En l ig h t en i ng t h e
E urop e a n Deb at e
T r a de a n d t h e 2 0 1 6 E u rop e a n R e f e r e n d um
Ronald MacDonald
Adam Smith Business School, University of Glasgow
Introduction
In this short paper we consider some of the issues
relating to UK trade in the context of the upcoming
European Referendum. In the first section we outline
what trade theory has to say about why countries
trade with each other. This section is designed to give
readers a toolkit that they can use to think through how
staying in or leaving the EU may affect the UK. In the
international trade literature openness to trade,
relative to a closed or autarkic economy, is seen as a
‘good’ because of the so-called ‘gains from trade’.
As we shall see, different trade models express the
gains from trade in different ways. In the initial
Ricardian model of comparative advantage, productivity
differences that exist within countries pre-trade make
countries better off with trade. In the more recent
so-called New Trade theories openness to trade itself
creates improved productivity in the trading countries,
thereby increasing economic growth – the more a country trades the greater these benefits will be.
The aspect of EU membership that is seen as of most
relevance to our topic is of course the Single Market.
The provision of a single market with a population of
approximately 500 million consumers provides the
opportunity for any participating country to increase
its degree of openness to trade, thereby maximising
the gains to trade. The creation of the Single Market,
in turn, relies on the elimination of tariffs and quotas
within the EU, the elimination of non-tariff barriers by
the harmonisation of regulations, prohibiting artificial
state aid and recognising other countries standards.
The other key element is the creation of a customs
union and with that the elimination of the border costs
of trade (i.e. the elimination of having to clear customs,
and the associated bureaucracy, custom duties and
custom delays). The bottom line in terms of trade and
the EU Referendum is: is the Single Market superior
in terms of the gains from trade relative to some
alternative? Hopefully this paper will provide enough
information for readers to make an informed choice
on this question.
In section 3 we go on to note some numbers concerning
the UK’s trade in goods and services with Europe and the
rest of the world. Following that, in Section 4, we try to
match some of the empirical data to the theoretical
models. Alternative models to the current UK
membership of the EU are considered in Section 5 in the
form of the Norwegian and Swiss relations with the EU.
1 Trade models and their predictions
In thinking about trade relations within Europe, and
indeed beyond, it is helpful to start with a little trade
theory: what do the key (economic) models of trade
say about the underlying reasons as to why countries
trade with each other rather than remaining in splendid
isolation, in a state of autarky? Rather than elaborating
these models in great detail we aim to capture the
‘textbook’ gist of the models with the hope that they will
prove useful tools in thinking about trade in the context
of Brexit.
The bedrock of trade theory is based on the insights
of David Ricardo, contained in his work of 1817 on the
distinction between comparative and absolute trade
advantage. Ricardian trade theory is also referred to
as Classical trade theory. Most trade examples focus
on two countries – home and foreign – and we use
such a two country setting here. Prior to Ricardo it was
thought that the two countries would trade with each
other, rather than remain in autarky, in terms of
goods with which they had an absolute advantage in
production. Adam Smith, for example, in his Wealth
of Nations set the scene for Ricardo’s work by focusing
on the importance of absolute advantage for
international trade:
"If a foreign country can supply us with a commodity
cheaper than we ourselves can make it, better buy it of
them with some part of the produce of our own industry
employed in a way in which we have some advantage.
The general industry of the country, being always in
proportion to the capital which employs it, will not thereby
be diminished ... but only left to find out the way in which it
can be employed with the greatest advantage."
[Smith, 1776]
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En l ig h t en i ng t h e E ur op e a n Deb at e
So in Smith’s view each country by focusing on the
production of the goods in which it has an absolute
advantage, in terms of the efficiency of production/low
cost, can be better off by engaging in international trade
rather than remaining in an autarkic situation. These
are the so-called ‘gains from trade’ – if countries trade
with each other with goods in which they have an
absolute advantage in the cost of production there
will be clear gains from trade in that both countries
will have a bigger bundle of goods to consume than
in autarky.
But what if a country has an absolute advantage in the
production of all goods produced? The great insight of
Ricardo is that even in this case there are still gains
from trade if a country specialises in goods in which it
has a comparative advantage. To illustrate Ricardo’s
thinking we take the classic ‘textbook’ model of two
countries – the UK and Portugal – each producing two
goods – cloth and port (see for example Krugman and
Obstfeld (1988)).
Table 1 Absolute versus comparative advantage.
Units of labour input to produce one unit of the good
Country
Cloth
Port
England
100
120
Portugal
90
80
As can be seen from Table 1, Portugal has an absolute
advantage in producing both goods and conversely
England has an absolute disadvantage in producing both
goods. However, notice that England has a comparative
advantage – is more efficient – in producing cloth and
Portugal a comparative advantage in producing port;
that is, it takes 100 hours of labour to produce one unit of
cloth, or produce 0.83 units of wine. In contrast, Portugal
needs 90 hours of labour to produce one unit of cloth, or
the same amount of labour input could produce 1.125
units of wine. So England is more efficient at producing
cloth and Portugal is more efficient at producing Port.
It therefore follows that if each country specialises in the
production of the good it has a comparative advantage in
the overall production of both goods increases and both
countries can be made better off by engaging in trade
with each other than remaining in a no trade or autarkic
situation. 1, 2
1
2
3
2
So the Ricardian model gives a clear prediction that
trading patterns will be determined by productivity,
or technological, differentials across countries and that
the goods traded are dissimilar. However, as we shall
see below, most trade today takes place in similar
goods. Nonetheless, productivity differences can still
play a key role in determining trade although for
perhaps different reasons to the original Ricardian
model. Despite this, the concept of comparative
advantage is still a useful one to have in assessing
trade and EU Referendum issues. Does the Single
Market provide a better platform for participating
countries to exploit their respective comparative
advantages than the alternatives? The trade theory
of both Smith and Ricardo is referred to as ‘Classical
trade theory’ in that the value and distribution of
products is determined by the costs of production.
The next major advance in trade theory came in the
form of the Heckscher-Ohlin-Samuelson model (HOS) 3,
which has as its heart, relative factor endowments
(i.e. the labour and capital inputs into the production
process) as the engine of trade. This model is referred
to in general terms as the Neoclassical trade model, as
it relies on standard neoclassical assumptions (that is,
demand, or preferences, in addition to the costs of
production side determine price or value). In its’ basic
form this is again a two country model in which country
preferences, and all other aspects apart from factor
endowments, are identical.
So assuming one country has a relative abundance
of capital whilst the other country has a relative
abundance of labour then the basic prediction of the
HOS model is that a country will export goods that use
its abundant factors intensively, and import goods that
use its scarce factors intensively. In the two-factor case,
it states: “A capital-abundant country will export the
capital-intensive good, while the labour-abundant
country will export the labour-intensive good." So in
contrast to the Ricardian model, comparative advantage
is here based on relative factors of production rather
than technological differences.
As long as the so called terms of trade – the rate at which England trades its cloth for Port with Portugal – falls in the range of 0.83 to 1.125 then both countries
will be better off in specialising in cloth and port respectively.
The basic Ricardian model has been criticised for only containing two goods and only considering labour as an input into the production process.
However, Dornbusch et al (1977) have shown that the Ricardian prediction still goes through in a model containing many goods. The introduction of capital
does not pose a problem if it appears as analogous to land as an input but it does pose a problem if it appears as a produced means of production
(see Steedman (1979).
This approach was initially proposed by Eli Hecksher and Bertil Ohlin and subsequently extended, particularly by Paul Samuelson
En l ig h t en i ng t h e E ur op e a n Deb at e
As Leontief (1951) initially noted, the HOS model was
not supported empirically when tested using US data.
In the early 1950’s the US, at that time regarded as
the most capital abundant country in the world, actually
exported labour intensive products and imported
capital-intensive products. The so-called Leontief
paradox may be addressed if it is recognised that there
are two categories of labour – skilled and unskilled.
With this distinction the US has a propensity to export
skilled labour intensive goods, and import unskilled
labour intensive goods. Despite this fix it is unclear how
useful the HOS model is in the EU context today given
that for the majority of members endowments are
likely to be broadly comparable. So relative factor
endowments are unlikely to be the key reason for
a decision to stay or exit the EU although the model
may be helpful in thinking about EU trade with the
rest of the world 4.
Both the Ricardian and HOS approaches focus on the
supply side of the production process. Although HOS
explicitly recognises preferences they are assumed
homogeneous, or identical, across individuals in
different countries and therefore the demand for
goods is identical across countries. However, as trade
has developed since the contributions of Ricardo and
HOS, we observe goods entering trade that appear to
be close substitutes for one another, although not
identical, yet are traded between countries. The
automotive industry is perhaps a good example of this
with a number of countries being car producers and
trading cars with each other – within the EU Germany,
the UK, France and Italy are all significant car producers
and all trade with each other (similarly there are many
advanced industrial countries outside the EU which
trade in cars with the European countries).
In order to explain such trade, Linder (1961) suggested
abandoning ‘production side’ comparative advantage
as a determinant of trade and focussing on the demand
side of the trade process. By focussing on the demand
side, Linder predicted that countries with similar
demand are more likely to trade with each other.
Specifically, Linder hypothesised that nations with
similar demands would develop similar industries
(i.e. the automotive industries mentioned above) and
these nations would then trade with each other in
similar, but differentiated goods. So for Linder, demand
plays a more crucial role than comparative advantage in
determining trade and in that way the Linder hypothesis
can explain the Leontief paradox.
4
5
The demand side of the trade equation and
differentiated goods are also important in New Trade
Theory (NTT), a group of work, most notably associated
with Paul Krugman and Elhanan Helpman (1985).
In the NTT model individuals have a desire to consume
a whole range of differentiated goods (goods which are
effectively similar and close substitutes for each other)
produced by monopolistically competitive companies.
The latter are able to reap increasing returns to scale in
contrast to the assumed production pattern of constant
returns to scale in the Ricardian and HOS models 5.
Increasing returns to scale come about when similar
businesses tend to congregate geographically or
agglomerate, a concept initially noted by Adam Smith
and discussed extensively in Krugman. That is, the
opening of similar companies in a particular location
attracts workers with skills in that business, which, in
turn, draws in more businesses seeking experienced
employees (we shall note the relevance of this for the
EU trade below). There may or may not have been a
reason to prefer one particular location to another
prior to the industry developing as an agglomeration.
But once the agglomeration develops firms that are
not part of it, and have located elsewhere, find that they
are at a disadvantage, because of network effects
(i.e. externalities from other firms) and they will tend
to move into the hub, further increasing its relative
efficiency. The agglomeration, in turn, is decided by
the size of the market.
A key feature of NTT is its focus on intra industry trade
in goods, services and capital which has increased
dramatically in recent years and which other trade
theories do not address (for example, over 70% of
international trade is today classed as intra industry).
The agglomerations or clusters of activity predicted in
NTT help to explain this phenomenon in that they
crucially rely on cross border supply chains for their
existence. The existence of clusters is also important on
the input side of the production process. For example,
the free trade of labour within Europe is crucial for the
success of the London-based financial sector with
approximately 10% of the 360,000 employed in the
financial sector coming from elsewhere in the EU.
The cluster idea may be illustrated by thinking of
agglomeration in Europe in terms of a Venn diagram
with overlapping circles centred on London and the
South East of England but spreading out beyond, a large
circle centred on Paris area and a further one centred
on the Ruhr in Germany. The overlap of the circles
indicates the dependence of one cluster on its neighbour
(s) in terms of the intra industry supply chains.
It is worth noting that most of the hard-nosed statistical tests of HOS are not supportive of the model; see, for example, Bowen et al (1987).
Returns to scale refers to how the output of a firm changes as the inputs – capital and labour - to the production process are increased. Constant returns to scale
– whereby output doubles as the inputs are doubled – is the assumption in both the Classical and Neo Classical trade models. Increasing returns to scale implies
output increases more than proportionally to increases in the two inputs.
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En l ig h t en i ng t h e E ur op e a n Deb at e
In this context the Brexit question is whether the UK
circle or agglomeration on its own would be sustainable
if barriers were placed on the intra industry trade
(in, for example, pharmaceuticals, the automotive and
aerospace industries). The relevance of this issue for
the Brexit debate is whether the former description
would still be viable if the UK were to leave the EU.
Or is membership of the EU necessary for the
continuation of the UK agglomeration in terms of the
second description? NTT suggests that the absence of
all forms of trade barriers within Europe are good and
trade enhancing, and the existence of barriers around
the EU are also good as the provide firms with a
sufficient sized market to reap economies of scale etc.
the two economies (i and j), and a decreasing function of
their cost of transport measured by their distance:
Melitz (2003) and Antràs and Helpmann (2004)
push NTT theory further to create ‘New’ New Trade
(NNTT) Theory. This approach emphasises firm level
differences in the same industry of the same country
and in understanding the challenges and the
opportunities countries face in the age of globalisation.
The key point in this model is that as trade barriers are
lowered competition is stimulated and low productivity
firms that had been protected with barriers, within the
very same industry go out of business and are replaced
by increased volume production of high-productivity
firms.
In testing the gravity model researchers also include
other terms which may create impediments, or
frictions, to trade such as whether the two countries
share a common language and crucially in the current
context whether they share a common border, which
introduces the border costs mentioned above. We
consider some of the empirical evidence on the gravity
model below.
2 The UK’s Trade with Europe and
the Rest of the World
In NNTT the resulting intra-industry reallocations of
market shares and productive resources are much
more pronounced than inter-industry reallocations
driven by comparative advantage. As a result of these
reallocations the average productivity of the country as
a whole increases, the gains from trade in the New NTT
model. So NNTT clearly supports the existence of a
single market in Europe – the productivity gains to a
country will be maximised in such an arrangement.
But in taking the NTTT to its logical conclusion it would
seem that all barriers to trade are bad, including
those external barriers protecting the Single Market.
However, such unified world market is unlikely to be
a realistic alternative to EU membership.
In this section we outline some trade numbers for the
UK. As a so-called small open economy, trade is central
to the UK economy with its trade share of GDP at around
60% compared to relatively closed economies such as
the US with openness ratios of 20%. Trade therefore
matters for the economic wellbeing of the UK economy.
The UK has a 51% trade share with Europe although this
proportion has been declining over time. Specifically, in
2014 total UK trade was around £750bn and the UK ran
a trade deficit with Europe of approximately £116bn.
Noteworthy in the context of Brexit, the UK imports
predominantly from the EU (53%) and exports mainly to
non-EU countries although 48% of UK exports are to
the EU.
An empirical model of international trade that can be
motivated by a variety of the trade models discussed
above is the so-called gravity model, which has become
the empirical workhorse in International trade (see, for
example, Bayoumi, Fazio, Kumar and MacDonald
(2003)) and the survey by Head and Mayer (2013)). This
model derives its name from Newtonian Physics, where
the attraction force between two objects is proportional
to their mass and inversely proportional to the distance
between them. Similarly, trade between two countries
can be modelled as an increasing function of the size of
The UK is the world’s leading exporter of services and
these make up over half of the UK’s total exports.
Britain runs a trade surplus in nearly every category of
services 6, except for tourism, and runs trade surpluses
in services with the US (the UK’s largest customer for
services), France, Germany, China and Australia. Cars
and pharmaceuticals are the UK’s largest manufacturing
export services but the UK’s overseas sales of business
services are almost 50% larger than either.
6
4
where F is the trade flow, M is the economic mass
of each country i and j , D is the distance and G is a
constant. In the gravity model distance is a function of
transportation costs and in particular transportation
costs are increasing in distance. So other things equal,
the further apart two trading nations or blocs are the
greater the transportation costs and the less they are
expected to trade. Trade is also seen to be directly
proportional to the mass of the two countries.
Services are defined by the following groupings: transport and communications; education, entertainment, publishing and information services; public relations
and management consulting; retailing and engineering services; law and accountancy.
En l ig h t en i ng t h e E ur op e a n Deb at e
Financial insurance services are often mentioned in
connection with EU membership and it is worth noting
some of the salient facts relating to this sector. In 2014,
financial and insurance services contributed £126.9
billion in gross value added (GVA) to the UK economy,
8.0% of the UK’s total GVA. London accounted for 50.5%
of the total financial and insurance sector’s GVA in the
UK and the sector employs around one million people
of which around two thirds are based around London.
Trade in financial services makes up a substantial
proportion of the UK’s trade surplus in services.
For example, in 2013/14, the banking sector alone
contributed £21.4 billion to UK tax receipts in
corporation tax, income tax, national insurance and
through the bank levy. As we noted above in terms
of the NTT model the finance cluster in the UK relies
heavily on the free movement of skilled labour within
the EU.
forward and so it would be expected that further
significant gains from trade would be made on the
services side if the UK remains in the EU.
Figure 1 summarises the UK’s top-10 partners in terms
of the percentage of overall trade. Eight out of the ten
partners are euro area countries with China and the
United States being the two non-euro members.
Germany easily tops the UK’s trade relationship with
over 12% of our trade in that direction, with the US
second and the Netherlands third.
The UK’s trade surplus in financial and insurance
activities has been growing as a proportion of GDP over
the last two decades, and although it dropped in 2008 it
has since recovered. In 2013, the surplus on insurance
and pensions was £20.9 billion and that on financial
services was £38.3 billion. These two sectors therefore
account for a large proportion of the services trade
balance of £78.9 billion.
The US is the insurance sector’s largest export market
and that sector’s trade is dominated by non-EU markets
(in 2013 the EU’s share of total exports in this sector
was 18%). Trade with the EU in financial services is
proportionately more significant, although it does not
represent the majority of trade (The EU’s share of total
trade in the sector is 42% in 2013). Taking exports
of insurance and financial services together, the EU’s
share was about one third of the total in 2013 in terms
of both gross and net earnings. The EU share of exports
of insurance and financial services has been on a gentle
downward trend in recent years: 35.5% in 2007 and
down to 34% in 2013. Taken alone, the EU’s share of
financial services has been static, and at times slightly
weaker, over the past decade.
Although the financial services sector has greatly
benefited from the single market it is fair to say that
overall the single market has been more successful in
reducing barriers on the goods side than in the service
sector (for example, professional services). However, it
is important to note that this is equally true in terms of
the trade in services outside the UK where it is widely
recognised that there tends to be a ‘home bias’ in terms
of expenditure on services due to trade restrictions on
services. However, recent moves within the UK, such as
the Services Directive (2006) and the EC Single market
strategy (2015), mean that this is likely to change going
Trade with the Netherlands is worthy of further
discussion since it highlights an important point that
the country where imports come from or exports are
destined to may not in fact be the country in which they
have been produced or are used. In fact much of the
UK’s trade with the Netherlands is a reflection of the
so-called ‘Rotterdam effect’: Rotterdam is Europe’s
largest port and many goods pass through there,
although they do not originate in the Netherlands.
Given that the UK currently runs a current account
deficit, as a percent of GDP of around 7%, it is perhaps
not surprising that the UK was a net importer in 2014
from 7 of its 10 main trading partners. As figure 2
shows, by far the largest bilateral imbalance was that
with Germany with a deficit of 36.3bn followed by a 26.2
bn trade deficit with China and a 12.3bn deficit with the
Netherlands. Proponents of Brexit often point to the
large trade deficit with Germany as indicating that it
would be in the EU’s interest to cut a good trade deal
with the UK in the Brexit case. However, the kind of
goods that the UK imports from Germany are probably
not that price sensitive and therefore there may be little
incentive for the EU in a post Brexit situation not to
impose tariffs on its goods which could further worsen
the UK’s external balance position.
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En l ig h t en i ng t h e E ur op e a n Deb at e
widespread digitalisation it may be thought that the key
prediction of the gravity model – that distance matters –
is redundant. So what does the evidence indicate? There
are a plethora of papers using sophisticated statistical
and econometric methods that support the basic
premise of the gravity model – distance does matter in
international trade, the mass of the countries or country
blocs you are trading with also matters as do the
additional frictions that add to the costs of trade.
3 Matching Trade Theory
with Trade Outcomes
Altzinger and Damijan (2009) provide a range of tests
of the Ricardian trade model in the context of EU trade.
Specifically, they use bilateral trade flows between 21
EU-member states for the period 1994-2004 (at the
NACE 2-digit industry aggregation). They use two
measures of productivity – unit labour cost and labour
productivity – to determine if they can effectively explain
the pattern of intra EU bilateral trade. Altzinger and
Damijan find that bilateral trade patterns are well
explained by the relative sectoral productivities.
Specifically, they find that relative unit labour costs
have good explanatory power for EU trade (statistically
significant and positive in 67% of country pairs). Their
alternative measure of productivity – labour productivity
– is a bit poorer at explaining bilateral trade patterns
but nonetheless still has a statistically significant effect.
On the basis of these tests we can expect gains from
trade for firms and industries that have such
comparative advantage in the single market. The
Altzinger and Damijan result is quite a powerful one
since as they note: ‘it is surprising how little empirical
evidence has this proposition gained over the centuries’.
It is noteworthy that all of the statistical studies they
refer to that are unsupportive of the hypothesis are
for country pairings outwith the EU.
Interestingly, however, Altzinger and Damijan are
unable to explain longer-term changes in comparative
advantage in terms of their productivity measures.
We suggest that this is perhaps because the original
Ricardian model is static in nature and does not, for
example, permit increasing returns to scale, a central
feature of the New Trade models.
The gravity model focuses on geographic distance and
country size/mass as the key elements in explaining
international trade although other impediments to
trade are included in the model when it is estimated
empirically. Perhaps in the current global age with
6
McCallum (1995) provided one of the first tests of the
gravity model for bilateral trade flows between Canada
and the USA and found that inter province trade is 20
times larger than trade between the two countries. He
attributes this ‘border effect’ to the totality of barriers
between the countries, including tariffs and non-tariff
barriers, and the ‘pure’ border effect (that is the
customs costs) mentioned above. A number of authors
have suggested that the large border effect that McCallum
finds is a result of statistical deficiencies in his modelling.
But it turns out that even when these have been
addressed the border, or home bias, effect is still large
(6 to 12 times). The existence of this border effect has
been replicated for other country pairings and it would
be expected that the existence of the Single Market in
EU would have considerable trade enhancing effects
along with the associated gains from trade.
A number of studies have applied the gravity model to
calculate the effects of EU membership on intra EU
trade (see, inter alia, Carrere (2006), Hufbauer and
Schott (2007) and Magee (2008)) and find large and
statistically significant effects. For example, for the
period 1962 to 1996 Carrere (2006) finds that intra-EU
trade increased by 104% over the period thereby
confirming McCallum’s initial result. Interestingly,
of the gravity studies that examine the effect of EU
membership on trade few if any find that EEA and EFTA
membership are significant determinants of trade
creation. Of course given that the UK has been a
member of the EU during the sample periods used in
these papers it is impossible to run the counterfactual
of what UK trade growth would have been had the UK
not been an EU member.
A more user-friendly way to illustrate the gravity model
is simply to compare the UK’s trade with two countries
of similar size in which one of the countries is closer
to home than the other. The Czech Republic and
New Zealand are both countries with similar sized
economies (both around the $200bn mark in 2014).
It turns out that the UK trades about 4 times more with
the Czech Republic than with New Zealand. Australia
and Spain are both similar sized economies
(approximately $1.4tn) and the UK trades about 3.3
times more with Spain than with Australia.
En l ig h t en i ng t h e E ur op e a n Deb at e
As noted, size or mass is also a significant determinant
of trade in the gravity model and it is noteworthy, as we
saw above, that the UK has a large trade deficit with
China and it represents a growing share of the UK’s
trade. Nonetheless the UK’s trade with the EU was 5.5%
of the EU economy in 2014 and only 0.9% of the Chinese
economy, so the latter is still not near matching the
critical mass offered by the EU market.
In the Norwegian case, agriculture and fisheries are not
covered by their EEA agreement, although both parties
have agreed to progressive liberalisation of agricultural
trade, which is achieved through the conclusion of separate
agreements on that basis. As member of the European
Free Trade Association (EFTA), Norway can conclude
bilateral Free Trade Agreement in terms of the EFTA
framework.
The nature of NTT means that it is not particularly
amenable to direct testing, although it has been tested
using advanced econometric testing. However, there are
a number of indirect ways of gauging the model.
At its heart is the assumption of increasing returns to
scale that are created by extending and protecting the
size of the market. Such a story has parallels with the socalled the infant industry argument and protectionism: by
protecting a particular industry with tariffs and
quotas the agglomeration story can be kick started.
Some economists have argued that protectionist
policies had facilitated the development of the
Japanese auto industries in the 1950s, when quotas
and regulations prevented import competition.
The cornerstone of EU-Switzerland relations is the
Free Trade Agreement of 1972. In contrast to Norway,
Switzerland is not a member of the EEA (this was rejected in a referendum in 1992). Instead, in 1992
Switzerland and the EU agreed on a package of seven
sectoral agreements “Bilaterals I” signed in 1999. These
include: the free movement of persons, technical trade
barriers, public procurement, agriculture and air and
land transport. Additionally, a scientific research
agreement fully associated Switzerland into the EU’s
framework research programmes.
It could similarly be argued that the agglomerations we
observe in the EU area today have come about and /or
been strengthened because of the existence of the
single market policies pursued. As noted above, the
agglomeration story is also consistent with the fact that
much of international trade today is intra industry trade
and this is an important part of the UK’s trade within
Europe. Furthermore, the agglomeration clusters rely on
the free movement of labour, particularly in the
financial services sector. If companies are able to reap
economies of scale then it would be expected that their
productivity would increase and the study discussed
above does in fact find support for the view that
productivity differences matter for trade within
Europe. New NTT also supports the view that greater
productivity gains will have followed from the
existence of the Single Market.
4 Other Country Experiences with
the EU – Norway and Switzerland
In this section we consider two other models – based on
the Norwegian and Swiss experiences – that the UK may
consider if Brexit were to occur and we also outline the
potential renegotiations that the UK would face were it to
leave the EU.
Norway is a member state of the European Economic
Area and as such is signed up to the four freedoms that
this entails, namely the free passage of goods, persons,
services and capital which in turn means that it recognises policies associated with these freedoms, (specifically: company law, competition, consumer protection,
environment, social policy, statistics and transport).
In 2004, a further set of sectoral agreements was signed
in 2004 – “Bilaterals II”, covering, inter alia, Switzerland’s
participation in Schengen and Dublin, and agreements
on taxation of savings, processed agricultural products,
statistics, combating fraud, participation in the EU Media
Programme, the Environment Agency, and Swiss
financial contributions to economic and social cohesion
in the new EU Member States. In 2010 an agreement
was signed on Swiss participation in EU education,
professional training and youth programmes.
Overall, there are currently around 100 bilateral
agreements between the EU and Switzerland and these
are managed through a structure of more than 15 joint
committees. The implementation of agreements means
that Switzerland has to accept relevant Community
legislation in the covered sectors.
Perhaps the most telling argument against these
alternative arrangements is the finding noted above
from gravity studies, that the EEA and EFTA do not seem
to stimulate trade and therefore generate the gains from
trade that full membership of the Single Market does.
Finally, in Figure 3 we show the total value of UK trade,
broken down according to the different types of trading
agreements currently in place. This figure shows that
only 15% of the UK’s total trade is with countries that
are not covered by any EU agreement. 21% of the EU’s
Preferential Trade Agreements are currently under
negotiation and it is likely (such as negotiations with
the US) that these will benefit UK trade considerably.
In terms of the Referendum debate, a crucial question
to ask therefore is whether the UK on its own could
renegotiate the potential FTAs in progress, and indeed
the existing FTAs, without the heft of the EU behind it?
And if it could how long would this take and how much
uncertainty would be associated with such a process?
7
En l ig h t en i ng t h e E ur op e a n Deb at e
Figure 3: Share of Total UK Trade by Trade agreement (% of Total)
Currently 85% of the UK’s trade is affected by trade
agreements negotiated with the EU, of which the Single
Market forms the largest part. 21% of EU preferential
trade agreements are currently under negotiation.
Would the UK be able to negotiate similar preferential
deals on 85% of its trade without the heft of the EU
behind it? Even if it could how long would this process
take and how much uncertainty would it generate?
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Conclusions
In this paper we have focused on some of the issues
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