Classics Revisited: Better Off Out?

The Benefits or Costs of EU Membership” by Brian Hindley and Martin Howe (1996)

30 years ago, two IEA authors published the first attempt at a cost-benefit analysis of Britain’s membership of the EU. 10 years after the Brexit vote, the book still works as a ‘Brexit Primer’

Introduction: Brexit before Brexit

At our conferences for students, I sometimes give a talk with the title ‘The Economics of Brexit’, which, as I’m always at great pains to make clear right at the beginning, is neither a pro-Brexit nor an anti-Brexit talk. It is a talk which spells out the trade-offs that Brexit involved: it is about how to think about Brexit, not which conclusion to reach. The first question that comes up during the Q&A is usually some variation of ‘All well and good, but where do you stand on Brexit?’, and the fact that that’s not obvious from the talk tells me I’m doing something right.

Like most people, I didn’t really think very much about these issues until around the time the referendum was announced, and we suddenly all had to become Brexperts (or at least, be able to fake it convincingly). In hindsight, I wish I had read Better Off Out? The Benefits or Costs of EU Membership by Brian Hindley and Martin Howe much earlier. Even though it was published 20 years before the referendum, 16 years before ‘Brexit’ was even a word, and a mere 3 years after the European Single Market came into existence, it still does a remarkably good job at explaining the trade-offs alluded to above. Better Off Out? essentially does what I’m trying to do in my ‘Economics of Brexit’ presentation, but better. Today, thirty years on, one could still read it as a Brexit Primer, even if it was not written for that purpose. The book already foreshadows many of the debates that would consume the nation 20-plus years later. But it was nonetheless not a prophecy, and contrasting what the authors thought a withdrawal from the EU could look like to what actually happened is in itself instructive.

Better Off Out? is a first attempt at a rough cost-benefit-analysis of Britain’s EU membership, of the type that would begin to proliferate 20 years later. That cost-benefit analysis is of a more qualitative than quantitative type, though, because, as the authors make clear right from the start, ‘the preliminary spadework that might make accurate estimation possible has not been done.’

Better Off Out? book is Eurosceptic in tone, but it is not a proto-Brexit manifesto. The authors’ overall verdict is:

‘The analysis provided here does not allow a confident claim that the British economy would gain from withdrawal. The central point, however, is that any economic gain or loss is small – [...] [e]ven the worst case [...] is a long way from economic suicide.’

If you are a Leaver, you can read that as an early rejection of ‘Project Fear’. If you are a Remainer, you can read it as an early rejection of the idea that EU membership is what holds Britain back. The authors’ point, though, is not that Britain should, or should not, leave the EU. It is simply that this is a question which cannot be decided on the basis of economics alone. It is a political choice – as, indeed, it would be, 20 years later, although the fact that the Remain side prioritised economic arguments to a much greater extent than the Leave side would be a cause of much misunderstanding.

The European Customs Union

But back to 1996. The authors deal with the different layers of Britain’s EU membership separately. One of those layers is, of course, the European Customs Union. I have to admit that until 2016, it was not clear to me at all why you would need customs checks within a free trade area. Surely, an FTA worthy of the name is about eliminating tariffs and quotas, so once those are gone, what exactly would a customs official do? Would they just sit there all day, waving everything through?

The answer, of course, is that when country X signs an FTA with country Y, that only means that they are happy to accept tariff/quota-free imports of goods and services from country Y (and vice versa). But at any given time, there will be plenty of goods and services sloshing around in country Y that aren’t actually from country Y. And these are not covered by the X-Y FTA. They need to be filtered out at the border. As long as X and Y have different trade arrangements with the rest of the world, they need customs checks between them. The only way for them to obviate the need for customs checks would be to adopt identical trade relations with the entire rest of the world. Which is one way to describe what a customs union is: it is an area with a common trade policy. Hindley and Howe already explained this well in 1996:

‘The distinction between a customs union [...] and a free trade area is that within a free trade area the free trade applies only to goods originating in the area, and not to goods imported from outside. Members of the free trade area may have differing external tariffs which could be avoided by trans-shipping goods through the country with lowest tariffs; so customs formalities are exercised on trade between members of the area and ‘rules of origin’ are applied to determine whether or not the goods concerned are entitled to free entry. Since it is necessary to prevent avoidance of customs dues through minor repackaging or representations of goods originating outside the free trade area, the rules of origin become quite complex.

On the other hand, a customs union requires that all its members maintain a single external system of tariffs and [...] quotas. Thus, members of a customs union lose the ability to forge their own relationships with other parties. It is, for instance, in principle possible for a country to be a member of two different free trade areas; but it is not possible for a country to be long to two different customs unions. [...]

The EU is in part a customs union. It aims for free trade between members, but maintains barriers against imports from non-members hence, trade between members is encouraged and trade with the rest of the world discouraged.’

There, in a nutshell, we already have the main advantages and disadvantages of a customs union, and criteria to decide whether or not it makes sense for a country or region to be a member of one. Customs unions eliminate the need for customs checks, and enable frictionless trade among its members. But that elimination of frictions comes at a cost, which is the loss of sovereignty over trade policy. A member of a customs union has no independent trade policy anymore: they outsource their trade policy to the customs union. Whether that makes sense or not depends on what you prioritise: frictionless trade with your nearest neighbours, or the ability to strike separate deals with other economies further away? This depends not just on current economic geography, but also on policy preferences. Pooling your sovereignty with your neighbours can work if you agree with them, and would do largely the same thing as them anyway. It becomes harder if we are dealing with diverging policy preferences.

The European Single Market

Now let’s move on to the European Single Market. The Single Market is a very advanced form of an FTA, which is characterised not just by the absence of tariffs and quotas, but also by a harmonisation of regulatory standards. It was still a fairly new arrangement when Better Off Out? was first published, but the authors already explained the trade-offs involved in it very well:

‘‘Harmonisation’ as practised in Europe has benefits, but it also has costs. The benefit is that a manufacturer in any European country can manufacture goods to the common European standard in the expectation [...] that he will not then have to meet different or additional standards or requirements in order to export into any member-state. The cost is that the standards adopted may be unnecessarily cumbersome and expensive for the home market and for exports outside the EC or may simply be inappropriate for the specific requirements of the home market or the country’s industry. [...] The direct cost is compliance with unnecessary standards in the domestic market and other EC markets, and possible loss of competitiveness in world markets.’

Quite so. Being part of an economic zone with common regulatory standards has its upsides even if those regulatory standards are far from ideal. They do not need to be the best possible standards, what matters is that everyone else within the economic zone accepts them too. But it does mean that members of that zone lose regulatory autonomy, and have to accept regulatory standards they might not have chosen for themselves.

Liberal Leavers vs liberal Remainers: a debate foreshadowed

Hindley and Howe already pointed out that an exit from the EU would not automatically lead to repeal of burdensome regulations: that would still require active political choices. In their words:

‘The cost imposed on British industry by EC social rules would be capable of being removed. Clearly, there would be a policy choice as to the extent that EC rules [...] would be continued as rules of national origin. A similar calculus would apply to environmental costs’.

And elsewhere:

‘The extent to which leaving the EU would result in a cost saving under this heading [excessive or unnecessary costs of EU regulations] would of course depend upon the policy choices made by the British Government after leaving – in particular, the extent to which it engaged in a bonfire of existing EU regulations.’

But while they recognised that Brexit (they did, of course, not call it ‘Brexit’ yet) would not guarantee regulatory cost savings, they saw them as a relatively easy Brexit win: ‘there would clearly be a better prospect of ending rules which […] impose large costs.’ With the benefit of hindsight, we can say that the word ‘clearly’ was doing too much heavy lifting here. There is not much appetite for deregulation at the domestic level either.

20 years after Better Off Out?, this would, in fact, become a point of disagreement between liberal Leavers and liberal Remainers (and after that, between liberal Hard Brexiteers and liberal Soft Brexiteers). The former pointed to all the deregulation measures that (Hard) Brexit would make possible. The latter agreed that Brexit would indeed make many things possible. But would it make them sufficiently likely to justify the cost of leaving the Single Market?

This was just one manifestation of a deeper divide, already anticipated in Better Off Out?:

‘An important matter underlying the economic costs and benefits of EU membership is an apparent cultural difference in attitudes to free markets between the ‘Anglo-Saxon’ and the ‘continental’ approaches. The latter exhibits a propensity to favour regulation over free markets. [...] That free markets are better for the general welfare than political processes is, of course, the central proposition of classical liberal thought. British Conservatives do not always apply it in full, but few of them would […] fail to pay it at least lip service. That their continental counterparts refuse even lip service reveals an intellectual gulf. Reflected in policy, it could become a political chasm.’

This goes to the heart of the divide between liberal Leavers and liberal Remainers which we would see 20 years later, including at the IEA. Liberal Leavers saw Britain as, essentially, a free-enterprise nation, albeit one that often fails to live up to its own ideals. The EU, on the other hand, was a place that did live up to its ideals, but those ideals were themselves the wrong ones, at least from a liberal perspective. Its ideas were corporatism, protectionism and interventionism.

Liberal Remainers had a more cynical – or as they would see it, a more realistic – view. They said that while Britain had indeed historically had a stronger classical liberal tradition than most of continental Europe, the average modern-day Brit was not particularly appreciative of that tradition, and did not treat it kindly. Liberal Remainers argued that, these days, the average Brit was just as hostile to free markets as the average continental European. Whether it is in the UK or in the EU-27, if you are a classical liberal in this day and age, public opinion is not on your side, and the general public is not your friend.

Brexit options compared

Last, but very much not least, Hindley and Howe already noted that a cost-benefit analysis of Britain’s EU membership needs to first answer the question: compared to what?

‘Britain’s economic circumstances as a member of the EU must be compared with its economic circumstances if it withdraws from the EU. ‘Withdrawal from the EU’, however, has no single simple meaning.’

We have since learned the hard way that it does indeed not.

The authors discussed a number of options. One was what would later become known as a ‘No Deal Brexit’: ‘Withdrawal might mean […] that membership was not replaced by any special arrangement between independent Britain and the EU.’ They considered this ‘the worst case’.

They also already discussed what would later become known as the ‘Norway Option’ or ‘EFTA/EEA Option’. They saw some attraction in this model, because:

‘the EEA […] is a free trade area rather than a customs union; hence its members retain responsibility for setting their own tariffs with countries outside the area and may enter into special trading relationships with third countries. This is a freedom denied to members of the EC, which is a full customs union. Second, EEA members enjoy in full the ‘four freedoms’ of the European single market: freedom of movement of goods, of services, of persons and of capital.’

But while they argued that ‘this arrangement should not be rejected out of hand’ and that it ‘can be considered as having considerable attractions in its substantive terms’, they did not seem enthusiastic about it:

‘The main defect of the EEA is that [...] [t]he EEA states are obliged to implement [...] single-market harmonisation measures. [...] Thus, EEA membership would do little to ease the present regulatory burden attached to the single market if that were thought to be one of the main drawbacks of full EU membership. [...] [I]t would leave the UK closely tied to the single market while limiting its ability to influence single-market rules. It would do little to free British industry of the existing regulatory burden imposed by single-market harmonisation directives’.

They seem keener on what they call the ‘Swiss/EFTA model’, similar to the Norway Option in principle but outside of the Single Market, if not very far from it. Their ideal model is an outer-tier membership model for the Single Market which was not seriously discussed during the Brexit years (although I have vague memories of seeing a proposal quite like that), a bit like Norway but without the drawback of rule-taker status:

‘[O]uter-tier Community members would adhere to those aspects of the Rome Treaty (and associated regulations and directives) which pertain to the single market and its four freedoms. They would retain full rights to vote on those matters, and free-trading rules would continue to be binding on all member-states, both inner and outer tier.’

To me, that sounds a lot better than what actually happened – although how realistic that was, we will probably never know. I suppose it would have helped if a few more politicians had read books such as this one before the Referendum, rather than panic-Googling ‘What is a customs union?’ after triggering Article 50, like a student half an hour before an exam they didn’t prepare for.