On June 23, a referendum will happen, to decide whether the UK will remain within the European Union. The political economy of Brexit—the exit of the UK from the EU—has further deteriorated after the assassination of a young member of British Parliament, Jo Cox, on June 16. The outcomes of referendum—“leave” or “remain”—whatever thin the margin, will have geopolitical and macroeconomic repercussions.
Janet Yellen cited the Brexit as one of the reasons for the Fed’s decision to keep interest rates unchanged. The US Treasury secretary Larry Summers also argued to maintain status quo in rates, given the sluggish growth in GDP in Q1, the significantly slow job growth, and the possibility of Brexit.
But this is not the first time, the countries in the EU have pressed an alarm to exit. It is important to recall the ‘oxi’ votes in Greece, as recently as a year back, which led to the renegotiations of fiscal austerity packages to prevent a Grexit. Contrary to fiscal austerity and debt burden which created the Grexit crisis last year, the immediate cause of concern for Brexit is the issue of sovereignty and the hard regulations that the UK had to accept with little in return, on the issue of immigration. Historically, no country has ever left the EU, and the likelihood of exit repercussions are least known. The UK, though a part of EU, has never adopted Euro as their currency and the country has maintained its own government, central bank and military.
The top think tanks in UK like the National Institute of Economic and Social Research (NIESR) have cautioned that with Brexit, “inflation would jump dramatically as sterling depreciates, investment would plummet and consumer spending would be hit by lower real incomes.” NIESR further warned that “the longer term impact of leaving the EU could reduce GDP by anything between 1.5% and 3.7% by 2030 depending on the subsequent relationship between the UK and the EU, as well as the rest of the world”. The OECD report published in April also warned that Brexit would be akin to a tax on GDP, and the extent of foregone GDP would increase over time. By 2030, GDP would be over 5% lower than otherwise.
The Bank of England’s Monetary Policy Committee, claims that Brexit is likely to weaken the pound enhancing the country’s export competitiveness. However, a former EU trade commissioner, Lord Mandelson, cautioned that free-trade agreements “do not come free” and exit can damage the economy. Barack Obama also has warned that Brexit would put the UK at the “back of the queue” in any trade deal. The French economy minister, Emmanuel Macron, has warned that Brexit will lead to geopolitical isolation of the UK as a tiny trading post on the edge of Europe. He cautioned that leaving the EU would mean the ‘Guernseyfication’ of the UK, which would then be a little country on the world scale. Russian president Vladimir Putin has accused UK prime minister David Cameron of holding the referendum to “blackmail” and “scare” Europe.
What would Brexit mean for London’s status as a world financial capital? As UK economy significantly depends on trade and finances, Brexit could take a toll on the economy. Firms and banks would relocate to other EU financial hubs, the main reason being the loss of passporting rights—rights which allow any British based bank or investment firm to trade across Europe. Further, UK would have to trade under the WTO rules and would have limited trade access like many other countries.
With the rise of terrorism, security concerns loom large when we talk about Brexit. The defence secretary Michael Fallon mentioned “it is through the EU that you exchange criminal records and passenger records and work together on counter-terrorism.” David Cameron himself admitted that membership of the EU made Britain safer. The EU has developed a common foreign and security policy. Brexit would also put the question of Scotland’s independence squarely back on the agenda.
From public finance perspective, the UK Treasury came up with three scenarios: One, if the UK leaves the 28-nation EU and becomes a member of the European Economic Area (EEA), like Norway, the UK economy is predicted to be 3.8% smaller, and tax receipts would be £20 billion smaller. Two, if the UK negotiates a bilateral agreement, such as that between Canada and the EU, GDP would be 6.2% smaller and the tax receipts would be £36 billion smaller. Three, if the UK gets WTO membership without any form of specific agreement with the EU, like Russia or Brazil, GDP would be 7.5% smaller and the hole in the public finances would be £45 billion. The worst of the three outcomes is WTO-type membership.
Estimates by Britain’s leading think tank Institute of Fiscal Studies (IFS) also warned that leaving the European Union would compel UK to adopt fiscal austerity measures by up to two years to achieve a budget surplus. IFS also warned the impact of lower economic growth and extra borrowing costs would knock a £20 billion to £40 billion hole in the government’s finances by 2020.
Finally, the IMF also warned that a Brexit could mean the UK missing out on up to 5.6% of GDP growth by 2019. In its annual economic outlook it said that it is the “largest near-term risk” to the UK economy. However, these views were dismissed broadly as “establishment views” by one of the authors of “The economists for Brexit” report, Prof Patrick Minford (a former economics adviser to Margaret Thatcher). He mentioned Brexit would damage the UK economy as “a load of complete nonsense”. The pro-Brexit negotiators argued that a Brexit will increase growth and productivity as it would be out of the protectionist trade agreement with the EU and it also help the country to build new trade relations with emerging economies.
“The economists for Brexit” campaigners like Matthew Elliot, chief executive of Vote ‘leave’, also said that the analysis was “partial” and those conclusions were derived out of “flawed EU-centric models”. Campaign co-chairman Patrick Minford mentioned that “the IMF report, like the Treasury’s, uses flawed models and makes deceitful assumptions to project doom and gloom from Brexit whereas with solidly based models and assumptions Brexit gives the UK more growth and better living standards.” Instead, he mentioned that “If we Vote Leave we can create 300,000 jobs by doing trade deals with fast growing economies across the globe. For Brexit campaigners, the formidable risk is to stay within the failing eurozone.
Having analysed these debates and research reports on Brexit, one can say three things are inevitable, ex-post to Brexit, which have direct implications for emerging economies. One, an emergency budget would be announced, with a major chunk of fiscal austerity measures—that is, with cuts on good public spending and a call on deficits. Two, the growth of the economy would depend on attracting skilled labour from other countries if the migration from EU is controlled. Three, the world class higher education institutions may be in doldrums, with fiscal austerity measures and immigration controls.
The authors are with National Institute of Public Finance and Policy, New Delhi Views are personal