Global perspective on protection, competition and growth within the EU

By Professor Patrick Minford CBE

It is interesting that, contrary to the conventional wisdom, education cannot account for differing growth and living standards. Nor can state support of R&D. Though richer countries generally have better and more education, the difference is nowhere near big enough to account for the differences in their living standards. A country that allows competition to work will harness the world’s existing knowledge via the newly competing goods that it will produce. It does not need to have educated workers if the capital that they use embodies the best knowledge.

The same is true of state attempts to boost R&D. If one thinks about it, it is easy to see why. A country that opens itself up to competition will import the knowledge without needing to do any R&D; R&D is a feature of new knowledge but to get rich one does not need to create new knowledge, merely to exploit what is available around the world.

By contrast if one looks at the differences in the obstacles to business – as summarised in a fascinating index produced by the World Bank (costs of firm set-up and closure from the World Bank Database) – one finds they are well correlated with differences in living standards and growth. One can create a measure of ‘business regulation and taxation’ by combining this index with an index of taxation levied by country. Models in which this measure affects productivity growth are consistent with (and cannot be rejected by) the data on GDP and growth in the post-war period. Chart 1 below shows the crude relationship. By contrast, models in which education and R&D support are predicted to enhance productivity growth are rejected by the data. Chart 2 shows how the data on the effect of business tax, education and R&D support tallies with what the models of their effectiveness imply.  In all except the business tax case the data is strongly at variance with the models. The panel in Chart 2 (top right; the model in which infrastructure spending affects growth) shows that infrastructure spending also contributes to growth, consistently with the business tax model in that infrastructure lowers business costs.

(The paper ‘Growth and Relative living standards – testing Barriers to Riches on post-war panel data’, further describing this research and giving a large number of references can be downloaded from my webpage at http://www.cf.ac.uk/carbs/econ/minfordp/index.html. It can be found in the ‘Supply side’ section.)

Business tax versus growth

Chart 1

Chart 2

95% bootstrapping confidence for different taxes

Glossary: Top Left (pi’) Business Tax model; Top right (infra): Infrastructure model:
Bottom Left (esub) Education model; Bottom right (govrd) R&D state support model

What has all this got to do with the EU?

The EU’s measure of business tax and regulation is not as good as the US’s, but it is typical of those in most successful rich countries. Therefore one might think that, from a business viewpoint, all is well in the EU.

It is true that within the EU’s domestic market (where the ‘single market’ exists) there is competition. This does not yet include many services (see Table 1 below for some measures of restrictions in services within the EU) – but the Commission is working on that and trying to widen the scope of the Single Market increasingly to them. Airlines and insurance are examples where there has been progress; and now the financial markets are to be opened up under the Financial Services Action Plan – it has its faults but we must see how it works in practice.

Table 1: Survey indicators of service barriers
(Scale 0–6 from least to most restrictive)

Note: Simple averages of indicators for seven industries – gas, electricity, post, telecoms, air transport, railways and road freight. Depending on the industry the following dimensions have been included: barriers to entry, public ownership, market structure, vertical integration, price controls. For the Rest of the EU, simple averages of individual EU countries.

Source: Nicoletti, G. and S. Scarpetta (2001), `Interactions between Product and Labour Market Regulations: Do they Affect Employment? Evidence from OECD Countries', Paper presented at the Banco de Portugal Conference on `Labour Market Institutions and Economic Outcomes', 3—4 June, Cascais.

The point is that in principle, according to the Single Market, there is competition in goods markets. However, how real is this when protection against producers outside the EU is as large as it is?  It is well-known that in agriculture, prices inside the EU are kept some 50% above world prices by the Common Agricultural Policy. What is less well known is that prices of manufactures are also kept substantially above world prices by a complex network of agreements and anti-dumping duties (or the threat of them). Estimates [Table 2] which carefully strip out the effects of transport and distribution suggest that the margin is around 40%; these tally with a wide range of other cruder estimates based on unadjusted consumer prices.

Table 2: Estimates of tariff-equivalents on
manufactured goods due to all trade barriers (%)
 

Note: Data are expenditure-¬weight¬ed average ratios of imputed producer prices to the landed prices of goods from the country with the lowest level of price in the sample.

Source:  Bradford. S. and R. Z. Lawrence (2004), ‘Has Globalization Gone Far Enough? The Costs of Fragmented Markets’, Institute for International Economics, Washington DC

The reasons for this protection are obvious: the EU has many manufacturers who, like farmers, demand protection. In 2005, we saw that, when trade in textiles with China was supposed to be entirely liberalised, protests from countries like Italy and Portugal forced the EU Commission to retract.  We had ‘bra wars’ as restrictions were brought in on the number of bras M&S could have made in China. Most recently, in protest against Peter Mandelson’s lack of action on anti-dumping in recent months, the group of industry associations of the EU wrote to Commission President, José Manuel Barroso, demanding renewed action against foreign competition; as they would say in The Sun, you couldn’t make it up!

In a book published two years ago, Should Britain leave the EU? Economic analysis of a troubled relationship,  I showed calculations of the cost in lost consumer welfare because of this protection (as a result of the higher prices consumers pay and the wasted resources in production of these goods that can be acquired far more cheaply abroad). It came to around 3% of GDP for the UK and, not surprisingly, to a similar percentage for the rest of the EU.

This calculation does not factor in any effect on growth. Yet pursue the argument above about how growth happens. If the EU erects barriers to foreign competition, not merely in agriculture (now a very small sector) but also in manufactures (still around 20% of EU GDP), then it is preventing foreign businesses from penetrating our markets with the best products and techniques of production. Therefore, protection is a hidden tax on business. If we let in cheaper manufacturing imports, large tracts of manufacturing in the EU would be eliminated – much as has occurred in the UK due to our particular lack of relative advantage in manufacturing. Resources released from manufacturing would then be redeployed into other – mostly service – industries, which again if freed from barriers would attract foreign capital and technology to cooperate with local labour. Productivity would grow as the EU concentrated on sectors in which it had relative advantages and used best-practice techniques from around the world to enhance these sectors’ performance.

As it is, protection rules – and with it stagnation by and large. The exceptions, such as Ireland and Spain, show up the rest. In Ireland, US capital inflow has been allowed to transform the economy and raise the growth rate. In Spain, which still has a relative advantage in manufacturing, resources have shifted from elsewhere in the EU into Spanish manufacturing. The same process is unavailable to Germany, Italy and France. The result has been disappointing growth for some two decades now.

To conclude, the EU’s protectionism not only reduces living standards by a steady fraction due to the inefficiency in production and consumption; it also retards growth by putting barriers to the inflow of new capital and technology into new sectors of the economy. It is time we did something about it – either by making much more trouble inside the EU to strengthen the hand of those with consumer interests at heart, or by asking for the return of powers over trade and competition so that we can bring down these barriers ourselves.

* Should Britain Leave the EU?: An Economic Analysis of a Troubled Relationship, BY Patrick Minford, Vidya Mahambare and Eric Nowell, Edward Elgar and The Institute of Economic Affairs, May 2005.  Available for purchase from the IEA, www.iea.org.uk. Further information can be found at http://www.cf.ac.uk/carbs/econ/minfordp/index.html under ‘Policy and Forecasting’.