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Reforming the EU's limited freedom of services

Reforming the EU's limited freedom of services

Brexit may help diversify UK exports

by Ben Robinson

Thu 3 Nov 2016

Brexit might provide a supremely helpful boost to the UK services sector - contrary to the expectations of many after the 23 June referendum. 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 were generated by the financial services sector, which accounts for around 10% of UK GDP. Non-financial services have not seen as strong export performance, partly because of a relative lack of EU liberalisation in these sectors.

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 the 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. As Mateusz Morawiecki, deputy prime minister of Poland, has rightly said, ‘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 and some government services are 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 impact 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, opportunities for expansion for the EU’s service firms are scarce, reducing the ability of these firms to benefit from economies of scale.

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 UK financial services sector is shrinking and is 10% smaller than before the financial crisis, on some estimates. Non-financial services, on the other hand, are growing. Meanwhile, 90% of global demand over the next decade will come from outside Europe, according to the Commission. Boosting the UK’s non-financial services sector will be key to its future prospects. The limited success of its attempts at service export diversification within the EU suggests Brexit, by encouraging UK services companies to diversify outside the EU, may help realisation of this goal.

Ben Robinson is Economist at OMFIF.

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