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Extract from An Illustrated Guide to the British Economy by Bill Jamieson.
Published by Duckworth,
61 Frith Street,
London W1V 5TA
Tel: 0171 434 4242
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Chapter 9
Britain and the EU
List of Charts

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EU overview

 
Source: Social Indicators of Development, Donaldson, Lufkin & Jenrette, 1997 

Britain and the EU: global share

Asean = South East Asia, Australia & New Zealand Source: SBC Warburg Dillon Read European Economic Analyser, Sept./Oct. 1997

EU trade

Source: SBC Warburg Dillon Read European Economic Analyser, Sept./Oct. 1997 

Almost a quarter of a century after joining the (then) European Economic Community, the UK is still a reluctant European. We recognise that the countries of the (now) European Union are critically important trading partners, and that free and equal access to their markets is vital for UK business. But we balk at participation in full economic, monetary and political union. 

A large section of British public opinion has never been able to shake itself free of doubts about the whole enterprise. Has membership of the EU really provided the boost to trade and jobs that was claimed at the time we joined? Has Brussels regulation and the pressure to join the Social Chapter with its extra costs on business really been in our interests? What is the economic case for further convergence? And is there really an alternative for Britain other than grudging and reluctant submission to the convergence agenda? 

This chapter examines the economic arguments originally advanced for Britain's membership and how her trade with the members of the EU has subsequently developed. 

It will look at the UK's dealings with the institutions of the EU and the budget record. Does the UK get out more than she puts in? And, finally, it will set out the development of the single currency and the issues that are pertinent to Britain. This issue is also examined further in Chapter 11. 

EU and US GDP growth 1980-98 (%)

1997 & 1998 = forecast
Source: OECD Economic Outlook, December 1996
 

Europe: global power of the future?

Source: What global role for the EU?, September 1997, Philip Morris Institute 

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Development of the EU

Though often set out in economic benefit terms, the drive towards European economic and monetary union is primarily political, and has been so since the beginning.

The idea of the EU stemmed from a profound wish among Europe's post-war leaders to draw a line under European conflict and to create irrevocable economic, monetary and political union. Indeed, the word "irrevocable" is used repeatedly throughout the Maastricht Treaty on European Union.

The economic rationale for a united Europe has deep historic roots, reaching back before the two world wars into the early nineteenth century and even before the unification of Germany. Friedrich List, the economist father of the Zollverein (customs union) argued in 1834 that a unified state was the only way of raising productivity and boosting industrialisation. The definitions of "unified" and the boundary of "state" were, however, matters on which Europe went to war.

The outstanding post-war driving force was the creation, by Jean Monnet, of the European Coal and Steel Community. Out of this desire for joint co-operation to prevent "uneconomic" competition and dumping, grew the European Economic Community - the "Group of Six" and the origin of the European Union as we now know it.

There have been many landmarks in its development, including Britain's accession in 1973, and a series of successful applications which took the membership in stages to its current total of 15. The Single European Act of 1986, heralding the single market, was a critical step which brought home to Britain the full extent of the EU's ambitions to create a common regulatory and administrative zone. There was a blizzard of harmonisation directives which did not go down well with Britain, in particular with its cost and bureaucracy-averse small business community which despised the Brussels paper-pushers. 

UK Trade with Europe: the upside ...

Source: UK Balance of Payments 'Pink Book', 1997, Office for National Statistics 

... and the down

Source: UK Balance of Payments 'Pink Book', 1997, Office for National Statistics

But the most significant step in the process of convergence was the Treaty of Maastricht. Hammered out in 1991, this laid down the conditions and the timetable for the achievement of European Monetary Union (EMU). Its protocols specified the convergence criteria on inflation, budget deficits and gross government debt that aspirant member countries had to meet, and fixed the starting date for the single currency at 1 January 1999. 

The drive towards a single currency was not immediately apparent in the late 1960s and early 1970s when the debate in Britain about "joining Europe" got under way. Membership of the "group of Six" was presented primarily as an economic matter, mainly of interest to businessmen wishing to increase their exports into continental Europe. For the political elite, membership of the Common Market was "the Big Idea", seized upon in the aftermath of the Suez debacle and the final collapse of empire. For the business elite, it was a means by which Britain could break free of increasing labour relations problems and balance of payments constraints at home. 

How has this rationale stood the test of time? By how much has Britain benefited through growth of trade with Europe? And how well has she done out of the institutions of the EU and, in particular, the EU budget? 

The individual economies of Continental Europe that comprise the EU have historically been, and will continue to be, critically important trading partners for the UK. Germany, for example, is one of the UK's largest export markets, accounting in 1996 for 22 per cent of visible goods exports. France accounts for 18 per cent, and Italy 8 per cent. 

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Where the markets are


Source: UK Balance of Payments 'Pink Book', 1997, Office for National Statistics

These markets have grown powerfully, but while UK exports to them have grown, so, too, have the EU's exports to the UK. Indeed, in every year since Britain joined the Common Market, she has incurred a balance of payments deficit. Over the near 25 years of membership the total trade deficit with the countries comprising the EC (now EU) comes to more than £100 billion. This is not to say that UK trade performance would have been better had it stayed out, but membership did not fulfil the early rhetoric of benefits. 

Imports of finished manufactured goods from the EU grew faster than exports. The problem is that membership increased imports from the EU countries, whose finished manufactures were near perfect substitutes for the UK's own, creating not only a severe trade imbalance, but unemployment in the domestic industries which bore the brunt of the penetration. Estimates of the full employment cost to the UK of EU membership range up to £206 billion (There is an Alternative: Britain and its relationship with the EU, Burkitt, Baimbridge and Whyman. Nelson & Pollard, 1996). 

The result has been the UK has had to rely on a surplus on her trade in services with the rest of the world to mitigate the deficit on trade with the EU. The EU accounts for less than half the UK's balance of payments and, even within the visible goods sector, 23 per cent of finished manufactures goes to countries outside the EU. 

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UK budget contributions

For many people in Britain, none of this much matters - it is history now. The most visible evidence of membership of the EU are the roadside signposts telling of a new bridge or building project financed by the EU regional fund. Britain would appear to be a substantial beneficiary of the EU budget. What are the facts? 

UK trade with the EU: seriously red


Source: UK Balance of Payments 'Pink Book', 1997, Office for National Statistics

In almost every single year of membership, the UK has been a net contributor to the EU budget, paying in more than she receives in grants and subsidies. 

For example, in 1994-95, the UK's gross contribution to the EU budget was £8.3 billion. After the abatement Mrs Thatcher negotiated at Fontainebleau in 1984 (which runs until 1999) and receipts from various programmes, the UK's net contribution to the EU was £2.45 billion. The graphs opposite show the UK's overall deficit with the EU (including goods, services investment income and transfers) and the net annual deficit with the institutions of the EU.

In per capita terms the UK is the third largest contributor to the EU budget after Germany and the Netherlands. By 1996/97 the 23 years of membership will have cost the UK an estimated £30 billion in net contributions at current prices. The EU social fund projects, a condition of which is that they are advertised and promoted as EU-financed, are thus effectively UK taxpayers' money re-cycled and re-labelled as being from the EU.

Around half of the EU budget is spent on the operation of the Common Agricultural Policy. This has not been of benefit to consumers (as it works to keep EU food prices higher than in world markets). The cost to the EU as a whole of the CAP and other agricultural support has been estimated by the OECD for 1990 as £48 billion to consumers, plus £27 billion to taxpayers.

The implied cost to the UK consumer, net of receipts to UK farmers, is estimated at £3 billion at 1990 prices in a typical year. Despite government pleas for reform, little seems to change: the CAP is a highly complex system of subsidies and grants, principally to French farmers, and attempts to modify these have run into intense political opposition. 

Overall deficit with the EU (£bn)


Source: UK Balance of Payments 'Pink Book', 1997, Office for National Statistics
 

Dealings with EU institutions


Source: UK Balance of Payments 'Pink Book', 1997, Office for National Statistics
 

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The UK and the Social Chapter

The EU Social Chapter, which covers employment rights, holiday entitlements and pay rates, social benefits and employee participation in workplace decision-making, is one of the most controversial aspects of EU legislation, from which the UK has negotiated a partial opt-out.

The fear in the UK is that signing up could destroy what competitive advantage Britain acquired in the 1980s and 1990s and that restrictive social legislation might make Britain and Europe a less attractive place for foreign companies to invest in.

Adding to UK fears is that much of the legislation (which is binding) can be introduced through Qualified Majority Voting under the Treaty of Rome as amended by the 1986 Single European Act - for example, Article 118a on Health & Safety at Work under which the 48-hour week is being proposed.

The direction of "Social Europe" seems desirable and worthy: works councils, parental leave, compulsory extension of full-time employees' terms and conditions to part-time and temporary workers, regulation on sexual harassment, minimum wage, 48-hour week, 13-hour day, 8-hour night shift, minimum four weeks' paid holiday, 40-week maternity leave and the acquis communautaire directive. But all this comes at an enormous cost.

Estimates of social costs to employers vary widely according to methods of calculation, but the lowest quoted figures put Germany's social costs at 32 per cent, France 41 per cent, Italy 44 per cent and the UK 18 per cent. The highest estimates put Germany at 90 per cent, France at 60 per cent and the UK at 30 per cent. 

Non-wage labour costs


Source: US Bureau of Labor Statistics, 1995
 

Europe's taxes on jobs

Source: Prices and Earnings Around the Globe, 1997, UBS

The key concern is that the Social Chapter has enshrined more rigidities into the European labour market, and is one of the major contributors to very high rates of unemployment. In 1997, there were approximately 19 million registered unemployed throughout the EU. The unemployment rate in Germany and France is twice that in the UK. In the UK the jobless figure has been falling at a brisk pace since 1995, while in most countries of continental Europe it has stayed high and in some cases continued to rise.

According to economist Professor Patrick Minford, a former member of the Treasury panel of Independent Forecasters, the combination of the minimum wage, rise in union power, and higher cost burdens on employers would, in even the best case scenario, damage output by 9 per cent with unemployment rising by three million (10 per cent of the labour force). According to Noriko Hama, international economist at the Mitsubishi Research Institute, "International companies like to invest where there is general prosperity with a fair and competitive market. A restrictive market in which allocation of resources is unfair or inefficient is unattractive to them."

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The UK and Maastricht

"Maastricht" and the historic project of monetary union it spawned was the product of three compelling ambitions in continental Europe. The first was a desire to create a single harmonised trading and business zone, with free movement of capital, labour and goods and a single tax and monetary regime.

The second was an ambition to create a European economic and political superbloc: a powerful third leg of the global triad comprising the US, Japan and the European Union. Through

monetary and political union, the EU will have a seat on the United Nations Security Council, representation on global financial institutions such as the World Bank and International Monetary Fund, and will subsume the separate memberships of Germany, France, Italy and the UK in the forum of the Group of Seven industrial nations. 

Is Europe working?


Source: Henley Centre, Global Outlook, August 1997

And the third was a longing - bordering among the French on a lust - to break the hegemony of the US dollar and to see the European currency develop into one of the world's strongest reserve currencies - indeed, an alternative reserve currency to the dollar. These objectives, if achieved, would raise the status of the EU and with it the EU's political status on the world stage.

The business community has been supportive of the perceived advantages: a single market, with a common tax and regulatory system; ease of mobility for capital and labour; greater ease of cross-border trading, pricing transparency, more stable, lower interest rates as a strong central bank bears down on inflation, and savings in transaction costs. Business also hopes to secure through a common currency permanently low budget deficits, government debt ratios and supportive fiscal policies throughout the single currency zone, further helping to ensure a backcloth of economic stability for corporate activity and investment. But there are serious worries over the lack of underlying convergence and low labour mobility.

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The criteria

To help prepare the way for monetary union, five convergence criteria were specified which countries aspiring to join the single currency have been required to meet in 1997 and sustain. These include low inflation, government debt of no more than 60 per cent of GDP, and an annual budget deficit of no more than 3 per cent of GDP. 

Convergence?


yoy = year on year
Source: SBC Warburg Dillon Reed European Economic Analyser, Sept./Oct. 1997

The bond convergence dream


Source: HM Treasury; SBC Warburg Dillon Reed European Economic Analyser, Sept./Oct. 1997

As the deadline has approached, some of the senior aspirant countries have been accused of "fudging" their debt and deficit numbers to meet the criteria. This has fuelled an intense debate on whether the criteria should be strictly met (the Bundesbank position) or criteria performance should simply be heading in the right direction (broadly the German and the French government positions). This debate has also reflected a divide over who should interpret member government performance and how the new European Central Bank should be accountable. This divide has partly, though not totally, been resolved by the creation of the proposed Stability Pact.

The policy of the British government has been to wait and see before making an irrevocable commitment, while at the same time ensuring that the main Maastricht criteria are met - particularly those on the budget deficit, inflation and gross government debt.

In addition the Labour chancellor Gordon Brown has specified other, domestic criteria that should be weighed in the UK debate about whether (and when) to join. His five key economic tests are: whether joining EMU would facilitate long-term investment in Britain; the likely impact on the financial services sector; whether the UK business cycle is compatible; whether the Euro would be sufficiently flexible to cope with economic shocks and disturbances that would be bound to occur; and whether joining the Euro would be likely to promote growth, stability and employment in the UK.

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Household debt: UK and Europe

One key difference between the UK and continental Europe is the relatively high level of indebtedness in the personal sector - largely accounted for by borrowing for house purchase. The difference has a direct bearing on the UK's membership of the single currency as households are much more exposed to fluctuations in interest rates than their continental European counterparts. As the graph shows, the figure for the UK is 79 per cent of GDP compared with 50 per cent in France and 24 per cent in Italy.

Great expectations?

Source: Consensus Survey of Economic Forecasters, August 1997 

Vulnerable to high rates

Source: Organisation for Economic Cooperation and Development, Balance Sheets of the Non-financial Sector

UK, EU and pensions

One of the most worrying issues for future EU finance ministers is how the continent will cope with huge unfunded pension liabilities - Europe's pensions "black hole".

These liabilities are colossal and they are not allowed for under the Maastricht fiscal deficit or government debt criteria. But they will have a profound impact on the EU's debt and borrowing profile. The OECD calculates that, if unfunded state pension liabilities are allowed for - the amount the government has to find to provide incomes for millions of citizens in retirement - the true level of public debt to GDP in the UK should be 74 per cent. But the UK is relatively well placed in this regard - well over 40 per cent of workers are contributing to private sector pension schemes of one form or another. For the Netherlands the figure for unfunded liabilities is 226 per cent and for Germany 142 per cent.

If this gap is to be filled by private provision Europe's workforce will have to find extra savings of more than £200 billion a year.

This has given rise to worries that, in a single currency system where liabilities are brought on to a single balance sheet, the UK and other relatively better funded countries could find themselves having to bale out their more indebted partners. Even if such liabilities can be legally ring-fenced in the event of a system default, there is a more immediate implication for interest rates in the single currency zone: the more debt that has to be funded, the higher that EMU interest rates are likely to be.

The seeds of Europe's pensions crisis ...

Source: Demographics, Europe 1997, Donaldson, Lufkin & Jenrette 

... and the price


Source: Organisation for Economic Cooperation and Development
 

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EU and tax

Central to the completion of the single market, single economy and single currency agenda is a standard or uniform system of tax. The EU is a long way from achieving this ambition, but the drive towards it is remorseless. For example, considerable pressure is being applied to member states by Brussels to eliminate duty free sales at airports by 1999. The Brussels argument in favour of the elimination of the duty free concession is that it detracts from sales of duty-payable outlets and is effectively a subsidy to the more affluent (who can afford to travel) paid for by those who do not - an assertion not immediately obvious at the height of the package holiday season. Scandinavian ferry operators are likely to be among the worst affected: because of high rates of tax on alcohol throughout the region, the cruises are hugely popular.

The EU's current approach to value added taxation places restrictions on the VAT rates that EU governments may set. The standard rate cannot be under 15 per cent and no more than two reduced rates are allowed on a specified list of goods and services. Despite these restrictions VAT rates vary widely across the EU and neither rates nor exemptions have converged much over the ten years 1987-99.

Harmonisation of alcohol and tobacco taxes features frequently at EU summits but so far change has been resisted by member governments, primarily to defend their own domestic alcohol industries (the French and Italians, for example, resist higher taxes on wine while the UK fights a constant rearguard action to prevent higher rates of tax on spirits, particularly Scotch whisky, of which she is, of course, the largest producer and exporter).

The introduction of the single currency is likely to give rise to a substantially enlarged budget "pool" at the centre, and this would point to higher rates of VAT (or fewer exemptions) in due course. 

EU taxes: no convergence yet

Source: Centre for Economic and Policy Research 

UK: lightest tax touch in Europe

Source: Centre for Economic and Policy Research 

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European Monetary Union and public opinion

The desire to create a common currency and with it supra-national political and budgetary institutions is fundamentally at odds with the patchwork quilt nationalisms of Europe. Indeed, one of the most striking features of the drive towards monetary union is the gap between the driving ambition of the EU's political and administrative elites and the indifference, if not scepticism, of ordinary people (this is particularly marked in, though by no means exclusive to, Britain).

Survey data reveals a telling gulf in attitudes - and a gulf that has been widening in the 1990s. Asked in a pan-European opinion poll whether "I feel almost as European as I do a citizen of my own country", only 33 per cent agreed, with the percentage falling to just 23 per cent in the Netherlands and 12 per cent in the UK.

Yet according to research by Eurobarometer, 63 per cent of top decision makers (TDMs) believe the EU plays too small a role in the world, and just over 50 per cent are in favour of a single currency - double the proportion in the general population.

A similar division is evident in the UK, with prominent sections of the business community more favourably disposed towards a single currency than the general population.

Overall, there have been few evident gains to the UK from EU membership, while her fishing industry has been decimated and consumers obliged to pay more for food. In economic terms, the UK might have been better off with a loose association such as that chosen by Norway, giving her access to the single market while avoiding the Social Chapter and budget contributions. Overall, the case for the EU on economic grounds remains unproven.

Feeling less European

Source: Henley Centre, 1997 

For/against the Euro


TDM = top decision maker
Source: Eurobarometer, 1996

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