. Simply not competitive and relatively expensive for the quality they provide.

Rollo said...

The powers that be in Europe are very aware of the competitive advantage of our service providers compared to theirs. That is why they are so keen to regulate London out of business, to the benefit of France and Germany. They would like to increase their protectionism in services, as they successfully do with goods.
Any slight benefit we have in services will be regulated away. And this regulation will damage our world wide business as well.

Anonymous said...

The idea of a trade war is one put about by the europhiles, and has no basis in truth, they are happy to rant o about how big a trading nation we are with the eussr, but can't see that should we do the best thing and leave the eussr won't want to lose that trade.

Anonymous said...

All this talk of winners and losers of a financial race misses the real point, which is quite simply who rules Europe.Why would any country join a club for their own purposes and advantages only to find you no longer control your own country. To put it in perspective if we had a referendum and voted to stay in Europe, over the next 20 years France and Germany would take all our service industry and what remains of our manufacturing

Stevlin said...

Our 'net' trade of goods/services is still negative, and on top of that we have to pay a hefty 'net' membership fee of £12 billion, lose our sole rights to fishing in our own territorial waters and also lose control of our borders.
Our future is global, not with the declining EU.

jon livesey said...

"All this talk of winners and losers of a financial race misses the real point, which is quite simply who rules Europe."

No, I honestly don't think that we miss that point. It's just a different point. And that different point isn't going to go away. Germany's basic tragedy, as a historian recently said, is its size: not big enough to establish hegemony, but too big to restrain itself.

The working out of that point - really, is Germany part of continental Europe or is continental Europe just part of Greater Germany, has been going on since the fall of Napoleon.

I am quite happy to concede that who runs Europe is the big point, but it's a very slow moving one, and within it we have shorter run issues like the EU and trade, which affect the prosperity of entire generations while the really big issues unfold on century long timelines.

We should remember that in the last part of the C19th and the first part of the C20th, while they prepared to fight two World Wars Germany and the UK remained one another's biggest trade partners.

Our job today is to get a good renegotiation for the UK, not to try to re-fight World Wars.

Rik said...

Fully agree with your basic analysis. First priority is get a good reneg result and second one get services up and running. Hamsters in east Rumenia can be saved later. It is the economy stupid and that sort of things.
Next to combining all problems likely solves absolutely nothing as people donot oversee it anymore.
And often you run straight into disaster that way.

Some further remarks:
1. Europe will be ruled much more democratic or it is imho very likely to fall apart. Times have changed.
2. It will however be governed more and more by a German style modell (or possibly even an AngloSaxon one). German style as that is the only main EZ model that looks longer term sustainable.
The Southern model is simply bankrupt. If you want to stay in the top league such a model (Hispano-Italian/French) is very unlikely to work. For mainly two reasons:
- potential revenue is considerably smaller than expenditure (financially unsustainable); and
- it simply has too many inefficienties. In competition inefficienties always longer term kill you, well the model.
Next to that massive corruption will longer term simply not longer acceptable in the EUs North.

3. The reneg has to keep focussed on the freetrade zone and preferably further deepen that (like with services). This means imho that whatever comes out an In or an Out, practically there should not be much difference.
In: means focus on freetradezone (plus), powers back (population simply demands that), huge influence on relevant decisions and able to block undesired new initiatives if relevant for you.

Out: basically means the same. You need to keep the freetradezone intact or you tank your economy. Get powers back because of an exit. Keep involved and heavily in decisionmaking on the freetradezone (plus) and block undesired stuff there as well.

I see not very much difference.

clinihyp said...

Surely the real questions here are what is the actual value of those services we export to the EU and why would those EU countries who buy them not continue to do so if we we were part of EFTA?

There are other considerations which you do not appear to have mentioned.

The proportion of global output accounted for by the EU27
is shrinking and will continue to shrink. Part of the EU's
relative secular decline is demographic.

100% of Britain's economy is subject to the EU's regulatory
burdens and costs, but less than 15% of GDP relates to trade with the EU.

Germany and Switzerland (the latter a non-EU country) are
more trade dependent on the EU27 than is the UK.

The proportion of UK exports going to the EU27 is declining.
The proportion of recorded total exports of goods and services going to the EU27 was 48% in 2010. Making a conservative allowance for the 'Rotterdam-Antwerp effect'.(for goods) reduces the proportion to 45%

Britain's net contribution to the EU was £8.1bn in FY2010
compared with £4.4bn in FY2005. It is moreover set to increase in forthcoming years. If Britain had had a Swissstyle relationship in FY2010 the net contributions could
have been 1/6th of what they were. They could have been £1.3bn a saving of nearly £7bn.

The costs to Britain of membership of the EU's Customs Union, specifically the opportunity costs of being unable to negotiate its own free trade deals, are substantial and will become more substantial, given the EU's shrinking share of global output.

Insofar as renegotiations are concerned, that is the biggest red herring of all. It is an irrefutable and indisputable fact that half the legislation affecting business is EU-sourced and cannot be amended and/or repealed whilst Britain remains a member of the Single Market. It is time for the truth to be acknowledged that the only way renegotiations take place is by invoking article 50 of the Lisbon Treaty, or the unlikely and impractical idea of all the other 27 members agreeing.

Cameron is misleading us with his spin regarding renegotiations or repatriation! How strange for someone who once described the EU in the following terms.

“If there is one political institution that needs decentralisation, transparency, and accountability, it is the EU. For the past few decades, something strange has been happening on the left of British politics. People who think of themselves as Progressives, have fallen in love with an institution that no one elects and no one can remove, and that hasn't signed off its accounts for over a decade”.

Gosporttory said...

Agree with most comments above, however clinihyp spells out the true picture of the EU Gravy Train fiasco best of all.

Anonymous said...

Anyone know the date that Cameron made his comments about the EU and where