Hamish McRae: Today Europe, tomorrow the world: a British bunker mentality will drag everyone down

It is Euro-constitution week - and time to start thinking about the long-term economic significance of the British public's anti-EU stance. We can see that not just in the showing by the UK Independence Party in the election results, but in the anti-European tone that both big parties took in the election run-up.

It is Euro-constitution week - and time to start thinking about the long-term economic significance of the British public's anti-EU stance. We can see that not just in the showing by the UK Independence Party in the election results, but in the anti-European tone that both big parties took in the election run-up.

Whatever you believe about the rights and wrongs of EU membership, this view will surely start to shape the structure of the economy.

It is surprising in some ways that it has had so little effect up to now. Some foreign companies that use the UK as a production base for shipping goods to continental Europe have warned about further investment, but actually the money has continued to come in. If you include portfolio investment - buying the shares of companies - the UK share of EU inward investment has fallen in recent years. But if you take direct investment - establishing plants - it seems to be rising. Certainly, London is increasing its lead as the main European centre for foreign investment, with 23 per cent of the total last year.

But it would be naive to expect this to continue. Indeed, you can already detect some slippage in the importance of UK-EU trade relations. The graph comes from a fascinating study by the Treasury and the Department of Trade and Industry, published last month, called Trade and the Global Economy. Its core message is that greater openness in world trade has been the key to greater prosperity in developed countries, and that trade has made a real contribution to the reduction of poverty in the developing world. More of that in a moment.

There are two striking things about the graph. One is the contribution that trade within the EU made to growth through most of the period from 1960 to 2000. A lot of this increased trade has been within rather than between industries. So the whole European industrial structure has become much more closely integrated.

The second thing, however, is the way in which British trade with the rest of the EU has started to fall as a percentage of GDP - a fall that started in the 1990s just at the time when our economy was outpacing the big three continental ones. Given that mainland European growth has been slow since 2000, I would expect the ratio to have fallen further since then.

This raises a question as to whether the UK is in the early stages of a longer-term trend: a reduction in the proportion of GDP that is traded with the rest of the EU. Note that, if this is right, the trend will have begun before the present hostility to the EU really built up and is a function of the slow growth of continental Europe vis-à-vis North America and East Asia.

I suppose the Europhobes would argue that if the EU is going to become less important to us and the US more so, it would be more in our self-interest to make the political switch in our trade relations from the EU to Nafta. It is certainly true that our largest current account surplus is with the US and our largest deficit with Germany, but the fact remains that roughly half our foreign income still comes from EU countries. So it does not seem wise to mess up our relations with them.

The much more sensible conclusion is that the UK has a huge interest in greater freedom in world trade in both goods and services. Greater economic success in core Europe - the original six members of the EU - would be helpful to us because that would increase export markets. But we need a successful world economy even more than we need a successful European one.

This is particularly evident in London and the South-east, where the big earners (aside from tourism) are financial services, telecommunications and other hi-tech sectors such as pharmaceuticals. These are global industries and we are fortunate to be seen to have a comparative advantage in them. Put simply, we need more globalisation.

And that is why the Treasury-DTI paper is so helpful. There is a fair degree of hostility washing around that "G" word, though perhaps a little less now that India is clearly joining China as a huge beneficiary of greater world trade. The key point the paper makes is that the benefits of openness need to be captured and managed so they help whole communities. It is important, for example, to have flexible domestic markets. Freedom of trade puts pressure on countries to make structural changes in their economies. Resources have to be shifted out of activities where there is little competitive advantage into ones where there is. New skills have to be learnt, relative wage rates have to change, people have to move jobs and maybe move homes.

So economic reform is important and the paper does point out that within Europe some reforms have begun - for example, the Agenda 2010 plan in Germany. Now, most of the German people I speak to reckon this plan is grossly inadequate, but this is an official government paper and it wouldn't be helpful for it to go on the attack. The section that is perhaps more convincing is the one arguing that trade in low-income countries has increased living standards. Some countries have not benefited from globalisation - even those that have started to make the appropriate reforms. And these need help, including better access to credit, debt relief and more. If some progress is made on debt relief after the latest G8 meeting, that is all to the good.

They also need an end to distorting policies of agricultural support in the developed world. The point here is that all countries have to work to increase support for trade liberalisation, and that brings the argument back to the UK relationship with the EU in the future.

There are solid reasons to expect the EU will gradually become a somewhat less important trading partner for the UK. But it will remain an enormously important player in world trade - a vital market not just for our goods and services but for the output of the developing world. The UK, together with Scandinavia and the accession states, should be a force keeping the EU as an outward-looking body. It is a force for reform of the common agricultural policy - pretty unsuccessfully so far, but still a force.

The danger is that we may distance ourselves from the show and so weaken our influence in keeping the EU as a core part of a multilateral trading system. And that would be bad news for us as well as Europe and the rest of the world.

So you think London house prices are high?

If you think London flats are overpriced, take a look at the New York Times Magazine. It is full of adverts for the homes of the East Coast establishment, ranging from Connecticut mock-Tudor palaces, through ski-lodges in Jackson Hole to secluded islands in the West Indies. Most remarkable - aside from the mammoth size of some of the places - is the price of property in Manhattan.

Standard flats on the Upper East Side are going for $2,000 (£1,100) a square foot, which is about the same as St James's in London. If you want to go swank and be on Central Park, add another 50 per cent. But maybe both markets are similarly overpriced - which brings me to some new research from Goldman Sachs on house prices in the US, the UK and Australia.

A chasm separates the views of many macro-economists and what seems to be happening on the ground. The economists say that house prices are overvalued by anything up to 40 per cent; yet house prices go on rising despite the efforts of the Bank of England to stop them. The Goldman paper is a piece of economic analysis, of course, but more sophisticated than those offered by the 40 per cent club.

It looks at a number of factors, including real and nominal interest rates, real household incomes, the expected return on alternative investments and demographics. It then takes these calculations back a decade. And its conclusion?

It reckons that UK prices have been overvalued since 2001, but only by about 15 per cent. Before that, they were undervalued. US values are also too high: by about 10 per cent. But the really overvalued market is Australia, by 39 per cent.

The Australian market seems to have turned already. A flood of houses on the market in Sydney are not selling, though the official index is still rising.

Clearly, anyone who wants to know whether there will be a crash here has a model to look at: assume that whatever happens to Aussie house prices will happen here - but in a much less dramatic form. Do not, however, expect a cheeky low bid for the penthouse of your dreams on Central Park South to succeed. At the rarefied levels of central London and Manhattan, somebody else will always have more money than you.