Monday, August 11, 2014

Boris Johnson, Gerard Lyons and policy-based evidence making

The UK can only achieve serious reform if it is serious about leaving, and it can only be serious about leaving if it believes this is better than the status quo of staying in an unreformed EU. It is.

– Gerard Lyons, ‘The Europe report: A win-win situation’

In recent years, policy wonks have led a campaign championing ‘evidence-based policy making’. A new policy should only be put in place after it has been rigorously weighed against the evidence. If the evidence points in another direction, the policy should be ditched. This, of course, rarely happens: politicians have a pet project that they are convinced must be a good idea, and commission research that supports the project and ignores evidence to the contrary. British civil servants have come to call this ‘policy-based evidence making’. Nowhere is it more apparent than in Britain’s Europe debate: pro-Europeans and eurosceptics too easily throw around spurious GDP and jobs figures, often with weak or cherry-picked evidence, to support their case.

The Mayor of London, Boris Johnson, is the latest culprit. He has ambitions to lead the British Conservative party, and on Wednesday, he made a speech laying out his preferred reforms to the EU. Although he was careful not to say it explicitly, the thrust of Johnson’s speech was that Britain would be better off leaving than staying in an unreformed EU. Such a stance would help him win a leadership contest, given growing euroscepticism among Conservative MPs.

However, “if we get the reforms,” Johnson said, “then I would frankly be happy to campaign for a yes to stay in”. He pointed to research published on the same day as the speech by his economic advisor, Gerard Lyons. The research considered the impact of EU withdrawal on London’s economy, and provided four costed scenarios:

  •  Stay in a reformed EU, which Lyons thinks would cause London’s economy to grow by 2.75 per cent a year, to £640 billion in 20 years. 
  • Leave the EU but with “goodwill” on both sides, and with the UK pursuing a “pro-growth, reform agenda”. This would cause London’s economy to grow by 2.5 per cent a year, to £615 billion in 2034.
  • Stay in an unreformed EU, with growth of 1.9 per cent a year and an economy of £495 billion in 20 years.
  • Leave the EU but pursue autarkic trade and subsidy policies, with 1.4 per cent growth leading to GDP of £430 billion. 

Johnson and Lyons think that London, and by extension the UK, would be best off in a reformed EU, but that leaving would be better than staying in the status quo. These figures, at first sight, seem implausible. Lyons argues that EU reforms could raise London’s growth rate by 45 per cent, and that the status quo is only slightly better than leaving the EU and pursuing autarkic trade policies.

What are the reforms that would lead to such impressive improvements in London’s growth rate? These were Boris Johnson’s suggestions: “complete the single market”; reform social and employment law to reduce costs to businesses; further reform of, or better, abolition of the Common Agricultural Policy (CAP); “managed migration so that we know how many people are coming in”; a yellow card procedure so that national parliaments can stop “unnecessary” regulations; and an “end to the pointless attacks on the City of London”.

Consider whether these reforms, some of which the CER would support, are likely to promote the rates of economic growth that Johnson and Lyons suggest.

  • The UK Department of Business, Innovation and Skills (BIS) estimates that completing the single market – by which BIS means a highly ambitious elimination of barriers to the trade in services – would boost British GDP by 7 per cent. If we spread that out over 20 years, that amounts to 0.35 per cent a year.
  • The CER Commission’s report on leaving the EU showed that EU social and employment rules do not prevent Britain from having one of the most flexible labour markets in the developed world; and that the negative impact of totemic rules like the Working Time Directive is small. There is little reason to believe that abolishing these rules upon EU withdrawal would have a large macroeconomic impact.
  • An abolition of the CAP would make little difference to London’s economy, since it has no farms that receive subsidies. A reduction of EU tariffs on agricultural products, on the other hand, might raise incomes by reducing Londoners’ shopping bills, but Johnson did not mention this.
  •  Counting immigrants from the rest of the EU would make no difference to the number who came. And, in any case, immigration raises GDP, rather than lowering it.
  • It is not possible to know whether greater use of a yellow card procedure – which is already in operation – would raise or lower GDP. More yellow cards might make services liberalisation more difficult, since national parliaments would have more power to thwart the European Commission’s efforts to open national markets. 
  • It is not apparent that the “pointless attacks” on the City of London have had a severe impact on London’s GDP. Rather, the main reason that UK banks’ regulatory costs have risen in recent years is due to domestic, not EU rules: the UK has been faster than other EU countries to raise capital, leverage and liquidity requirements.

A detailed and fair-minded appraisal of the macroeconomic consequences of these reforms might undermine the entire argument, and they are not available to the reader of Lyons’s report. The economic forecasts were provided by the Volterra consultancy, but the appendix does not tell the reader the method by which Volterra arrived at their figures. It simply says that “a reformed EU would, for example, offer free trade in services on the basis of passported regulation”, meaning a services market in which any supplier in the EU can provide services in another member-state without meeting its regulations. A free-trading Britain outside the EU “would encourage trade in services across the globe”. Their model, on the other hand, of an unreformed EU is one whose “prospects … are restricted on the supply side”. Then the report simply lists the GDP and employment numbers that Volterra has attached to these unspecific assumptions without explaining the model the consultancy used.

The report offers very little analysis of what might happen to the UK economy if it left the EU. Foreign direct investment (FDI), which the National Institute of Economic and Social Research has rightly pointed out is the constituent of GDP that is most at risk from an EU exit, receives one mention. Lyons acknowledges that Britain attracts more FDI than any other member-state, and cites a CityUK survey where 38 per cent of financial and professional services bosses said they would move some of their business outside London if Britain left. But Lyons dismisses their concerns, saying this “mirrors comments made by City leaders on the effect of the UK not joining the euro.” A fuller discussion is warranted. It is true that Britain’s decision to stay out of the euro did not prompt international banks to move operations out of the City. But Britain’s EU membership is one reason why: single market rules have allowed the City to be the eurozone’s wholesale banking centre. And higher trade barriers arising from an EU exit would be likely to reduce FDI in many sectors of the economy: market size is an important determinant of FDI flows, and Britain outside the EU would have less access to the single market, unless it pursued the ‘Norwegian option’ of joining the European Economic Area.

The discussion of the possible post-exit trade agreements is very brief: a page and a half. The Norwegian, Swiss and Turkish options are rightly dismissed as politically unworkable (all would require the UK to sign up to rules or trade agreements with little say over them). Lyons says that “the UK option” would be better. This would be a “comprehensive free trade agreement”. But it is hard to see how this option would lead to the kinds of growth rates he suggests. He thinks that the City would have less access to EU services markets than it has now. “It is unlikely [full access] will be granted”, and “it is not optimal” to lose full services market access, he says. And he does not believe that many EU rules would cease to operate in Britain – rules which he argues elsewhere in the report are severe constraints on British economic growth. While UK business “would decide to mirror EU regulations on products and services to allow ease of selling into the [EU] market”, he writes, these “would be business decisions, not something imposed by a centralised bureaucracy”. The report does say that Britain could repeal social and employment law. But it is hard to see how this would result in the growth that the report forecasts.

It is not ungenerous to say that the report’s headline figures were designed to lead to the conclusion that the current state of Conservative politics dictates: that staying in a reformed EU would be best; that leaving would be fine; and that the status quo is so bad that it is only marginally better than leaving the EU and erecting barriers to foreign competition. These are implausible claims that require some serious empirical backing to be convincing. The report does not even try.

John Springford is a senior research fellow at the Centre for European Reform.

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