Leaving the EU: an assessment of its impact on services and trade

June 2016

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Contents Forewords 3 Introduction 6 Key findings 6 Research approach 7 Context 7 Composition and direction of UK services trade 9 Financial services 10 Other business services - country breakdown 11 Summary observations on sector trade by partner 12 Econometric estimates - services trade 13 Approach 1: Effects of intra-EU liberalisation 14 Approach 2: Gap between EU preferential access, and “Most 15

Favoured Nation” access Approach 3: Gap between actual EU access, and bound WTO 16

access Econometric estimates on the goods trade 16 Aggregate estimates 16 Conclusion 18 Bibliography 19 Appendix - key terms 20

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Foreword Jo Valentine, Chief Executive, London First

The services sector is a cornerstone of the UK economy. It comprises four fifths of our GDP. And while we may not see ‘made in Britain’ stamped on the bottom of much, we are the second largest exporter of services in the world. An enviable and precious position.

London is Europe’s service sector hub, bringing benefits to the UK as a whole. Through our membership of the European Union, the UK accesses a huge pool of skilled labour, a vast home market and trading links to the rest of the world. Leading in Europe we can push for further trade liberalisation across the Single Market. Leaving poses a risk to the UK services sector, and crucially, to job prospects for the next generation.

The breadth of London’s business community is in evidence in the forewords to this report; from lawyers to fintech, infrastructure to architects; the different perspectives of these service sector leaders unite in the belief that leaving the EU will lead to services trade restrictions and damage to our economy.

You will see in this report that Frontier Economics estimates that even if we gain a ‘most-favoured nation’ status it will cost in the order of £80 billion of lost services trade a year. There have been a lot of big and frightening numbers in this campaign. But the fact is that the service sector is at the heart of our economy, for the UK and especially London. Exporting services is a fragile business to be in for a nation trading on its own. Ours has been the product of deep relationships and years of work within the EU, resulting in the removal of non-tariff barriers, open procurement rules, and, the right to open an office in London and start trading across the EU.

It is not that life will come to an end in London if we leave. It is simply that we are making it needlessly difficult for ourselves. Equally, when it comes to further services liberalisation in the EU and trade deals that make it easier to sell and buy services around the world, no one else has a dog in the fight the same way we do.

We can stay in and build on our advantage. Or we can cause years of disruption and reduce our leverage in search of an uncertain future.

Gregory Hodkinson, Group Chairman, Arup

Arup is a global leader in the professional services sector with some 13,000 designers, engineers, planners and consultants working around the world. Headquartered in London, Europe is an integral part of Arup’s business and has been from the earliest days of the firm when Sir Ove Arup – a UK-Danish citizen – founded the firm that bears his name today.

Over the years, Arup has deployed its skills on many iconic European projects, including the Pompidou Centre in Paris, the Allianz Arena in Munich, and the famous Øresund Bridge linking Denmark and Sweden. Europe remains an important market for the firm, so we are mindful of the political and economic cooperation that makes it easier for the firm to access clients and staff, and deliver quality projects across the region.

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The UK’s EU membership is an important factor in securing the movement of skilled labour and technical expertise that Arup relies on. Not only that, but membership helps provide a stable regulatory environment that breaks down political barriers and fosters business confidence.

This report focuses solely on trade in services, but it is important to note that our sector does not exist in a vacuum. A slowdown in investment and growth in any one area of the economy inevitably has implications elsewhere. So while the findings of this report will raise legitimate concerns for service sector businesses in London and across the UK, it is important that the issues are understood and fully debated ahead of an historic vote on the future of the UK.

Dean Finch, Group Chief Executive, National Express

National Express is proudly a British company providing services across the UK, Europe, North America, North Africa and the Middle East. Two-thirds of our business is now abroad and they are the fastest growing parts of our business. I believe it is because of an ambitious, outward-looking approach that companies like National Express have grown and prospered.

With a population of over 500 million, the European Union is a market that we have benefitted from. I believe a decision to leave could cause both a recession in the UK and significant uncertainty in our relationship with our major trading partner.

While it is by no means perfect, I believe there is also much more benefit to be had from remaining part of the club, arguing for further reform to level the playing field rather than having the odds permanently stacked against us.

We should be proud and confident of our success as a country and our opportunity to lead such reform in Europe. Within transport – despite common myths – we are often world-leading. It is by taking such confidence and ambition we should face the future and do so as part of the European Union.

John Davies, Chair, Lawyers – In For Britain

It is often not fully appreciated that the UK legal profession is very much a global leader in international legal markets, creating many jobs for both lawyers and others alike, and generating substantial income from international clients to the benefit of the overall economy. Many of the members of Lawyers – In For Britain regularly provide legal advice on international matters from the UK to clients based in the EU and elsewhere.

Restrictions on the provision of services from the UK through a Brexit would harm this successful legal profession whose most valuable clients include services providers such as financial institutions and technology and communications companies. Furthermore, if the UK were to leave the EU, neither freedom of establishment nor freedom to provide services for lawyers and others would be guaranteed or protected. The UK is the foremost centre for international dispute resolution and this is underpinned to a substantial degree by the common rules on enforcement and jurisdiction of the EU – there is also no guarantee that this would remain in place under any revised trading relationship outside the EU.

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More generally, leaving the EU would lead to a loss of influence of English law. Just as the UK is much the largest non-Euro member state, exerting considerable influence over financial regulation through the Bank of England, so it is much the largest common law jurisdiction with substantial influence over the development of the EU legal and judicial system.

The Treasury and others have predicted a negative impact of Brexit on the overall UK economy. The legal services market would also be adversely affected. Indeed, an independent report for the Law Society in September 2015 conducted by Oxford Economics concluded that providers of legal services would be disproportionately affected by any adverse economic effects resulting from a UK departure from the EU. The report found that the longer-term effects were adverse in all of the scenarios that they had considered plausible. On the worst case scenario they found that annual output in the UK legal sector to 2030 could be reduced by £1.7 billion (an amount equivalent to the current turnover of four of our largest UK law firms combined).

Salvador García Andres, Chief Executive Officer, Ebury

Ebury is a British company that is a European success story. From starting up in a basement in London in 2009, Ebury now employs 350 people across nine countries in Europe.

London was deliberately chosen as the start-up location by the European founders, due to the UK government being the first member state to take advantage of an innovative piece of European legislation.

This state-level entrepreneurialism has been a catalyst for London’s flourishing FinTech sector. As a UK financially regulated business, we rely on the EU to allow us to “passport” this regulation across all markets, without having to apply to each country's individual regulator.

Far from being a hindrance to business, EU membership has been both the catalyst and the continual enabler for our business and people to flourish. The FinTech sector is an increasingly significant contributor to the UK economy, and in our view, maintaining membership of the EU is a key dependency for this growth to continue.

Sir Terry Farrell CBE, Principal, Farrells

Britain should be a leader in Europe and the only way to be so is by remaining within the European Union. The EU, and the upcoming single market for services, creates enormous opportunities for British architects, designers and developers.

Withdrawing would put the incredible growth in this sector at risk, halt inward investment and make it more difficult to secure the talent we need to compete.

But beyond the economic arguments, the reason to remain is profound: European unity is vital for peace, growth and prosperity. We must embrace this enormous potential and regain our place at the centre of the European Union.

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Introduction London is the hub of the European Union’s services sector, and the UK is the second-largest exporter of services in the world. Services account for 80% of UK GDP.

This success has been underpinned by a distinctive combination of attributes: stable, business-friendly regulation; global openness to trade, investment and migration; a vibrant and liberal culture that attracts people from around the world; and membership of the EU Single Market. Taken together, they have laid the foundations for a virtuous circle as London has emerged as the place where talent can find opportunity and business can find talent.

The economic impact of this conducive environment is seen most clearly in the growth of London’s financial and business services sectors. Despite being badly hit by the 2008 financial crisis, these two industries have together driven around half of London’s output and jobs growth since 2006. Looking ahead, London has the potential to drive further growth for the UK by capitalising on global opportunities in emerging markets and further integration of the European services market.

The precise benefits of Single Market membership, present and future, are less easy to observe and more complex to calculate than the elimination of tariffs on goods. Given the importance of the services sector to the UK economy, leaving the EU would create a substantial risk. This report draws on work commissioned by London First from Frontier Economics to analyse the historical impact of EU services trade liberalisation on the UK economy and the implications, under three scenarios, of leaving the Single Market. The research draws heavily on a body of work prepared by the OECD on measures of services trade restrictiveness.

Key findings

• Services liberalisation has meant that the UK has benefitted from both greater access to the EU market and through increased competition in the UK services sectors.

• Through its membership, the UK has promoted trade liberalisation across the EU, and has benefited from increased trade in services, estimated at between £36 billion and £68 billion in service exports, and £21 billion and £39 billion in services imports.

• If, instead of the EU Single Market in services, alternative arrangements based on free trade agreements currently in force had been in place, the impact on UK trade would be significant. Even based on generous assumptions about continued access to the market, but with some increased costs and difficulties in intra-company transfers and similar restrictions, we estimate overall UK trade (imports and exports of goods and services) would have been lower by between £67 and £92 billion a year.

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Research approach Commissioned by London First, Frontier Economics used econometric evidence relating to changes in services trade restrictiveness, and to flows of services and goods, to quantify the impact leaving the EU would have on the UK’s services sector. They did this by testing the question: what would have been the effect on trade if levels of services trade restrictions in the EU were higher? That in turn has provided an indication of the benefits of EU-induced services trade liberalisation.

This is, therefore, essentially, a retrospective analysis over the last decade or so, using historical data to estimate relationships, and to infer effects. But it also has prospective value – it can be used as a basis for quantifying the benefits of future liberalisation; including possible losses from losing access to EU-specific liberalisation.

Context The UK services sector

The UK is the second-largest exporter of services in the world. In 2014 services accounted for almost 80% of UK GDP and 80% of employment.1 Services – and therefore the UK – benefits disproportionately from EU efforts for services trade liberalisation. Access to competitive services inputs is also a major determinant of competitive advantage in trading goods, as traditional factors that affect goods’ traded costs, such as tariffs, have declined globally. Thus the fortunes of the UK’s goods sector are strongly linked to those of its services sector.

Furthermore, the EU 2014 Skills Panorama predicted that until 2025, employment growth will be driven by services trade, particularly professional services, and business services and computing.2 The liberalisation of services trade in the EU is therefore critical to the UK’s economic success, and our ability to shape the future of the Single Market is a key prize of the UK’s EU membership.

Services trade occurs through four channels:

1. Cross-border supply

2. Consumption abroad

3. Commercial presence (investment)

4. Movement of natural persons.

Liberalisation of services trade has long been a central pillar of the European market: Chapter 3 of the Treaty of Rome, establishing the European Community, provides for the progressive liberalisation of services; services liberalisation was one of the key objectives of the European Union created in 1993, and the objective was further reinforced by the EU’s 2006 Services Directive.

Trade liberalisation in services involves reducing barriers or obstructions to all four channels of supply, and includes:

• market access barriers e.g. limits to the number of sellers in a market, restrictions on levels of foreign ownership, restrictions on forms of commercial entity;

1 OECD (2016), OECD Services Trade Restrictiveness Index (STRI): United Kingdom. 2 Employment share of occupations (%) in United Kingdom in 2013, Skills Panorama,

http://skillspanorama.cedefop.europa.eu/en/countries/united-kingdom/.

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• regulatory measures that discriminate between foreign and domestic firms; and

• non-discriminatory regulation, which can reduce trade because it imposes inefficient costs or because of costs of regulatory fragmentation (e.g. requirement for supervisory approval in several jurisdictions).

These barriers do not have numerical figures attached to them, unlike tariffs that are often placed on goods trade. However, legal experts at the OECD have prepared a Services Trade Restrictiveness Index (STRI) which compares the restrictiveness of services trade flows.

Frontier Economics have used this data to estimate the benefits of EU services liberalisation to the UK economy, and so the possible impact of Brexit on UK services trade. This data excludes regulatory measures, so this analysis does not capture the full benefits of Single Market membership. In particular, loss of access to the “passporting” regime for financial services firms, whereby they can trade across the continent from the UK, is not assessed and would be very substantial. Indeed, given the importance of this as a determinant of businesses’ decisions to locate in London, the effects of losing access to passporting are likely to overwhelm effects of other restrictions. This may be the subject of further research.

Benefits of being in the EU

The UK has benefitted from services trade liberalisation across the EU. These reform efforts, which are still a work in progress, have boosted the UK economy by improving access to partner markets, and by increasing competition in UK services sectors. The UK would not have had the ability to influence EU services reforms, or fully reap the benefits of these, were it not for its membership.

Source: Frontier Economics analysis based on OECD data.

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Composition and direction of UK services trade The UK enjoys a large and varied services sector; but official OECD figures underline the importance of both financial services and business services to Britain’s exports – and the degree to which these sectors are heavily integrated across Europe. Meanwhile, Britain’s largest services import is in the travel sector, reflecting UK citizens’ travel to the EU for business and personal purposes, including around health and education.

Source: Frontier Economics analysis based on OECD data. N.B. Capitals indicate sector headings; lower case are sub-sector components of the sectors presented

Due to commercial confidentiality, for most sectors, the OECD’s data on Trade in Services by Partner Country (TISP) simply breaks down into Eurozone and EU non-Eurozone countries. Country breakdown is not available for communications, construction, insurance, financial, computer and IT, royalties, other business services, and personal / cultural / recreational services; while breakdown by country is only available for total services, transport (including subcategories), travel (including subcategories), and government services.

Accordingly, to estimate country splits, it is necessary to draw on World Bank Time Series Data – a research dataset collated from multiple sources. However, only bilateral flows are reported (no import / export split); and the data is only as recent as 2010 or 2011.

An alternative approach would be to use “mirror” flows, e.g. German exports to UK as a proxy for UK imports from Germany, but the mirror data would show many gaps, and is even less reliable if reporting conventions vary across trading partners.

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Financial services The financial and insurance services sector contributes about £120 billion in GVA (9% of the UK total) and employs over one million people (4% of total employment). This sector is particularly important in London, employing 358,000 people (32% of employment in the sector).

It is a major trading sector, accounting for almost a quarter of total UK exports. UK financial services trade is around 3% of GDP, twice the average EU level and three times the average OECD level. The relative openness of the sector means it has benefitted more from EU membership than other sectors. There has been substantial liberalisation of the sector in the UK, but also in the EU, benefitting UK-based suppliers. The sector has also attracted significant foreign direct investment, particularly as it has benefitted from access to the “passporting” regime which has substantially reduced regulatory burdens. The entry of foreign firms into the UK is associated with sector-wide gains and positive spill-overs, driving productivity in the sector. The impact of EU services liberalisation has allowed London to further develop as a financial hub and become a leader in areas such as Euro-denominated transaction despite being outside of the Eurozone.

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Source: Frontier Economics analysis based on OECD data

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Summary observations on sector trade by partner The importance of EU trade to the UK lies both on the export side and the import side, and reflects the level of interdependency between the EU and the UK. Imports of services are a major contributor to the competitiveness of the UK economy, e.g. transport services, which increase connectivity.

The sectoral breakdown can act as a rough guide to the regional impact of services. While business and financial services sectors are concentrated in London, they emphasise they carry considerable economic importance across the country.

Also notable is the importance of UK-US trade in financial services. US banks tend to export through affiliates that are based in London. Around 40% of US banks’ foreign affiliate sales are based in London, with a further 20% in other European markets.3 But the UK-US trade dimension is indirectly a story about the UK’s links with the EU.

The UK only accesses US markets as part of the EU trading bloc, and as President Obama has recently highlighted, it remains doubtful that the UK would be able to negotiate a free trade agreement with the US for many years to come, if at all.4 One need only look at the protracted North Atlantic Free Trade Agreement negotiations and ratification process of the early 1990s to see how difficult this process would be. Whereas the US has shown interest in negotiating free trade agreements with trading blocs such as the EU and NAFTA, it has shown little interest over the years in negotiating free trade agreements with individual nations, however sizeable – and so major world economies such as Brazil, China and Japan have no free trade agreement with the US. It is thus quite feasible that no such agreement would materialise, further harming UK trade with its second-biggest trading partner after the EU.

Thus the UK is in a unique position in trading in financial services. As the Governor of the Bank of England recently observed, the UK is a financial services hub – membership of the EU affords access to EU markets (e.g. through passporting) and makes London an efficient hub to serve the EU.5

3 US International Trade Commission, 2012. 4 William James, ‘Obama Says Post-Brexit UK-US Trade Deal Could Take a Decade’, Reuters, 24 April 2016,

http://www.reuters.com/article/us-britain-eu-obama-comment-idUSKCN0XL05L. 5 Statement by Governor of the Bank of England to Parliamentary Select Committee (8 March 2016) that absence of access to

common regulatory framework will encourage banks to relocate.

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Econometric estimates – services trade There are a limited number of existing studies on the effects of trade restrictiveness on the services trade. The landmark Nordas and Rouzet (NR 2015) study has several key findings. It notes significant impacts of changes in restrictiveness: a one percentage point increase in restrictiveness in services trade can reduce exports from that country by around 0.63%, and imports of services by 0.31%.

NR 2015 also notes that the effects of trade restrictiveness on exports are stronger. It also shows that when domestic markets are regulated competitively, home country exporters are more competitive in trading partner markets.

Furthermore, NR 2015 found statistically significant results reported for banking, insurance, legal services, air transport, maritime transport, and computer services.

This report is based on estimates from a similar model. Some limitations include:

the treatment of zero-data flows – some of which are zero because they are confidential; and

various specifications were estimated; the preferred specification is to use data reported by importers, and to replace “zero” data with reported export data.

The subsequent estimates generated proved to be significantly higher than NR 2015, though did not contradict the same study’s central thesis. This report finds that a percentage point increase in restrictiveness reduces exports of that country by around 2.5%, and reduces imports by around 2%.

The impacts of EU services liberalisation can be assessed in three separate ways, using three separate approaches. A complication with the data on restrictions which was captured for 2014 and 2015 is that some liberalisation has already taken place, and so cannot be readily disentangled from the data on how much liberalisation is EU-specific, and how much is on a “Most-Favoured Nation” (MFN) basis. Three separate approaches thus sought to circumnavigate this.

Approach 1 examined evidence on implementation of the EU Services Directive, and other liberalisation initiatives (such as financial services, and telecoms), and it estimated reductions implemented to date. This gave an understanding of the effects of EU-initiated services liberalisation.

Approach 2 estimated the gap between: (i) restrictions that apply within the EU to services suppliers, and (ii) restrictions that currently apply on a MFN basis. This is complicated by the lack of a unified database distinguishing between EU-specific measures and more general measures. This approach considers restrictions on the movement of people – an obvious way in which leaving the EU will affect services (e.g. by restricting movement of employees, and the ability to recruit). It also considers specific sectors of interest e.g. certain professional services, financial services, and where movement of people (employees) was likely to be important.

Approach 3 differentiated between current liberalisation, and the liberalisation the EU has committed to in the World Trade Organisation (WTO). There is a significant gap between current restrictions applied, on both a preferential basis within the EU and on a MFN basis on one side, and binding commitments entered into at the WTO on the other. WTO-bound commitments represent significantly higher levels of restrictions on services trade – and so represent an upper bound (i.e. “how bad it could get”) on restrictiveness that could apply to non-EU members if the EU were to become protectionist.

Taken in combination, the three approaches thus yielded estimates from a “best-case” scenario to a “worst-case” scenario.

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Approach 1: Effects of intra-EU liberalisation This approach considers the effects in a counterfactual case, in which EU services liberalisation had not been implemented. It is particularly interesting as EU-sponsored liberalisation reflects, in large part, pressure brought by the more economically liberal member states, such as the UK and the Netherlands. As such, this exercise served as a quantitative measure of the value of the UK’s participation in EU processes – the benefits of liberalisation to the UK are a function of how much effort the UK is prepared to invest in the EU.

There have already been some ex-post studies of the implementation of the EU Services Directive of 2006. EC Staff Paper 456 (Monteagudo, Rutkowski and Lorenzani) provides some data on the extent of the cut in restrictiveness. It cites a range of 10% to 50%, with a median range of around 30-35%. Its measured reductions follow a different methodology to the STRI and are not directly transposable (e.g. their focus is on cross-border supply and commercial presence). Nonetheless, a conservative estimate is that across the EU as a whole, services trade restrictiveness declined by around 10-20% following the implementation of the EU Services Directive

The results in (i) NR 2015, plus (ii) Frontier Economics’ modelling, and services trade data, combine to obtain an estimated range of how much trade would be lost if these reductions were not to apply today. The findings show that:

• a 10 percentage point increase in STRIs with EU countries would reduce UK services exports by between £14 billion and £58 billion, and would reduce UK services imports by between £7 billion and £34 billion (depending on the elasticities used) – reductions in the order of 6% to 30% (£36 and £21 billion mid points); and

• a 20 percentage point increase in STRIs would reduce UK services exports by between £28 billion and £109 billion, and reduce services imports by between £14 billion and £64 billion (£68 billion and £39 billion mid point); and

• the losses come relatively more from lower trade with the EU (45% of the loss in exports and 67% to 75% of the import losses). This is because trade with the EU would be affected by increased restrictiveness in both the UK and EU, whereas for non-EU trade, only UK restrictiveness is assumed to change.

By redoing the preceding calculations from the bottom-up, and by aggregating sector-specific results, rather than using averages across all sectors, insurance, financial, computer and legal services sectors each have high exporter elasticities (in excess of one for the first three), and comprise relatively significant components of UK services trade (41% of exports and 28% of imports).

In the counterfactual case in which EU Services Directive-led liberalisation had not happened, and if STRIs were 10 percentage points higher in each sector, overall there would be a 10.5% reduction in UK services exports and a 8.7% reduction in services imports. The findings show that:

there would be a £20 billion reduction in exports and £10 billion reduction in imports; and

the main affected sectors would be financial services exports (-£7.8 billion), computer/ IT exports (-£1.5 billion), travel exports (-£2 billion), other business service exports (-£3.4 billion), financial services imports (-£1.5 billion), travel imports (-£2.7 billion) and other business service imports (-£1.9 billion), and

of the lost trade, 41% of the export losses would come from lower exports to the EU, and 55% of the import losses would be from lower imports from the EU. In the sector-

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specific projection, the EU share in lost trade is somewhat lower, as financial services make up a large part of the impact, and UK exports are focused on serving non-EU countries, and

a 20 percentage point change would have twice the impact (exports fall by £40 billion, imports fall by £20 billion), and

this result assumes that both UK and EU services restrictions would have been higher. If only foreign barriers are taken into account, a 10 percentage point increase in EU STRIs would reduce UK exports by £3 billion on UK exports and UK imports by £9 billion.

Approach 2: Gap between EU preferential access, and “Most-Favoured Nation” access This approach focused on identifying the gap between EU-specific restrictions, and those applying on a MFN basis. There were several key flash points, particularly around restrictions on the movement of people; most EU jurisdictions implement “economic needs” tests, or limits on the length of stay for non-EU nationals (e.g. as intra-corporate transferees, contractors). EU nationality requirements also apply to certain professions, most notably law.

A simulated change in restrictiveness as a consequence of these measures, using an OECD services restrictiveness simulator, assumes that restrictiveness will increase both in the UK and EU, having a “double whammy” effect on any UK–EU trade. This is a reasonable assumption to make, given that sensitivities surrounding the movement of people are central to the referendum.

The restrictiveness gap for legal services, as a result of EU nationality-related requirements, is around 20 percentage points, i.e. if the UK were not an EU member, it would face levels of restrictiveness around 20% higher in legal services.

This in turn implies around a 16% fall in exports of legal services – worth around £0.6 billion per year.

For financial services, the changes in restrictiveness are smaller – around 5 percentage points, implying a fall of around £1.5 billion per year (-4%).

But the data on restrictiveness excludes regulatory measures, since these are not treated as services restrictions, because prudential measures are “carved out” of services commitments. Consequently, these results do not capture other effects of leaving the EU, such as loss of access to the “passporting” regime. Given the importance of this as a determinant of the decision for a company to locate in London, the effects of losing access to passporting are likely to overwhelm the effects of other restrictions.

These estimates use a conservative assumption that average difference in restrictiveness between EU access and MFN across all sectors is close to that for financial services, i.e. around 5 percentage points. A mid-point of elasticities calculated by NR 2015, and those calculated by Frontier Economics is used, i.e. around 1.6 for exports and 1.1 for imports.

Accordingly, the effects on the services trade of moving from EU access to MFN access would be around £9 billion for exports and £8 billion for imports, which includes only the effects on UK-EU trade flows.

Again, it is worth recalling that this is likely to be an underestimate, because this report focuses principally on effects reflecting impediments to the movement of people.

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Approach 3: Gap between actual EU access, and bound WTO access Bound WTO commitments – that is to say, legal commitments which were entered into by the EU, under the General Agreement on Trade in Services (GATS) at the WTO – were finalised between 1994 and 1998. Bound commitments represent “ceiling levels” of restrictions – they are the maximum amount to which the EU and its members can go to, without raising the possibility of dispute settlement proceedings.

There is some “water” in the WTO commitments – that is, there is a substantial gap between bound commitments and actual MFN liberalisation, and (a fortiori) preferential access granted by EU members to one another. When the EU agreed its WTO commitments, it allowed individual members to specify their own particular restrictions – hence there is no uniform binding EU ceiling.

Measures of the extent of the “water” in commitments can be drawn from Mirodout and Pertel (2015). It found that the average gap between bound and applied rates was around 36 percentage points. This provides a simple average for EU countries for which data are available, though it likely understates the gap between bound rates and EU preferential rates. As such, it again provides a basis for a conservative estimate which underestimates the true scale of the gap.

In modelling the effect on trade if services restrictions went back to “ceiling levels”, again the mid-point of elasticities calculated by NR 2015 and by Frontier Economics is used, i.e. 1.6 for exports, 1.1 for imports. We assumed that EU STRIs increase to GATS levels (No UK STRI increase was assumed, although this is also possible).

The modelling found an annual loss in exports of around £27 billion (-14%) and a loss in imports around £34 billion (-29%). Trade losses are linear with the size of STRI increase. Thus under this scenario, an 18 percentage point EU STRI increase lowers UK exports by £13.5 billion, and UK imports by £17 billion.

Econometric estimates on the goods trade In addition to the services trade, the goods trade was also modelled. A gravity model of trade was used to test the effect of STRI. The effects were quite stark: a one percentage point fall in services trade restrictiveness increases goods trade flows by around 1.5%. Applying similar reasoning, if absent of EU liberalisation, STRIs were 10 percentage points higher, UK goods exports would be £65 billion lower, and imports would be £90 billion lower (reductions of around 21%). If STRIs were 20 percentage points higher, UK goods exports would be £123 billion lower and goods imports £170 billion lower (reductions of around 41%).

Aggregate estimates This research shows the combined value of the UK’s services exports and imports is estimated to be £57 billion to £107 billion a year higher, thanks to services liberalisation secured by the UK’s membership of the EU.

Services restrictiveness affects goods trade because of the role services play as inputs into the production and distribution of goods. The value of exports and imports is estimated to be £155 billion to £293 billion a year higher as a result of services liberalisation.

Therefore, total UK trade (the combined value of imports and exports of goods and services) is estimated as being £212 billion to £400 billion a year higher thanks to the UK’s membership of the EU.

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Restrictions of services in the event of Brexit

Inside the EU’s Single Market, UK firms benefit in being able to receive and supply EU services, and in being able to supply services across the EU without significant barriers.

Outside the EU, UK firms could face many possible restrictions such as maximum foreign equity shares, limitations on stays for intra-company movement, government controls on specific sectors, and other legislative and regulatory frameworks which would hurt UK suppliers.

The access UK firms would have would depend on the post-withdrawal agreement the UK reaches with the EU.

Estimates of impact of services regulations

This research models the impact of some restrictions the UK is likely to face.

On leaving the EU, the UK would face a more restrictive regime because the free movement of people would no longer apply (unless an arrangement is negotiated that explicitly accepts this). This would make it, for example, more difficult for certain categories of professionals – especially lawyers, and to a lesser degree, accountants, to practise across Europe, and increase the costs and difficulties for firms in making intra-corporate transfers of personnel. The logic also applies the other way – EU services suppliers would face greater barriers to supplying the UK market.

Were the UK to negotiate a MFN set of preferential terms with the EU, and to cease the free movement of people, then the impact would be that total UK trade, measured by the combined value of goods and services, would fall by between £67 billion and £92 billion a year. Services trade between the UK and the EU would fall by £17 billion, which is a very conservative estimate. Goods trade would also fall by between £51 billion and £75 billion as a result of the effects of services trade restrictions on the ability of goods sectors to access competitively priced inputs.

The EU-Canada trade agreement – a model advocated by some leave campaigners – largely restates the existing restrictions on free movement of people and is likely to lead to a similar fall.

As noted above, these calculations are likely to be a very substantial underestimate as they don’t capture regulatory measures such as losing access to the financial services passport regime.

These figures are also just the impact on trade from services restrictiveness and represent just one of the ways the UK economy would be hit. The UK economy would also likely be damaged by barriers to goods trade and reductions in foreign direct investment.

An alternative approach

We also estimated the potential worst-case scenario for the UK: leaving the EU with no favourable access to the EU, and the EU increasing service trade restrictiveness to the maximum levels they are allowed to as part of their obligations with the WTO. It assumes no increase in UK restrictiveness in response to EU policy reversals.

Based on this, we estimate that if EU members were to impose restrictions on non-EU members to the full extent allowable by their WTO commitments, the cost to the UK would be around £27 billion in services exports and £34 billion in services imports.

Under this scenario, goods trade would also fall by up to £197 billion a year.

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Conclusions This research estimates that total UK trade (i.e. the combined value of goods and services) has been between £212 billion and £400 billion a year higher because of the benefits of services liberalisation secured by the UK’s membership of the EU.

Leaving the EU is likely to increase trade restrictiveness in services, which b

These estimates do not take in to consideration the potential impact of the EU’s plans for further liberalisation of the Single Market – both completing what has been agreed in the various directives but also the further measures which are planned in digital, energy, banking, trade and other sectors – which suggest that there are further additional benefits to be had.

Finalising further steps towards greater trade openness across the EU will unlock greater economic benefits for London and the UK. Planned initiatives include the elimination of non-tariff barriers to trade, the achievement of further efficiencies and co-ordination across key markets, and the completion of the Digital Single Market (DSM) – that is, the full harmonisation of online standards, regulations and practices, and the joining up of what currently tends to function as a collection of individual, national markets. The goal is ultimately to reduce transaction costs, improve consumer confidence and trust, and broaden the extent of cross-border e-commerce. Leaving the EU when it is on the cusp of deepening trade liberalisation across member states would compound the negative impacts cited in this paper.

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Bibliography • William James, ‘Obama Says Post-Brexit UK-US Trade Deal Could Take a Decade’,

Reuters (24 April 2016), http://www.reuters.com/article/us-britain-eu-obama-comment-idUSKCN0XL05L.

• Skills Panorama, ‘Employment share of occupations (%) in United Kingdom in 2013’ (2014), http://skillspanorama.cedefop.europa.eu/en/countries/united-kingdom/.

• Sebastien Mirodout and Kätlin Pertel , ‘Water in the GATS: Methodology and Results’, OECD Trade Policy Papers 185, (2015).

• Josefa Monteagudo, Aleksander Rutkowski and Dimitri Lorenzani, ‘The Economic Impact of the Services Directive: A First Assessment Following Implementation’, European Economy Economic Papers 456 (June 2012), http://ec.europa.eu/economy_finance/publications/economic_paper/2012/pdf/ecp_456_en.pdf.

• Hildegunn Kyvik Nordås and Dorothée Rouzet, ‘The Impact of Services Trade Restrictiveness on Trade Flows: First Estimates’, OECD Trade Policy Paper, No. 178 (6 February 2015), http://www.oecd-ilibrary.org/docserver/download/5js6ds9b6kjb.pdf.

• Organisation for Economic Co-operation and Development (OECD), ‘Services Trade Restrictiveness Index’ (2016), http://www.oecd.org/tad/services-trade/services-trade-restrictiveness-index.htm.

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Appendix — key terms

Some services trade terminology:

• “Restrictions” – policy measures that limit the supply of services in a sector through any of the modes of supply.

• GATS – The General Agreement on Trade in Services of the WTO, under which jurisdictions, including the EU and its member states have undertaken multilateral commitments on services liberalisation.

• MFN – Most Favoured Nation. A commitment to apply to any nation treatment no less favourable than that accorded to others. A core obligation under the GATS

• Bound MFN services commitments – the liberalisation commitments undertaken under the GATS. These constitute a baseline level of liberalisation i.e. a ceiling on the level of services trade restrictions that a jurisdiction can impose. Exceeding this ceiling opens the possibility of legal challenge.

• Applied MFN services commitments – the degree of liberalisation actually implemented by WTO members. The actual degree of liberalisation must at least be equal to that specified in bound commitments, and is often significantly greater than in bound commitments (i.e. actual restrictions are lower than ceiling levels). A jurisdiction may raise applied MFN restrictions up to the ceiling level in MFN commitments

• Preferential services commitments – those negotiated by parties to a free trade area (e.g. EU members). As with MFN commitments, we distinguish between bound commitments and those actually applied.

This report reproduces the results of research by Frontier Economics. This report is printed, published and promoted by Will Higham, on behalf of London First: Remain in Europe Campaign, both of Middlesex House, 34-42 Cleveland Street, London W1T 4JE. www.londonfirst.co.uk