Britain’s priority: overcoming European growth lag

Diversions and disruption ahead on EU journey Britain has suffered a GDP growth turnround compared with the European Union of around 1.5% a year since the Brexit referendum in 2016, the largest divergence for nearly 50 years. Lost economic output, on these estimates, amounts to around £30bn a year, or £570m a week. This is […]

Diversions and disruption ahead on EU journey

Britain has suffered a GDP growth turnround compared with the European Union of around 1.5% a year since the Brexit referendum in 2016, the largest divergence for nearly 50 years. Lost economic output, on these estimates, amounts to around £30bn a year, or £570m a week. This is more than the £350m weekly net transfers to the EU that Brexit campaigner Boris Johnson, now prime minister, exaggeratedly claimed in 2016 Britain would save by leaving the EU.

Overcoming the growth lag, coupled with defeating the coronavirus outbreak that has hit Britain harder economically than almost every other industrialised nation, are overriding priorities for Johnson’s hard-pressed government. The Christmas Eve conclusion of the 1,246-page EU-UK trade and co-operation agreement, signed on 30 December with provisional effect from 1 January, marks a new beginning, with the UK brandishing restored ‘sovereignty’ over borders, money and laws – however misleading the claim may be.

Crucial for the future, Johnson must rebuild damaged British credibility with the EU, vital for managing a complex relationship that almost certainly will be fractious. Key aspects include efforts on financial services co-operation – largely neglected in the trade deal. One reason why UK financiers have greeted the 24 December agreement with relative equanimity is because the Bank of England and Treasury have long prepared for a ‘no deal’ outcome. The City of London as long ago as summer 2016 gave up hope of full access to the single market and concentrated on bespoke deals for different sectors. The exodus disaster scenarios have so far not materialised, though euro-denominated assets have started to move to EU.

The UK and Europe will have to manage differences in regulatory approaches, under the supervision of a new EU-UK partnership council charged with resolving disputes, opening the way to EU retaliation should economic standards start to deviate significantly. For both domestic and international audiences, Johnson urgently needs to explain how the UK will use new-found freedom from the EU’s judicial embrace to enhance battered welfare and living standards. The prime minister’s latest proclamations ‘to turbocharge our ambition to be a science superpower’ or promote ‘free ports’ as new enterprise zones (already largely allowed under EU rules) have been typically heavy on trademark bombast and light on detail.

Britain has to climb out of a deep, largely self-produced economic hole

Coupled with the travails of tackling a Covid-19 resurgence driven by virus mutation, Britain has to climb out of a deep, largely self-produced economic hole. In the five years since the referendum in 2016, counting Britain’s estimated 11.2% contraction in 2020, the country has recorded annual average GDP growth of minus 1.0%, compared with growth of 0.1% in the euro area (see table below). The negative 2016-20 growth differential of 1.1 percentage points contrasts with a positive differential of 1.2 percentage points in 2011-15 – an overall growth swing of minus 2.3 percentage points.

Referendum-induced uncertainties, compounding the UK pandemic downturn, have produced a radical downwards shift in UK economic performance compared with its European partners. In the 25 years up to 2015, since the birth of the European single market in the early 1990s, Britain’s annual average GDP growth was 0.6 percentage points higher than the euro area’s. Britain had the same annual growth advantage in the 35 years 1981-2015, reflecting a GDP spurt in the 1980s after the economic reforms of Margaret Thatcher’s government. The positive growth gap in the 45 years 1971-2015 (the UK joined the then European Economic community in 1973) was only 0.2%, reflecting sub-standard 1970s UK growth.

The UK-Europe growth deficit of the last five years partly reflects the special circumstances of 2020. According to the Organisation for Economic Co-operation and Development’s December economic outlook, Britain’s 11.2% GDP decline last year puts it in 45th place in the GDP performance table out of 47 countries listed, with only Argentina and Spain faring worse. GDP contracted 7.5% in the euro area last year and 5.5% for the whole OECD. In 2015, the UK was in the middle ground, with its 2.4% GDP rise making it 24th in the league table, compared with rises of 1.9% for the euro area and 2.6% for the OECD.

The five-year comparisons contain some distortions. The UK’s accounting treatment of closed schools may have exaggerated the downturn in last year’s OECD estimate. Britain’s comparative economic picture could improve this year if growth rises above the European average after last year’s massive contraction. The OECD is forecasting a 4.2% UK GDP increase in 2021 compared with 3.6% for the euro area. Supporters of EU departure such as Gerard Lyons, Johnson’s former economic adviser and erstwhile candidate for the Bank of England governorship, have long argued that a ‘Nike swoosh’ of growth awaits the UK once it quits the EU. There is much ground to make up.

The negative UK-EU growth turnround of 1.5 percentage points a year in the past five years appears a valid estimate based on four decades of statistical comparisons. This equates to lost output of 6% of GDP since the referendum, a worse result than the UK Treasury’s frequently derided May 2016 forecast of the consequences of a ‘leave’ vote as well as more recent assessments from the independent UK office for budgetary responsibility.

The Treasury’s pre-referendum forecast was inaccurate in one major point . Despite the ‘leave’ vote and the pandemic, unemployment has not risen by between 520,000 and 820,000, as the Treasury predicted, but remained stable at around 1.7m between mid-2016 and mid-2020 – although worse is forecast this year.

EU won most battles on withdrawal agreement , trade accord better balanced

The Christmas denouement came after weeks of brinkmanship, amid repeated threats that the UK and EU would fail to meet the ultra-tight end-2020 timetable to add a trade deal to the delayed agreement on EU withdrawal, which entered force on 1 February 2020. After protracted political and judicial skirmishes, countless U-turns, two UK general elections and three prime ministers, the outcome is a ‘halfway house’ accord encompassing interlinked financial, trade, legal and political arrangements – in line with predictions soon after the referendum. The agreement, embodying departure from the EU single market but special customs arrangements for Northern Ireland that will prevent a ‘hard border’ on the island of Ireland, bears considerable resemblance to goals outlined by Theresa May, Johnson’s predecessor, in her January 2017 Lancaster House speech. She took the edge of the ‘hard Brexit’ feared by business by urging a ‘bold and ambitious free trade agreement’ , involving partial membership of the customs union, continued tariff-free trade and an ‘implementation phase’ to avoid a Brexit cliff-edge.

In the withdrawal agreement finally approved by the UK parliament in January 2020, the EU won most of the battles over substance and timing. This partly reflected tactical incompetence by May’s divided government. David Davis, Britain’s 2016-18 secretary of state for exiting the EU and initial chief negotiator, showed particular ineptness. In just one of a series of notable reversals, Davis had to cave in quickly in June 2017 on his unrealistic wish to develop a trade deal at the same time as withdrawal terms .

The 24 December trade agreement appears better balanced. Mutual interest pushed both sides into compromises where each was able to declare at least partial victory. Johnson has been forced to admit that UK and EU traders will face considerable additional border trade bureaucracy. But the prime minister was able to restate familiar arguments about Britain ‘having its cake and eating it’. He cited the UK’s final withdrawal from the jurisdiction of the European court of justice, stating with some accuracy that the deal confounded critics claiming the impossibility of having ‘free trade with the EU unless you conformed with the EU’s laws’.

As Charles Grant from the Centre for European Reform has written, achieving a free trade agreement in 10 months is unusually quick: normally it takes the EU five to seven years to negotiate an FTA. As recent as July 2017, after May’s disastrous decision to call a June 2017 general election, UK ministers were suggesting a new trade accord could come into effect in summer 2022. Ursula von der Leyen, the European commission president, on the other hand could plausibly maintain that EU discipline over a ‘long and winding road’ of negotiations led by Michel Barnier had yielded satisfactory results. Charles Michel, president of the European council, extolled the EU’s ‘unprecedented’ unity bringing a ‘fair and balanced agreement that fully protects the [EU’s] fundamental interests’.

The UK and EU remain bound by complex interactions: ‘long and winding road’ stretches further

What will happen next? The UK and EU will remain bound by complex interactions over trading and investment standards including state aid, under the terms of the ‘partnership council’ (mentioned 170 times in the Christmas Eve accord). Ken Clarke, the former UK chancellor of exchequer who retired from the House of Commons in 2019 after 49 years and has now joined the House of Lords, believes the Brexit issue will soon fade in significance for the UK population as  fears recede of widespread disruption at the borders. However he points out unresolved problems over police, security and judicial co-operation as well as possible problems from the EU’s right to interfere in UK regulatory processes. Given widespread EU fragility in many areas, any indication that Britain starts to prosper outside the EU would lead to destabilising reactions from other EU countries fearing that other member states might seek similar routes.

Ludger Schuknecht , former chief economist at the German finance ministry and deputy OECD secretary-general, points to the delicate two-pronged nature of the EU-UK relationship. He welcomes the German-style ‘pragmatic’ deal that takes account of British ambitions on ‘sovereignty’, but still binds London into a constructive relationship with Brussels. The new EU-UK regulatory equilibrium will do more than simply hold the British in check , Schuknecht says. Britain’s new competitive leeway outside the EU could be beneficial by encouraging the EU to be more dynamic and open.

According to veteran European observers such as Ivan Rogers, former UK ambassador to the EU, who resigned in January 2017 and has consistently criticised the UK negotiating stance, the EU understanding could lead to near-continuous arguments. The agreement actually incentivises those who most wish to diverge from EU standards, such as the Brexiteer Conservative ‘European research group’, to look for fights. Across a still-to-be-drawn map, von der Leyen’s ’long and winding road’ stretches far ahead. Diversions and disruption will be part of the journey.

David Marsh is Chairman of OMFIF.

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