On 22 June the so called Five Presidents’ report, authored by Jean-Claude Juncker, Donald Tusk, Jeroen Dijsselbloem, Mario Draghi, and Martin Schulz, was published, outlining plans for strengthening economic and monetary union. Iain Begg assesses what the report means for the future of the euro. He finds that while some of the proposals are well-judged and combine ambition with realism, others are too vague, and that there are still areas, such as the future role of the ECB, that deserve attention. He also notes the risk that some EU countries may lack an appetite for further governance changes and that the proposals may be challenging for the UK.

Since the Greek crisis first erupted in the autumn of 2009 – yes, it is that long ago – the EU has put in place a range of new governance mechanisms designed to make economic and monetary union (EMU) more effective and resilient. Yet, by common consent, there is more to be done. The latest proposals come in the form of what is being called the Five Presidents’ report, made public on the 22^nd of June 2015.

It contains updated plans for ‘Completing Europe’s economic and monetary union’ in three stages by 2025, with the aim of dealing with many of the flaws exposed by the crisis in the original design of EMU, and follows the Four Presidents’ report on achieving ‘Genuine economic and monetary union’ published in 2012. The four Presidents were those of the European Council, the European Commission, the European Central Bank and the Eurogroup, the last being the body which brings together the finance ministers of Eurozone countries. This time Martin Schulz, President of the European Parliament, has muscled his way on to the cover page as the fifth.

Two of the Five Presidents, Jean-Claude Juncker and Donald Tusk, Credit: European Council (CC-BY-SA-ND-NC-3.0)

While such plans are, on the whole, welcomed by the UK, keen to see a restoration of stability across the Channel, they are also a source of some anxiety. One of the lower profile themes on the UK’s renegotiation agenda is to make sure that new deals agreed by the Eurozone do not place the country at a disadvantage. It may lack the visibility of the debates around immigration and benefits, but could potentially be more disruptive and maybe even threatening to UK interests. In particular, the prospect of financial regulations inimical to the City of London has been a persistent concern.

The 2012 Four Presidents’ report proposed closer integration in four main areas. These were: banking union; closer integration of budgetary policies, including a possible additional budgetary capacity at Eurozone level and a common debt instrument (a limited form of Eurobond called Eurobills); better coordination of economic policies other than fiscal policy; and a strengthening of democratic legitimation and accountability – potentially bringing about at least a degree of political union.

In the end, only the banking union dimension made much progress, first through the agreement of a new structure for prudential supervision of banks (the single supervisory mechanism, with the European Central Bank at the pinnacle of a network of national supervisors), and a common approach to resolving failing banks (the single resolution mechanism). Some of the Member States outside the Eurozone voluntarily agreed to participate in these initiatives, although it will be no surprise to readers that the UK was not among them.

The same broad headings remain in the new report, but some of the more contentious components have been dropped or toned-down in scope. There is no longer any mention of new fiscal capacities nor of debt mutualisation. Instead there is a more vague call to create a ‘fiscal stabilisation function’, the details of which will be worked out by an expert group to be set up in due course. Principles for fiscal stabilisation include avoiding a system that will result in permanent cross-border transfers – plainly intended to allay the concerns of the creditor countries – as well as ensuring compliance with fiscal rules and the common EU (NB: not just Eurozone) Fiscal framework. The discussion also makes clear that any new arrangements are not to be used for crisis management.

Two of the more eye-catching new proposals are intended to complete banking union. The first is to establish a common deposit insurance scheme to complement the protections offered to depositors by national agencies. This was one of the original ideas for banking union which failed to garner enough support after 2012, for the basic political economy reason that creditor countries saw it as potentially an open-ended commitment to bail out debtor countries – in other words a moral hazard risk. The new proposal suggests making the common scheme a form of reinsurance for national deposit insurance, providing top-down funding when the national scheme is in trouble, rather than an all-encompassing supranational one. It will be based on contributions from the banking sector, rather than public money, and is a sensible compromise solution that should make it easier to accept.

The second development will be what is called a ‘bridge financing mechanism’ as a backstop to the single resolution fund already agreed at the end of 2013. Critics had complained that the fund in question risked being too small and too slow to build up to its target size (it was to take ten years and thus not to be fully operational until 2025). There is a clear logic to making money available rapidly given the continuing precarity of many European banks.

If both these proposals make headway, the result would be a more integrated and resilient Eurozone banking system and would go a long way towards breaking the ‘doom-loop’ in which problems in the banking system cause problems for public finances (think of Ireland, Spain and Cyprus), or problems in public finances cause banking fragility (Greece). But agreement will be hard to reach for the same reasons as before, namely that creditor countries will fear that they will be put at risk, even though the plan is, ultimately, to raise money from the financial sector rather than tax-payers. Restoration of ‘normal’ bank lending is, nevertheless, vital to restore economic growth and to reduce the dangerously high levels of unemployment in many Member States.

The report also emphasises the importance of the Capital Markets Union which is at the top of the agenda of UK European Commissioner, Lord Hill. In other currency areas, such as the US dollar, private financial flows mitigate many of the consequences of an asymmetric shock affecting only certain regions, but cross-border flows of this sort have been more limited in the Eurozone, inhibiting an important adjustment mechanism. It is not a magic bullet, but a deepening of European capital markets should, in time, complement other mechanisms.

On fiscal policy, the Five Presidents are more circumspect than was the case in 2012. They reiterate the importance of fiscal discipline – referring to ‘responsible budgetary policies’. Apart from the suggested new approach to fiscal stabilisation, they call for the creation of a European Fiscal Board to act as an independent check on the conduct of fiscal policy. Many countries have already set up their own fiscal councils (the UK’s equivalent is the Office for Budget Responsibility – OBR), but they differ in their scope and influence. The OBR, for example, was given responsibility for official forecasts as well as examining the government’s fiscal plans, whereas (as an illustration) the Irish Fiscal Advisory Council is asked only to assess the government’s forecasts and budgetary plans.

The Five Presidents’ advocacy of this new Board is justified by the claim that it would ‘lead to better compliance with the common fiscal rules’ and would result in ‘stronger coordination of national fiscal policies’. It stops short, however, of saying that it would facilitate the setting of a common Eurozone fiscal stance, the absence of which is something that many critics of euro governance have bemoaned. Indeed, many leading economists have argued that a collective fiscal stimulus is precisely what the Eurozone needs today to boost economic growth, but that it cannot be achieved while decisions on fiscal positions are left to national authorities. A consequent danger is that the Five Presidents’ ideas will be seen (fairly or not, but it is often perceptions that matter as much as intent) as offering no way out of the prevailing austerity narrative.

There is also a hint that the new fiscal board should contribute to ‘informed public debate’. This would be welcome, but the new board will need to demonstrate its independence from, notably, the European Commission, if it is to become a distinct and credible voice. Two other institutional innovations discussed are a move towards common Eurozone representation in external fora, such as the International Monetary Fund, and a rather tentative floating of the idea of a Eurozone Treasury. The latter is bound to be highly contentious, even though the Five Presidents assert firmly that tax and spending decisions would continue to be taken at Member State level. A possible implication of a new Treasury is the need to appoint a Eurozone Finance Minister, but that is not examined in the report.

Over the last few years, the European Central Bank has greatly expanded its governance role, not only in the formal powers associated with banking union, but also in, for example, being one of the three institutions in the Troika overseeing countries subject to macroeconomic adjustment programmes. Some readers may, therefore, be surprised that, although one of the Presidents is Mario Draghi, the report makes no direct proposals about the future role of the ECB in economic governance. Some might say that is because the ECB has, on the whole, been decisive and effective so that it is best to leave well alone, but it is a dimension of completing EMU that others might think warrants examination.

A key challenge in completing monetary union will be to obtain public support for what are often politically difficult measures. Proposals by the Five Presidents around legitimation and accountability are similar to those set out in 2012, referring to the role of national parliaments and the European Parliament. The lack of progress on this component of a closer EMU is, itself, a source of dismay in several national capitals, although the Five Presidents note that the right (already agreed) to call European Commissioners to appear before national parliaments ‘should be exercised more systematically than at present’.

It is worth recalling that all these proposals will add to the array of governance changes already introduced since 2010. The fiscal compact, agreed despite David Cameron’s veto in 2011, and other reforms have established a more rigorous system for monitoring and coordinating national fiscal policies, while complementary governance innovations have been designed to curb damaging macroeconomic imbalances. The setting-up of the European Stability Mechanism (ESM) provided a permanent fund to be used to assist countries facing problems in funding their borrowing, and there is more systematic annual monitoring of national economic policy through the ‘semester’ process. Many of these new arrangements were introduced outside the European treaties, for example through separate treaties relating to the fiscal compact, bank resolution and the ESM. One other suggestion put forward by the Five Presidents is to integrate some of these into the EU legal framework, something that could well be seen as provocative in the UK if not handled with care.

For many national governments, the appetite for yet more change is limited, and this may make a number of them reluctant to countenance further extensive reforms. Brussels insiders seem to be agreed, however, that this could be the last chance to establish an enduring system for the governance of the euro. The Five Presidents are less ambitious than the Four and this is probably a wise choice. But they will need to deliver and thereby break the unfortunate propensity to announce wide-ranging initiatives at EU level, only for them subsequently to be watered-down to the much more limited reforms able to command a consensus. Wish the Five Presidents luck; they will need it.

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Note: This article gives the views of the author, and not the position of EUROPP – European Politics and Policy, nor of the London School of Economics.

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About the author

Iain Begg – LSE, European Institute
Iain Begg is Professorial Research Fellow at the European Institute of the London School of Economics and Senior Fellow on the UK in a Changing Europe Initiative of the UK Economic and Social Research Council.

The UK’s EU referendum is likely to be heavily influenced by the extent to which David Cameron is successful in his attempt to renegotiate the country’s terms of membership. Iain Begg writes that while Cameron’s intention appears to be to gain enough from a renegotiation to win the referendum, he faces a difficult balancing act in keeping other EU governments on side. Should the rest of the EU reach the conclusion that retaining the UK is not worth the price that has to be paid, the country could find itself slowly pushed toward the exit door.

There is a presumption that the possibility of the UK leaving the EU (Brexit) is a choice for the British people alone. They will assess the new deal that Cameron is able to achieve and decide whether it is enough to allay concerns about continued membership of the EU.

What this narrative overlooks is that the momentum on the other side of the English Channel is towards deeper integration. It is most visible in the wide-ranging efforts to complete economic and monetary union, but there is also evidence of a desire for more extensive common policies in other areas, such as migration, internal security and justice, or energy policy.

The upshot is that the UK is increasingly the exception to common policies, a stance that is a source of growing irritation in other EU capitals. If that irritation intensifies further, there may come a stage where others say ‘enough is enough’ and start to contemplate pushing the UK out of the EU. As things stand, ‘Brexpulsion’ rather than ‘Brexit’ may appear unlikely, but if the UK seeks ever more exceptions, it could well come on to the agenda.

Push or jump?

Over the years, the UK has been keenest on the economic dimension of integration, especially the single market, and instinctively suspicious of the political dimensions. The prospect of reconciliation between traditional enemies, binding European countries into an ‘ever closer union’, has never really resonated in Britain, so that it is no surprise that exemption from this pledge is one of Britain’s demands. Latterly, however, even the single market has come in for criticism because it is associated with common regulations that many UK businesses find onerous.

In practice, the pitch that David Cameron is making to the rest of the UK contains two very different messages. The first, already prominent in his 2013 Bloomberg speech in which his opening sentence states ‘I want to talk about the future of Europe’, is that a successful EU requires reform, particularly to meet the intensifying competition from emerging markets. He also notes ‘a growing frustration that the EU is seen as something that is done to people rather than acting on their behalf’. There are many in Europe who agree with these sentiments and would support moves to achieve, for example, better regulation. The audience for these demands is EU countries frustrated (for whatever reason) with ‘Brussels’, economic actors who want a more effective, nimble and, often, limited EU, and the national leaders most concerned about Europe in the world, such as the Swedish and Dutch Prime Ministers.

It is the second dimension of Cameron’s case that is more challenging, not least because his principal target audience here is domestic and mainly composed of mild Eurosceptics. He knows that the hard-line Eurosceptics are pretty much a lost cause and will vote ‘no’ regardless of what goodies he brings back from his tour d’Europe. He also faces the rather ironic difficulty that some of the changes he wants will diminish the attractiveness of the EU for staunch pro-Europeans. By seeking, via re-negotiation to change the terms of UK membership of the EU, he is trying to pave the way for the waverers in a referendum to vote ‘yes’. Calls for curbs on EU migrants, more say for national parliaments and protection from Eurozone initiatives that take too little account of non-participating countries speak to this second audience.

The list of areas that the UK has chosen to shun is substantial and growing, but the number of countries sharing British preferences is, for the most part, shrinking. The most high-profile are the euro, with 19 participants and the likelihood that the number of ‘outs’ will fall further later in this decade; and the Schengen area in which only Ireland and Cyprus may stay with the UK outside within three or four years. The UK opted-out of a raft of justice and home affairs provisions, then restored a minority of them; it has refused to participate in banking union, despite the pre-eminence of the City of London as a global financial centre in Europe; and recently rejected calls to share some of the burden of absorbing the ‘boat people’ crossing the Mediterranean, apparently earning Cameron some choice language from Italian Prime Minister, Matteo Renzi.

What this overview of UK exceptionalism reveals is that although no single dossier is crucial, it is their proliferation that is striking. In each case, there are some other countries that share Britain’s reluctance to participate, but none which seeks so many exceptions. Attempts to construct Venn diagrams show the extent to which the UK is outside the core, as can be seen from the simplified version of a chart constructed by Funda Tekin of the Institut für Europäisches Politik, presented in the figure below.

Figure: Europe: united in diversity

Note: Figure adapted from Differentiated Integration at Work by Funda Tekin.

Reports circulating after the June 2015 European Council suggest that the strategic objective for Cameron is to achieve enough from his ‘renegotiation’ to enable him to advocate and then secure a yes vote in the referendum and, by so doing, to put to bed an issue that has haunted – and often traumatised – his party since the mid-1980s. But he faces a tricky balancing act, as do some of the leaders most sympathetic to his predicament. They have to be aware that defeat for Cameron makes Brexit a virtual certainty, with little chance that a change of heart could be achieved in a second referendum as happened twice in Ireland.

There have already been a number of occasions where a choice between the UK and the wider EU interest has had to be confronted, particularly by the Germans. For example, following the European Parliament elections in May 2014, the UK objected to the imposition of the Parliament’s preferred candidate (the so-called spitzenkandidat) as President of the European Commission. To judge by the briefings at the time, David Cameron clearly thought he had secured the backing of the German Chancellor, Angela Merkel, to block Jean-Claude Juncker, only to be swiftly disabused when Merkel realised that there would be significant objections on the grounds of democratic principle, both within Germany and elsewhere. Merkel could have backed Britain and would have influenced many others, but ultimately chose not to, and in the end, only Viktor Orbán of Hungary joined the Cameron camp.

Similarly, noting that concerns about the impact of migrants are prominent in German politics, Cameron thought he would find allies in Berlin in his quest to curb freedom of movement of labour. Again, however, he was firmly rebuffed on the grounds that so fundamental a principle was not, and could not, become negotiable. Nor is his stance on migrants likely to find favour in Warsaw where his Polish counterpart, Ewa Kopacz, recently gave his proposals to curb in-work benefits for migrants a frosty reception.

Three dilemmas will now have to be faced. The first, underlying one, is that the UK is on a quest for shallower integration at a time when, in one way or another, the other Member States, though clearly to differing degrees, are more receptive to a deeper EU, at least in areas such as economic governance. The second dilemma is whether UK antagonism to deepening – even where the UK ostensibly encourages the process, despite insisting on being outside it – has become an obstacle to achieving some of the changes considered necessary to enable the EU overall, and certainly the Eurozone, to function effectively.

The longer-run implications for the EU constitute a third dilemma. Should the UK be regarded as one of a kind, or will further concessions to the UK trigger a series of demands from other Member States for their own exceptions? If so, the shift from a two (or multi) speed model of integration towards the same objectives will be replaced by an à la carte model which many Member States would find unappealing. In resolving each of these dilemmas, the same question crops up: is retaining the UK in the EU worth the price that has to be paid? So far, the answer has been a qualified ‘yes’, albeit with clear signals that unrealistic demands will not be accommodated.

In UK labour law there is a concept of ‘constructive dismissal’ which refers to circumstances in which the employer makes life so unpleasant for the worker – for example by giving them demeaning tasks, or subjecting them to forms of bullying – that the latter quits. Where it is proven in an industrial tribunal, the employer becomes liable for having unfairly dismissed the employee, even though an actual firing did not occur.

This concept may be useful in examining how a Brexpulsion might occur. If the UK repeatedly finds its position on key political or policy issues rebuffed, or is excluded from decisions, it may be the Brits who pull out, but it will be for reasons akin to constructive dismissal. The UK government’s advice to employees who think they have a case for constructive dismissal therefore makes interesting reading:

If you do have a case for constructive dismissal, you should leave your job immediately – your employer may argue that, by staying, you accepted the conduct or treatment.

If the constructive dismissal parallel holds, the implication may well be that the UK should jump out of the EU before being pushed, but there should be no doubt that it would still constitute Brexpulsion, rather than a reasoned choice to exit, because the patience of the UK’s partners will have become exhausted. We are still some way from such a scenario, but the illusion that the forthcoming referendum on Brexit is a choice for the UK voters alone needs to be dispelled. We have to talk about it.

This contribution is an abridged version of a policy analysis published by the Swedish Institute for European Policy Studies.

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Note: This article gives the views of the author, and not the position of EUROPP – European Politics and Policy, nor of the London School of Economics. Featured image credit: Number 10/Arron Hoare (Crown Copyright)

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About the author

Iain Begg – LSE
Iain Begg is a Professorial Research Fellow at the European Institute, London School of Economics and Political Science, and Senior Fellow on the UK Economic and Social Research Council’s initiative on The UK in a Changing Europe.

To what extent do the problems illustrated by the Greek debt crisis threaten the future of the Eurozone? Iain Begg writes that while the prospects for Greece continue to be deeply uncertain, the wider reforms that have been pursued across the Eurozone since the crisis still give reason for optimism about the future of the single currency.

Since 2009, when the extent of the problems in Greece’s public finances first became known, Europe’s leaders have struggled to contain the ensuing crisis. The latest episode culminated in an agreement last month on yet another bailout for Greece, on condition that Greece implement yet more public expenditure cuts and accelerate its programme of economic reforms designed to improve the growth potential of the economy. These reforms will be challenging and many critics are already predicting failure leading to a further round of difficult negotiations.

Credit: Thorsten Hansen (CC-BY-SA-3.0)

Against this gloomy backdrop, it is easy to be pessimistic about the chances of Greece staying in the euro and even about the long-term survival of the Eurozone. However, what is too easily overlooked is the strength of the political commitment to make a success of the euro, with both creditor and debtor countries agreed that an unravelling of the currency will not solve their problems. In addition, there have been significant changes in the governance mechanisms of the euro which give grounds for optimism. Even the UK, so often reluctant to participate in the deepening of European integration, has supported these initiatives, despite being outside most of them.

Several explanations for the Eurozone’s difficulties have been put forward, some focusing on fundamental design flaws, some on policy mistakes and others on political problems. Procrastination in confronting the crisis has also been evident, and even in the latest deal on Greece, it was clear that many euro members were torn between their own national interest and the common interest. The Greek leadership had not only miscalculated the strength of its bargaining position, but also upset many of its partners by the tone it adopted, especially towards Germany. But objections to the Greek demands were even greater from countries as different as (rich) Finland and (poor) Slovakia as from Germany. Quite simply, the others did not trust the Greeks.

An underlying explanation is that the architecture of the Eurozone was always an uneasy compromise between competing national views on what was desirable. Unlike other monetary unions, the Eurozone was deliberately set up without any formal system of fiscal transfers between members of the sort that could have helped to deal with divergences in economic performance. By contrast, in the United States, if a state experiences a sudden downturn in its economy, for example because one of its key industries faces difficulties, additional spending from federal programmes is triggered automatically. Such transfers mitigate the effects of the downturn. Europe also has relatively limited flows of labour between countries, and private financial flows are markedly lower than elsewhere, meaning that other potential adjustment mechanisms are inadequate.

At an institutional level, elements that were lacking when the euro was launched were a lender of last resort function from the European Central Bank (ECB), the absence of tools for crisis management and no source of loans for countries (initially Greece, but also Ireland, Portugal and Cyprus) which faced a liquidity crisis. In fact, one of the features of the euro’s design is what is known as the ‘no bail-out clause’, a treaty article that prohibits both the ECB and other governments from directly buying the sovereign bonds emitted by euro member governments. These deficiencies were, to a considerable extent, disguised by the rather benign global economic conditions of the period from 1998-2008, greatly helped by the growth of China – a period sometimes referred to as the ‘great moderation’.

The comparative success of the euro during its first decade, both in maintaining price stability and in facilitating steady growth, proved to be built on shaky foundations. In much of southern Europe steady economic growth seemed to have been achieved and, in one of the many paradoxes of the euro’s history, Germany was seen by many as the ‘sick man of Europe’ until as late as the mid-2000s. With hindsight, though, it is now obvious that southern Europe was becoming increasingly uncompetitive. Unit labour costs, a measure of the cost of producing goods and services, had been rising continuously in the Mediterranean countries between the launch of the euro and 2008, but had been stable in Germany.

The annual change was small, with increases of two to three percentage points, but over a decade, the cumulative effect was substantial. By 2008, the increase relative to Germany was as much as 25 per cent, so that it should not be a surprise that the balance of payments positions of countries like Greece, Portugal and Spain had become alarming, with all three reaching deficits of 10 per cent or more of GDP by 2008. Financial markets, however, did not seem worried, with bond spreads converging during the first half of the 2000s and more money invested in these countries. In addition, the monitoring of individual Eurozone economies by the European authorities was lax.

Spain and Ireland were also hit by speculative bubbles in the property market which resulted in bank failures and meant that the national governments had to bail out their banks. In the cases of Ireland and Cyprus, the cost was too high for them to bear and the state then had to be bailed out by the rest of the Eurozone. Spain narrowly avoided a similar fate, but still needed some support to rescue its banking system. These difficulties highlighted the absence of a Eurozone banking union and the inconsistency between a common currency and separate national banking systems.

How, then, can optimism about the future of the euro be justified? The answer is that Europe’s leaders have been introducing far-reaching reforms intended to improve the resilience and effective management of the single currency. Indeed, since 2009, another paradox of the euro is that while the rest of the world sees only dithering, denial and double-dealing, the pace of governance reform in the Eurozone has, at times, been frenetic. New measures have been introduced to strengthen national fiscal discipline and to improve the coordination of fiscal policy, and a procedure for identifying and, if required, correcting other sorts of macroeconomic imbalance – backed by the threat of financial sanctions for backsliders – has become law. A new loan fund to support countries in difficulty has also been established.

Significant steps towards creating a banking union have been taken with the agreement of a new structure for prudential supervision of banks (the single supervisory mechanism, with the European Central Bank at the pinnacle of a network of national supervisors), and a common approach to resolving failing banks (the single resolution mechanism). By taking on these and other new responsibilities, the European Central Bank is slowly becoming a fully-fledged central bank, rather than a mere custodian of price stability, and the first elements of a capital markets union are being introduced.

Many of these new measures remain to be properly tested and there are bound to be concerns about their effectiveness, not least because of past experience of non-compliance, including by Germany. Nevertheless, there are good reasons for believing that the Eurozone’s leaders have made such substantial changes that – to misquote the American author, Mark Twain – rumours of the euro’s likely demise are greatly exaggerated.

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Note: This article was originally published in Chinese at the People’s Daily. It gives the views of the author, not the position of EUROPP – European Politics and Policy, nor of the London School of Economics.

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About the author

Iain Begg – LSE
Iain Begg is a Professorial Research Fellow at the European Institute, London School of Economics and Political Science, and Senior Fellow on the UK Economic and Social Research Council’s initiative on The UK in a Changing Europe.

How would leaving the European Union affect the UK’s economy? Iain Begg writes that with pro-EU and anti-EU campaigning groups now officially up and running ahead of the UK’s planned referendum, British voters will undoubtedly be confronted with a series of contradictory claims and counter-claims on the costs and benefits of membership. He argues that it would be unwise to take any of these claims at face value and that the best any researcher can hope to produce is a range of projections, hedged with health-warnings about the reliability of the estimates or the accuracy of the scenario depicted.

The launch in the last few days of groups to campaign for and against UK membership of the European Union has, predictably, seen the publication of claims and counter-claims about the costs and benefits. Anyone hoping for clarity from these data is, however, bound to be disappointed, as the numbers being bandied about are, with few exceptions, more likely to be misleading or downright wrong than helpful.

• According to Britain Stronger in Europe ‘our economic partnership with Europe is worth £3000 per year to every household’ and part of the reason is that ‘the average person in Britain saves around £450 a year because trading with Europe drives down the price of goods and services’.
• Meanwhile Vote Leave tells us that ‘Britain sends over £350 million to the European Union each week’ and goes on to highlight ‘£19.4 billion – the amount the UK would save by no longer having to contribute to the EU budget and invest in our priorities’.
• Its competitor on the ‘no’ side, Leave.EU says that ‘leaving the EU could make the average UK household £933 better off. Freedom from excessive regulations and contributions to the EU budget will significantly lower costs for business and save the treasury billions of pounds per year’.

The first thing those of us asked to judge the veracity of the claims should become accustomed to saying is ‘it depends’. Nearly every figure relies on some sort of assumption and, unsurprisingly, if you want a negative figure, you assume the worst, and vice versa. As the persistent misrepresentation of the 3 million jobs associated with the EU as being ‘at risk’ outside the EU shows, politicians often blithely ignore the small print on estimates.

There are also little tricks of the trade that are used to stretch a point or to obfuscate what is being measured. Notice, for example, that one of the BSE (did anyone ponder the likely acronym?) figures quoted above is per person and the other is per household, but how they relate to each other is not explained. Notice, too, that the VL arithmetic is a tad dubious: £350 per week times 52 weeks is £18.2 billion, not 19.4.

Take the simple question of what the UK contributes to the EU budget. Surely, this must be a matter of record and can be resolved quickly by looking at the accounts? Well, no. The Treasury presents a comprehensive report on the EU’s finances every year which becomes the basis for many of the competing claims, but what the Treasury publishes does not even accord fully with what the European Commission records.

The Treasury numbers show that, after the UK rebate, the gross payment to the EU was around £14.4 billion in both 2013 and 2014. This is the amount the Treasury actually sends to Brussels. However, some of this money returns to the UK in the form of grants or subsidies, whether to farmers, local authorities or companies.

The Treasury computes a figure for the total receipts accruing to the public sector and arrives at a net contribution (contributions minus receipts) which reached £10.5 billion in 2013 and dropped off a little in 2014 to £9.8 billion. Six years earlier, the net contribution had been barely a third of this amount, but much of the increase is explained by the profile of spending over the seven year cycle (the last one ended in 2013) on which the EU operates its budget. Big multi-annual programmes are typically slow to start and the bills – especially for regional development projects – tend only come in towards the end of the period.

But that is not the full story. By counting only the public sector receipts, the Treasury leaves out flows from the EU budget to the UK private sector from the net contributions calculation. On its own analysis, these additional flows in 2012 (the last year for which sufficiently detailed data are available), were worth a further £1.5 billion to the UK. Assuming a similar figure for 2013, the net contribution would be £9 billion. This is still a very large amount of money, but to put it in perspective, is around half a percentage point of UK GDP. More than five times as much is spent each year on interest payments on the national debt.

Working out the other costs and benefits of the EU is, methodologically, a much more perilous exercise. It can be done using a variety of statistical and modelling techniques, but all of them rely in one way or another on being able to specify what conditions the UK would face were it not in the EU. This notion of the ‘counter-factual’ sounds simple enough, but is fiendishly complex in practice, because it requires assumptions to be made about all sorts of factors.

Would there be new trade barriers or would time-consuming customs checks be reintroduced if the UK left the EU? Would farmers succeed in obtaining the same level of subsidy as they do at present under the Common Agricultural Policy or even prise more out of the tax-payer, as their Norwegian counterparts do? Would any new regulations to replace those imposed by Brussels significantly reduce the financial burden on business and, if so, by how much? Would prices creep upwards in the shops without the restraining influence of the single market and, even if they did, would it be because of inefficiencies?

Anyone can come up with plausible enough answers to these and the many other questions that would have to be answered to arrive at a credible assessment, but there will inevitably be uncertainty around each and every one of them. Small differences in the value to assign to any relevant variable can easily tip the net balance from favourable to unfavourable. The best that any meticulous researcher will be able to produce is a range of projections, hedged with health-warnings about the reliability of the estimates or the accuracy of the scenario depicted.

Some do this in a suitably circumspect way. For example, in a study published earlier in 2015, Open Europe – a think-tank usually associated with the Eurosceptic side of the debate – concluded that UK GDP could shrink by 2.2 per cent by 2030 if the UK strikes a poor deal with the EU on exiting, but be up to 1.6 per cent higher under a more positive scenario. Contrast this cautious verdict with the spuriously precise figures of £3000 gain and £933 loss per household quoted above and ask who is more credible.

The expression often attributed to Benjamin Disraeli that ‘there are three kinds of lies: lies, damned lies and statistics’ may need to be reframed to give special prominence to the misuse of statistics on the UK and Europe.

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Note: This article gives the views of the author, and not the position of EUROPP – European Politics and Policy, nor of the London School of Economics. Featured image credit: Frits Ahlefeldt-Laurvig (CC BY-SA-ND-NC 2.0)

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About the author

Iain Begg – LSE, European Institute
Iain Begg is a Professorial Research Fellow at the European Institute, London School of Economics and Political Science, and Senior Fellow on the UK Economic and Social Research Council’s initiative on The UK in a Changing Europe.

Earlier this year, the so called ‘Five Presidents’ report’, authored by Jean-Claude Juncker, Donald Tusk, Jeroen Dijsselbloem, Mario Draghi, and Martin Schulz, was published, outlining plans for strengthening economic and monetary union. Iain Begg writes on proposals adopted by the European Commission on 21 October to implement the recommendations in the report. He notes that the new plans show Eurozone reforms with a decidedly integrating impact are going ahead, and that there could be some potential consequences for the UK’s attempts to renegotiate its EU membership.

The UK has repeatedly encouraged the Eurozone to integrate more closely to make the single currency function better, while simultaneously fretting about the risks of a Eurozone caucus deciding on policy reforms contrary to British interests. This concern is now emerging as one of those crucial to attempts to renegotiate the UK position in the EU.

Although many critics of the EU pour scorn on its apparent inability to resolve the euro crisis and bemoan the procrastination in decision-making, the reform of economic governance in recent years has been far more extensive than these critics realise.

A roadmap for further reform was set out in what has become known as the Five Presidents’ report, published at the end of June 2015 to decidedly mixed reviews. Some, including former Italian Finance Minister, Fabrizio Saccomanni, complained that it was a missed opportunity because too many of the trickier issues, such as how fiscal policy can contribute to macroeconomic stabilisation, should have been addressed more forcefully.

However, implementation of the report is now in progress following proposals adopted by the Commission on 21 October 2015. The background is explained in a Commission communication setting out five areas for action, already anticipated in Commission President Juncker’s State of the Union address delivered in September.

The first initiative will be to refine what is known as the European semester, the annual economic cycle though which economic policies are coordinated. It does so by assessing national economic plans and issuing what are known as country-specific recommendations (CSRs) aimed at influencing national policy-making.

The main changes that the Commission proposes to the semester are to improve the connections between the national level and the Eurozone level, recognising that how the Eurozone economy as a whole evolves matters, and to pay more attention to the effects on jobs and social conditions. In addition, the document advocates enhanced diffusion of best practice and possibly more funding for ‘technical assistance’ to support reform.

The second, an interesting development, is the formal decision to create a European Fiscal Board. An element of earlier governance reforms was the insistence that Eurozone countries create an independent fiscal council, part of the rationale being to act as a watchdog on how governments conduct their public finances. In the UK, the Office for Budget Responsibility fulfils this function.

The proposed new Board, which will have five members, will have the task of assessing fiscal developments in the euro area as a whole and – in what could be a significant development (see article 2a of the decision) – advising on the fiscal stance of the euro area as a whole. It will also collaborate with national fiscal councils and provide ad hoc advice to the Commission.

Three further measures are proposals rather than done-deals, some of which are likely to encounter resistance from a number of EU countries:

• First, the Commission wants to see the establishment of competitiveness boards in each member state, although its current proposal is that these should be voluntary for those not in the euro area. These boards are intended to oversee reforms aimed at making economies more competitive and to be operational by the middle of 2016. They are to be independent of government and to have an advisory rather than executive function, although the document hints at a more formal role in the future.
• Collective representation of the euro area in international bodies, such as the IMF, is a second proposal. There is good sense to this proposal insofar as it is curious to have the euro represented by individual countries in some settings, but by the ECB in others. However, countries like Belgium which, for historic reasons, have a special status in the IMF, may be uneasy about losing their role.
• A third ambition is to consolidate banking union, building on the launch last year of the single supervisory mechanism, led by the European Central Bank, and the agreement on a common approach to resolving failing banks. This will entail pressure to complete the enactment of the provisions for bank resolution already passed in secondary legislation. The Commission also wants a bridging facility to underpin a fund created to support bank resolution, because the existing fund, paid for by levies on banks, will take until 2025 to reach its intended size. A much more contentious proposal is to introduce a pan-European form of deposit insurance, but details will only be published later in the year.

These five measures are a beginning because the plans for new governance initiatives will, starting in 2017, extend ‘to more far-reaching measures… to complete the EMU’s economic and institutional architecture. This will involve sharing more sovereignty and solidarity and will have to be accompanied by strengthened democratic oversight’. In particular, new proposals on common budgetary policies and on improving accountability are expected.

For the UK these developments are likely to lead to new tensions about the pace and direction of economic integration. Just the expression ‘sharing more sovereignty’ will raise many hackles, but the more subtle worry is that the UK will again be on the margins of significant developments which are accepted not just by the Eurozone countries, but also by many, if not most, of those not in the euro.

In 2011, the UK was in a minority of just two countries opposed to the fiscal compact and has irritated some of its potential allies by refusing to take part in the quota system for re-settling the migrants crossing the Mediterranean. Even Denmark, which is the only other country with a formal opt-out from the euro, seems disposed to go along with much of banking union and it remains to be seen whether others will want to participate in the new integrating measures described above.

In principle, the semester applies to the UK, although the only time it really becomes visible is when ‘Brussels’ issues CSRs, typically to a chorus of complaints about sticking its nose into matters that should not concern it. Earlier this year, for example, the perfectly reasonable judgement that the UK housing market could do with reform was condemned by several politicians.

The new plans show that Eurozone reforms with a decidedly integrating impact are going ahead and that economic policy decisions will be increasingly about the Eurozone as a whole. The dilemma for the UK is whether it is comfortable being in a shrinking minority of non-participants in significant domains of economic governance. There are also bound to be questions about the possible consequences for the renegotiation of the terms of UK membership of the EU. It can be lonely on the outside.

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Note: This article first appeared at The UK in a Changing Europe. It gives the views of the author, and not the position of EUROPP – European Politics and Policy, nor of the London School of Economics. Featured image credit: from the Completing Europe’s Economic and Monetary Union report, European Commission.

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About the author

Iain Begg – LSE
Iain Begg is Senior Fellow on the Economic and Social Research Council’s The UK in a Changing Europe and Professorial Research Fellow at the European Institute, London School of Economics and Political Science.

In his letter to Donald Tusk, David Cameron stressed the importance of Eurozone and non-Eurozone members being on an equal footing. Iain Begg argues that this request is problematic. Among the issues raised, he writes that it would be a mistake to think that the interests of the nine member states that are out of the Eurozone are closely aligned and that the numerical balance will remain the same in the long term. As a consequence, the UK may find that support from the non-euro countries is more brittle than Cameron expects.

The long-awaited letter from David Cameron to Donald Tusk, detailing the areas in which the UK wants to secure a new settlement in its relationship with the EU, places considerable emphasis on the importance of respecting the differences ‘of its many member states’. It stresses that he wants the euro to succeed and will not stand in the way of the deeper integration that all sides agree are vital for its success. Equally, the UK case for a new deal for those outside the Eurozone emphasises that changes must ‘respect the integrity of the single market, and the legitimate interests of non-euro members’.

The first of the four areas for reform set out in the letter starts from this proposition that there are now ‘two sorts of members, those in and not in the euro’. It then lists a series of principles that should govern the future relationship between the two classes of members, with the tacit assumption that there is sufficient common ground among the ‘outs’ for them to have shared aims. There are two respects in which this strategy could prove to be risky.

First, although there is an evident cleavage today between the Eurozone nineteen and the nine other member states, it would be a mistake to assume that this numerical balance will persist, or indeed that the interests of the nine, as a bloc, are closely aligned. Certainly, the victory of the Law and Justice party in Poland’s October 2015 general election and the current stances of the Czech and Hungarian governments make early accession to the euro unlikely. However, only Denmark, formally, has no obligation to join the euro whereas, in technical terms, the seven others (including Sweden, regarded by many as closest to the UK in its opposition to the euro) are in ‘derogation’ – that is deemed not yet to be able to join the euro – but still expected to do so in due course.

The settlement that the UK seeks is, however, for the long-term and will require treaty change, so that the political dynamics cannot be ignored. Moreover, governments in most of the ‘out’ countries have rarely lasted more than one term and further changes in sentiment towards the euro could happen quite quickly. Over the next decade, it is likely that enough progress will be made in completing the governance reforms needed to strengthen economic and monetary union and ensure its long-term sustainability. When (rather than if) that process nears completion, today’s justifiable suspicions about joining a failing enterprise based on a flawed architecture of economic governance will abate and the advantages of being part of the euro club will again influence the debate.

It is also noteworthy that all the other outs are now signatories to the separate inter-governmental treaty establishing the ‘fiscal compact’ – the arrangement under which fiscal policy is more closely coordinated among countries – and that, unlike the UK, several seem disposed to be part of the banking union that is progressively being constructed. Even Denmark, despite its formal opt-out, has maintained a fixed exchange rate against the euro through its participation in the exchange rate mechanism (ERM II) which came into being after the launch of the euro. In short, rather than the division being between the nine and the nineteen, the chances are that several of the nine will switch sides over a ten or twenty year horizon, leaving the UK in a shrinking minority.

Poland is likely to be pivotal in this regard and is already positioning itself as a leader among the increasingly assertive central and eastern European bloc of member states. Although some observers wonder whether there might be traffic in the other direction – notably renewed speculation about a ‘Grexit’ – research conducted in mid-November for The UK in a Changing Europe project found that there is no real appetite in Greece for leaving the euro. In addition, given how long treaty change takes and the likely reluctance of the European body politic to want a further revision soon, the underlying question many negotiators will pose is whether significant changes to accommodate the non-Euro countries can be justified.

The second risk concerns the nature of further economic integration. The rationale behind Cameron’s position is that some of the actions that the Eurozone might take to enhance the functioning of the euro could have an adverse effect on the single market. The latter is about ensuring the free movement of goods, services, labour and capital. The UK concern is that actions to shore-up the ‘monetary’ in economic and monetary union (EMU) could lead to conflicts if they erect new barriers to these four freedoms. However, this analysis neglects the fact that the ‘economic’ in EMU is about much more than the single market.

An economic union implies the building up of common policies and economic institutions. The emerging banking union, for example, entails a common approach to prudential supervision of banks and mechanisms for resolving failing banks, with the latter including a common resolution fund to facilitate the orderly winding-up of failing banks. A potential extension of banking union will be the establishment of a form of common deposit insurance, more limited than the extensive federal provisions in the United States, but nonetheless implying closer economic integration.

Other directions in which an economic union move could include a collective approach to corporate taxation, something that would allay public concern about the ability of many multi-national companies to play governments off against each other, or measures to integrate labour market policies. None of these will happen overnight and the appeal to the integrity of the single market will continue to resonate for many other member states, but the UK does need to be aware that the euro cannot be seen purely as about the currency.

It is worth pointing out, too, that while there will be some sympathy with Cameron’s insistence that the non-Euro countries should not be liable for the costs of dealing with Eurozone problems, there will still be occasions when a country requires support from the EU as a whole. This happened with Romania and Hungary during the financial crisis, resulting in EU-28 mechanisms being deployed to assist them financially.

The difficulty that will arise is judging when an economic problem is purely euro-related or might justify a full EU-28 engagement, or indeed a voluntary contribution from outside the Eurozone, as when the UK participated in the Irish bailout in 2010.

The conclusion to draw is that the UK may find that support from the non-Euro countries is more brittle than the Prime Minister expects and that by focusing mainly on tensions between the euro and the single market, insufficient attention will be paid to the deepening of integration underway as part of the construction of economic union.

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Note: This article first appeared at The UK in a Changing Europe. It gives the views of the author, and not the position of EUROPP – European Politics and Policy, nor of the London School of Economics. Featured image credit: Public Domain

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About the author

Iain Begg – LSE
Iain Begg is Senior Fellow on the Economic and Social Research Council’s The UK in a Changing Europe and Professorial Research Fellow at the European Institute, London School of Economics and Political Science.

Statistics on the impact of EU membership are likely to be heavily contested by both campaigns during the UK’s EU referendum. Citing recent examples from Vote Leave, the Sunday Times and the Centre for Economics and Business Research, Iain Begg warns that these figures can make misleading assumptions or even be downright inaccurate.

In war, according to the ancient Greek dramatist Aeschylus, truth is the first casualty. Plainly, he had not foreseen the Brexit referendum campaign which continues to be dogged by blatant abuse of statistics. As explained in a previous blog, all sides are at it, coming up with spuriously precise figures, using the wrong concepts and definitions, or mixing up sources in a manner that amounts to comparing apples with oranges. Although some data on the UK and the EU can be difficult to understand or interpret correctly, it is hard to avoid the conclusion that the desire to mislead trumps any doubts about accuracy. This contribution looks at three recent examples, all of which illustrate how easy it is for misleading statistics to become accepted facts.

First, on 7 February, the Sunday Times had a front page article asserting that “six out of 10 Conservative backbenchers contacted by this newspaper said they backed Brexit”. Readers who turned to the continuation of the story on page 2 then had it explained that 238 MPs had been contacted, 144 had replied, 66 of those replying had said ‘they would campaign to leave’ and 50 said ‘they were committed to remain’. Standards of mental arithmetic may have declined with the ubiquity of calculators, but 66 out of 238 contacted is 28%, while 66 out of 144 giving an answer is 46%; neither is six out of ten. The article went on to claim that the figures ‘suggest well over 100 backbenchers will be campaigning against their leader ahead of the referendum’, presumably based on some unexplained extrapolation from the 66.

The following day, the Centre for Economics and Business Research published a report, commissioned by London First, assessing the impact on London of being in the EU single market. The report notes the daunting methodological challenges associated with defining the ‘counter-factual’ of what would have happened had the UK not joined the EU in 1973, but nevertheless estimates very precise figures, including for the impact of potential further deepening of the single market. The report claims that these latter deepening measures (for example, to complete the digital single market) alone will add 3.4% to gross value added (GVA, a measure of the output of the London economy) by 2030, and will generate 75,000 jobs in the capital.

While there is no reason to doubt that these figures have been honestly arrived at, it is the precision which is misleading, because they rely on very strong assumptions. If the assumptions do not hold, the predictions are unlikely to be accurate, however fancy the modelling techniques used. The sensible approach is to put forward a plausible range for the forecasts, rather than precise figures and to emphasise that over as long a period as fifteen year the range will be extended.

Example three is a claim, prominent on the front page of The Times on New Year’s Eve, that since joining the EU in 1973, the UK has paid over half a trillion pounds to the EU. This figure was based on ‘new research’ by the Vote Leave campaign in which the payments from earlier years have been inflated to current prices and aggregated over the 43 years from 1973-2015. Because prices have risen nearly ten-fold since 1973, the relatively small payment of £187 million in 1973 becomes nearly £2 billion in today’s money, and so on. Although this technique is a commonly used one, it does require that the raw data are accurate.

Those used by Vote Leave were not and here is why. The EU budget has, for many years, been around 1% of the gross domestic product (GDP) of the Union and the starting point for calculating what each Member State contributes is also 1% of its national GDP. In annual statements published by the Treasury on European Union Finances, there is a simple table which shows this ‘gross contribution’, but then also has a line showing the rebate to which the UK has been entitled since 1985. Both the Treasury and the European Commission have confirmed that what the UK actually pays to Brussels is the hypothetical gross contribution less the rebate. In other words, if we could examine the transactions on the Treasury’s bank account we would see the actual payment by the UK over the years is always substantially below the notional gross contribution.

Vote Leave’s study used slightly different numbers published by the Office for National Statistics (ONS), but does not take account of the rebate and therefore greatly exaggerates what the UK has actually paid to the EU. A new paper ‘Who pays for the EU and how much does it cost the UK?’ analyses the payments to the EU in detail and replicates the Vote Leave methodology, using the same ONS data, for the actual payments and finds that the £500bn claim overstates the true payment by £110bn, meaning that it is 29% too high. The paper also shows that relative to our prosperity (as measured by the actual payment as a percentage of our gross national income), the UK is the EU country that consistently pays the least towards the EU budget.

There is no question that over 43 years, the amount of money the UK has contributed is substantial, and that there are plenty of other ways that the money the UK ‘sends to Brussels’ could be used, be it for more nurses, better flood defences or any of the other alternatives so often canvassed. On the home page of Vote Leave’s web-site there is, at the time of writing, a taxi-meter style of counter showing the amount clicking up by the second and having now attained £505.4bn. The counter is dramatic; it is visually striking; but it is also wrong.

Is it too much to hope for a bit more honesty in the use of statistics, or are we condemned to what the fifth century Chinese general Sun Tzu said: “All warfare is based on deception”?

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Note: This article first appeared at our partner site, LSE Brexit Vote. It gives the views of the author, not the position of EUROPP – European Politics and Policy, nor of the London School of Economics. Featured image credit: Nina OA (CC-BY-SA-2.0)

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About the author

Iain Begg – LSE
Iain Begg is a Professorial Research Fellow at the European Institute, London School of Economics and Political Science, and Senior Fellow on the UK Economic and Social Research Council’s initiative on the UK in a Changing Europe.

One of the key fault lines in the UK’s debate over EU membership concerns the amount the country contributes to the EU budget. Iain Begg writes that both sides of the referendum campaign are guilty of misleading the public over the issue, with the leave side frequently quoting contributions without applying the rebate, and the remain side comparing apples and oranges by balancing budget contributions against other benefits.

Claims and counter-claims about how much it costs the UK to belong to the European Union abound. Unsurprisingly, both sides of the debate cherry-pick the statistics that support their side of the argument, but both are also prone to misrepresent the facts and to neglect data that tell a different story.

Part of the explanation for this confusion is that there are conceptually very different ways of measuring the flows to and from ‘Brussels’ through the EU budget. All EU members pay in to it and all receive money from EU spending programmes, ranging from the Common Agricultural Policy to the Horizon 2020 research initiatives. However, some EU spending does not directly come back to members because it is for policies implemented collectively, notably to support what the EU does in the rest of the world, such as spending on humanitarian aid. And a relatively small proportion of EU spending (around 6 per cent) is on the administrative costs of running the Union.

Video: Explainer on the EU budget

Source: UK in a Changing Europe

The EU budget amounts to around one per cent of the total annual output of the EU, as measured by gross domestic product (GDP). To fund it, member countries are expected to contribute one per cent of their respective national GDPs. However, ever since Margaret Thatcher negotiated the famous rebate in 1984, the UK has been required to pay less than this proportion, with others then obliged to pay relatively more to make up the difference. The result is that the actual amount that the UK ‘sends to Brussels’, to use a phrase often employed in the debate, is not the hypothetical gross contribution, but an amount that has already been reduced because of the rebate.

Although this is well-known, campaigners all too frequently use the higher figure, despite the fact that it is wrong (and some of those making the claim know this full well). For example, the often heard claim that the UK sends ‘£350 million per week to the EU’ is based on this incorrect measure. The amount that the Treasury remits to Brussels, and thus the direct cost to UK taxpayers, always has the rebate deducted before payment is made. Because of this, the correct figure, taking account of the rebate, should be around £280 million per week (based on 2014 data).

The contention (by the Vote Leave campaign – featured prominently on its home page) that the UK has paid more than half a trillion pounds is also wrong. The calculation aggregates UK payments to the EU since first joining in 1973, after reflating the amounts from earlier years to current prices. While the methodology employed can be justified, the Vote Leave calculation also makes use of the wrong figure, again by ignoring the rebate. An amended calculation (using the same methodology but applying it to the amount the UK actually pays) shows that the half trillion figure exaggerates the true figure by fully £110 billion.

There are other ways of looking at what Britain pays, for example by taking account of money that flows back to the UK through spending from EU programmes. A net contribution can be calculated in this way by deducting what the UK receives from what it contributes. In 2014, the receipts were a little under £6 billion. Throughout the country’s years of membership since 1973, only the UK and Germany have consistently been net contributors to the EU’s finances, although in recent years, many more countries have joined them.

Remain campaigners know this, but often blur the picture by arguing that the UK benefits in other ways. They then arrive at a figure which conflates budget flows with a range of other benefits to arrive at figures such as a net £3,000 gain per household per year. This too is misleading for the simple reason that it is comparing apples with oranges. In short, they are all at it. Citizens, voters, commentators: beware.

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Note: This article first appeared at UK in a Changing Europe. It gives the views of the author, and not the position of EUROPP – European Politics and Policy, nor of the London School of Economics. Featured image credit: Images Money (CC-BY-SA-2.0)

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About the author

Iain Begg – LSE, European Institute
Iain Begg is a Professorial Research Fellow at the European Institute, London School of Economics and Political Science, and Senior Fellow on the UK Economic and Social Research Council’s initiative on The UK in a Changing Europe.

Have the negative economic consequences brought about by the financial crisis made European welfare states unaffordable? Iain Begg writes that while there is some validity to criticisms of welfare spending, the welfare state performs a number of core functions that ensure it will continue to be around for the foreseeable future. He also notes that European welfare states have shown a greater capacity for change than is often recognised, with the shift toward a system that gives priority to social investment making a real difference in several countries.

Many Europeans regard the establishment of the welfare state as one of the major achievements of the 20^th Century. Yet, in a time of stagnating economies and increasing strain on public finances, difficult questions are now being asked about whether welfare states have become too big, too resistant to change and, as a result, too much of a drag on the economy. A phrase often repeated by Angela Merkel, the German Chancellor, sums up the difficulty: Europe, she claims, has seven percent of the world’s population, twenty-five percent of its GDP yet accounts for as much as fifty percent of the world’s social protection spending.

Her message is that this is unsustainable. Welfare states have to be funded by imposing taxes on workers and companies, so that they make production more expensive in countries with generous welfare states. But this financing burden makes those workers more expensive to hire than their counterparts in emerging markets, while the tax on companies can induce them to relocate to jurisdictions with more favourable tax regimes.

Some critics go further by arguing that the underlying reason for the crises affecting so many European countries is that public debt had been pushed upwards by the inexorable demands of the welfare state. The reasoning is that, because politicians fear a backlash from voters if they try to cut welfare provisions, they are reluctant to impose cuts on welfare budgets, and are also scared of raising taxes. Instead, they prefer to borrow ever increasing amounts, leading to a steady increase in debt levels. When an economy is growing, this does not matter because a strong economy means there is less demand for a number of welfare payments (such as unemployment benefit) and tax revenues are buoyant. Moreover, as long as GDP increases, the economy can ‘carry’ a higher debt level.

However, when there is a downturn, especially one as severe as that which hit several European countries in recent years, governments have to meet existing obligations and face new demands on the welfare system arising directly from the crisis. Certainly, in countries like Greece and Portugal, the increase in social distress is highly visible, but even in countries facing less severe problems – Germany and the UK included – there has been a worsening of social conditions. This leads directly to a budgetary crisis. The dilemma that governments then face is how to achieve significant reform of the welfare state at precisely the time when more people need its help.

Is the welfare state still worth having?

While there is some validity to these criticisms of European welfare states, they are also simply too crude to tell the whole story. Welfare states in Europe fulfil three distinct functions and it is crucial to understand the balance between these functions in assessing their sustainability and effectiveness in dealing with social risks. The first function is to offer an institutionalised means of savings for the population as a whole. Europeans have become accustomed to the idea that they should be net contributors to the welfare system during their working lifetimes, but then draw from the system in old-age through public pensions.

Second, the welfare system redistributes economic resources in various ways. An example would be tax systems which take less (and sometimes even give money back – an issue that has been central to the UK renegotiation with the EU) from poorer people and more from richer people. This redistributive function has been described as ‘Robin Hood’ after the famous historical character who took from the rich and gave to the poor. A related effect is achieved by public services which facilitate the sharing of risk between vulnerable people and secure people, a good example being universal health care. If you are sick, no matter what your income is, you may face risks that you could not afford to cover on your own.

Homeless in London. Credits: Victoria Johnson / Flickr (CC BY 2.0)

These first two functions have in common that the welfare state is only one of several ways of dealing with the same challenges. The risk may fall purely on the individual or, in some countries, the risk sharing and the savings may be internalised within families. This can work effectively if families remain physically close to each other and can spare resources to look after older or infirm family members. But in today’s world in which labour mobility is increasingly important, it is common for families to be much more dispersed. They may still be able to share incomes, but directly offering care is much less practical.

It is the third function which is often least appreciated by critics of European welfare states, namely investing in the capacities of both individual people and society as a whole. Basic education is a long-standing role of the state, but in many European countries, welfare states are now allocating a growing share of their budgets to various forms of social investment that go well beyond educating children. An important motivation behind policies such as enhanced child-care or increased opportunities for retraining or further education for adults is to ensure that the supply of labour is increased.

The social investment function of the welfare state helps to explain the apparent paradox that some of the countries in Europe which spend the most (as a proportion of gross domestic product) on welfare are also frequently placed highest in international league tables of competitiveness, such as those produced by the World Economic Forum. By investing in the workforce, countries like Sweden and Denmark are able to boost the human capital of their populations. As a result, the cost of welfare policies does not undermine competitiveness as much as might be expected, because it is offset by higher productivity and employability of workers. In this sense, the welfare state is a productive factor rather than something which damages the economy.

Nevertheless, the balance matters. Some countries, especially in southern Europe, created generous pension systems and then found that they were becoming unaffordable. As the number of pensioners rose relative to the size of the working age population, it became increasingly difficult to fund the agreed payments. It is a problem that will strike all countries subject to rapid ageing, including China where the long-term consequences of the one-child policy will have a dramatic effect on the balance between young and old.

The solutions to this problem are analytically quite straightforward: raise the pension age, reduce the generosity of payments or find alternative sources of revenue, for example by raising taxes or using the returns from a sovereign wealth fund invested abroad. However, the experience of many European countries has also shown that making change is politically very tricky. Pensioners are more likely to vote in elections and, not surprisingly, they will tend to support political parties that offer them better terms. As the proportion of pensioners in the population grows, so too does their political influence and this is where the reluctance of governments to make unpopular decisions can have damaging effects on public finances. Many European governments have reason to fear the power of the ‘grey’ voter.

On an optimistic note, European welfare states have shown a greater capacity for change than is sometimes realised. The debt problem is real, but across the continent, the shift towards a system that gives priority to social investment is making a real difference. In spite of everything, and Chancellor Merkel’s concerns, they will be around for the foreseeable future.

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Note: This article originally appeared at the People’s Daily. It gives the views of the author, and not the position of EUROPP – European Politics and Policy, nor of the London School of Economics.

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About the author

Iain Begg – LSE, European Institute
Iain Begg is a Professorial Research Fellow at the European Institute, London School of Economics and Political Science, and Senior Fellow on the UK Economic and Social Research Council’s initiative on The UK in a Changing Europe.

One of the key issues in the context of the UK’s EU referendum is the effect a Brexit would have on the country’s economy. Iain Begg assesses the economic claims that have been made so far in the campaign, noting that there have been misleading figures put forward by both sides of the debate.

Two recent assessments of the economics of Brexit, from the Treasury and a new group calling itself Economists for Brexit, come to diametrically opposed conclusions. They add to an array of claims and counter-claims, many of which come up with apparently firm predictions, but have subtle differences that make direct comparisons difficult. Voters are entitled to be confused and to wonder whether anyone can be believed.

The Treasury study can be interpreted as representing the government standpoint. George Osborne, the Chancellor of the Exchequer, quoting from the lengthy analysis by his officials of the likely long-term impact of leaving the EU, tells us that the average household would be worse off by £4,300. The figure is the mid-point of a range of estimates based, in turn, on three different scenarios about how the UK’s trade relationship with the EU would evolve after a Brexit. The underlying projection is that GDP would be 6.2 percent lower and the headline figure is obtained by dividing that GDP loss by the number of households.

The Chancellor is flatly contradicted by the new group who argue that ‘Brexit will result in a better economic outcome than remaining in the EU’. They do not provide the same sort of precise figure as the Chancellor, but one of its members, Patrick Minford, refers in the new document to a previous analysis published in 2015 in which he and his co-authors ‘identified 3.2-3.7 percent of GDP in ongoing costs’ of continuing membership of the EU. They also point to potentially very dramatic longer term negative effects on UK GDP, resulting from what they portray as the looming threat of unfunded pension commitments in many core EU countries.

London – The Gherkin & Canary Wharf. Credits: Harshil Shah / Flickr

To understand how such different answers can be arrived at for ostensibly the same question, it is important to look both at the methodologies employed and the nature of the assertions made. It is routine for economists to use sophisticated models to generate projections of future developments in the economy. Typically, these models rely on a range of assumptions about what would happen in the absence of whatever change is under discussion. This ‘counterfactual’ is then used as the benchmark against which to assess how the change will affect the economy.

In the Treasury exercise, the main focus is on how trade enhances GDP and they use a technique often used by applied economists for this purpose – the ‘gravity’ model – which starts from the empirically well-founded proposition that trade will be more intense between countries geographically close to one another. Key assumptions are that the UK maintains its access to non-EU markets, but has diminished access to the EU, that there is a reduction of foreign direct investment into the UK and that there is a diminution of competitive pressures which results in slower UK productivity growth. These can be considered reasonable assumptions.

The three scenarios examined by the Treasury are:

• what has become known as the Norway/EEA model, despite it having been rejected by the Prime Minister, in which the UK largely retains access to the European single market
• the bilateral trade model in which a trade deal between the UK and remainder of the EU is negotiated, as is the case today for the EU with Turkey and with Canada
• the WTO model in which the UK has the same access to the EU market as other members of the World Trade Organization, one consequence would be tariffs on some UK exports

According to the Treasury projections, UK GDP would be lower than it would otherwise be by 2030 under all of these scenarios, but least under the first model and most in the WTO variant. In each case they present a range, reflecting differing assumptions about the intensity of the effects on key outcomes, such as on productivity. In all cases, because GDP is lower, there is a negative effect on tax revenue which means that the public finances deteriorate by much more than the gain from the UK no longer having to pay towards the EU budget.

The approach of the eight ‘Brexeconomists’ is to assess a range of effects on UK economic prospects, including regulation, the trade regime, immigration, the position of the City of London and the public finances. The part of their analysis which is most directly comparable with the Treasury projections is in a chapter which uses the University of Liverpool ‘rational expectations’ model to assess the effects of Brexit. Such models assume that economic actors adapt quickly to the new environment and, as a consequence, can rapidly exploit new opportunities. Key assumptions are that prices fall, benefiting consumers, there is a windfall gain from lower regulation and there is an immediate gain to the public finances from no longer having to contribute to the EU budget.

Questions also arise about the numbers being quoted and how they are ‘spun’. In the Treasury projections, the headline figure of a loss of £4,300 is criticised for being ‘per household’, when it is not a measure of household income and for implying (though it was never actually said) that people will be worse-off. It is more common to refer to GDP per head of population, but despite what some critics have argued – see, for example, Andrew Neil’s entertaining interrogation of a Minister – there is nothing intrinsically wrong with using households. Clearly, though, the latter results in a higher headline figure for the simple arithmetical reason that the aggregate loss is divided by a smaller number: the equivalent figure for GDP per capita is £1,800.

Because the ‘loss’ projected by the Treasury is relative to what would have happened and GDP would be expected to rise by perhaps 2 percent per year, taking it to 30 percent higher by 2030, the effect of Brexit would be to lower it to 27 percent higher in the best case and just 20 percent higher in the worst case.

Similarly, the 4 percent gain projected by the Economists for Brexit would mean boosting GDP growth to 34 percent by 2030. However, the economists provide only limited evidence to back their claims, some of which rely more on assertion than on hard data. For example, while recognising that there could be threats to London’s pre-eminence in financial services, they quickly dismiss them even though the City itself has repeatedly stressed the risks. The report also states that the deregulation that will follow a Brexit is modelled as ‘a fall in the employer rate of national insurance by 2%’. Even if is accepted that some forms of regulations will change, there is no explanation for why it should be worth this amount.

In summary, both reports are only as good as the assumptions they make and the real question voters should ask themselves is ‘are these assumptions credible’. Those of the Treasury are at least broadly in line with many other assessments; those of the ‘Brexeconomists’ will raise more eyebrows. Even so, the Chancellor’s highlighting of a loss of £4,300 is misleadingly precise.

The opening sentence of the Economists for Brexit paper states that ‘a lot of economic nonsense has been talked so far in the Brexit debate’. Indeed; but the bad news is that much more will follow before June 23.

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Note: A version of this article originally appeared at UK in a Changing Europe. The article gives the views of the author, not the position of EUROPP – European Politics and Policy, nor of the London School of Economics.

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About the author

Iain Begg – LSE, European Institute
Iain Begg is a Professorial Research Fellow at the European Institute, London School of Economics and Political Science, and Senior Fellow on the UK Economic and Social Research Council’s initiative on The UK in a Changing Europe.