Sussex European Institute


How Brexit will hit the economy

Dr Peter Holmes

Peter Holmes

By a narrow margin the UK has voted to leave the EU partly because  many people felt that recent global and European integration has disproportionately benefited metropolitan elites and this has led everywhere to a backlash against free trade and immigration.  But will the solutions offered by Brexit  solve all the problems? Almost certainly not. The overwhelming consensus among economists has been that Brexit would be economically damaging, across all classes and regions,  for two reasons. First the huge uncertainty created would spook financial markets and scare real industrial investors. Second the final outcome would be sure to hurt trade and hence GDP,  jobs and public services.

The leave vote seems to have been very much influenced by myths about migration.  Surveys show people systematically overestimate the numbers of migrants, and fail to appreciate that migrants overall pay more in taxes than they cost in benefits or public services. Moreover most net migration has been non-EU citizens whose entry the government could have limited if it were so easy. The purely xenophobic element in Leave could not have been eliminated by better information, but it was undoubtedly fuelled by falsehoods.

The impact will come in three stages. There can be little disagreement about the nature of the immediate impact:  we  already see it. The pound has slumped, as has the stock market and there is anxiety all over the world.  Britain has a the biggest current (trade) account deficit, in history, the biggest of all major countries today. This requires massive international funding flows to continue. The Back of England might be forced to raise interest rates to keep the money coming in or alternatively cut them to keep the economy from collapsing.

The second stage of impact is likely to bring a significant loss of trade under all possible scenarios. Any trade deal that is likely to be negotiated will be highly unfavorable in one of two ways. Either it will involve exclusion from the European Single Market or it will mean membership of the European Economic Area, like Norway with access to the Single Market being conditional on full implementation of EU single market rules including free movement of labour, with no say in their setting, and a continuing budgetary payment.  If we are not in the EEA we can either try to seek a one-off deal like Canada or else just face trading with the EU as an ordinary member of the WTO which means facing import duties (10% on cars), some non-tariff barriers (eg barriers to UK “testing and certification”, rule of origin issues) and potentially anti-dumping duties. Foreign investors will no longer feel safe to see the UK as  a gateway to the EU, as reports in the Chinese press already indicate.

The fall in trade will then be translated into a slightly less than proportionate fall in GDP.  The Treasury model is one of the most detailed and in line with others it projects a larger fall in trade and hence GDP the less close our new relationship is, ranging from about a 4% fall in GDP if we are in the EEA to a fall of 5-10% if we have no trade deal at all. Importantly the degree of uncertainty as well  as  the estimates of GDP loss increases with the degree of remove from our present situation. Brexiters claim that falls in trade with the EU will be replaced by new links with other partners, but there is no basis for this.  It is only possible to speculate on what the new trade deal will be. This means that the second stage impact will begin very quickly. Uncertainty about market access is itself a barrier to trade and discourages investment. On the other hand in the interim  there will be strong incentive for EU immigrants to rush in before the door closes!

Finally the long run growth rate: Brexiters say free of EU regulations and powered by trade deals with ..(who knows?) our economy will boom. There is not the slightest shred of evidence for this; indeed the evidence is that the UK’s long run economic decline stopped just as we entered the EU.

Something must be done for those who feel disadvantaged by globalisation but the UK has always been free to maintain its social safety nets and has chosen to dismantle them. Now it will be freer to remove them.

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By: Laura Arnold
Last updated: Thursday, 14 July 2016