Farmers’ market: The Common Agricultural Policy colours Brussels’ thinking on all aspects of trade

    Farmers’ market:
    The Common Agricultural
    Policy colours Brussels’ thinking on all aspects
    of trade

    Sober logic says ‘out’

    5 March 2016

    I like to think I’m a rational economist. Of course, like all of us, I make many choices based on intuition — but always coloured by my view that properly functioning markets are the route to prosperity. Whether the UK should remain in the European Union is a decision for all of us in which the head must surely prevail over the heart. So here’s my sober analysis of the economic factors that will guide me to vote ‘out’.

    History suggests that political arrangements make little difference to economic performance. Economic welfare is determined by the stock of physical and human capital and its evolution and use, shaped by the extent to which legal and political institutions support rather than hinder market economies. The size and composition of the political unit is not the crucial factor. Having said that, relative economic performance depends on policies that improve performance, combined with sensible fiscal regimes and monetary institutions. A cool assessment of the impact of Brexit would test the extent to which the EU acts as either a constraint or a stimulus to healthy markets. This test turns on the character of its decision-making in the past and the guidance that offers for the future.

    The Common Agricultural Policy (CAP), dating from the 1957 Treaty of Rome, was the then European Economic Community’s first major policy initiative and has coloured Brussels’ thinking ever since. At the CAP’s heart have been high protective tariffs that raised prices for consumers, and complex inter-ventions to support farmers. The EU’s overall approach to international trade, regulation and labour markets follows the same thread.

    Economies benefit from being open to trade, and from exposing domestic markets to competition. The single market has been a disappointment in these respects: it has allowed producers with market power to diminish competition from imports. Large EU firms lobby constantly to protect themselves, at cost to the consumer. The key test is not the mercantilist capacity to export to the US, China or continental Europe, but our willingness to expose domestic markets to trade from such economies. Brexit offers us the opportunity of pursuing a more liberal approach to our inter-national trade.

    Despite attempts to reform the CAP, it still absorbs about 40 per cent of the EU budget. It is a bureaucratic regime whose objectives could be achieved at lower cost. Only 75 per cent of spending directly reaches the farmer, and four-fifths of that goes to the top 10 per cent of farms by income. CAP tariffs continue to raise UK food prices above world prices while its export subsidies hinder progress in world trade reform — and hurt the world’s poorest countries.

    Modern economies need regulation, but they must be able to adjust to changing circumstances. The EU finds it difficult to agree policy directives and even more difficult to rectify regulatory mistakes. These cumbersome processes frame rules for around 60 per cent of EU economic activity, making the process of adaptation slow and expensive. Sclerosis is aggravated by powerful political lobbies. Besides the farm lobby, there is a green agenda that often coincides with Catholic social teaching — at best ambivalent about markets. This leads to clumsy regulation of sectors such as biotechnology and constraints on innovation — in genetically modified crops, for example.

    In practice, the UK government cannot reliably construct a ‘blocking’ minority of votes in the Council of Ministers to protect UK interests. The European Parliament has a pan-European majority disposed to social and green regulation and EU-wide rule-making. The parliament also exerts pressure on the Commission to remove member states’ opt-outs.

    In addition, the European Court of Justice has consistently decided cases that have extended the scope of EU regulation. The ECJ has developed a jurisprudence on indirect discrimination that interacts awkwardly with national legislation on gender discrimination. This was at the heart of the single-status pay review that has been hugely expensive for UK local authorities. The Transfer of Undertakings directive increases the cost of rationalising employment in the public and private sectors. The Working Time directive was not about any conventional understanding of safety in the workplace, but about regulation of employment practices: expensive for many employers, it has caused particular problems for the UK’s largest employer, the NHS.

    The Artists’ Resale Right that gives artists a right to share in the resale value of their work — which Christopher Silvester writes about on page 32 — offers an instructive example of the way EU can impose a policy that has major effects on UK interests. The proposed financial transactions tax is a serious threat to another sector in which the UK has a dominant position.

    The UK’s net contribution to the EU budget is £10 billion; our gross EU-related expenditure is £16 billion. Much of that might still be spent if we were outside the EU, but the programmes involved could be made more cost-effective and better focused; £10 billion may appear modest in the context of total public spending of £750 billion — but would more than cover the cost of free long-term social care for the elderly, or of 2p cut in basic-rate income tax.

    Financial markets associate the EU with low inflation and relative stability. Foreign exchange markets already have a downer on sterling over Brexit, and it’s likely that an ‘out’ vote would result in a fall in sterling. Brexit would particularly focus market attention on the slow progress in reducing the UK’s budget deficit.

    In the absence of a policy response from the Bank of England, a lower exchange rate would eventually lead to higher domestic prices. The questions are whether the Bank would passively accommodate a lower exchange rate or whether it would try to offset a weaker pound with higher interest rates. In the early 1990s, after sterling left the ERM, the pass-through into higher inflation was weaker than expected. When sterling fell sharply in 2008, UK authorities made no attempt to offset its consequences but the beneficial impact of a lower exchange rate on exports was disappointing, while the impact on prices was much more direct, reflecting rising oil, food and commodity prices at the peak of the Chinese investment boom.

    The Bank of England has an inflation target set by the Chancellor — which would normally require tighter domestic monetary conditions to offset a lower exchange rate. But commodity prices are weak and the effects of a lower exchange rate may be easier to contain than in 2008. A lower exchange rate should help correct the current account deficit.

    Indeed, a weaker exchange rate combined with tighter monetary conditions could offer an effective policy mix. Higher interest rates would contain domestic demand and help restrain a potential bubble in the housing market (apart from London); it would make the UK more internationally competitive.

    It’s probable that a lower exchange rate would also be matched by a weaker gilt market. Rating agencies have warned that Brexit would have implications for the UK’s AAA credit rating. Lower government bond prices — which mean higher yields — will reduce the costs of funding company pensions. It will also increase incomes from annuities. UK owners of shares in FTSE 100 companies would benefit too: these companies tend to have extensive overseas (mainly US) earnings that would rise in value as sterling fell. But a weaker pound will also make foreign purchases more costly for UK residents, including ownership of foreign homes and foreign travel.

    In conclusion, let’s remember how much the UK benefits from an independent monetary policy, a flexible exchange rate and a central bank that takes decisions specifically suited to our own circumstances. How could we not also benefit from being able to make national decisions about trade and regulation? For me, that’s the nub of a persuasive liberal economic analysis which informs the rational case for Brexit.