The main takeaway from a speech last week by Mark J. Carney, the governor of the Bank of England, on Britain’s European Union membership was that it is good for economic dynamism but creates challenges for financial stability.
His first point is right; his second point needs qualification. Although European Union membership creates challenges for stability, it also gives Britain opportunities to make its economy steadier. If Britain grasps these, the European Union can act as a shock absorber.
Membership in the bloc has made Britain more open to trade and more closely linked with other European Union economies. As a result, Britain is more exposed to shocks coming from across the English Channel. But membership can also dilute the effect of domestic shocks, as these reverberate across the European Union and further afield, rather than being contained within the country.
Britain’s exposure to European Union problems is fairly obvious after the still-fresh euro crisis. Given that 40 percent of British exports are to the eurozone, recession there dragged on the British economy.
There was financial contagion too. British banks suffered losses because they had lent to eurozone countries. Meanwhile, eurozone banks cut their lending to Britain as they retrenched, increasing the effect of the credit crunch.
European Union membership, which gives British financial firms a “passport” to operate across the other countries, is also one reason Britain’s banking industry has grown so rapidly in the past generation. While this has created wealth, Britain was hit especially hard during the global financial crisis because of its dependence on the industry.
Britain’s ability to share its pain with the rest of the European Union is less at the top of people’s minds. But it is no less real. When Britain suffers a decline in domestic demand, its companies can find alternative sources of business across the Channel, softening the impact on incomes and employment at home. The European Union can provide what Mr. Carney calls a “second engine.”
Britons can also take advantage of free movement of labor to find work abroad. At present, European Union citizens are coming to Britain because it is generating lots of jobs. But in the future the tables could be turned.
Free movement of capital helps in a downturn too. Because British savers don’t have all their eggs in the domestic basket, the effect on their wealth and income is cushioned.
The European Union’s single market is not perfect. So Britain’s ability to spread shocks to other parts of Europe is not as effective as, say, California’s ability to share its pain with the rest of the United States. But the European Union economy is becoming more integrated, in part because of initiatives like the union of capital markets, the union of energy and extension of the single market to the Internet. So, if Britain stays in the European Union, it will find it an increasingly effective shock absorber.
European Union membership has also helped make Britain more efficient and fleet of foot, according to Mr. Carney, fostering dynamism. This makes it resilient when there is trouble.
A final factor that determines stability is effective financial regulation. Although neither Britain nor the European Union did a good job in the approach to the credit crunch, the regime is now better. Britain has had a big influence on those rules, both via its European Union membership and because it has weight in global standard-setting bodies, in part because it can often bring along the rest of the European Union with it.
Mr. Carney pointed out that some new European Union regulations are not appropriate. Britain doesn’t always get its way. In particular, the bankers’ bonus cap makes it harder to claw back compensation when things go wrong — meaning financiers may have less incentive to take care in the first place.
The governor also argued that closer union among eurozone countries will require more harmonization of financial regulations. If so, it will be important to ensure that inappropriate rules aren’t imposed on Britain. Avoiding that risk is rightly one of the government’s priorities as it seeks to renegotiate Britain’s relationship with the European Union.
On the other hand, Britain benefits from having a single set of high-quality financial rules across the European Union.
This means it can have reasonable confidence that European Union banks operating in Britain are properly regulated.
If Britain were to quit the European Union and wanted its banks to operate across the Channel, it would still have to follow the bloc’s financial rules. But it would have less influence on what those rules were, increasing the risk that they were lower quality and less suited to its needs. It would move from being one of the main rule makers to being a rule taker.
Mr. Carney acknowledged many of these points. But his conclusion plays some of the positives of being part of the bloc. Provided that Britain fights to improve financial regulation and the single market’s shock-absorbing capacity, European Union membership will be good for stability, as well as dynamism.
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