I’m not losing sleep over Brexit, but the topic gets a lot of attention. After reviewing several analyses, across reputable sources, I think that nobody has a clue what would happen if the UK voted to leave.
The UK has historically been a magnet for migrants
And not knowing is what makes Brexit such a negative market event in the short term. Staying in, at least, we know what it looks like.
A recent analysis by the British Treasury, hardly a disinterested party, says that an exit would leave the UK worse off, even if it remained a member of the European Economic Area, as Iceland and Norway. The main costs, in the long term, would come from less openness to trade and less foreign direct investment, both of which would crimp productivity growth. The net fiscal gain, according to the Treasury, would be negative, because weaker tax receipts would outweigh contributions to the European Union. Under the worst-case scenario, the country would lose about 7.6% of its GDP a year over 15 years.
Brexit Does Reduce the Fiscal Deficit
According to various studies at the Centre for Economic Performance (CEP) of the London School of Economics, Brexit does reduce the fiscal deficit. That would be, according to CEP, the main benefit. The principal cost would be less trade with the European Union. A big uncertainty in these studies is what it means to be outside the EU, since there is no exit agreement. How high would tariffs and other trade barriers be? In a static model, with no changes, for example, in productivity, the CEP analyses predict a cost between 1.3% and 2.6% of GDP.
Besides trade and fiscal costs, a big factor in the long term is immigration. The UK has historically been a magnet for migrants. The educated ones are attracted by The City; the unskilled ones find jobs at the low end of the services industry. This would remain true, at least in the medium term, inside or outside the EU, but Brexit would presumably reduce entry of EU citizens. European immigrants contribute positively to UK’s finances and, perhaps, productivity as well. After immigration and foreign direct investment, and their effect on productivity, are baked in, the cost estimated by CEP rises to 6%-9% of GDP.
Does Brexit Mean Scoxit?
Deregulation is a big selling point for Brexit fans. Yet they forget that the UK is perfectly capable of producing bad policies and red tape on its own. Some shining examples: land-use laws in London; the delay in the expansion of Heathrow; the big jump of the national minimum wage. Among the probable political fallout, I would highlight “Scoxit”—i.e. Scotland’s exit from the United Kingdom. Northern Ireland, too, might rejoin the rest of its isle. Brexit could then turn Great Britain into Little England: a small, wealthy, insular, strategically-located country, focused on finance and trade. That might not be a bad thing. Singapore, after all, is the envy of many, but it might not be what Britons envision for their country.
President Obama’s statements in April suggested that even trade with the U.S. would suffer, but sweeping assertions that “the UK would lose access to [such and such] market” seem to me incredible.
The British know-how for finance and trade, and the financial plumbing, wouldn’t vanish overnight, even if the cost of trading with, investing in, and moving in and out of the UK rose marginally. In any case, the market consensus is that, right after leaving the EU, sterling would fall further.
Within two years that would stoke inflation and reduce the trade deficit—which might not be bad things, considering today’s state. The performance of equities would be mixed. Large-cap corporations receive a significant share of their revenue far away from the UK or Europe, so the sterling value of their profits could rise. Companies in the small- and mid-cap indexes tend to be more focused in the UK and the Continent, so they would most likely underperform. A clear winner would be volatility.
Brexit or Not, Growth Will Slow
Brexit uncertainty, is expected to dampen growth in Q2, as firms put off investment. Unemployment remains at a decade low, while the employment rate is the highest since records began in 1971.
The economy is now 8% bigger than at the start of the 2008 recession—for comparison, the eurozone’s GDP regained its 2008 size just last quarter. Growth in the UK has been entirely due to the service sector. Both construction and manufacturing are still below the levels of eight years ago, an in fact have been shrinking over the last few quarters.
