Brexit might not bring economic disaster, but that does not mean it would be astute to leave.
After months of personally grappling with this issue, I’ve finally reached a conclusion on which way to vote in the EU referendum on Thursday. In this article I shall review the key economic issues associated with Brexit and argue that a vote to remain is the most probable path to a more prosperous Britain.
The immediate aftermath
No economist worth their salt – and even most Brexit campaigners – have ever tried to deny that Britain leaving the EU would generate an immediate negative macroeconomic shock to the UK economy. Since the UK is currently running a record current deficit at 7% of GDP, which must be financed by capital inflows, it is highly vulnerable to any loss of confidence from international financial markets. Most experts predict this would significantly reduce value of the pound – some estimates forecast a fall of between 15% and 20% – which would instantly create upward pressure on prices as imports become more expensive.
In the immediate aftermath of a Brexit, it’s likely that the sharp fall in capital inflows, sterling depreciation and prolonged uncertainty over Britain’s new relationship with Europe would spark a recession in the UK economy. Estimates vary on the length and depth, but surely if one considers the performance of the UK economy over the last decade, any form of economic slowdown is undesirable?
The long term economic consequences of leaving
While there is little disagreement on the short term effects of leaving the EU, there is less unanimity among predictions of what the post-Brexit UK economy would look like in the long term. However, most economists seem to think that the long term effects of leaving would be negative. A plethora of reputable, independent organisations predict that economic output would be lower post-Brexit in the long term than it would otherwise be if Britain remained part of the EU: The Centre for Economic Policy Research, The OECD, The Centre for Economic Performance at the London School of Economics, PwC and Oxford Economics to name a few. These organisations, unlike the Treasury, are not the creatures of George Osborne, so it may be worth paying heed to their warnings.
However, that is not to say all economists believe Brexit would bring negative economic consequences… but most do. In a profession renowned for its divisions, there have been few questions that have elicited such agreement. There are a few esteemed economists, such as Patrick Minford and Roger Bootle, who do make lucid, compelling economic arguments for Brexit, yet they are in a small minority.
Trade: would Brexit offer the UK a better deal?
The most often-quoted benefit of EU membership is the tariff-free access to the single market that it affords British businesses. Brexiteers correctly argue that free trade deals are not necessary to trade with other countries – Britain’s largest trade partner, the United States, hasn’t traded freely with the UK since 1776. However, to only discuss tariffs and trade deals is to miss the point. Globally, tariffs have fallen considerably since 1973 when the UK first joined what-was-then the European Economic Community, so a post-Brexit Britain would find international trade easier than when we initially joined.
Yet, tariffs are only one barrier to trade. There are others too, especially geographical distance and regulatory barriers; physical proximity and EU membership enables trade between Britain and Europe to overcome both. But furthermore, trade between Britain and the continent is actually greater than would be expected based on geographical distance. Recent analysis by the Centre for European Reform, a think-tank, calculates that the flow of goods and services across the Channel is 55% greater than a gravity model of trade (where trade volumes are determined by physical distance and economic mass) would predict. Thus, the EU does indeed create trade, and the benefits of membership come from new economic activity facilitated by the single market, rather than commerce simply being diverted outside the EU by the common external tariff. The economic integration of the EU promotes cross-border supply chains, which is undoubtedly advantageous in an ever-increasingly complex global economy.
There are practical issues too. Currently the EU has negotiated trade deals with over 50 countries (although progress is being made with other, much larger economies, such as China, America and India). This means that a post-Brexit Britain would need to renegotiate a deal with all of them, while at the same time frantically trying to salvage its economic relationship with Europe after the divorce. Since Britain has spent the last four decades inside the EU, its civil servants have little experience of forging bilateral trade agreements. After activating article 50 of the Lisbon Treaty, Britain would have a mere two years to forge free trade deals with the EU and all the other countries it currently trades with freely due to EU membership. Considering that trade deals are rarely ever quick and easy to negotiate, even the most optimistic Brexiteer would have to concede that it would be a tall order.
Consequences for London? Pity the City
One of the biggest losers from a Brexit would be the financial centre in the City of London. Financial and business services account for over 1/10th of both British output and government tax receipts. Furthermore, it is one of the few areas in which Britain runs a trade surplus with the rest of the world. While London’s dominance of global finance would not end if the UK decided to leave, chunks of the industry may decide to move. For example, Dublin and Luxembourg excel in fund management.
But there is a larger, less talked about, issue here. Currently the European single market is not complete: it only accounts for goods, and full integration in service trade has not yet been achieved. Services account for 70% of Europe’s economic output and generates over 90% of new jobs, yet it only accounts for 20% of intra-EU trade. A move to extend the single market seems both plausible and logical. Considering the fact that Britain has a strong comparative advantages in services, and that they represent around 80% of GDP, the UK would be a clear winner from what seems to be an inevitable move towards further integration in services trade. London would become to Europe what New York is to America: financial services would migrate to London and the City would not only retain, but extend its hegemonic position as a global economic hub.
The future of Britain and the EU
One aspect of this debate is that we must appreciate that there is no status quo. Whatever the result of the referendum on 23rd June, the EU will not be the same organisation in ten or twenty years time. Therefore, it’s more important to consider what the future EU will look like, rather than the current one.
Britons have many gripes about EU rules and regulations, yet most EU members also want less, not more, red tape. The European Commission is now proposing fewer rules and is even withdrawing existing ones. It’s slightly ironic for the UK to consider leaving right at the point when the EU is becoming less intrusive and adopting a more liberal approach to economic regulation.
Another important point, made by President Obama during his visit to the UK in April, is that EU membership does not diminish, but amplifies British influence in the world. According to some estimates, the UK is set to overtake Germany as Europe’s largest economy by 2030. Furthermore, current demographic trends indicate that Britain may also soon become Europe’s most populous state. In light of this, and the fact that no EU state has a natural claim to leadership – Germany may be an economic powerhouse, but is reluctant to lead on foreign policy matters; France possesses military might, yet its economy is performing weakly – the UK could very plausibly hold more influence in the future EU. This would enable Britain to push for a more liberal, competitive and dynamic Europe.
What are the real costs of remaining?
Immigration has taken centre stage in the Leave campaign’s argument and there are legitimate concerns about the strain on housing, public services and infrastructure that such a rapid influx of people creates. However, as Jeremy Corbyn correctly identified during his interview with Andrew Marr on Sunday, European free movement merely exacerbates these issues: the root cause is successive failures in government policy. Furthermore, EU migrants tend to be better educated than non-EU migrants, so the economic benefits they bring will be even higher. Rather than shutting the doors, it would be better to invest more in infrastructure and loosen planning regulations to facilitate the construction of homes.
For all the claims made of the EU’s bureaucratic and intractable nature, membership has not prevented Britain from being one of the most flexible and lightly regulated economies in the rich world. Arguments about red tape holding back the UK economy are simply a red herring.
The biggest red herring of all however, is the cost of membership of the EU. It perplexes me why the Leave campaign have chosen to make this a central issue when the net membership cost cost of £8.5bn accounts for little over 1% of government expenditures. It really is a non-issue.
The most pernicious cost of EU membership, which sadly seems to have flown under the radar during this dismally dumbed-down debate, is the common external tariff. The EU is a protectionist trading bloc which imposes a sizeable wall of tariffs and other trade barriers around its single market in agriculture and manufactured goods. Therefore, leaving could very plausibly reduce the cost of imports and consumer prices would fall by 8%. However, the gain from falling tariffs would be offset by any depreciation of sterling, so it is difficult to predict whether leaving really would leave us better off.
Conclusion: It’s not broken, so don’t Brexit
In both the short and long term, the consensus seems to be that leaving the EU would be detrimental to the British economy, and therefore the material wellbeing of all who live here. It’s unlikely that the UK’s global terms of trade would improve, and London, the powerhouse of the British economy, would almost certainty suffer. All countries, including Norway and Switzerland, who desire access to the European single market must agree to free movement, so leaving the EU in order to control migration would be futile.
But a more forward looking voter would consider what the future holds for a Britain inside the EU. The EU is finally becoming less bureaucratically overbearing; a move towards further integration of trade in services looks inevitable in future; and the UK is projected to become the largest, both economically and population-wise, EU state, and thus a very credible candidate to lead the continent in a more liberal, dynamic direction. To leave now would not only be economically unwise, the UK would also miss a huge opportunity.