Understanding Brexit and the need for EU reform

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The turmoil in the wake of the United Kingdom referendum result in favour of leaving the European Union offers some important lessons with respect to the importance of institutions and how they are managed over time, as well as the information available about costs and benefits of economic policies.

It seems counterintuitive for a majority of U.K. citizens to vote to leave the EU given that on paper it offers a much larger common market and economic space for individuals and firms in the U.K., which should boost economic activity and performance.

Much has been made of the so-called four freedoms that go with EU membership: namely, free movement of goods within the single market, free movement of workers, the freedom to establish and provide services, and the free movement of capital. Indeed, the creation of the common currency can also be seen as reducing the transactions costs of doing business within the EU. Even some standards can be seen as necessary to facilitate trade and commerce by creating common definitions of products.

While these economic freedoms are a major strength of the EU community, they have in practice been accompanied by the growth of a bureaucratic and administrative apparatus that had resulted in a regulatory environment not always economic-growth enhancing.

For example, there are EU regulations dealing with food safety designed to ensure public health and high quality products, which in their implementation ultimately raise the cost of doing business.

Energy policy obliges member states to ensure “security of supply” in the event of supply disruption and an emphasis on renewable energy, which is not always a cost-effective policy when it comes to consumer energy costs. Consumer protection laws within the EU have seen a shift from minimal to maximal harmonisation requirements, which again can result in substantial regulatory burdens.  

For some examples of what these regulations can entail, there have been standards with respect to how “curvy” a cucumber or banana can be. And standards as to the size of vacuum cleaners and the condensation efficiency of tumbler dryers in an effort to promote lower energy consumption.

The result is a rather large bureaucracy and associated costs of enforcement with not always apparent results with respect to energy efficiency or consumer safety. At the same time, many of these laws are not EU bureaucratic decrees but the result of lobbying by interest groups via the governments of member states. Nevertheless, there is a cost to red tape, and in the case of the U.K. has been estimated at £33.3 billion (pounds) annually. Yet it has also been suggested by the OECD that British markets are already among the least regulated in the developed world, making the gains from Brexit problematic.

There’s indeed a need for change in the EU and particularly the need for a fifth freedom—the freedom from excessive government regulation in the conduct of economic affairs. What is particularly unfortunate is that in the case of the U.K., the political leaders of the exit side have been quite irresponsible in advocating for departure without any plan for implementation or any set of policy goals that exit from the EU should achieve. Even the often touted “Norway option,” which would retain access to the European market, also leaves many regulations in place making the exit’s benefits dubious at best.

What has been done is establish an economically uncertain path, which may damage economic performance in the short term. Moreover, rather than simply departing, the U.K. might have been more effective as an advocate for change within the union.