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Brexit and Its Economic Fallout

Jun 15 2016 - The United Kingdom is now in the midst of a Shakespearean dilemma, “to stay or not to stay”. Voters will decide in a referendum on June 23 whether to stay in the European Union or to break the four decades old relationship they forged, i.e. opt for “Brexit” as it is popularly known. If the majority decides to leave, it will have implications for Britain across the spectrums, political, economic, and social. While in the last referendum on this issue in 1975, an overwhelming 68 percent of the electorate had decided to stay, this time the margin will be narrower, one way or the other. Britain’s departure from the EU will also undoubtedly set a bad example for advocates of Customs Union, an economic arrangement of sovereign countries set up to facilitate trade and economic integration through trade.

While there are many issues relating to the current mood of disillusionment with Britain’s ties with EU, they are not all economic. The most important ones are: immigration, excessive EU regulations, budgetary contributions, loss of sovereignty, and EU social policy. However, all of them have economic side-effects, including the non-economic ones, immigration and EU’s regulatory influence. Prima facie, Brexit appears to be a dramatic move; nonetheless most analyses show that the most important long-term impact could be minor in terms of GDP and unemployment rate. As one meta-analysis points out, the decision to leave the EU appears to be mainly a political consideration about sovereignty and self-determination.

From the policymaker’s perspective, the most important lesson is that the forecasts on GDP are very uncertain. Nine out of ten economists surveyed indicate that in the short-run the economy will experience a downward adjustment, but the loss of income is small. But in the long run, there is a potential for greater loss, and the risk of bigger losses is large.

Fortunately, Britain is not in the same shoes as Greece, since the former has its own currency – the pound sterling – and has not embraced the Euro. It has also been doing much better than its EU partners in recent years. However, EU is Britain’s most important trading partner, accounting for half of all UK exports and imports. UK exports to the EU correspond to almost 15 percent of national output (GDP). Eurosceptics, i.e., those who believe that membership in EU is hurting the UK, counter that “membership of the single market imposes too many regulations on Britain in exchange for too little opening of European markets and that Britain’s trade with countries outside Europe would be higher if it left”.

Unfortunately, should Brexit occur, the UK will need to negotiate a new trade relationship with the EU, and outcomes will depend on the terms of the subsequent trade arrangement and the regulatory framework that it adopts once it is free of EU’s regulatory framework. And there are many alternative trade regimes that have been circulating in the research and media world to capture the short and long-term economic impacts in the post-Brexit world. A sampling of these include joining the European Economic Area (EEA, like Norway), entering into a Customs Union (like Turkey), negotiating a Free Trade Agreement (that eliminates export tariff barriers, like Canada), and the Swiss model (continued bilateral negotiation). Some of the core metrics include GDP growth, trade volumes, inflation, household spending, employment, property values, and assets prices.

A quick survey of economic forecasts based on quantitative models indicates that Britain might benefit or lose from breaking up with the EU. However, the most important conclusion seems to be that the magnitude of the economic impact is hard to predict. Any divorce lawyer will tell you that. Most domestic relationships don’t go sour for economic reasons, rather due to social or personality conflicts. But, any breakup affects both parties and other family members. Britain’s mood until June 23 is captured by a song “Should I Stay or Should I Go” by the English punk rock band The Clash written in 1981. The latest opinion poll indicates that there is a greater than even chance that the Brits will decide to leave, unless Prime Minister Cameron can get the voters out in droves.

The writer is an economist, and writes on public policy issues for this newspaper.

This story was originally published by The Daily Star, Bangladesh

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  • HelenaH

    Hello – I think Mr Cameron is worried about getting voters out in droves because they are all going to vote Leave. PS This is a very good article. Thank you Dr Shibli. We are just so excited to work with our Commonwealth more.