Would Brexit spell economic disaster for the UK?

Image: Jeff Djevdet

With the EU referendum fast approaching, much has been made of the consequences, particularly economic, of a British exit from the European Union. However, because of the uncertainty over what Britain’s relationship with the EU would look like following a Brexit, it’s very difficult to know what the economic ramifications would be. In this article I examine some of the concerns voiced by the “remain” side and ask whether Brexit really would spell economic disaster for the UK.

 

“Britain depends on EU membership for free trade with Europe”

It may be true that the EU gives British exporters tariff-free access to a market of 500m people, but Europe is actually decreasing in relative importance to British trade. In 2014, about 45% of British exports went to the EU, down from almost 55% in 1999[1]. This is largely because the EU economy has been growing more slowly than the rest of the world, particularly emerging markets.

Furthermore, membership of the EU is not a necessary condition for free trade with Europe. Every country from non-EU Iceland to non-EU Turkey is part of the European free trade zone.

It’s almost certain that the UK, Europe’s 2nd largest economy, would be able to negotiate some sort of trade deal with the EU; however, the economic consequences of Brexit depend very heavily on the terms that deal. An ideal scenario would be a “Single Market-Lite” arrangement – leaving the EU, but staying inside the single market – but this would likely be very difficult to negotiate as it must also include voting rights over the rules governing the single market[2]. Perhaps a more politically feasible alternative would be a comprehensive Free Trade Agreement, ideally one that includes access for financial services and a say over how standards and regulations are implemented.

As our closest neighbours and the largest economy in the world, the EU will always be a crucial trade partner to the UK and, if the right trade deal can be negotiated following an “out” vote, there’s no reason to think this successful economic relationship can’t be maintained.

 

“By leaving the EU, the UK would lose clout when negotiating trade deals”

While its difficult to believe there wouldn’t be a new trade agreement between Britain and the EU, we must remember that British trade with 60 other countries is currently based on agreements made with the EU as a whole[3], meaning new deals would need to be negotiated. It’s intuitive that membership of a larger bloc provides more bargaining power than a small country, but that doesn’t mean small countries cannot strike trade deals on their own. Here’s a comparison: in 2015, the total GDP of the 55 countries that the EU has a trade agreement with was $7.7 trillion; contrast this to Chile who had agreements with countries who’s aggregate GDP totalled $58.3 trillion[4]. Not only does this discredit the notion that we need the EU to make trade agreements with the rest of the world, but it also casts doubt on how effective the EU is at linking our economy to the rest of the world.

 

“Brexit could reduce the flow of migrant workers who are hugely beneficial to the UK economy”

There’s no doubt that Britain’s economy benefits hugely from the flow of migrant labour coming from Europe. Free movement helps fill skills shortages, it has a net benefit to British public finances, and the supply of young workers helps pay for the retirement of Britain’s swelling ranks of pensioners.

A Brexit would likely result in a reduction of net migration into the UK, but that’s not necessarily a bad thing. For all the benefits immigration brings, it also exacerbates the UK’s shortage of affordable housing and it’s difficult for public infrastructure to keep up with the volume of new people entering the country every year – 336,000 in the year to June 2015[5]. Building new homes, schools and hospitals takes time so reducing immigration to a manageable level may even be a good thing.

However, with a growing economy, exceptionally low unemployment, and a minimum wage set to rise to £9 per hour by 2020, Britain will remain an attractive place to emigrate to and Brexit poses little danger of cutting off the UK’s supply of migrant labour.

What’s more is that European free movement of labour forces the government to discriminate against non-EU migrants. Remember the new law that states non-EU migrants earning less than £35,000 a year must go home? Not only is it unfair, but it also smacks of desperation. The government, unable to curb EU migration, has resorted to extreme and unjust measures in its attempt to meet its 2010 election pledge to reduce immigration below 100,000. A fairer, points-based system would be a better way to ensure that Britain can maintain its valuable supply of immigrants, but at a pace which public infrastructure can keep up with.

 

“Half of the UK’s Foreign Direct Investment comes from Europe”

EU countries account for around half the stock of foreign direct investment in the UK, and much of the FDI that comes to Britain, especially from China and India, is heavily influenced by Britain’s economic ties with the EU. Furthermore, with investors being the jittery bunch that they are, the uncertainty caused by a Brexit would very possibly have an adverse effect on on foreign investment in Britain, especially in the short-term. Proponents of Brexit cannot escape the fact that, until a new economic relationship with Europe has been established, uncertainty would most likely diminish the amount of foreign capital flowing into the British economy.

Yet, we must also remember that the UK, which is the 3rd largest recipient of FDI globally[6], offers investors many advantages that would be unaffected by Brexit such as language, light regulation, low business rates and deep capital markets. Ultimately, the UK will remain an attractive place to invest and, once clarity had been restored to economic arrangements with the EU, there’s little reason to think a Brexit would seriously hinder foreign investment in the UK in the long term.

 

“Brexit would cause a rout on the pound”

If there were an abrupt interruption to the capital inflows Britain receives from abroad, the reduced demand for sterling would cause the currency to depreciate. In fact, Goldman Sachs predicts there could be a 20% fall in the value of the pound[7]. Aside from making holidays more expensive for Brits, this would likely lead to higher inflation due to the relatively higher cost of imports.

However, there could also be an upside to this: a weaker pound would make British exports more competitive abroad. For a long time now, Britain has run a trade deficit with the rest of the world – we buy more than we sell, and borrow (in the form of FDI) to make up the difference. Perhaps a currency devaluation is the shock Britain needs to wean itself off borrowing from abroad and correct the current account deficit that has been anathema to policymakers for years. Indeed, the same Goldman Sachs team that predicted a fall in the value of sterling also conceded that the last time the pound fell in value by 20%, during the global financial crisis of 2008, the current account deficit shrank from 3.4% of GDP to virtually zero[8].

 

Conclusions?

 A Brexit would almost certainly be detrimental to the economy in the short run, primarily because uncertainty over Britain’s future relationship with the EU would diminish the flow of foreign investment into the UK, causing a fall in the value of sterling and potentially limiting growth. Yet, as we’ve seen, a depreciation of the pound could be the shock the UK economy needs to rebalance its economy to close its trade deficit with the rest of the world.

It’s almost certain that a new trade agreement would be made, meaning that Britain would likely maintain it’s access to trade with Europe. Furthermore, striking it out on its own would allow Britain to forge new economic links with foreign countries – something that Chile has been much more adept at than the EU. Once clarity on Britain’s relationship with the EU is re-established, foreign capital would likely return because the the UK economy offers far more advantages to investors than just EU membership. Moreover, Brexit would enable Britain to reduce net migration to levels at which public infrastructure can keep pace, while simultaneously giving the UK the opportunity to access to talented workers from across the globe, not just one continent.

To conclude, Brexit is likely to be damaging in the short run, but there’s no reason to think it would dent the UK’s long term economic prospects. In fact, it might actually help them.

 


 

[1] http://webarchive.nationalarchives.gov.uk/20160105160709/http://www.ons.gov.uk/ons/rel/international-transactions/outward-foreign-affiliates-statistics/how-important-is-the-european-union-to-uk-trade-and-investment-/sty-eu.html

[2] http://openeurope.org.uk/intelligence/britain-and-the-eu/what-if-there-were-a-brexit/

[3] http://www.ft.com/cms/s/2/70d0bfd8-d1b3-11e5-831d-09f7778e7377.html#axzz43HiPHWSS

[4] http://www.civitas.org.uk/press/no-benefit-for-uk-trade-from-eu-collective-clout/

[5] http://www.bbc.co.uk/news/uk-34931725

[6] www.parliament.uk/briefing-papers/SN06091.pdf

[7] http://www.theguardian.com/business/2016/feb/04/brexit–slash-sterling-20-warns-goldman-sachs

[8] ibid

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