The United Kingdom and the EU

Table of Content

2 Withdrawing from the EU: macroeconomic advantages and disadvantages for the UK
2.1 Nigel Pain’s and Garry Young’s article on the economic impact of UK withdrawal from the EU
2.2 Economic changes from leaving the European Union
2.3 Macroeconomic effects of withdrawal

3 Adopting another way: benefits and disprofits of joining the EMU
3.1 Benefits from joining the EURO
3.2 Disadvantages from joining the eurozone

4 Conclusion: better off with the European Union but without the Euro

5 Bibliography

2 Withdrawing from the EU: macroeconomic advantages and disadvantages for the UK

My following paper will deal the article of Nigel Pain and Garry Young, ‘The macroeconomic impact of UK withdrawal from the EU’, from Economic Modelling, Volume 21, Issue 3. The article focuses on both the costs and benefits of a UK withdrawal from the EU. I will show that withdrawing from the European Union is not to aspire for the UK. Furthermore I will explore whether or not it would be advisable for the UK to abolish its national currency, the Sterling, and to adopt the European Currency, the Euro.

2.1 Nigel Pain’s and Garry Young’s article on the economic impact of UK withdrawal from the EU

Nigel Pain and Garry Young use one of the “leading macroeconometric models of the UK economy to assess the macroeconomic consequences of UK withdrawal from the EU.”^[1] In order to evaluate this heavily important topic both authors use a model with endogenous location decisions and endogenous technichal progress and they draw on “research that highlights the role of EU policies in determining the scale of international trade and investment linkages of Member States.”^[2] The estimates of the macroeconomic costs and benefits of UK withdrawal from EU are derived from a macroeconometric model of the National Instite of Economic and Social Research (NIESR). It is important to differ this model from an analysis that could be undertaken on a CGE model. The NIESR macroeconometric model NiDEM “allows for an endogenous monetary policy, and hence, an endogenous exchange rate, with the monetary authorities setting policy in order to achieve a given inflation target.”^[3]

Pain and Young explore four separate factors that could be affected due to a withdrawal of the UK from the EU: (1) foreign direct investment (FDI), technical progress and exports, (2) UK-EU trade policy, (3) agricultural policy and agricultural imports, and (4) budgetary policy. In addition, the authors also include other issues, such as the potential impact of product market segmentation and the potential loss of economies of scale.

By taking into account these 4+ factors, Pain and Young simulate the macroeconomic impact of UK withdrawal using the NiDEM model of the NIESR. The model “embodies extensive forward-looking behaviour in the private sector as well as in financial markets. This means that changes in the expectations of future events have an immediate impact on current behaviour.”^[4] As Pain and Young state, “NiDEM is theoretically coherent and quantified by means of empirical estimation over recent historical experience.”^[5]

The authors come to the conclusion that withdrawing from the EU would not rise the unemployment rate significantly, but there are long term costs, such as a lower GDP in the long run. In the following, I will relate to the article from Pain and Young and explore the benefits from withdrawing from the EU as well as the disadvantages, i.e. economic setbacks the UK would have to suffer.

2.2 Economic changes from leaving the European Union

As I mentioned above, Pain and Young name four potential economic changes that might occur after leaving the European Union.

Foreign companies in the UK have helped to raise productivity levels, “both because their average productivity is higher than that of the UK-owned firms and because there are spillovers that raise the productivity of domestic firms.”^[6] FDI itself has a significant effect on the level of technical progress and therefore on labour productivity. Withdrawal from the EU would cause an enormous decrease in the level of FDI, which would result in lower technical progress and labour productivity.

After withdrawing the EU could impose tariffs on UK exports until a customs union or free trade agreement could be negotiated with the UK – which is not for sure. Pain and Young find that the average tariff level would be somewhere around 6.7% on UK exports. Furthermore, border controls would have to be reintroduced, new paperwork to be established. The “costs of such measures in the EU and EFTA were estimated to be equivalent to approximately 2% of transaction values.”^[7] Therefore, the total costs of exporting to the EU were 8.7%. This means that given that about 57% of all UK exports go to the EU, this “translates into an ex-ante 5% rise in the efective relative price of UK merchandise exports.”^[8]

Pain and Young assume that after a withdrawal from the EU, the UK government would try to maintain the level of agricultural subsidies. This means that all subsidies to producers would have to be paid directly by the UK out of its budget rather than out of the EU budget. However, the UK could lower the tariffs on imports – which have been set by the EU – which mean that the price of such imports could fall by 20%.

Moreover, the authors assume that “withdrawal means that the net public expenditure is £3 billion per annum lower than would otherwise be the case.”^[9] This does already take account of the lower level of import duties and agricultural products. Additional expenditure might be one way to alleviate this.

2.3 Macroeconomic effects of withdrawal

When looking at the simulations of the National Institute model of the UK economy (NiDEM) we have to consider that NiDEM has “separate demand and supply relationships for six sectors of the UK economy.”^[10] Each sector has its own production function “with constant returns to scale, so that withdrawal does not generate lower scale of economics.”^[11] Monetary policy is set to ensure that inflation does not raise above a medium-term target level of 2.5%. All simulations have been carried out over a 30-year base. The key results are as following:

The UK GDP would fall up to 2.5% after 20 years of withdrawal, the real gross national income and national wealth would decrease by 1.5% after 20 years. This is a result of the reduction in technical progress which is derived from the lower level of inward FDI. Especially manufactured exports are hard hit by the reduction in technical progress; exports fall by 7.5% in the long run. Consumer price leve would only remain constant under an active monetary policy. Passive monetary policy would decrease the consumer price level by 6% after 8 years and 4% after 18 years. Taxes would have to rise by 0.2% (active monetary policy) or 0.9% (passive monetary policy) after 18 years^[12]. This is because in the long-run taxes have to be raised to ensure that the government remains solvent. In the short-run, the government would have a budget surplus as the transfers to the EU would drop out.

Even though quantifying the impact of withdrawal from the EU on the UK is very difficult “given the range of factors that need to be considered and the absence of any detailed estimates of the overall benefits received from three decades of membership”, the NiDEM model used in the analysis of Pain and Young provides us with profound information on the risks of withdrawing for the UK economy.

[...]

^[1] Nigel Pain and Garry Young, ‘The macroeconomic impact of UK withdrawal from the EU’, in: Economic Modelling, Volume 21, Issue 3, May 2004, 387.

^[2] ibid., 388.

^[3] ibid., 388.

^[4] ibid., 400.

^[5] ibid., 400.

^[6] ibid., 395.

^[7] ibid., 397.

^[8] ibid., 397.

^[9] ibid., 399.

^[10] ibid., 400.

^[11] ibid., 400.

^[12] ibid., 400-404.