Would a British exit from the EU be good or bad for business? What would a Brexit actually mean for SMEs?
Alina Vasile-Floroaie, one of our management consultants, and former Project Manager for the European Committee of the Regions, looks at what a possible Brexit would mean for UK SMEs and helps us to decide how to answer the EU referendum question on 23rd June.
Should the United Kingdom remain a member of the European Union or leave the European Union?
Would a British exit (Brexit) from the EU be good or bad for business? What would a Brexit actually mean for small and medium enterprises?
Small businesses make up more than 99% of all private sector businesses in the UK. While 80% of CBI (Confederation of British Industry) members support a pro-EU vote in the referendum, another survey carried out by Sage showed that more than half of UK business owners (56%) would currently vote to remain in the EU, a fifth (20%) would vote to leave and a quarter (25%) are undecided. This shows that the result of the referendum is far from certain.
The UK’s relationship with the EU deeply affects British businesses. We will take a look at some of the major economic implications of the UK’s EU membership, while trying to go beyond political demagogy. These are arguments business owners cannot ignore, regardless of any personal views on the issue. Even more so as the Financial Reporting Council urged companies to include the potential cost of quitting the EU in their financial statements.
Do the benefits of EU membership outweigh the costs?
Looking at the UK-EU economic relations and analysing the economic impact of EU membership, should provide us with concrete data to understand the possible implications of alternative arrangements or a Brexit. Various studies have attempted to quantify the benefit or cost to the UK of its membership of the EU. However, this is a very difficult exercise and depends on a wide range of assumptions. Estimates vary significantly. Nor can we include any potential scenarios or models of new relations between the UK and the EU. Instead, we will focus on what it means for the UK to be an EU member and what it means for a UK small business to be able to do business within the EU.
What is the European Union?
The European Union is an economic and political partnership between 28 European countries, created to foster economic cooperation mainly through the creation of a Single Market. The UK has been a member since 1973. The Single Market is based on four fundamental freedoms of movement of goods, services, capital and labour.
This primarily means that countries benefit from harmonized rules for trading across not just the EU, but the European Economic Area (including Norway, Iceland and Lichtenstein). This gives businesses the possibility to sell/buy or move goods and services across the EEA without paying any customs duties, whilst a minimum set of harmonized standards (regulatory, quality, environmental, etc.) apply.
The EU has exclusive competences in relation to commercial policy, customs policy, competition law and monetary policy (for the Eurozone only). As such, the EU has a common international trade policy and agreements with many countries around the world. But in areas such as economic cohesion, social policy, consumer protection, environment, energy and the internal market, the competency is shared between the EU and the member states, meaning both the EU and the national governments may decide and make laws.
The Single Market provides opportunities for economies of scale, competition and innovation
- UK businesses can take advantage of the £1500bn and 500m people in the Single Market. In 2014, the UK’s exports to the EU accounted for 45% of its total exports, compared to only 16% to the USA. Goods and services imported from the EU represented 52% of the total. As a bloc, the EU is by far the UK’s largest trading partner. The UK is more dependent on the EU for its trade than the EU is on the UK. Around half of the UK’s total trade is with the EU, while just 11% of EU trade is with the UK.
- The Single Market allows businesses to operate unhindered in all member states. Businesses can for example organise supply chains and finances using any supplier, anywhere in the EU. It has been estimated that UK trade with some countries in Europe could have increased by as much as 50% as a result of EU membership.
- The Single Market provides opportunities for economies of scale, competition and innovation, which enhance business productivity and would be difficult to replicate outside the EU. Exports and productivity are closely linked, and the numbers show that between 1996 and 2004 the productivity growth for UK exporters was 1.3% compared to 0.8% for non-exporters.
- Increased trade with Europe since the early 1980s may be responsible for UK income per head being around 6% higher, since “EU countries trade twice as much with each other as they would do in the absence of the Single Market programme”. And looking ahead, Oxford Economics estimates that UK exports to the EU are expected to increase by more than $140bn, which represents by far the largest source of future growth.
- The elimination of import and export duties is a very important aspect of free movement of goods and services. If the UK decides to leave the EU, new taxes, customs costs and more administration procedures will need to be re-introduced. 90% of British exports, by value, could face tariffs, with some sectors being hit in particular (textiles 10% and transport equipment 7%). All this would add not only red tape, but will cause businesses to lose time with customs clearance and declarations, and money, with increased transport cost. Overall firms’ competitiveness might suffer.
- If the UK is no longer part of the coordinated VAT collection of the EU, and assuming the government maintains the sales tax at its current level, businesses will have to pay VAT on imports without being able to combine it with national payments. Cash flow problems might appear, and more working capital pressure will be put on businesses whose viability might become uncertain. Products imported from the EU could also face tariffs, impacting final consumer prices.
- A great achievement of the Single Market has been the introduction of standard product testing and the harmonisation of raw material tariffs, all of which has been beneficial for businesses. Leaving the EU would mean that the UK would have to introduce national standards, alongside the EU ones. For businesses this would incur important extra costs, while impacting also efficiency and effectiveness.
While the UK would likely be free to strike new trade deals based on domestic priorities it would have less leverage and be a lower priority than the EU for other countries. In the eventuality of a Brexit, the UK would also face the huge challenge of renegotiating the existing EU deals that would no longer apply.
Free movement of capital generated more than 3 million jobs in the UK and increased investment flows to the UK
- The UK is the most attractive location in Europe for global investors. It is the biggest recipient of foreign direct investment (FDI) in the EU, and the fourth in the world. And one essential attribute investors mention for choosing the UK is the access to the European Single Market. Investment flows across borders inside the EU have roughly doubled following the introduction of the Single Market.
- In 2014, EU countries represented 48% of the FDI in the UK, and they accounted for 44% over the period 2005-2014. All these investments generated more than 30,000 jobs, according to a major accounting firm, which is more than any other country. The uncertainty of the UK’s EU membership poses a great risk to FDIs as investors are likely to freeze or considerably reduce their investments.
- If we take a closer look at the value of the UK’s exports, divide this by UK GDP and apply that result to the UK labour force, we can estimate that more than 3.3 million jobs in the UK are directly or indirectly linked with the export of goods and services to the European Union. We can say these jobs depend on EU membership to the same extent that the UK’s trade with separate EU countries depends on EU membership.
- If the UK leaves the EU, the impact would depend on the new relationship between the UK and the EU. However, it is safe to say that trade and investments would be the most impacted sectors.
Free movement of labour helps UK businesses address skills shortages
- The Single Market allows businesses to employee EU nationals without requiring procedures for visas or work permits. An eventual Brexit, would not only imply more HR costs (time and money), but it would also impact on productivity if the labour force decided to leave or it became scarce. Projected growth would be severely impacted, especially for small businesses. And if we consider that the SMEs with the biggest turnover are active in the construction and manufacturing sectors, which employ a large percentage of non-UK born workers, their profitability will suffer.
- According to the Chartered Institute of Building (CIOB), migration provides flexibility, improved productivity and reduces costs. Overall, almost 16% of the workforce is non-UK born, according to the Office For National Statistics. And they are employed mainly in food and apparel manufacturing, food and beverage activities, buildings and landscapes, computer programming and consultancy.
- Free movement of labour helps UK business address skills shortages. Additionally UK firms can access specialist skills that are increasingly important to high value-added industries. More than 60% of migrants from western and southern Europe are university graduates, while 25% of eastern Europeans have university degrees, similar to the proportion of the UK-born workforce. The UK attracts the highest number of university-educated migrants: more than any other EU country, especially in the financial, technology and media industries. According to a study by University College London, almost 40% of EEA migrants have a degree, compared to 20% of UK nationals, whilst they have been consistently younger than the native population (32-34 years compared to 38-40 years).
The UK’s net budgetary contribution is a small net cost relative to the benefits
- A very popular argument supporting an eventual Brexit is that the UK contributes more to the EU than it takes back, which in theory is a valid one if we look at the net contributions. The UK’s gross contribution to the EU Budget is a function of VAT receipts, gross national income, customs duties and levies on sugar production. Uniquely among the Member States, the UK has benefited from a rebate (‘abatement’) on its EU Budget contributions since 1985.
- The UK net contribution to the EU budget amounted to less than 0.4 per cent of British GDP in 2014. And with a £150 per capita basis, the UK contributes less than Germany (£213), Sweden, Denmark, the Netherlands, and Belgium. As a comparison, that’s around a quarter of what the UK spends on the Department for Business, Innovation and Skills, and less than an eighth of the UK’s defence spend.
- However, the direct net economic benefits of membership to the UK are between £62bn and £78bn every year, according to the Confederation of British Industry (CBI).
The impact of EU regulation is overstated, as the UK has one of the most competitive regulatory environments in the developed world
- Campaigners for a UK exit from the EU complain about EU regulatory excess. But achieving the extensive harmonisation of laws and levels of economic integration necessary to achieve the openness of the Single Market would be impossible without this complex and continuous exercise. Some voices estimate that national regulation is 2.5 times more cost effective than EU regulation. Moreover, SMEs have criticised the EU for being too opaque and difficult to influence. But the UK government estimates that although the 100 most expensive regulations cost the UK economy £27.4bn per year, the benefits total £57bn.
- The costs to businesses of complying with EU regulations are not equivalent to their economic impact because they will be offset by benefits, most obviously to employees and consumers. And CBI members view EU regulation as having a positive impact on their businesses, particularly when it comes to common product standards, health and safety standards, and sector specific legislation. The opinions are less positive mainly in relation to employment rights legislation.
- The UK is the second least regulated product market after the Netherlands, according to OECD. And as the fourth least regulated labour market regulation, regulation in the UK is comparable to the US or Canada. Thus, evidence seems to suggest there is no conflict between EU regulations and a highly liberal market economy. Furthermore, one of the most heavily regulated areas in the UK, and one with great consequences for productivity, is the system for obtaining planning permissions, which has no connection with EU legislation. This shows that EU membership has not stopped the UK from having one of the most competitive regulatory environments in the developed world.
- Businesses, and especially small firms, need to bear in mind that even if the UK exits the EU, they will have to follow EU regulations if they want to continue trading in the EU. And some companies might struggle to implement different sets of rules at the same time, European and British. Moreover, if the UK is outside the EU it would not be able to influence any future legislation.
Uncertainty is the biggest price to pay
Lord O’Donnell, the former Cabinet Secretary, has warned that Brexit could be a protracted process, lasting ten years, rather than the two years stated in Article 50. The endpoint for the UK-EU relationship would be subject to a negotiation. Business would face high and increasing levels of uncertainty during this process, impacting on investment decisions and with macroeconomic consequences.
Surveys show that political stability is one of the most important factors in making the UK an attractive investment location. Businesses have been concerned that referendum uncertainty is affecting their decisions. A referendum could reduce UK GDP growth by 0.4% in 2016 and by 0.5-0.7% in 2017 by one estimate. However, a vote to exit would by no means end the uncertainty given the need for further and lengthy negotiations.