But the evidence from the first decade or so of the UK’s membership of the then Common Market strongly indicates that these dynamic gains failed to materialise and that UK economic performance deteriorated. Despite this, and despite the EU’s undeniably weak recent economic record, the UK political class remains deluded about the potential growth benefits of aligning with the EU.
The history of Britain’s engagement with the EU has been one of surrendering control and paying through the nose in search of illusory economic gains. This is painfully obvious in the case of the recent ‘reset’ agreed by the UK government, as we have pointed out here and here. But this pattern goes all the way back to the original decision to join the then Common Market in the early 1970s.
The case for joining was based on a number of key arguments:
- The UK’s economic performance in the 1950s and 1960s had been much weaker than that of the European ‘six’ and joining them would help close the growth gap
- The UK was over-reliant on slow-growing distant Commonwealth markets and needed to re-focus on dynamic closer European ones
- Joining the six would create a huge and dynamic ‘home market’ for UK products, which would allow UK exports to grow faster, improve the balance of payments, and let UK industry reap ‘dynamic’ gains in terms of increased returns to scale, greater specialisation and faster productivity growth
It was recognised at the time that there would be significant costs associated with entry – joining the Common Agricultural Policy would mean a significant rise in food prices, entering the customs union of the Common Market would mean abandoning preferential trade arrangements with Commonwealth countries and there would need to be substantial net fiscal transfers to the Common Market. But it was argued that the dynamic gains of joining would outweigh these.
Did this prove correct? In our view, the empirical evidence – especially for the first decade or so after the UK joined – suggests it did not. Indeed, there is a good case to be made that joining the Common Market exacerbated rather than alleviated the UK’s economic problems.
A careful look at the costs of membership shows that the dynamic gains promised from joining the Common Market would have needed to be large to offset the static costs of joining.
- Food prices: the UK had for decades pursued a cheap food policy based on importing goods from low-cost world markets and supporting domestic agriculture mostly with direct payments rather than inflated prices. As a result, there was a large gap between retail food prices in the UK and the Common Market. Indeed, the government’s own White Paper in 1970 estimated that joining could raise food prices by 25%. This would amount to a substantial real income shock, with the cost of living index rising by 4-5%. Switching to relatively expensive European food imports would also imply a significant additional drain on the UK’s then-fragile balance of payments.
- Loss of trade preferences: The UK stood to gain by the removal of tariff barriers on exports to the Common Market which accounted for around a fifth of UK exports in 1970. But the UK would forfeit trade preferences elsewhere – in the markets of the European economies in EFTA (around 15% of UK exports at the time) and in Commonwealth countries (around 30% of UK exports). The importance of the latter is often forgotten. Although the extent of Commonwealth trade preferences had narrowed since the 1950s they remained significant – the UK imported around 90% of its imports from the Commonwealth duty free and perhaps 60% of UK exports to the Commonwealth benefitted either from duty-free entry, entry at a preferential tariff rate, or both. Contemporary estimates suggested that the loss from these preferences would be £200-300 million per year or 0.4-0.5% of UK GDP. Even the CBI, which supported entry, acknowledged that the loss of these preferences alone would cancel out the gains from freer trade with the Common Market six.
- Balance of payments costs: the UK experienced significant balance of payments problems in the 1960s, leading to a substantial devaluation of sterling in 1967. In a static sense at least, Common Market entry would add to these pressures. The government’s 1970 White Paper suggested increased costs of food imports of £100-250 million plus a worsening of the non-food trade balance of £125-275 million, implying a balance of payments drain of 0.4-1% of GDP. A drain on this scale risked provoking further significant exchange rate depreciation.
- Fiscal transfers to the Common Market: there was considerable uncertainty about the scale of the UK’s net contributions to the Common Market just prior to entry, but by the end of the 1970s it had become substantial at around £1 billion or 0.2% of GDP, representing not just a fiscal transfer but an additional balance of payments drain.
A variety of contemporary estimates collected by Miller in 1971 suggested an average static cost of Common Market membership of around 1.5% of GDP, with higher-end estimates over 2% of GDP (see Chart 1). These are large figures and imply that dynamic gains would have needed to be very large to make joining worthwhile. Crudely put, the UK economy would need to have grown by around 0.2 percentage points per year faster than it otherwise would have done for a decade to offset these static costs.
Chart 1 – Contemporary estimates suggested heavy costs for entering the EU
Sources: Miller (1971), Hansard
Is there any evidence that this actually happened? For the first decade or so of membership, it is very difficult to see any evidence of substantial dynamic gains:
- The rate of productivity growth and GDP growth in the UK did not improve. ONS data show that output per hour grew by 2.3% per year from 1973-1982, compared with 4.5% per year in 1963-1972. Some estimates suggest that total factor productivity growth (i.e. including the productivity of capital as well as labour) in manufacturing was actually negative in this period. As a result, the UK’s GDP performance was poor in the decade from 1973-1982, with growth of just 1.5% per year versus 3.5% per year in 1963-1972. Total investment shrank by 0.1% per year from 1973-1982 (see Chart 2).
Chart 2 – UK economic performance deteriorated in the decade after 1973
Source: ONS, Federal Reserve Bank of St. Louis
- UK GDP per head declined further compared to GDP per head in the Common Market. This ratio fell from 94% in 1972 to 89% by 1982. It is true that the rate of decline in this measure slowed in the decade after the UK joined the Common Market but this was not because UK productivity performance improved, but rather because productivity growth in the Common Market slowed sharply, from just under 4% to 2%. The UK joined at precisely the moment that the rapid postwar productivity growth of the Common Market countries came to an end.
- The UK’s share of world trade continued to shrink, dropping from around 8% in 1972 to around 5% in 1984. There was then a statistically significant improvement in the later 1980s but this can plausibly be traced to important structural reforms in the UK, not Common Market membership (see Landesmann and Snell). Reorienting UK trade toward the European six proved remarkably ill-timed as the much-derided Commonwealth markets proceeded to grow at around 2 percentage points a year faster than the Common Market six from 1973 onwards.
- The balance of payments did not improve. Far from enjoying an improved trade balance as pro-Marketeers argued, the UK saw its trade balance worsen substantially after joining the Common Market. In 1969-1972 the trade balance averaged -0.4% of GDP i.e. was in broad balance but in 1973-1979 averaged -2.7% of GDP (see Chart 3). This hefty deficit put pressure on the currency, with the pound depreciating by over 15% between 1973 and 1978. Only the advent of North Sea Oil at the end of the 1970s allowed the balance of payments and sterling to recover.
Chart 3 – the UK’s external competitiveness worsened after 1973
Sources: UNCTAD, World Bank, ONS
So, what went wrong? Apparently the benefits of a huge ‘home market’ and increased specialisation and returns to scale did not feed through to British industry as hoped.
Perhaps these benefits were never going to be very substantial. Certainly, there was a good deal of scepticism about them in the years just before the UK joined the Common Market. Careful analyses showed that the evidence that the formation of the Common Market had given a big boost to the competitiveness and growth rates of the six members was weak. Much of the dynamism of the six in the postwar period was due to big transfers of labour from agriculture to manufacturing, a process that had already been largely completed in the UK decades before. The UK could not hope to tap into this source of gains.
One pair of observers argued persuasively that believing that dynamic effects of Common Market membership would offset the heavy static costs of joining would represent a ‘triumph of hope over experience’. Many economists agreed. A poll of British economists in 1971 was evenly split between those favouring membership and those against.
Fast forward to today and we see the same sort of wishful thinking at work, with the British political class still mesmerised by the idea that ‘aligning’ with the EU will deliver a boost to UK growth and somehow avoid them taking the more difficult policy decisions that might actually raise long-term UK growth rates. Sadly, the economics profession is overwhelmingly of the same mind, a very different situation to the diversity of views (and genuine interest in the empirical data) evident in the early 1970s.
This obsession with EU alignment exists despite the fact that the EU itself – in sharp contrast to the situation 50 years ago – has an undeniable recent record of weak economic performance both in absolute terms and relative to the other major regions of the world. If pro-Marketeers were hopelessly optimistic in 1973 about the gains from joining the ‘six’, their counterparts today are verging on the delusional.
