Let us take the example of insurance regulation. It is not something that captures the imagination of most people but it is a very important sector for the UK and it illustrates the point simply and well. By insurance regulation, I do not mean the regulation of the sale of insurance and pensions – that is an area reserved for EU member states. I am referring, instead, to the regulation of insurance companies themselves – their levels of solvency and so on.
If we want to promote free trade, there are four ways of doing it.
We could vest all power for the regulation of insurance companies in the bureaucracies in Brussels and ensure that every insurance company has to follow the same regulations. This has now effectively been done and is known as harmonisation. There is little sense in which that bureaucracy is politically accountable – I would be surprised if one in a hundred MEPs took any interest in its activities.
As I said in the meeting last week, when the Single Market was created Ted Heath pointed out that this was a single market and not a free market. Insurance illustrates this very well. Insurance companies will all have to follow the same rules upon the implementation of a directive related to a regulatory system called Solvency II – but will be much less free than before Solvency II. The centralised rules will be highly restrictive and perverse, encouraging investment in risky sovereign bonds. It will be very difficult ever to change the rules again.
Next, we could pursue something called ‘mutual recognition’. This is what the free-market wing of the Conservative Party thought the Single Market would deliver. Unfortunately, this principle has been undermined more and more as time has gone on and been replaced with harmonisation. But it did work for a while. The Third Life Directive allowed insurance companies to operate anywhere in the EU without establishing a subsidiary. It abolished quite a lot of national regulation, especially where that regulation interfered with free trade. There was a minimum set of regulations – which was not very well designed, as it happens – that all companies had to follow and, as long as they did, they were free to do business anywhere in the EU. This meant, for example, that Legal and General could sell policies in Holland, regulated by the British regulator. The Dutch purchaser of Legal and General policies would then be purchasing a UK-and not a Dutch-regulated policy.
This worked okay – but only okay – and provides for a sort of competition between regulators. If a particular national regulator was too lax or too tough or produced poorly designed regulation – then the policies sold by the companies it regulated would not be attractive.
We could have ‘super-mutual recognition’ whereby the EU had no minimum level of harmonisation at all. If a Dutch person bought a policy from a British company it would come with a stamp (metaphorical, if not literal) saying ‘regulated by the UK FSA, not by the Dutch regulator’. Such clarity can be helpful and certainly would have been helpful in clarifying the rights and obligations under deposit insurance during the banking crisis.
Mutual recognition was the horse that the free marketeers backed when the Single Market was developed. A mixture of harmonisation and mutual recognition is also the horse that we have tended to back all the way round the world when it has come to promoting free trade in banking. I am now not so sure.
It is this mindset that has also led to the Basel Accord. People want free trade in banking, but they want to make sure that banking systems in (say) the UK are protected from the failure of the UK branch of a bank regulated by (say) the Japanese regulator. So we try to get international agreement on regulation and the result is EU regulation and the Basel Accord in banking. In the end, we are trading the problems that arise from regulatory uniformity, the centralisation of regulation and a higher level of regulation than we ourselves would want for the benefits of free trade within that regulatory framework. As Ted Heath pointed out, we have traded a free market for a single market.
Maybe we should try a fourth way and, effectively, go back to how we used to do things, though this would effectively mean the end of the Single Market project. Any EU country that wishes to allow branches of companies domiciled in other countries to offer their services in the domestic market should be free to do so. But, we should repatriate regulation to the nation states – and, of course, make the case for abolishing such regulation in our domestic markets. If a British insurer wishes to sell products in (say) Holland, it should – if the Dutch government wishes – establish a subsidiary regulated by the Dutch government. The European Court should rule on whether the Dutch regulation impedes cross-border trade (for example, does it require that all policies are hand delivered by people who speak Dutch?). But, as long as Dutch and the British-owned companies are treated in the same way, that should be that.
Countries within the EU might agree to unify their regulatory approaches bilaterally or multilaterally in order to make it easier for cross-border business to take place. Indeed, we might make agreements with non-EU countries such as Canada to unify regulation. Small countries will have an incentive to do that.
There is no question that, in some respects, this approach will raise the costs of doing business. It was to avoid these costs that the Single Market was created. It will raise the transactions costs of trade. But, trade will not be greatly distorted and greater freedom will be possible for liberal countries. If the UK is best at producing insurance, then all the meaningful economic activity can take place in Britain. Decentralising regulation would surely bring enormous benefits again. Not least because some countries could blaze a trail, like Britain did in the nineteenth century, by creating unregulated insurance markets that were the most secure in the world.
We could follow this route in banking too. We could then wind up the Basel Accord and go back to regulating our own banking system – if we wished to do so.
This is a complex issue and, for some good reasons, we have trodden the wrong path. It is time to turn around and go the other way. The main role of the EU should be to ensure that any national regulations that exist do not impede trade significantly. When I helped with the establishment of the Polish actuarial profession, Commercial Union (now Aviva) rapidly established a highly profitable Polish-regulated subsidiary. Soon, there will be one incoherent and intrusive regulatory system only, across all 27 countries. It seems to me that this is not a great leap forward for free trade.