Might Brexit prove beneficial to the UK services sector? Fears over losing access to the European single market for services companies, which make up 80% of UK GDP, was a primary motivating force for those who argued in favour of remaining in the European Union ahead of the UK-EU referendum. However, while the UK exported £89bn in services to the EU last year, generating a £21bn surplus, almost 25% of these exports and 65% of the surplus were generated by the financial services sector, which accounts for approximately 10% of UK GDP. The dominance of financial services in UK-EU trade suggests an underlying lack of EU liberalisation in other areas of services on which the rest of UK service-based GDP depends.
Professional services, research and development, design, engineering, transport, communications and online retail firms each contribute a sizeable share of UK output, though the amount of EU trade in these sectors is significantly lower. This reflects a reality of an EU single market that has implemented three of the ‘four freedoms’ of labour, capital and goods, but has manifestly failed to sufficiently liberalise services. According to Mateusz Morawiecki, deputy prime minister of Poland, ‘The freedom of services is essentially non-existent’.
Within the EU, just 4% of services are traded cross-border, according to the European Commission: 42% are provided by domestic firms, and the majority of the rest by US firms. Some services, including healthcare andsome government services are i not trade intensive. Many others, including transport and logistics, IT and internet-based services, back office support functions and online retail, are eminently tradable. Yet just 14% of small and medium-sized enterprises – which make up 99% of EU companies and account for two thirds of private sector employment – sell their goods cross-border in the EU. Only 7% of SMEs with an online presence trade cross-border in the EU.
This reflects the presence of non-tariff barriers within the EU, including differing regulations, insurance requirements and standards across countries, as well as differing rules on qualifications and industry association membership. As a result,
The limited liberalisation of services has had negative consequences. The dominance of financial services in UK exports has created a disconnect between the companies that sell into the EU and the large majority of service firms that do not. Even companies that do not trade cross-border must conform to EU rules and standards, leading to significant costs and complications despite a lack of widely shared benefits. This has contributed to a significant ‘north-south’ divide in wealth within the UK and an unbalanced economy that is over-reliant on finance.
Within the broader EU the lack of services liberalisation has created tensions between western European firms that dominate their home markets, and central and eastern European service firms which struggle to export to their richer neighbours. This has led to a relatively low level of intra-EU convergence, and a persistent gap in per capita wealth between the economies of central, eastern and southern Europe, and the richer economies of the north-west.
The EU is suffering from slow productivity growth, low demand and insufficient investment. Greater services liberalisation could alleviate many of these challenges and spur significant catch-up growth in less wealthy European countries. Liberalising services trade by reducing non-tariff barriers could increase productivity within the EU by 5%, according to the World Bank. Full implementation of the ‘digital single market’, which aims to improve business conditions for internet-enabled firms, could raise EU growth by €415bn a year, according to the Commission.
The UK has championed the issue of greater integration and liberalisation of European markets, particularly of services, as a member of the EU. This has been, in part, an attempt to boost the UK’s non-financial services firms.
The share of financial services in the UK economy is shrinking (10% smaller than before the financial crisis). Non-financial services, on the other hand, have grown by 25%. Meanwhile, 90% of global demand over the next decade will come from outside Europe, according to the Commission. Financial services are likely to suffer if Britain loses the passporting rights that allow UK-based firms to trade within the EU. The loss of access to the single market is unlikely, however, to negatively affect the dominant portion of UK service firms that do not trade with the EU.
The hope for the UK is that, after Brexit, firms will face less regulation and be freer to export outside the rather restrictive EU market. The share of financial services in the UK economy is shrinking (10% smaller than before the financial crisis). Non-financial services, on the other hand, have grown by 25%. Meanwhile, 90% of global demand over the next decade will come from outside Europe, according to the Commission. Financial services are likely to suffer if Britain loses the passporting rights that allow UK-based firms to trade within the EU. The loss of access to the single market is unlikely, however, to negatively affect the dominant portion of UK service firms that do not trade with the EU.
A ‘hard Brexit’ may not be the disaster for UK services which some predict. For the EU, however, failure to achieve greater liberalisation of services is likely to continue its current malaise and perpetuate intra-EU imbalances.
Ben Robinson is Economist, OMFIF.