When you’re behind, play a big hand: “EU-light”

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Prime Minister Cameron and other party leaders are playing catch-up to the rise of the UK Independence Party (UKIP). Cameron has been forced to play a bold hand: push for EU reform, including tighter immigration and benefits rules, cheaper UK membership and more generally less EU interference in the UK’s day-to-day running. Think of it as “EU-light” – all the benefits of full-fat EU membership without the downsides.

The goal of rolling back the scope of the EU’s mandate and pairing back its running costs is laudable and overdue, in my opinion. The EU, as well as its predecessor the European Economic Community (EEC) and ECSC, originally had a clear goal of securing peace and political harmony in the wake of two bloody world wars and rebuilding Europe’s economic prosperity to compete with the new world powers, the US and USSR. A key tenet of this plan was the promotion of the free movement of goods, capital and labour amongst EU members.

On that front, the EU has been a success. There have been no major conflicts in western or central Europe for 70 years, bar the 1990s Yugoslav wars, EU membership has risen nearly fivefold to 28 members, and capital, goods and labour flows have risen exponentially.

But as is often the case with political creations, the EU has somewhat lost its way. Uneven economic development amongst EU members has seen many struggle to recover from the global financial crisis. Political unity is fragile at best. The EU’s original remit has grown uncontrollably, as vested interests have proliferated and budgets ballooned. This bureaucratically bloated, expensive and often unresponsive union would benefit from some serious house-keeping. But with so many now directly or indirectly relying on the EU as a financial and political crutch, and the number of EU members still more likely to rise than fall in my view, rolling back the EU is proving near-impossible.

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Figure 1: Net immigration from the EU into UK is at record highs. Source: http://www.ons.gov.uk/ons/rel/migration1/migration-statistics-quarterly-report/august-2014/sty-eu-migration.html

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Figure 2: Worker remittances from the UK to host countries hit $23bn in 2012. Source: World Bank Bilateral Remittance Matrix 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

Immigration – the elephant in the room

The issue of immigration is just as economically complex and politically charged. Put simply, Cameron is calling for control over the quantity and quality of immigrants to the UK, as well as the social benefits they are entitled to. Net immigration from the EU into the UK jumped 50% in 2013 to 124,000 and rose to a record high of 142,000 in the 12 months to June 2014 (see Figure 1). The total number of EU nationals in the UK rose 7% in 2013 to 2,507,000. In contrast, other developed countries, such as Australia and New Zealand have controlled immigration flows with a degree of success for many years. In Switzerland, a referendum held in February 2014 on imposing immigration quotas passed, albeit with a slim majority.

But it’s a step into the unknown for an EU member and controlling immigration without distorting the labour market, tightening entitlements and facilitating integration requires a great degree of finesse. And while UKIP has the luxury of talking about populist immigration policies, Cameron has the far tougher job of showing he can actually deliver. He has some support from like-minded EU leaders in the Netherlands, but ultimately needs some heavy-weight allies, and that means Germany or at least France.

France and Italy are unlikely to tow the UK line. The odds of France pushing for EU reform are near nil in my view – after all France can’t even reform its own house. Italy’s reasonably inexperienced prime minister is unlikely to rock the boat, particularly given the country’s economic challenges.

German Chancellor Merkel and Cameron are at loggerheads, despite being proponents of fiscal discipline and Germany’s traditional alliance with France softening under President Hollande. Merkel has not taken kindly to the UK threatening to break up a club sixty years in the making and potentially setting a precedent for other countries to pick apart the EU’s founding principles.

I also think Germany, the EU’s de-facto leader in chief, and other EU heavyweights are concerned about the wider economic impact of curtailed immigration to the UK. To the extent that emigration flows at least partly reflect countries’ differing economic prospects, reduced immigration to the UK could lead to:

  • Upward pressure on already high unemployment rates in source countries mainly in central and southern Europe.
  • A commensurate fall in remittances from UK-based workers to their home country, which the World Bank estimated at $23.6bn in 2012 (of which, for example, $1.2bn flowed to Poland). See Figure 2.
  • Fiscal and social pressures in these countries and potential immigration into other wealthy EU countries with generous social benefits.

In theory, improving these source countries’ economic and job prospects could slow or even reverse immigration flows to richer EU countries (e.g. the UK). But in practise large financial transfers to poorer EU countries have not always been a long-term panacea. More on that in following commentaries.

 

Olivier Desbarres is a former G10 and emerging markets economist, rates & currency strategist with 15 years experience. He has written extensively on EU membership and is now an independent commentator.

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