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Does the Bank of England know much more?

The Bank argues that EU membership has helped to open UK trade, labour and capital to international markets. The risks of the openness and interdependence are explained in depth, as well as the risks of future financial integration of the eurozone and of misguided ‘maximum harmonisation’ in EU regulation

Since the evidence collected by and available to the government is so inadequate, one may reasonably wonder whether the other main agency responsible for the UK economy, the Bank of England, might not have been collecting its own data over the years and conducting its own analyses of the impact of the EU. The answer is that it has not.

Its report, called ‘EU membership and the Bank of England’, issued in October 2015, makes this abundantly clear. It is not a storehouse of hitherto unpublished evidence. It has no databases of its own. It identifies eleven ‘previous assessments of the impact of EU membership on the UK economy’ from other sources and notes that they all ‘produce a wide range of estimates by using different analytical approaches to compare the status quo of EU membership with hypothetical cases in which the UK either was not a member of, or had a different relationship with, the EU.’[1]

The report has no time for any of them saying, ‘It is difficult to quantify the precise impact of EU membership on the UK economy. First, it is impossible to say with certainty what the UK economy would have looked like had the UK not joined the EU in 1973. Second, EU membership affects the UK economy in many different ways, through many different channels, at least some of which are difficult to quantify, or to separate from other changes to the UK economy taking place over the same period. Third, any quantitative assessment will necessarily depend on a wide range of uncertain economic assumptions. Fourth, the impact of EU membership is likely to have changed, and will change further, over time as the shape and structure of the framework circumscribing the UK’s membership of the EU evolves.’[2]

The eleven studies play no part whatsoever in its subsequent report, which also makes no attempt to measure either the benefits or the costs of EU membership, and therefore does not make a case either for Leave or Remain. There is no support at all for the confident claims made by the present prime minister about the benefits of membership. The tone is altogether more cautious and rather than provide a balance sheet, or a recommendation, its aim is simply to show how EU membership ‘affects the Bank of England’s ability to fulfil its mission to promote the good of the people of the United Kingdom by achieving its statutory objectives.’[3]


Openness in trade

The main theme of the report is the role of openness to trade in goods and services, and to the movement of people and capital, have helped to make a dynamic UK economy. ‘These channels from openness to dynamism operate in the EU as they do elsewhere, and it is very likely that the openness associated with membership of the world’s largest economic area with free movement of goods, services, capital and labour has led to greater economic dynamism in the UK.’[4]

‘Over the past forty years, the UK has become a much more open economy. This has been consistent with a general trend towards openness among advanced economies and the globalisation of the world economy since the mid-1990s. The evidence very strongly suggests that the increase in trade openness of the UK associated with EU membership has been greater than the global economic trend. Trade costs have fallen faster in the EU than internationally and the flow of trade between the UK and its partners has grown faster than might be expected based on size and proximity.’[5]

These are much the strongest words in support of EU membership to be found in the entire report, and also the most relevant to the Brexit debate. It is therefore worth stopping to consider the four items of evidence cited in support of the claim.

They are preceded by a word of warning: ‘Quantifying the specific impact of EU membership on the openness of the UK economy is not straightforward. This Chapter identifies various channels through which EU membership has very likely supported greater openness of the UK economy, though it can be difficult to separate out this EU effect from that of both domestic legislation and the general trend of advanced economies towards increased openness and globalisation. In cases where the UK and other EU member states share a common experience that is demonstrably different from the experience of non-EU economies, that is taken as supporting evidence that the EU has played a role in supporting greater openness of the UK. In some areas, it is possible to establish the likely impact of the EU more precisely by comparing metrics of openness with other EU members and non-member states.’[6]

  1. Total trade relative to GDP has increased in the UK from 40% of GDP in 1973 to 60% of GDP in 2014. Whereas, in contrast, it has lagged in two of three non-member countries considered, Japan and the US. In the report’s view, this measure of trade relative to GDP is important as an index of trade intensity which is in turn an index of trade openness, which can be expected to yield certain economic benefits.[7]

Trade relative to GDP is a slightly odd index to use. It is, as they acknowledge, always higher in smaller countries and lower in larger self-sufficient ones, but this increase in UK trade relative to GDP is ‘relative to others of a given country size’, though the others are not named.[8] More importantly ONS figures show that as a proportion of UK GDP trade with Europe has been steadily declining since 1973-74, so the UK’s increasing ‘openness’ must be with non-member countries. [9]

  1. 2. Trade costs of EU countries trading with each other were lower than the trade costs of Japan, the US and Canada trading with them, and even with the trade costs of Japan and Canada trading with third countries. This fall in trade costs is responsible, the report suggests, for the increase in trade intensity mentioned.[10]

Since the measure of trade costs included transport, as well as tariffs, legal and regulatory costs, the former is not altogether surprising. The more helpful data would have been about trade costs variation over time but that is not given. No mention is made of the fact that despite their higher trade costs, the exports of both goods and services of the United States and Canada to the EU have nonetheless grown at a faster rate than those of the EU countries to each other.

  1. Service trade costs have tended to fall in the EU countries but have increased in the US. In part, they suggest, ‘this reflects the EU’s initiatives to deepen the integration in services over the past fifteen years.’ [11]

Again, while this may be true, it seems at odds with the fact that EU services exports to each other have grown at a slower rate than those of the U.S, and many other non-member countries to the EU.

  1. A survey of some 300 estimates based on gravity models of trade found that, on average, trade has increased more than these models would lead one to expect.[12]

This finding depends entirely on the view one takes of the merits of gravity models, and of their margins of error which are not reported. In view of the fact, that the author of one of the most celebrated and popular applications of the gravity model, long used to extol the merits of the euro, has been withdrawn with an apology, we are entitled to be a little wary.[13]

This is the sum total of evidence which ‘very strongly suggests that the increase in trade openness of the UK associated with EU membership has been greater than the global economic trend.’[14]

Whether anyone would want to take ‘an increase in trade intensity and openness greater than the global trend’ as a compelling argument for continued membership of the EU is doubtful. If they did, they would probably also want further reassurance and replication of the measures used, evidence that trade intensity or openness has improved UK economic performance in some measurable respect either exports, productivity or GDP, and also evidence that these improvements outweigh the costs of membership.

However, as noted, the bank’s aim is not to make any such an argument for membership. It is merely to show that ‘EU membership has very likely supported greater openness of the UK economy.’

Openness in the labour market

On labour mobility, the report notes the vast difference between annual inter-state mobility in the US (2.5%), and the mean inter-state mobility in the EU (0.3%)[15], while intra-EU variations in mobility within EU countries are considerable, with Finland, Denmark and the UK close to the US rate. A few studies are cited showing the impact of immigration on wages: one suggesting it has no impact on GDP or wage levels , others a small positive effect on GDP, another a small negative effect on wage levels, in particular on earlier immigration. It does not touch on the impact of immigration costs on education, health and welfare services. Overall, the report takes no view about the present level of immigration in the UK.[16]

Openness in the UK capital market: the contribution of membership decreases and increases risk

Openness of the UK capital market, not surprisingly, takes most of the time and attention of the report. EU membership may have contributed to it, since ‘capital account liberalisation in the UK largely occurred before other EU countries so EU membership itself is likely to have played less of a role in increasing the UK’s openness to foreign capital’, though it ‘has probably increased the openness of other EU member states to capital flows, [which] will in turn have increased the openness of those countries to the UK.’[17]

In addition, there is some evidence that the UK’s membership of the EU has played a role in facilitating the attractiveness of the UK as a destination for Foreign Direct Investment (FDI) from outside the EU, as ‘one of a number of factors that affect foreign investors’ decisions to invest in the UK, alongside others, such as the integrity of the UK legal system, the availability of particular skills and services, and the status of the English language.’[18]

‘The EU has also probably had a powerful impact on the UK’s openness to financial services as a result of the Single Market in financial services and regulation of the EU financial sector.’[19] The most important of these is the passport regime which enables firms authorized in one member state to operate in another without the inconvenience and regulatory hurdles of setting up a subsidiary there.[20] None of these contributions are amenable to measurement.

Much of the report reads like a lecture course on capital markets and their contribution to creating a dynamic economy, as well as their vulnerabilities and deficiencies. It also includes detailed accounts of the global and euro-area financial crises, and of subsequent changes to the UK financial system and its relationship with the international and EU regulatory framework created in response to the crises.

These defy summation, but the main theme is that interdependence is a necessary consequence of openness and because it diversifies risks across countries, ‘it should lead to lower economic volatility’. Along with increased participation of foreign institutions in the UK, this makes for ‘a diversified financial system which should be more resilient and competitively intense.’[21]

However, interdependence with other economies, also means ‘the UK economy is more exposed to economic and financial shocks from overseas’ and open to ‘channels of contagion’[22] which may ‘accentuate existing imbalances’[23], as the global and euro financial crises demonstrated.  Since then ‘the UK’s institutional framework for financial stability has been comprehensively reformed’ to ‘provide the UK with a coherent architecture of national macroprudential and microprudential regulators and supervisors commensurate with the scale and nature of the risks that the UK’s high degree of financial openness can pose.’[24]

Openness in the UK capital market: union-wide harmonisation vs national flexibility

‘Financial stability is ultimately a national responsibility. The Bank of England…. is accountable to the UK Parliament. The UK taxpayer is the ultimate backstop of the UK financial system.’[25] However, UK authorities depend in no small part on the quality of regulation in the home jurisdictions of foreign financial firms active in the UK. The UK’s membership of the EU is especially relevant in both respects.

Thus far EU membership has not prevented ‘the [Monetary Policy Committee] from achieving monetary stability in the UK. Although closer integration with the EU has changed the nature and amplitude of shocks to which the UK economy is subject, and the complexity of the policy response, a floating exchange rate and the UK’s institutional and monetary policy framework has enabled the UK to absorb these shocks with little impact on underlying price stability’.[26]

That said EU ‘directives and rules define many of the Bank of England’s policy instruments particularly in relation to financial stability’[27]. Further still, ‘the majority of the legislation and regulation applying to the financial sector in the UK is determined at EU level.’[28] 

So far, flexibility in applying EU rules to address the particular risks they face has in the main been respected by the European Commission. However, the general movement away from setting minimum standards in favour of ‘maximum harmonisation’, which prevents national authorities from strengthening regulation to meet particular risks in their jurisdiction, has in some instances been problematic.

How financial regulation in the EU evolves will be important to the resilience of both the euro area and the UK. It is important, particularly given the influence of the ECB and of the members of the single currency within the EU, that arrangements are put in place so that the future development of the EU regulatory framework aids the necessary deepening of integration in the euro area without impairing the ability of the Bank of England to meet its financial stability objective and without compromising the Single Market.

The bank remains neutral with both sides as winners

One of the bank’s objectives is ‘to support the economic policies of the government’[29], and since one of those policies is to remain in the EU, the surprising thing about this report is perhaps that it does not end up making a strong case for continued membership, but rather leaves both sides able to claim it supports their campaigns.

Its main argument throughout is for openness, which both sides would find attractive, and the Leave campaign would want to claim as its trump card.[30] The report is at some pains to say that the EU membership is not the sole means of openness. Its evidence on membership’s contribution to trade openness is limited and inconclusive, even inconsequential. On labour mobility, it is selective and non-committed, and while evidence on capital mobility points to gains for the financial sector from membership, but these are overshadowed by the risks posed by the future ‘imbalance’ between union and national regulation, with the bank confident it could better handle those risks by itself.

Leave supporters will surely see all this as making a case for independence, and indeed the prospect of allowing what is, by many measures, the world’s largest financial centre to be regulated from Brussels, preoccupied by the problems of their own currency, as an especially high risk. They will also draw comfort from the reports frequent references to strengths of the UK economy, which have nothing much to do with the EU membership.

‘The UK is amongst the most dynamic advanced economies in the world….The dynamism of the UK economy is the product of a variety of drivers including economic openness, flexible labour and product markets, deep human capital, well-developed physical infrastructure, a competitive fiscal regime, as well as the clarity and integrity of the rule of law.’[31]



[2] Ibid. p.10

[3] Ibid. p.3

[4] Ibid. p.4

[5] Ibid. p.4

[6] Ibid. p.17

[7] It is worth adding that in the bar charts in the Annex 3, the UK emerges by this measure to be less open in trade, than the EU15, the rest of the EU, than OECD as a whole, and about the same as NAFTA, and in services less open than all of the others except NAFTA p.89. Plainly, there is an extended debate to be had about this data, but the Bank does not have the time, in this report to enter it, but its preliminary word of warning was entirely justified.

[8] p.18, p.87 Annex 2

[9] Office for National Statistics, ‘Economic Trends Annual Supplement No. 32’, 2006 Edition, ed. David Harper, Palgrave Macmillan, 2006, plus the 2005-2013 figures from the ONS, show a downward trend, from 19.83 per cent in 1973 to 17.10 per cent in 2013. Williamson has similar figures indicating the peak year for integration or trade intensity with the EU was 1974 when the proportion topped 22 per cent. In 1979, it was just over 20 per cent, and in 2007 and 2008 just under. by Samuel H. Williamson, ‘What Was the U.K. GDP Then?’ Measuring Worth, 2015:

[10] In Annex 3, the UK trade costs in goods, are higher than those of France, Germany and Italy, and in services higher than those of Germany. p.89, Chart 3C. Once again, these measures themselves merit extended debate. Again, the report’s preliminary word of warning about these measures seems entirely justified

[11] Ibid p.19

[12] Ibid p.19

[13] Reuven Glick and Andrew K. Rose, Currency Unions and Trade: A Post‐EMU Mea Culpa: June 16, 2015.

[14] p.4

[15] Ibid p.30

[16] Ibid pp.43-44

[17] Ibid p.53

[18] Ibid p.23

[19] Ibid p.53

[20] Ibid pp.23-25

[21] Ibid p.4

[22] Ibid p.65

[23] Ibid p.68

[24] Ibid p.5

[25] Ibid p.5

[26] Ibid p.5

[27] Ibid p.3

[28] Ibid p.6

[29] Ibid p.3

[30] Openness not Isolation is the title of a winning IEA Brexit essay prize.

[31] Ibid p.3

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