How Serious Is Brexit?

By David Bassanese | More Articles by David Bassanese

With the Brexit vote looming large, markets are understandably on tenterhooks as to the outcome.

To my mind, the great problem with the Brexit vote is not so much the global economic consequences should the UK decide to leave the Europe Union, but rather the sheer uncertainty or “event risk” ahead of the decision.

A month or so ago, it seemed safe to ignore the Brexit vote. After all, it was still some time away. And although polling suggested the voting would be close, there remained a large slab of undecided voters. The betting markets, moreover – often the best predictor of events – still gave around an 80% chance to voters deciding to Stay.

What has rattled markets of late is the fact that the official polls have detected a moderate swing to the Leave camp, placing it just ahead of the Stay brigade. More ominously, however, is the fact that even the betting odds have narrowed, with the risk of Brexit rising from around 20% to 40%.

So how the vote goes remains to be seen. But my hunch is that global markets should soon get over this sideshow whichever way the vote goes.

As for the UK itself, I must say of have some sympathy for the Leave arguments, and do not think the consequences for the UK of exiting the EU would be as dire – especially over the long-run after some short-run adjustments.

In a mirror image, while the short-run consequences for the EU itself would likely be small, the longer-run consequences or a Brexit could be dire – especially if the UK economy powers ahead without it.

How serious is Brexit? Let’s put some numbers around it. For starters, the UK only accounts for around 2.5% of the global economy. The European Union accounts for around 16% of the global economy – or is roughly the size of the United States Economy. So even with the EU itself, the UK account a moderate 15%.

So should the UK fall into a whole, its unlikely to inflict too much damage on the global economy, though it would add to the negative risks for Europe. That’s likely why, incidentally, in post-Brexit negotiations the EU would be unlikely to simply jack up trade barriers and try to bury its English neighbour.

Of course, as pointed out by Capital Economics, it’s also true that just under half of UK export go the EU, and a full 60% toward countries either in the EU and enjoying a free-trade deal with the EU.

Exports, moreover, account for around 30% of UK GDP.

In a worst case scenario, in which the UK loses access to its free-trade arrangement with EU, it would be subject to tariffs under the EU’s “most-favoured” nation rules. But even here, (an admittedly post-Brexit) UK business group has estimated estimates suggest the average tariff on UK exports to the EU would be only 4.4%. That said, some sectors – such as agriculture, food, drink and car manufacturers could face tariffs of 10% of more. But most services – clearly the more important sectors of the future – are largely tariff free.

Note, moreover, that under EU rules any member deciding to leave has two years to negotiate the terms of withdrawal. It seems likely that, after tempers settle down, the EU would be prepared to negotiate a fairly open trade deal with the UK – if only to help many remaining EU member countries for whom the UK remains an important export market. Indeed, the USA is not a member of the EU and appears to have little trouble exporting into the region. The UK would then also be free to negotiate its own trade deals with non-EU countries.

As just as New York remains an important financial centre, so to I suspect London would retain its importance in global and European financial affairs. Indeed, exiting the EU might give the City new regulatory freedom to promote its services in both Europe and across the globe.

More generally, I also suspect the UK would do better by shedding itself of the excess regulatory burdens imposed on it by the European continent’s corporatist mentality.

Indeed, many suggested the UK faced economic wreckage were it to drop out of the European Exchange rate Mechanism back in 1992. As it turned out, however, dropping out of the ERM allowed the UK to cut interest rates to deal with a home-grown recession, and also allowed the Pound to drop to a more competitive level. The economy soon recovered.

Should the UK leave, the EU I think it would never look back and would the EU economically a clean pair of heels.

The longer-term challenges for the EU, however, would only intensify should the UK succeed without it.
 

David Bassanese

About David Bassanese

David Bassanese is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR)

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