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Brexit: a déjà vu?

Key takeaway – History has proven that the United Kingdom (UK) is a reluctant European: it systematically questions – but eventually integrates in – the European Union (EU). On June 23, 2016, a referendum will decide whether the UK should remain in the EU. This is not a first: in 1974, just one year after accession, the Labour party promised – as a way to win the 1975 elections – a referendum on Britain’s withdrawal (Brexit). Once in power and after having obtained significant concessions from its European partners, the Labour government campaigned for the “remain” option, winning an ample majority. In today’s Britain, all this is about to play out again. The Conservative government – after having called for an “in/out” referendum and obtained advantageous EU concessions – is now campaigning for staying in. It will get its wishes: Brexit – an untested, market-unfriendly process – looks unlikely. The economic impact would be severe: in the short term, the UK stock market could drop between 15 and 25 percent and trade volumes would shrink by 2.5 percent per year, despite an above-10 percent exchange rate depreciation. Over the long term, GDP could be 6 percent lower than otherwise. Such an impact would reduce Britain’s global influence and trade ties, and transform the UK into an isolated medium-sized economy.

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Brexit: a déjà vu?

Key takeaway – History has proven that the United Kingdom (UK) is a reluctant European: it systematically questions – but eventually integrates in – the European Union (EU). On June 23, 2016, a referendum will decide whether the UK should remain in the EU. This is not a first: in 1974, just one year after accession, the Labour party promised – as a way to win the 1975 elections – a referendum on Britain’s withdrawal (Brexit). Once in power and after having obtained significant concessions from its European partners, the Labour government campaigned for the “remain” option, winning an ample majority. In today’s Britain, all this is about to play out again. The Conservative government – after having called for an “in/out” referendum and obtained advantageous EU concessions – is now campaigning for staying in. It will get its wishes: Brexit – an untested, market-unfriendly process – looks unlikely. The economic impact would be severe: in the short term, the UK stock market could drop between 15 and 25 percent and trade volumes would shrink by 2.5 percent per year, despite an above-10 percent exchange rate depreciation. Over the long term, GDP could be 6 percent lower than otherwise. Such an impact would reduce Britain’s global influence and trade ties, and transform the UK into an isolated medium-sized economy.

The EU’s second-largest economy, the UK … The EU – a bloc of 28 countries, 500 million (mn) citizens and a 2015 gross domestic product (GDP) in excess of 16,220 billion (bn) US dollars (USD) – is the second largest economy in the world[1] and offers to its members a single market with free movement of goods, services, capital and workers. The UK – with four countries[2], 64.5 mn inhabitants and a 2015 GDP of about USD2,850 bn – is the globe’s fifth-largest economy and the EU’s second-largest, after Germany. The economies of the EU and the UK are interconnected via: i) trade links, as about 50.0 percent of UK trade is conducted with the EU; ii) investment flows, as the EU is the largest investor in the UK, with 66 mn pound sterling (GBP) per day[3] and 46 percent of the total stock[4]; and iii) labor migration: every year, over 150,000 EU citizens emigrate to the UK (circa half of total net UK immigration).

… will decide on EU membership on June 23, 2016. In 2011, internal pressures from anti-EU factions and the rising popularity[5] of the UK Independence Party (UKIP) forced the Conservative party to endorse an “in/out” referendum[6]. In January 2013, UK’s prime minister David Cameron promised, if victorious in the 2015 election, the renegotiation of EU membership terms, followed by referendum. In 2015, after the Conservative victory, Mr. Cameron requested the EU more advantageous[7] conditions. In February 2016, after reaching a satisfactory agreement – which gives Britain “special status” and will take immediate effect if the UK votes to remain in the EU – Mr. Cameron simultaneously: i) announced the referendum will take place on June 23, 2016[8]; and ii) started campaigning against Brexit.

The options[9] are “remain” … “Remain” supporters are convinced that an exit would weaken both the EU, which would risk further disintegration, and the UK, which would have to: i) negotiate a new trading relationship with the EU to retain access to the single market; ii) still apply EU policies, pay budget dues[10] and open its borders to EU workers in order to allow British firms to sell in the single market without suffering tariffs and restrictions; iii) try to get more investment from countries outside the EU; and iv) risk disintegration if Scotland prefers to stay in the EU. The majority of “remain” supporters can be found in Scotland and Wales and among labour and liberal democrats voters.

… or “leave”. “Leave” supporters, more likely to vote, find a committed backing in the older, less educated and poorer segments of the population and among UKIP and conservative voters. According to Brexit supporters, leaving would allow Britain to[11]: i) control expensive immigration from the EU and enforce the government’s target of a total net migration under 100,000 per year; ii) regain control over crucial policies (i.e., employment, health); iii) reduce its contributions to the EU budget, and iv) negotiate its own deals, free from job-reducing regulations, and decide its own laws and trading partners.

All this is not new: the UK has been a reluctant European from the onset. After the conclusion of World War II (WWII), a few leaders proposed[12] a process of European integration, starting by strengthening economic ties and eventually resulting in political union. In 1951, six countries, known as the founding members[13], formed the European Coal and Steel Community (ECSC), the initial embryo of the European Union (EU). Afraid of losing sovereignty and anxious not to damage trade relationships with its former colonies (the Commonwealth), the UK decided not to join. In that moment, the new European group accounted for only 10.0 percent of UK’s exports. In 1957, the ECSC was expanded into a more comprehensive European Economic Community (EEC). Uncomfortable with the project, the UK declined to join once again.

During the 1950s and 60s, the UK tried to promote alternative arrangements, but eventually gave in … In 1956, the UK proposed the formation of a free trade area, with the objective of promoting trade without sacrificing sovereignty, and offered to the EEC to join as a member[14]. In 1960, the failure of the negotiations prompted the creation by the UK and six smaller European economies[15] of a parallel organization, the European Free-Trade Association (EFTA). Soon after, several factors forced UK to change its stance and embrace the EEC: i) a weak domestic economy; ii) the disappointing performance of the recently-constituted EFTA; iii) the economic success of the EEC; iv) weakening economic relations with the Commonwealth[16]; v) a deterioration of the special relation with the United States (US) as a result of the 1956 Suez crisis; and vi) mounting pressure from the US to join the European institutions to fight protectionism from the inside. Gradually, the British political leadership embraced the conviction that staying outside of the EEC would translate into a substantial loss of economic and diplomatic relevance.

… and embarked in a complex negotiation process leading to EEC accession in 1973. Despite strong domestic divisions[17], the UK applied for membership in 1961, 1967[18] and 1972. During the negotiation, the UK requested numerous exemptions, resulting in two vetoes from the French government (in 1961 and 1967), which feared that UK would undermine the Franco-German alliance and act as “an American Trojan horse”. The impasse led the EEC to near paralysis. After French President De Gaulle left office in 1969, negotiations resumed, led by the governing Conservative party, and on January 1, 1973 UK became an EEC member. The British public opinion remained divided, with significant opposition inside all main political forces.

In 1975, two years after it got in, the UK called for a referendum to get out … After accession negotiations, two issues resurfaced and required renegotiation: a) the UK’s financial contribution to EEC budget[19]; and b) its participation in the common agricultural policy (CAP). Ahead of the October 1974 general election, the Labour party promised an “in/out” referendum[20]. Once in power, the Labour government announced the referendum and – after having renegotiated the membership terms and obtained significant concessions (namely, a reduced budget contribution and direct subsidies to UK’s farmers) – campaigned for maintaining EEC membership. On June 5, 1975, the referendum was held – so far, the only one celebrated in the EU. With a 64.0 percent turnout, the votes in favor of “remain” amounted to 67.2 percent.

… and constantly renegotiated the terms, opposing further integration. Across the years, and particularly between 1975 and 1985, successive UK governments submitted to the EU a continuous flow of requests[21] to further improve membership terms and opposed most proposals for further economic and political integration. From the beginning, the UK showed reluctance in monetary policy coordination and foreign exchange (FX) management[22]. In the 1992 Treaty on European Union, better known as Maastricht Treaty, the UK opposed political integration[23], resisted the concept of “common defense”[24], and – to maintain full control over oil and natural gas resources – requested[25] the exclusion of articles on energy. Finally, the UK opted out of the Schengen agreement to abolish border controls inside the EU, and – when the European Charter of Fundamental Rights came into force in the Treaty of Lisbon in 2009 – it obtained[26] a watered-down enforcement.

Today’s Brexit is “1975 all over again”, but in a context of higher interdependence. In 2016, the 1975 process is being replicated: an initial call for referendum was followed by renegotiation of membership terms. Once significant concessions were obtained from the EU, the UK government started a campaign in support of maintaining the membership, arguing that Brexit would impact the UK economy via trade, investment and labor flows. Today, the main argument against the EU – a loss of sovereignty, as the EU imposes legal limits to member states – is weakened by four decades of steadily increasing economic interdependence, despite political reluctance. In 1973, the six founding members represented 10.0 percent of UK’s exports, while in the 2015 the EU represented 51.0 percent of exports of goods, and 45.0 percent of total exports, including services. In 2013, EU investors owned 46.0 percent of UK assets held by foreigners, while 43.0 percent of UK foreign assets were in the EU[27]. The inflow of EU migrants increased substantially after the 2004 expansion of the EU in Eastern Europe, tripling to almost 257,000 EU immigrants by 2015.

An exit from the EU is contemplated in European treaties … The Treaty on EU establishes that “any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements[28]. After the European Council (EC) has received the withdrawal intention, the exiting country has a maximum of two years to reach an agreement on the “post-exit relation framework” with the EU. The negotiation period could be extended, but only with a unanimous vote of EU members[29].

… but the process is untested and entails a lengthy negotiation period … The practical aspects of such process are untested[30]. In case of Brexit, three developments are improbable: i) non-collaboration (given mutual economic interests); ii) further large concessions from the EU (because of the political bitterness that Brexit would create in the EU members); and iii) UK concessions towards further integration (given the political cost of accepting EU legislation after a “leave” vote). After Brexit, the collaboration between UK and EU will oscillate between two scenarios[31]: a) a Norway-like arrangement: a five year negotiation[32] – with minimal economic disruption and little impact on global growth and markets – resulting in a new comprehensive free trade agreement retaining most of the membership features (e.g.: covering 75 percent of good and services exchanges between UK and EU and ample access to the financial markets); and b) WTO’s “most favored nation” (MFN) policy: a decade-long negotiation – which would depress investment and immigration flows and hamper global growth and markets – would result in commercial exchanges taking place under MFN treatment – i.e: equal trade advantages as the MFN by the granting country – in this case the EU.

… and a severe impact. The economic consequences of Brexit are serious[33]; the impact would be severe at the beginning, and remain relevant in the long term. In the short term, the UK stock market would drop between 15 and 25 percent and trade volumes would shrink by 2.5 percent per year, despite an above-10 percent exchange rate depreciation (Table 1). Over the long term, GDP could be 6 percent lower than otherwise, equivalent to wiping out one third of the 2015 value of the economy of London metropolitan area. In 15 years and every year thereafter, British households would be GBP4,300 poorer in 2015 terms, i.e. every year they would lose the equivalent of 17 percent of the 2015 median household income.

Undecided voters will be pressured to vote “remain”. According to recent polls, the “remain” option enjoys a slight majority[34], which is likely to strengthen in the run to the elections because: i) the active involvement of “leave” supporters in most polls has probably overstated their actual weight[35]; and ii) the “remain” option benefits from a strong institutional and business backing. Brutally stated, Brexit would finalize the transition of the UK from empire to island. Such an impact is too much to bear for both politicians and citizens, as it would reduce global influence and trade ties, and transform the UK into an isolated medium-sized economy. As a result, there is only a 30.0 percent probability of Brexit (Table 1).

Table 1: To Brexit or not to Brexit?

Brexit: a déjà vu?

Source: Authors’ calculation on Société Générale, Quantifying Brexit, 2014; What if…? The Brexit briefing, 2016; Bank of America Merryl Lynch, 2016; Euler Hermes, Brexit: What does it mean for Europe?, 2016; and UK Government, Treasury analysis: the immediate economic impact of leaving the EU, 2016.

Note: ST = short term, by end 2016; LT = long term, cumulative by 2025. *Compared to the level expected in case of no Brexit. **Uncertainty has hit trade, investment and consumption in 1H-2016. ***52W range: 1.384 – 1.593.

  1. Economic growth: over a decade, the level of nominal GDP would decline between 4.0 to 6.0 percent. A “leave” vote would create uncertainty[37]: households and corporates would need to understand the transition’s modalities and length, and the shape of future UK-EU relations. A dampened business and consumer sentiment[38] would hamper consumption, investment and trade flows. Gradually, as the engagement terms become better defined, new restrictions would kick in. In the EU and the rest of the world the impact would be moderate to low. In the UK, however, financial sector activity would decline[39] and lower consumption, investment and trade would reduce growth. Lower growth would weaken the currency while keeping inflation pressures under control, creating the conditions for low interest rates for a prolonged period of time.
    1. Lower trade flows would reduce UK GDP by 0.4 percent per annum[40]. According to the UK Treasury, 12.6 percent of UK GDP depends on exports to the EU[41], the main trade partner for goods (in 2015 it received 45.0 percent of UK total exports)[42] and services (in 2015, the EU absorbed 37.0 percent of UK total services exports). On average, a Brexit-induced increase in tariff and non-tariff barriers would decrease trade by 2.5 percent per year for a decade (Table 1). Likely, in the years immediately after Brexit the decline would be more pronounced, and would recover when other markets start absorbing UK exports.
    2. Declining FDI would reduce UK GDP by 0.25 percent per annum. According to the UK Treasury, 48.0 percent of the FDI stock comes into the UK from the EU[43]. An exit from the single market would entail a drop in foreign funding for British corporates equal to around 0.5 percent of GDP, equivalent to a decline of 50.0 percent in inward FDI coming from the EU. Assuming half of the drop gets funded by the same firms with retained earnings, the reduction in investment would amount to about 0.25 percent of GDP[44] per year, resulting in an accumulate reduction on investment equivalent to 2.5 percent of GDP in a decade (Table 1).
    3. Migration and regulation are unlikely to impact growth. Over the coming decade, both “remain” and “leave” votes are unlikely to alter the dynamics of UK labour supply. As the validity of any free trade agreement with the EU will be linked to the free circulation of EU citizens[45], no significant inflow or outflow is expected. In the longer term, however, Brexit might reduce supply, lowering potential growth[46]. Benefits arising from a decrease in UK regulation have also been overstated: the economy is already one of the least regulated in the world[47], and there is little room for improvements stemming from deregulation.
  2. Financial markets: short term volatility would bring about looser monetary policy, currency depreciation and lower profits. In the UK but also, to a lesser extent, in the EU, a “leave” vote would bring about volatility[48] in stock, bond, and currency (both the GBP and EUR) markets, and interest rates are likely to be lowered. In the long run most of the effect is likely to dissipate.
    1. The financial sector will suffer uncertainty and lack of access to the single market. The financial sector, a central driver of the UK economy[49], is one of the sectors most threatened by Brexit. Over the past few years, the gradual loss of influence of the UK on EU financial-policy making has created uncertainty. As a result, international institutions have been holding investments and hiring decisions. In the initial phase after a “leave” vote, interbank rates would rise; such financial tightening would force the Bank of England (BOE) to cut rates. After Brexit, the UK would have to abide by the EU rules in order to access the single market, but would have lost influence on its regulation[50]. This tension will benefit competing financial centers in Europe.
    2. The GBP would depreciate by about 15.0 percent in the short term and ten percent in the long term. A substantial part of the impact on the currency of a potential Brexit process has already taken place[51]. Yet, after a “leave” vote, uncertainty will dominate and the GBP will suffer a sharp depreciation[52] before stabilizing at around 10 percent below its current level[53], as uncertainty fades away (Table 1). Over the longer term, dramatic exchange rate movements are unlikely; the economy is likely to recover led by currency depreciation and higher growth than in the rest of the EU – creating expectations of a normalization of interest rates. The UK’s fiscal and trade deficits will add a mild depreciation pressure[54].
    3. The stock market could lose between 15.0 and 25.0 perce In the UK, portfolio investments from abroad suffered from the economic slowdown, the increasingly dovish BOE stance, and the fears of Brexit. Brexit driven outflows are estimated to account for 40 percent of the fall, i.e. -GBP34bn out of the total -GBP85bn. In the short term, Brexit would sink[55] the FTSE 100 index[56]. Yet, firms listed in the FTSE 100 obtain around 77.0 percent of their revenues from international sales[57] and only 17.0 percent of them from the EU. The long term impact of Brexit impact would be less pronounced but still significant (-8 percent if compared with the “remain” scenario – Table 1) due to higher raw materials costs induced by a weaker GBP. Wages would be hardly impacted and are unlikely to depress profits[58].
    4. Bonds yields would likely stagnate[59]. A “leave” vote would bring about weaker growth and further BOE monetary easing, potentially reducing already low yields[60]. In the medium term, inflation risks, political uncertainty and credit ratings downgrades could increase yields[61]. A “remain” vote will increase the chance of a rate hike; increasing gilts yields would negatively impact sovereign bonds prices.
  3. Both the UK and the EU would lose relevance, but the EU could become more cohesive. Brexit would result in a loss of relevance at the global level. The EU would remain the second largest economy in the world, but its gap with China would narrow by 50 percent. Britain would remain a relevant international actor, but would gradually be overtaken – as it has already been by Brazil, Russia and India in PPP terms – by emerging economies. Yet, Brexit could facilitate EU progress in those areas that the UK has been steadily opposing: i) a deeper banking union; ii) capital market integration; and iii) a common defense policy[62].

We thank Eduardo Eguren, Mehmet N. Erten and Pablo Gallego Cuervo for comments and suggestions, PulsarKC for data collection. All errors are ours.

[1] In 2015, GDP at current prices for the European Union was USD 16,220.37 bn, second only to the United States at USD 17,947bn. Source: IMF, 2016.

[2] England, Scotland, Wales, and Northern Ireland.

[3] For example, between 2014 and 2020, under the Horizon 2020 program, the EU plans to spend GBP 80bn on research; 3.0 percent of total R&D spending in Britain is funded by the EU.

[4] The EU is the main destination of UK investments, and accounts for 43.2 percent of the total outflows.

[5] After the May 2010 general election, where one of UKIP’s electoral program most popular elements was a referendum to leave the EU, UKIP support rose steadily, from 2.0 percent in mid-2010 to 12.0 percent by January 2013, to peak a few months later at 15.0 percent. In the general election of May 2015, UKIP obtained over 3.8 mn votes, 12.6 percent of the total, up from 3.1 percent in the previous general election.

[6] In 2011, the UK Parliament adopted the EU Act, requiring a referendum to be held on amendments of the two primary EU Treaties (the treaties that transfer sovereign responsibilities to the EU): the Treaty on European Union and the Treaty on the Functioning of the European Union.

[7] Key points are: i) the UK is not part of a move towards “ever closer union” with other EU member states, one of the core principles of the EU; ii) the UK will keep the pound and will not participate in euro zone (EZ) nations bailouts; iii) special protection for the City of London; iv) reduced child benefit and migrant welfare payments.

[8] The referendum was originally promised for 2017 but a new surge in UKIP’s popularity shortly before the 2015 elections forced the government to commit to move forward the date of the referendum. Following the Conservative Party’s victory in May 2015, the renegotiation took place in early 2016. Shortly after the conclusion it was announced the final date, June 23 2016. The referendum was scheduled after the celebration of elections in Scotland, Wales and North Ireland.

[9] The question will be: “Should the UK remain a member of the EU or leave the EU?”.

[10] In 2015, the UK was a net contributor to the EU budget: from a gross contribution of GBP17.8bn, GBP4.9bn were rebated and GBP4.4bn paid back for farm subsidies and other programs. EU subsidies account for 54.0 percent of British farm incomes and 62.0 percent of UK agriculture exports go to the EU.

[11] In decreasing order of relevance, according to polls results in as of May 7, 2016.

[12] The 1948 Hague Congress was a pivotal moment in European federal history.

[13] Belgium, France, West Germany, Italy, the Netherlands and Luxembourg (Treaty of Paris).

[14] The arrangement would have: i) provided UK industrial products access to the newly-formed EEC customs union; ii) maintained UK farmers’ protection; iii) preserved preferential relation with the Commonwealth; and iv) increased UK’s leverage in the integration process.

[15] Austria, Denmark, Norway, Portugal, Sweden, and Switzerland. Finland would join in 1961 and Iceland in 1970. The population of the EFTA was around 90mn, roughly half the size of the EEC at the moment. Source: European Economic History: From Mercantilism to Maastricht and Beyond, D. Hansen, 2011.

[16] In 1954, Commonwealth countries represented 48.0 percent of British imports and 49.0 percent of exports, but only 19.0 percent of its imports and 20.0 percent of exports in 1972.

[17] The Labour Party and unions led the anti-Europe movement. The European Community was perceived as overly liberal and a threat to the domestic welfare system.

[18] In both cases, UK’s application was accompanied by those of Ireland, Denmark and Norway.

[19] To the principle of financial solidarity in the Community, UK opposed the principle of a “juste retour” of each country’s contribution, in the shape of expenditure incurred on its territory, ignoring all other advantages of belonging to the community. In 1979–1980, the UK contributed 20.0 percent of Community revenue but enjoyed only 12.0 percent of its expenditure. The imbalance was provoked because then the budget was funded with levies on non-European agricultural products, and UK was a large importer of these from Commonwealth countries.

[20] In October, 1974 the Labour Party Manifesto asked to “give the British people the final say through the ballot box” whether to remain in the EEC.

[21] In the UK, the division of public opinion on EU membership has been traditionally utilized by the opposition to erode ruling governments or, within parties, as a tool to challenge leadership. In fact, even when the same party remained in government, new leaders would refuse to endorse previous agreements. For example, the new leader of the Conservative Party, which had initially requested and negotiated UK’s membership to the EEC, put forward a new request to reduce British contribution. In 1979, Ms. Thatcher adopted an even tougher approach, and in 1981 obtained a two-thirds reduction of UK’s net contribution. Additional adjustment mechanisms were added in 1985. In the decade following accession, opposition to the EU was strong. The opposition weakened during periods of poor domestic economic performance, in particular during 1977-1984. In the years after the 2008 crisis (2009-2012), when anti-EU arguments were a commonplace in most European countries, the balance remained overall in favor of “remain”.

[22]In 1971, the US unilateral decision to stop convertibility of the USD to gold had brought the Bretton Woods System to an end. In 1979, the six founding members – in an attempt to stabilize inflation and stop exchange rate fluctuations – created the European Monetary System (EMS) and the European Currency Unit (ECU, an artificial currency developed for accounting purposes). The UK initially declined to join (only member in the EEC to do so), eventually joined in 1990 but permanently withdrew in 1992. In 1999, the EMS was succeeded by the EU-led Economic and Monetary Union (EMU), which established a common currency, the euro (EUR). The UK also opposed the establishment of the EUR as the single currency, supporting instead maintaining the ECU as a parallel currency.

[23] In the text of the Treaty, the expression “Union with a federal purpose”, endorsed by the majority of delegations, could not be adopted because of opposition from the UK. Later, in the 1997 Treaty of Amsterdam, the UK lobbied to adopt “a blocking minority”, to weaken the supranational drift of the text.

[24] In the text of the Treaty, the UK pushed for the less comprehensive definition “common defense policy” as opposed to the concrete “common defense” called for by France and Germany. Finally, both concepts are included in the same convoluted sentence: ‘the common foreign and security policy shall include all questions related to the security of the Union, including the eventual framing of a common defense policy, which might in time lead to a common defense.’

[25] Along with the Netherlands.

[26] Along with Poland.

[28] Treaty on the European Union, Art. 50.

[29] If the country decides to rejoin, it would be subject to the same process of any other applicant.

[30] No member state has left or even held a national referendum on withdrawal from the European Union, though in 1975, the UK held a national referendum on withdrawal from the EEC. In 1985, Greenland, part of the Danish Realm, voted to leave the EU’s predecessor, the EEC. Algeria left upon independence in 1962, having been a part of France until then.

[31] Several models can be used as a template for UK-EU relationship after Brexit: i) the Turkey model: the UK and the EU set a customs union or a generic free trade agreement with restricted scope; ii) the Switzerland model: UK develops numerous bilateral and joint agreements with the EU members and iii) the Norway model: UK joins the European Economic Association (EEA) adopting large parts of European legislation and accepting free circulation of services, goods, people and capital from EU members and participating in a number of European programs. Any of the options above would require the UK to abide by most of EU regulation, especially if UK pushes for access to the financial services market.

[32] Within the initial two-year period, an agreement is unlikely. The UK Treasury estimates a 10 year period to conclude the negotiations.

[33] Trade: On leaving the EU, in addition to losing its current access to the EU Single Market, the UK would no longer benefit from the EU’s free trade agreements with the rest of the world. The UK currently benefits from such agreements with over 50 countries, and would benefit from the successful conclusion of agreements with a further 67 countries currently under negotiation, including the US, Japan and India. There is no guarantee that the EU would agree to an interim continuation of free trade, and it seems certain that UK exports would face higher tariffs than its former EU partners in third countries (placing British exporters at a competitive disadvantage).

Foreign investment: Leaving the European Union would reduce flows of foreign direct investment (FDI) into the UK by more than a fifth, damaging productivity and lowering people’s incomes. Cars and financial services – two important UK industries – would receive less investment from foreign firms that use the UK as a base to access EU markets. Also, the UK’s ability to negotiate concessions from regulations on EU-related transactions would be seriously eroded. Overall, incomes could fall by about 3.4 percent just from lower foreign investment.

Real estate: In 2016, short-term expectations for growth in house prices have been declining steadily, affected in part by the possibility of Brexit. In Q1 2016, transactions in commercial real estate had fallen by nearly 40 percent.

Labour market: There are signs that the risk of leaving the EU is affecting the labour market. The Recruitment and Employment Confederation have reported that “employers are turning to temps and contractors to provide a flexible resource, as a way of hedging any possible change to the UK’s relationship with Europe, and the implications this would have for the economy”.

Immigration: Between 1995 and 2015, the number of immigrants from other EU countries living in the UK tripled from 0.9 mn to 3.3 mn. In 2015, EU net immigration to the UK was 172,000 (gross immigration of 257,000), only just below the figure of 191,000 for non-EU immigrants. EU immigrants are more educated, younger, more likely to be in work and less likely to claim benefits than the UK-born. About 44 percent have some form of higher education compared with only 23 percent of the UK-born. It is likely then that after Brexit, skilled EU immigration would be cut and there is little realistic prospect of non-EU skilled immigration being expanded.

[34] Most of the polls carried out had a sample size of 1,000 to 2,000, resulting in a +/- 3 percent margin error, larger than the average difference registered between the “remain” and “leave” option.

[35] Large divergences between phone and online polls have been found, suggesting that the relevance of “leave” support is overstated.

[36] GDP calls refer to impact by 2020-2030. Some forecasts:


  1. UK Treasury: base case (bilateral free trade agreement) sees a decrease of 6.2 percent in nominal GDP (at 2015 prices) after 15 years compared to the baseline of EU permanence. In the worst case (WTO rules) GDP declines by 7.5 percent and in the best case (EEA, Norway style) GDP declines by 3.8 percent.
  2. Oxford Economics: from no impact to -4 percent in absolute level of nominal GDP and -3 percent on GDP per capita by 2030, combining 3 political stances (populist, moderate, liberal) and 4 types of trade agreement (WTO, customs union, bilateral agreements, free trade agreement).
  3. London School of Economics: from -1.3 percent to 2.6 percent impact in income per capita (permanent changes in average income that occur immediately after Brexit).
  4. PwC/CBI: from -3 percent to -5 percent change in nominal GDP by 2020. In the best case, a FTA is signed within five years, in the worst case, WTO rules apply after a longer negotiation.
  5. SocGen: Between -0.5 percent and -1 percent of reduction in nominal GDP every year over the decade following Brexit.


  1. London School of Economics: estimates Europe’s GDP to be between 0.125 percent and 0.25 percent per annum below the growth rate achieved in the event of no exit, over the decade following withdrawal. In absolute terms, the impact in the EU would around half of UK’s loss. Ireland would be the most affected in terms of loss of income per capita (between -1 percent and -2.3 percent) followed by Netherlands (-0.3 percent to -0.7 percent). Non-EU countries experience some small income gains (Turkey, Taiwan profit the most, less than 0.1 percent increase in income per capita).

[37] Even in the case of a “remain” vote, economic activity would take some time to normalize, as delayed investment and consumption decisions are adopted.

[38] March’s PwC/CBI survey shows a decline in optimism in March 2016 for the first time in over a year. On a quarterly basis, in Q1 2016, business confidence has declined by over 20 percent. GfK survey shows a strong deterioration of consumers’ perception about the state of the economy.

[39] UK financial services firms would face costly upheaval in the event of a vote to leave the EU. Over 5,000 UK firms, including banks, investment firms and insurance companies, hold passports which enable them to provide their financial services and establish branches in other EU member states. In order to continue trading across the Single Market firms could have to restructure themselves. This could include creating or reconfiguring subsidiaries in EU member states which, by being located in the remaining EU, would have access to the passport. Such actions would involve relocating activities and jobs to the remaining EU. Restructuring businesses and relocating staff would take a considerable time. Securing a banking license in some member states can take six months to a year, and the further tasks associated with relocating operations can take much longer than this. The relocation of financial services activities and staff outside of the UK would have an immediate negative impact on jobs, exports and tax revenue. There are over one million jobs within the financial services sector. If the UK left the EU then tens of thousands of jobs in the sector would be at risk.

[40] SocGen, Quantifying Brexit: 0.3 percentage points out of 0.5 of total impact.

[41] Conversely, in the EU 3.1 percent of GDP depends on trade with the UK.

[42] The EU membership has been estimated to increase by 55.0 percent UK trade with the rest of the EU. At the country level, Ireland, Netherlands and Belgium have the largest exposures. Yet, the weight of the EU in UK total exports has declined from over 60.0 percent of in 2006 to 45.0 percent in 2015, as a result of both the EU crisis and Asia’s resilience (Asia’s share of UK total exports rose from 13.0 percent in 2006 to over 20.0 percent in 2015).

[43] The US, with 24.0 percent of the UK-based FDI stock, is second.

[44] The EU would not suffer a noticeable impact. Some small Eastern European economies receive significant net FDI flows from the UK, such as Bulgaria (6.1 percent of total) and Poland (4.2 percent of total). However the UK investment in large EU economies is small. Source: SocGen, Quantifying Brexit, 2016.

[45] Switzerland, which voted in 2014 to impose quotas on EU immigration, has been threatened with a cancellation of its trade agreements if it tries to implement it.

[46] A reduction in the growth of labour supply would reduce potential output in the UK, but the expected changes in the flow of migrants do not warrant such outcome. Following the accession of 10 countries in 2004, UK, along with Ireland and Sweden, decided not to apply the seven-year transition period for migrants from new countries, resulting in a massive increase of migrants from Poland, Lithuania and Slovakia. In the next accession, the UK changed its stance, adhering to the transition program banning immigration from Bulgaria and Romania. There are no significant EU expansions expected in the next decade – maybe Turkey at the end of the period, but would have to go through a lengthy transition – and is unlikely that Brexit might result in an expulsion of existing immigrants making improbable a strong or rapid decline in labour supply compared to the baseline. In fact, it might result in an increase as migrants flock in during the negotiation period before current policies change.

[47] UK has the second least regulated product markets in the developed world (after the Netherlands, also a EU member) and a level of protection in the labour market similar to the US, Canada or Australia, well below the rest of Europe.

[48] The volatility will create important tactical opportunities for investors able to estimate post-normalization equilibrium levels.

[49] The UK has the largest financial and insurance sector in percentage of GDP of G7 economies. It reached nearly 10.0 percent of GDP in 2009 (US 7.0 percent, Germany and France below 4.0 percent) and has now declined to around 7.0 percent. It accounts for over 11.0 percent of total tax revenues and 3.6 percent of employment (2012).

[50] While the European Banking Authority (EBA) has been headquartered in London, it is increasingly managed by the EZ countries. Additionally, EZ countries are now embarked in developing the European Banking Union[50] which does not include the UK. Outside the EU, UK would find impossible to maintain privileges like, for example, being the main euro clearing house, a benefit that the ECB tried to curtail – by imposing a rule according to which clearing centres representing more than 5.0 percent of the activity must be located in the EZ – but was ultimately maintained by the European Court of Justice as it was considered to go against the single market principle.

[51] As of May 26, 2016, the GBP appreciated by 2.4 percent against the USD since February 20, 2016 (announcement of the referendum) and 2.0 percent against the EUR. However, since the beginning of the year, GBP depreciated by 1.0 percent against the USD and by 3.1 percent against the EUR.

[52] An alternative view posits that in the short run the GBP would strengthen in spite of the result of the referendum, given that even in the event of a “leave” vote, short positions would have to be covered.

[53] Brexit-induced GBP depreciation levels (to 1.250 in the short term and 1.300 in the long term) are calculated based on the GBP/USD rate as of June 1 2016 of 1.441.

[54] SocGen (The Brexit briefing) estimated that over the last 15 years a widening of the deficit from 0.0 percent to 5.0 percent of GDP was accompanied by a fall in the trade weighted index of 15.0 percent. They estimate the Brexit related widening of the deficit to be below 1.0 percent of GDP, resulting in an expected depreciation of the currency by 3.0 percent plus an additional 2.0 percent from confidence effects.

We doubt that there would be significant inflation consequences from that fall because the weaker growth outlook would make the output gap wider than otherwise would be the case and so inflation expectations would remain well-contained. The cumulative widening of the output gap over 10 years, relative to what it otherwise would be should be about 5.0 percent (0.5 percent x 10), so on average 2.5 percent, a sizeable amount. There would, however, be some partial offsetting influence on the output gap from the reduction in potential output that would arise from the lower investment path so let’s say the output gap averages 2.0 percent.

[55] Quantifying Brexit’s impact on UK stocks is a challenge because of the high correlation of the FTSE 100 across global stock markets. Performance has been negative in the first quarter (decline of 1.1 percent), in line with global trends. As of May 26, 2015, FTSE 100 has remained relatively flat, increasing marginally by 0.4 percent, since the beginning of the year and increased by 5.4 percent since the announcement of referendum i.e. February 20, 2016.

[56] Bank of America Merryl Lynch estimates a 6.0 percent upside potential for UK and EU stocks in the event of a “remain” and a 15.0 percent downside adjustment in the event of a “leave” vote.

[57] In line with comparable countries: France’s CAC 40 79.0 percent, Germany’s DAX Index 77.0 percent.

[58] SocGen estimates around 0.5 percent decline on average for 10 years, in line with nominal GDP. SocGen (The Brexit briefing).

[59] The day in which the referendum was announced demand on gilts auction rose to four times the supply.

[60] Analysts are divided: SocGen expects a 0.5 percent decline in 10-year yields BofML expects an increase of 0.1 percent in 10-year gilt yields.

[61] Credit ratings downgrades in G7 economies (France, Italy) in the past have not resulted in significant changes in yields.

[62] Military collaboration between the three largest EU members – Germany, Britain and France – has only recently recovered from the divide that followed Britain’s alliance with the US during the Iraq War. France and Germany, while still subject to NATO, would try to move closer. Britain holds one of Europe’s two seats in the Security Council and leads the EU in military spending. In 2015, the UK spent USD65 bn, the third largest budget after the US and China. France spent USD53 billion and Germany USD44 bn.

Alessandro Magnoli Bocchi
Over the past 20 years, Alessandro Magnoli Bocchi has been working in the field of economic analysis and international investments in the Middle East, Europe, the USA, Asia, Africa, and Latin America. Since 2012, Founder and CEO, Foresight Advisors - economic and business advisory services.From 2008 to 2012, Chief Economist and member of the management team and Investment Committee at Kuwait China Investment Company (KCIC).

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