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Impact of a Brexit involves many economic uncertainties

Economic Report

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  • Most probably, the majority of the British population will vote in favour of EU membership in the Brexit referendum
  • A Brexit would be less favourable than retention of EU membership for both the UK and the EU due to the economic and political effects
  • If a Brexit actually happens, the impact on British trade, the financial sector and the discussions about independence for the various UK countries could be significant

At this point, we expect the British population to vote in favour of EU membership in the referendum that will be held before the end of 2017. We base this opinion on the national consideration of the economic and political interests that would be involved if the UK were to leave the EU (a Brexit). There are however two important footnotes to make, and these involve aspects that could increase eurosceptic sentiment. Firstly, the extent to which the British government succeeds in getting EU treaty reforms. One of Cameron’s demands is the limitation of access to social security by immigrants in order to reduce the inflow of immigrants from the EU. This conflicts with the principle of free movement of persons, one of the fundamental principles of the union. In the absence of concessions from European government leaders, this could increase the risk of an exit. In other areas, concessions appear to be more likely, such as reforms to improve competitiveness, reduce bureaucracy, protect non-eurozone countries, a greater role for national governments and exempting the UK from the treaty objective of ‘ever closer union’.

Secondly, the turbulent summer, with the Greek debt crisis and the refugee crisis, has increased eurosceptic sentiment among the British population. According to a poll conducted in September by the Mail on Sunday, a majority of British people (51%) voted in favour of exit for the first time in years. This does not necessarily give a true impression, since British polls conducted last year for the federal elections and the Scottish referendum were well wide of the mark.

Further European integration would be threatened by a Brexit

A UK exit would be undesirable for the EU for three reasons. First of all, the UK is a substantial member state with GDP of around 10% of the GDP of the EU and a contribution of approximately 10% of the EU budget. Secondly, a Brexit would break the trend of continuing further European integration and could thus be a problem for the unification of Europe, certainly since the potential departure of Greece from the eurozone is still fresh in people’s minds and also given the current political divisions between EU countries on how to deal with the refugee crisis. Furthermore, there is the question of whether a Brexit would have a domino effect. Euroscepticism has risen in many countries (see also Political developments in Europe). A setback in European integration could damage the strength of Europe as a block and its global position. 

Figure 1: Dutch exports to the UK by sector
Figure 1: Dutch exports to the UK by sectorSource: OECD

Thirdly, the European economy would suffer as a result of the trade interests involved in a Brexit. Any reintroduction of import duties could be detrimental to the disposable income of EU consumers and European investments as a result of mark-up on British products. In addition, European products would become less attractive to British consumers as a result of import duties. Given the EU’s trade surplus with the UK, the effect of this could be significant. In 2014, EU exports of goods to the UK accounted for more than 6% of total exports[1]. In particular, Germany (6%), France (8%) and the Netherlands (8%, figure 1)[2] export a relatively large proportion of their goods and services to the UK. The introduction of import duties on British goods could however to some extent be offset by diversification of trade flows within the EU.

Britain’s membership of the EU is of special importance to the Netherlands, since the two countries in most cases share the same views with respect to regulation. Moreover, the UK is a strong countervailing party for major countries Germany and France. In the event of a Brexit, the Netherlands would thus lose an important and strong ally in European policy discussions.

Footnotes
[1] Not adjusted for re-exports.

[2] Export values for Germany, France and the Netherlands are adjusted for re-exports and date from 2011.

British considerations

The impact of a Brexit on the UK economy is as yet uncertain, but it would be felt in many different ways. Various studies have attempted to assess the effect on British GDP, but their estimates range from -5 to +6 percentage points. The loss of access to the European internal market could indeed have a huge economic impact. In the short term, the legal uncertainties surrounding a Brexit could have a negative impact on investor sentiment.

UK trade has relatively a lot to lose after a Brexit

The EU is an important market for the UK: 40% of total British exports go to the EU (figure 2) and exports to the EU in 2011 added 10% to British GDP. The free trade of British goods to the EU would disappear after a Brexit. Without a free trade agreement, import duties could be reintroduced. Most probably, the British authorities would make every effort to conclude at least partial trade treaties with the EU in the wake of a Brexit, but it is still not certain to what extent free trade would return and how long this would take.

Although more than half of total exports to the EU concerns commercial services and services are mostly exempt from import duties, there could be obstacles as a result of legislation and regulation. Furthermore, the EU is an important market for all British sectors (figure 3). Trade limitations would therefore be felt in all sectors.

Figure 2: EU is an important destination for British exports
Figure 2: EU is an important destination for British exportsSource: OECD
Figure 3: EU is an important market for all British sectors
Figure 3: EU is an important market for all British sectorsSource: OECD
Figure 4: EU a large supplier of British goods imports
Figure 4: EU a large supplier of British goods importsSource: Office for National Statistics (ONS)

In the absence of new trade treaties with the EU, the UK would have a trade regime based on the Most Favoured Nations (MFN) regulation of the World Trade Organisation (WTO). The MFN tariffs would apply to more than 95% of the value of the goods exports from the UK to the EU and the trade-weighted tariff for the UK would amount to more than 3%. Businesses in sectors with high MFN tariffs, such as the automobile industry with tariffs of 10% and the tobacco industry, for which tariffs of up to 74.9% apply, would see their competitive position worsen significantly as a result of high mark-ups. This would have a negative effect on the competitiveness of British exporters (compared with competitors within the EU and competitors in countries with which the EU has a trade agreement) and in view of the relatively large volume of trade with the EU, there would be a negative effect on the UK economy. Furthermore, after a Brexit all the trade treaties that the EU has concluded with other countries would lapse and British exports of goods to these countries would also be subject to import duty. It is likely that the British government would impose limited import duties on European goods, in order to cultivate good will in the EU and to protect British households and businesses against higher prices as a result of import duties (55% of British imports come from the EU, figure 4).

New opportunities for British trade?

Without EU membership, the UK would be free to conclude bilateral free trade agreements, for example with the USA and emerging economies. A bilateral agreement would probably be much quicker to conclude, because then the views of 28 different countries do no have to be taken into account. For example, in the past two years Switzerland and Iceland have succeeded in concluding a free trade treaty with China. However, for a relatively small country such as the UK it will be difficult to win favourable terms in treaties with large countries such as China and the USA. A block like the EU is better positioned since the interests of the collective are protected. Moreover, concluding treaties of this kind often takes years, so that any benefits to the UK would only be felt in the long term.

The British financial sector at risk

The British financial sector centred in London would be at risk after a Brexit, since banks could lose their access to the EU internal market and their passport rights (mutual recognition of banking licences). Non-tariff trade restrictions could thus hinder the export of financial services. Many businesses from outside the EU, and banks in particular, use the UK as an access point for the EU as they benefit from the free traffic of goods, services, capital and people. Increased direct investment from non-EU countries in the financial sector and the volume of exports of financial services to the EU reflect the importance of the EU passport (figures 5 and 6). If the UK loses its access to the internal market and transactions with businesses and banks on the European continent become more difficult, banks and other financial businesses could leave London for continental Europe. A number of banks and investment firms have already stated or warned that they would leave London if a Brexit occurs.

Figure 5: Increasing FDI (from outside the EU) in financial services                   
Figure 5: Increasing FDI (from outside the EU) in financial services                    Source: ONS
Figure 6: Large proportion of British exports of financial services to the EU
Figure 6: Large proportion of British exports of financial services to the EUSource: World Trade Organisation

EU immigrants, government finances and regulation

Although changes to EU immigration policy are one of the priorities of the British government in the renegotiations of the EU treaties, the inflow of immigrants from the EU has a number of potentially positive effects on the British economy. Most EU immigrants travel to the UK for work-related reasons: either because they are certain to find a job, or because they are looking for work (figure 7). More than 40% of all immigrants from the EU into the UK in 2014 had completed tertiary education (figure 8). This figure is high in comparison to other EU countries with a large inflow of EU immigrants. Furthermore, the proportion of immigrants with low-level education is relatively small. This inflow of well-educated people has a positive effect on the British economy, since they are on average highly productive. This effect could disappear if restraints are imposed on the flow of immigrants. In addition, Dustmann and Frattini (2014) found that immigrants from the EU contributed more in tax than they received in benefits between 2001 and 2011. They thus had a positive net effect on government finances.

Contrary, the British government could achieve net savings of between nine and ten billion pounds a year on its contribution to the EU budget if the UK were to leave the EU. This represents approximately one-seventh of the estimated budget deficit for this year.

After a Brexit the British economy could benefit from deregulation of the labour market, abandonment of an expensive energy policy and the possibility of importing cheap food from anywhere in the world. Small businesses in particular suffer from high costs due to European regulation. If the UK leaves the EU, this will however not necessarily mean revocation of legislation and regulation. If the UK wishes to retain access to the internal market, it will have to keep some of the EU regulation. Since British companies are part of many European production chains, this may be necessary for many sectors. The UK would in this case still be subject to some of the costs of legislation and regulation, however it would lose its input in their formulation.

Figure 7: Employment is the motivation for EU migrants
Figure 7: Employment is the motivation for EU migrantsSource: ONS, International Passenger Survey
Figure 8: Relative high proportion of well-educated EU immigrants into the UK
Figure 8: Relative high proportion of well-educated EU immigrants into the UKSource: European Commission
Note Figure 7: EU2: Bulgaria and Romania; EU8: Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia and Slovenia; EU15: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Italy, Luxembourg, the Netherlands, Portugal, Ireland, Spain, Sweden and the UK.

Divided opinions between the UK countries regarding a Brexit

The divisions between the various UK countries regarding a Brexit could also breathe new life into the issue of the independence of these countries. Scotland, and to a lesser extent Wales and Northern Ireland are more pro-European than England. Since England has a larger population, the result of the Brexit referendum could be tilted towards ‘exit’, while the other UK countries could vote to stay in the EU. This would lead to discussions on independence within the UK, particularly in Scotland, and could even lead to complete or partial dissolution of the UK.

Brexit – alternative scenarios

One option for the UK after leaving the EU would be membership of the European Economic Area (EEA), like Liechtenstein, Norway and Iceland. The EEA is reasonably closely connected to the EU and gives access to the internal market while offering freedom with respect to regulation. The disadvantage of EEA membership would be that the UK would not be able to conduct an independent immigration policy, it would still have to deal with EU regulation but would have much less influence in this area, and it would still have to pay around half its current contribution to the EU budget. So this is not an attractive option for the UK.

The UK could also decide to become a member of the European Free Trade Association (EFTA), like Switzerland, which has looser ties with the EU. Access to the internal market would be maintained, however the banks would lose their passport rights. This is therefore also not an attractive option for the UK. 

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