10 July 2017

How to make the European Union popular again

by Pieter Cleppe

Originally published by The Conservative.

In the course of the last year, the UK has been accused of “threatening” to go for the so-called Singapore option in case the European Union is inflexible during the Brexit negotiations. In particular, the Chancellor Philip Hammond has suggested that the country may cut taxes in retaliation for the EU complicating Brexit.

First of all, we should ask what would be so threatening for the EU if Britain does this. A stronger UK economy – the result of relaxing the tax burden on those who are creating wealth – would also benefit the economies of mainland Europe, as they trade extensively with the UK. The German car manufacturer would be able to sell even more cars to the British. It would also put pressure on European governments to lower their own corporate tax rates.

Second, the UK was already lowering its corporate tax rate before the Brexit vote, in response to international competition. There are similar corporate tax cuts (or plans for tax cuts) in Finland, the United States, Belgium, the Netherlands, France, Japan and Italy. Even the German finance minister Wolfgang Schäuble has promised to cut corporate tax, oddly enough not long after warning Britain not to do so in the context of Brexit.

The UK may or may not lower its corporate tax rate after Brexit. But what may indeed lead it down the Singapore route is trade policy. Britain will be able to decide its own tariffs and conclude trade deals on its own, as this power will be transferred to it after it leaves the customs union, which may happen only some time after Brexit, given that Britain needs to adapt its own customs bureaucracy first.

One of the main features of Singapore is its policy of unilateral free trade, to a great extent at least, something it has in common with Hong Kong and South Korea. While there are many things that could be improved in Singapore, starting with its lack of free speech even when it comes to the city-state’s economic policy, its trade openness is clearly the core factor in its enormous economic growth over the past 50 years.

So why are so many people against unilateral free trade?

Many commentators feel it is unfair to allow market access to businesses from countries that do not offer the same kind of market access in reciprocity. China, for example, obviously does not practise free trade. Instead, it has a corrupt protectionist state-driven economic model. That model is, however, already a massive improvement on China before it opened up to the world in 1978. If the West had kept its doors shut until Beijing somehow magically converted to Western liberalism, none of the 700 million Chinese would have been lifted out of poverty and no cheap products would have been enjoyed by Western consumers, helping them to cope with ever-expanding tax and regulatory burdens.

European and American protectionist populists may argue that China has eroded the West’s manufacturing base, hurting the middle classes badly. That is an incorrect assessment. The problem is not so much that businesses have moved to countries where people are still willing to do the hard work needed to produce basic materials, and that this has destroyed jobs. The real problem is that, thanks to the burdensome tax and regulatory policy choices of the West – including America, where the corporate tax rate has risen to 35 per cent – not enough new jobs have been created. While China has been experimenting with elements of capitalism, the West has been lured into adopting elements of socialism, despite the massive failure of this model of development in Russia and many other countries.

Insisting on reciprocity means, in practice, closing your markets. Which countries in the world have done the most to restrict trade and promote self-sufficiency? Zimbabwe and North Korea.

Surely, some middle way should be found, some may say. In order for companies to grow into world players, they need some state protection first; when they have grown up it’s fine to stop protecting them. Here’s how to deal with this argument: while it is true that some companies do benefit from protectionism, one should look at the total cost to the economy.

First, protectionism faces consumers with either less choice or higher prices of products and services. Second, companies that do import bear the brunt – and these days it’s getting harder to distinguish between importers and exporters, given the ever more complex cross-border supply chains in many industries. Protectionism distorts market processes, reducing prosperity. To deal with the restrictions, companies need to find second-rate service providers or pay more for goods than they would have otherwise. In orthodox economics, one needs to look at the interests of the consumer, as the French nineteenth century economist Frederic Bastiat so eloquently pointed out. Why? Everyone is a consumer, plain and simple.

Some may object that unilateral free trade is mainly good for the strong in society. This has also been refuted by evidence. Open Europe’s very first research paper back in 2005 concluded that EU protectionism mainly hurts society’s poorest members, given that they spend the highest percentage of their income on food and clothing compared to wealthier income groups. Food and clothing are precisely the kind of items made more expensive as a result of the EU’s protectionism.

If food is so important, shouldn’t the European Union – or Britain after Brexit – shield its agricultural markets and shower them with subsidies? We wouldn’t want to have our food supply shut off by Russia, would we? Again the facts reveal the obvious. When New Zealand opened up its agricultural sector at the beginning of the 1990s, food production tripled. In contrast, while its counterparts in New Zealand are thriving, Europe’s dairy sector has become ever less competitive. That’s no surprise, given that it’s forced to operate in the context of the EU’s economic model for agriculture. Protectionism is precisely what undermines the vibrancy of our agricultural sector.

Opening up trade unilaterally isn’t only about slashing tariffs on imports to zero. It’s about allowing goods to be imported easily, making the process of inspecting them at the border as smooth as possible. It’s about allowing services and goods providers from other countries to offer their services in a convenient way, getting rid of the unnecessary bureaucracy required to buy a car in another country or to buy insurance from abroad. It’s about a predictable, open and smooth process for immigration. While the differences in levels of wealth in today’s world may still be too big to allow completely unrestricted migration, there is no reason why people who apply for a work visa shouldn’t get a quick answer or why the process shouldn’t be fluid for businesses.

At Open Europe, we’ve pointed out that the UK has massive opportunities to boost its trade after Brexit, suggesting that it should prioritise China, India, Pakistan, Bangladesh, Israel and Nigeria. These opportunities are just as great for the EU27. The EU should stop trying to overload trade agreements with all kinds of technical standards and understand that countries won’t be lining up to trade with Europe if it insists that they need to abide by Brussels regulations. Also, the UK or the EU should try to convince protectionist countries like China, which will not accept a complete opening of markets, to at least open certain sectors of its economy or adapt its regulations for a specific sector in order to allow foreign companies to provide services. Also, If EU-US trade talks are revived, why link the opening of agricultural markets – a thorny issue everywhere in the world – to the opening of other, less controversial, markets?

With regard to freeing up internal trade, there is much the European Union can still do. It should learn from Brexit and realise that a member of the club is leaving because the club hasn’t been focusing on its core job: to scrap barriers to trade between countries. Buying a car in another EU member state or using the services of foreign airline or telecom operator should not be difficult. Every time the EU has faced opposition, it’s because it is organising fiscal transfers, imposing conditions linked to these fiscal transfers or sticking its nose into most sensitive topic in every country in the world: immigration.

If only the EU would become what it was sold to the British as in the 1970s – a mere free trade arrangement – it could be popular again. The EU’s insurance market hasn’t been opened up. Its attempt to boost the free flow of services got stuck more than 10 years ago. Why not allow a limited number of European countries to open up their services markets for each other, bypassing approval by the likes of Germany? And if Brussels keeps failing to close large-scale trade deals, why not let single member states try their luck? Iceland, Norway and Liechtenstein are part of the EU’s single market but can already close their own trade deals.

In conclusion: a new push is needed to reinvigorate Europe’s sclerotic welfare states, and more trade openness is the way to get this going. While multilateral trade deals and grand bilateral trade agreements have proved hard to close, unilateral free trade hasn’t been properly tried in Europe. With Brexit, the UK has the chance to do so and the countries of the EU can be inspired by its success.