16 May 2016

The economic consequences of a UK exit from the EU

Those campaigning for Britain to leave the European Union claim that doing so would make their country both freer and richer. They assert that after a British exit, the UK could quickly negotiate a bespoke agreement with the EU that offers all the benefits of free trade without the costs of EU membership; strike better trade deals with other countries; and reap huge benefits from scrapping burdensome EU regulations. But this is a delusion

In fact, a UK exit would entail huge economic costs for Britain. The uncertainty and disruption of drawn-out and doubtless acrimonious divorce proceedings would depress investment and growth. Permanent separation would reduce trade, foreign investment, and migration, hurting competition, productivity growth, and living standards. And “independence” would deprive Britain of influence over future EU reforms – notably, the completion of the single market in services – from which it would benefit.

The London School of Economics’ Centre for Economic Performance calculates that the long-term costs to Britain of lower trade with the EU could be as high as 9.5% of GDP, while the fall in foreign investment could cost 3.4% of GDP or more. Those costs alone dwarf the potential gains from a British exit. The UK’s net contribution to the EU budget amounted to only 0.35% of GDP last year, and scrapping EU regulation would bring limited benefits, because the UK’s labour and product markets are already among the freest in the world.

The exit process would generate prolonged uncertainty. Officially, it is meant to take two years. But it would probably take much longer. In the 1980s, it took three years to negotiate the exit of Greenland (population: 50,000), and the only controversial issue was fish. Extricating Britain (the EU’s second-largest economy, with a population of 64 million) would be far more complex.

Britain’s new trade deals with non-EU countries would probably involve worse terms

Moreover, any agreement on a new economic relationship with the UK would require unanimity among the EU’s 27 remaining members. And Britain would also have to renegotiate – from scratch – the 50-plus trade deals that the EU has with other countries. All of this would take a long time.

In the meantime, Britain’s trading rules and domestic regulations would be up in the air. Investment and employment decisions would be postponed or canceled. The pound would plummet. The foreign investors financing Britain’s current-account deficit – which hit 7% of GDP in the final quarter of last year – might drive up the risk premium on UK assets or, worse, pull out. All of that would weaken economic growth, jeopardising the government’s fiscal plans.

Once the agreements were made, Britain would have worse access to both EU and global markets. Economically, the least painful option would be to seek membership of the European Economic Area, along with Norway, Iceland, and Liechtenstein. That would provide almost full access to the single market - with opt-outs from EU agriculture and fisheries policies - albeit with customs controls and other trade barriers such as rules-of-origin requirements.

Politically, though, EEA membership would be a raw deal. Britain would have to comply with single-market rules and legislation in areas such as consumer protection, the environment, and social policy – rules that it would have no say in creating. It would also have to contribute to the EU budget, without receiving any spending in return. And it would have to allow EU citizens free entry, a political bugbear for most supporters of a UK exit. Given that the key motivation for a British exit is to restore the country’s supposedly lost sovereignty, a deal that gives the UK no say, but requires that it pay and obey, would be deeply unpalatable.

Trading with the EU according to World Trade Organisation rules, as the United States and China do, would involve the fewest political constraints. Britain would be free to keep out hard-working, taxpaying EU migrants. But this would entail reciprocal EU controls on UK migrants, harming Britons twice over.

This approach would also entail import tariffs on British goods – including a 10% duty on its car exports to the EU – as well as non-tariff barriers. UK-based financial institutions would lose their passport to export freely to the EU. And without full access to the $16 trillion EU single market, with its 500 million consumers, foreign investment would drop. Intermediate options, from the Swiss to the Canadian model, are scarcely more appealing.

Many economic actors would want to hamper their British competitors.

Brexit supporters claim that Britain could strike its own special deal, cherry picking the provisions it likes. The UK would have the whip hand, they argue, because it buys more from the EU than it sells in return. But this, too, is a delusion. The US also has a trade deficit with the EU, yet it doesn’t get to dictate terms in the negotiations over the Transatlantic Trade and Investment Partnership. Moreover, exports to the EU, at 13% of GDP, matter more to the UK than exports to Britain (just 3% of GDP) do to the EU.

In short, the EU would call the shots – and doubtless be tough with the UK. Many economic actors – from German car manufacturers to French farmers to financial centres around the EU – would want to hamper their British competitors. For their part, EU governments would want to punish Britain, not least because they know that a velvet divorce with Britain would bolster anti-EU parties, such as France’s far-right National Front, which has already called for a referendum on EU membership.

Britain’s new trade deals with non-EU countries would also probably involve worse terms. While the UK wouldn’t be hamstrung by protectionist interests in the EU, its smaller economy, largely open markets, and desperation for deals would weaken its clout. Indeed, the US has stated that it has no immediate interest in negotiating a trade deal with Britain. And the protectionist tone of the current US presidential election campaign suggests that the next few years will not see much trade liberalisation.

Thinking through all the economic implications of Brexit is complicated. But the bottom line is simple: leaving the EU would make Britain much worse off.


Copyright: Project Syndicate, 2016.




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