Econ Brexit Paper / Team A
What are the pros and cons of Brexit for the UK? Explain them in economic terms.
Following Brexit, UK faces an uncertain economic future.
Whilst sovereignty is regarded as a key Brexit benefit, UK’s economy is likely to be negatively impacted in both the short- and long-term. This is because, since Brexit, UK GDP growth rate declined to 1.8% in 2017 (with 2019 projections of 1.5%), inflation rose from 0.5% to 3% and pound sterling (GBP) has devalued 14% against the dollar (Exhibit 13).
UK could benefit from GBP devaluation by attracting multinational trade as exports become cheaper overseas (p.13). However, this raises the spectre of export tariffs, resulting in decreasing exports and domestic production, an increase in unemployment and lower GDP. Plagued with the loss of EU four freedoms, UK must now negotiate new trade deals with EU and other countries. Due to the different potential trade and passport privilege loss consequences, UK will therefore need to select carefully the most workable UK/EU trade option (EEA, Swiss, Canada or WTO – pp.16-17).
Brexit may also have further negative unemployment ramifications. This is because, despite declining unemployment rates between 2011 (8.04%) and 2017 (4.34%), following Brexit 76% of British CEOs are considering moving headquarters outside UK. Indeed, the potential displacement of London as a global financial hub could lead to mass unemployment in UK’s financial services sector, which accounts for 11% UK tax revenue (p.14). Such unemployment rises will lead to weaker productivity (as aggregate demand outgrows supply), resulting in higher inflation and stunting GDP growth. Additionally, whilst UK household spending increased 4% between 2016 and 2017 suggesting domestic confidence, UK household debt increased by 152.73% which, if it continues to grow, will impact GDP growth.
Finally, the combined effect of rising inflation, GBP devaluation, increased unemployment and weaker productivity strengthen the argument against Brexit. This is because it is forecast the combined effects of these economic factors will require UK to borrow up to an additional £60b over the next 5 years, by contrast to its 2015 annual EU membership cost of £8.5b (pp.13 and 15).
What are the pros and cons of Brexit for the EU? Will the EU be strengthened or weakened with the removal of the UK from the Union?
Following Brexit, EU also faces an uncertain economic future.
Whilst EU GDP growth rate initially increased between 2016 (1.9%) and 2017 (2.7%), it is likely that EU will be negatively impacted in the short- and long-term. This is because GDP growth is projected to decrease in 2018 (1.9%) and 2020 (2.3%).
EU/UK migration restrictions are likely to have a strong negative impact, especially if a hard Brexit becomes a reality and migration is heavily curbed. This is because EU/UK positive net migration increased heavily between 2003 (13%) and 2016 (43%) with almost 50% having or seeking employment. Additionally, if a hard Brexit occurs, many of the 1,000,000 EU workers in London (p.14) might have to return to Europe. Whilst EU unemployment rates had declined between 2015 (9.39%) and 2016 (8.54%) and migrants could seek work throughout EU, any labour supply influx within EU will have a negative economic impact. This is because it would lead to unemployment and decrease inflation, which is already low (1.3%) but projected to fall in 2019 (1.1%) and compares poorly to the 1997-2018 average of 2.47%.
An EU/UK export decrease due to the potential imposition of tariffs could result in decreased EU domestic demand, which would decrease GDP growth. This is because several EU members benefit from UK’s EU membership as UK/EU 2015 exports totalled US$250.4b while imports totalled US$433.1b (Exhibit 6). Consequently, for example, potential reduction/loss of UK/EU automotive industry commercial imports (responsible for 12% of UK exports) could have serious consequences for the Ruhr valley steel industry.
Lastly, the complexity of UK’s separation and the uncertain responsibilities of existing debt obligations suggest negative short-term results for EU and EU member state budgets. This is because EU members (particularly Germany) would bear a greater burden to cover UK’s missing EU budget contribution. Additionally, as it is difficult to quantify UK’s stake in EIB loans totalling €20b, there has been speculation that UK may seek shares in major EU assets during Brexit negotiations.
Although UK was part of the European Union, the country never joined the European Monetary Union. What would be the potential consequences on the UK of adopting the Euro?
The Euro is a stable currency with comparatively less volatile interest rates than GBP. Such stability stems from the European Central Bank’s (ECB) role to safeguard stability by setting a centralised monetary policy for EU members who adopt Euro (p.6). Consequently, as UK has extensive foreign direct investments (£1.5tr in 2016), if UK had joined Euro, consumers may have had increased confidence in such investments.
However, if UK had joined Euro, this could have affected consumer spending, investments and GDP growth either positively or negatively. This is because, by joining Euro, UK would have yielded monetary policy decision-making to ECB (p.6).
Whilst there are advantages to centralised EU monetary policy, a country with an independent currency and central bank can more successfully implement monetary policy based on its own future economic health and needs. This is because ECB cannot change monetary policy to suit each specific EU member as demonstrated by the recent Eurozone crisis. Indeed, evidence suggests that, had UK joined Euro, it may at times have experienced negative consequences. This can be demonstrated by comparing 2001-2005 GDP per capita growth in UK (2.3%), Germany (0.51%) and France (0.92%) (Exhibit 4). Had UK joined Euro, during that period ECB policy to lower interest rates to assist France and Germany would not have benefitted UK (whose economy was growing healthily) as it would have led to high inflation.
A further disadvantage of centralisation is that it removes the ability for a central bank to take a reactive stance to economic chance. This is because ECB monetary policy decisions relate to “where the economy will be…[when policy]…will actually take effect” (Allard, Managerial Economics, chapter 6, section 8). Consequently, decisions can take a long time to affect individual economies and, as the future is unknown, decisions are inevitably educated guess which may prove incorrect.
Lastly, Euroscepticism has existed for many years and became particularly volatile in respect of Euro. It is therefore impossible not to ignore the potential effect such Euroscepticism would have had on short-term consumer spending if UK had joined Euro.