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Thursday, June 23, 2016

After The Brexit Referendum

Updated: June 27, 2016

The much speculated Grexit is no more a threat, at least for now. Instead, last Friday, June 23, 2016, the Britons did something unthinkable – the Brexit. A lot happened during the referendum campaingning - arguments, fear mongering, gossiping, and even, false promises. The results have brought in a fresh wave of shock, allegations, disillusionment, and desperation. While all this may not seem to matter now as the deal is sealed, the possibilities (read, fallout) that may become realities still command attention. Some of the notable events so far:

  • UK stands divided on voting lines
  • David Cameron quits
  • Pound tanks to a 31-year low, currently trading at 1.34 per Dollar
  • Approximately, $2 trillion wiped out from world markets
  • UK set to lose its AAA rating: S&P
  • Boris Johnson garners support for his claim to the Prime Minister's office
  • Post results Bregret sets in
  • Over 300,000 Britons sign up for a fresh Parliamentary debate of Brexit
  • EU asks for exit process to start as early as Tuesday, June 28, 2016
  • Call for a second independence referendum in Scotland has increased; it voted 62% in favor of staying with the EU
Friday's events not only stumped the experts worldwide, they also brought the judgement of the average English voter into question. It may be hard to imagine how the political ambitions of an unloved former London Mayor (Boris Johnson) and a repeatedly rejected Nigel Farage could blind the public to reason. Farage, the UK Independence Party chief, has a history of losing each of his attempts in the General Elections. "Google Trends" probably holds the answer. It reported a spike of 1024% in searches related to Brexit after the results were formally announced!

The search terms above and the "rethink" petition reflects the casual approach and indifference of the voters. This should not have happened. Enough material and analysis by experts (not only the political "remain" camp) was freely available that warned of serious economic repercussions, particularly for the UK. It is unclear whether the Britons actually realized that this was a binding referendum. While the whole region is in for a political upheaval, the economic ramifications will be the first to strike.


Why The Original Debate Still Matters?


The arguments are not dead. In fact, they have become even more relevant after the verdict. The "leave" front-runners have casually shrugged off some of their most advertised claims and people are beginning to realize how shaky the whole premise was. The following original analysis throws light on how this happened and what may follow.


The Brexit Trigger


For long, the Tories have considered the European Union as a deadwood and an encumbrance on British politico-economic power. Farage has been the flag-bearer of a toxic anti-EU campaign, which seems to have actually harmed his cause more than anything. His latest “Breaking Point” poster and Jo Cox’s killing seem to be tipping the balance in favor of the “remain” camp. Inside James Cameron’s Conservative Party, Michael Gove and Boris Johnson are the most vocal proponents of British exist from the European Union. The momentum has been building for a couple of years now and Cameron has allegedly been incapable of handling his pro-Brexit party members despite his own views against it. The aftermath of the 2008 recession and the current migrant crisis has added steam to the demands for a “free” UK. The Conservative Party emerged victorious in the 2015 General Elections and the Prime Minister got busy with renegotiation of its terms with EU. Tomorrow’s referendum is an accession to the clamoring within his party.


EU Membership Cost

In 2015, UK’s annual membership costs were GBP 17.8 bn, which dropped to GBP 12.9 bn after rebate. Under a special agreement in place, UK gets a discount on its annual contribution. When talking about outflows, the rebate and other inflows are ignored by the Brexit supporters. This final cost comes to about GBP 35 mn per day. Of this contribution, the Union annually spends GBP 1 bn on aids. As a standing policy, Britain has a target of aid spending of 0.7% of GDP, whether in or out of EU. Therefore, this is not really a EU specific cost.  In 2015, approx. GBP 6 bn came back in the form of grants and subsidies.


The Debate

The Economist sums the debate in the following inclusive list.

Both “exit” and “remain” camps have been throwing up a lot of numbers to justify their stand, but the certain thing about the economic impact of the vote is that “it’s uncertain”. This is an unprecedented situation and any attempt to draw parallels with any existing system can at most lead to some broad pointers. The “leave” supporters believe that Britain will be able to negotiate all new agreements with the EU on its own terms. It will be a huge mistake, however, to ignore political and policy impact of Brexit that will affect trade relations, new or old. Some experts believe that it might take about 5-7 years for Britain to be able to forge stable trade alliances with EU nations. It might as well take longer.

One of the tall claims made by the "leave" camp was that the outflow (an exaggerated GBP 350 mn weekly) on account of EU membership cost will be used for NHS funding. As it stands now, they have backtracked.

Asked by ITV's Good Morning Britain whether he could guarantee that the £350m that was sent to the EU would now go the NHS, Mr Farage said: “No I can’t, I would never have made that claim. That was one of the mistakes made by the Leave campaign.” (Source: The Telegraph)


The Immigration Problem 

The whole anti-immigrant rhetoric by the "exit" leaders has raked up unfounded xenophobia among the masses. This comes with an utter disregard for the ground reality. Various studies have proved that the EU migrants are net contributors to the UK economy. The Qualified EU workforce boosts the economy rather than hampering growth. Their share in health and social benefits cannot be treated as a burden, as long as, they are contributing positively to the exchequer and helping the economy. The influx in not going to stop even if UK leaves EU. In addition, Britain will not be able to impose an immigration policy, which is too restrictive if EU trade relations are to be maintained.


The Economic Impact

British Pound will be among the first casualties (estimated loss of 15-20%), coupled with a jolt to the markets. Amid the confusion that will follow Brexit, recession is a distinct probability. The Government estimates loss of roughly 500,000 jobs. The country’s export will be severely hit as the Union consumes over 45% of its goods/services. The “leave” campaigners have mooted a EU-Canada like deal, which excluded services, as a better alternative. However, this will not work for UK because services constitute almost 80% of its GDP! The treasury has already warned against such move, which could shrink British economy by 6%, leaving households worse off by GBP 4,300 annually by year 2030. Depending upon how the new agreements shape up, commodity supplies (including food items) from EU may become costlier due to new taxes and tariffs. These are the estimates born out of conjecture – the real picture could be brighter or murkier than this.

One of the reasons Brussels is concerned is because UK is one of the top 3 contributors to the EU budget. The Union’s economic problems and dependence on a handful of nations is already out in the open. Brexit will set a precedence that can potentially destabilize it. Members like France, Italy and Netherlands are increasingly losing faith in the organization and may want to snap their ties too. Pressure on weaker nations, largely seen as an economic burden, will also mount. For instance, the bailout of Greece did not go down well with several members. European economic woes have also pushed the number of immigrants to Britain considerably, especially after the recession (2008-10). This is also one of the biggest arguments in favor of the exit.


Alternatives After Exit

If the voters choose to leave EU, UK will need to choose one of the following 5 possible trade models:

  • Join European Economic Area (consists of Norway, Iceland and Liechtenstein), a solution adopted by EFTA states that did not join the EU (except Switzerland)
  • Switzerland like bilateral agreements with EU
  • Establish a customs union or a thorough free-trade agreement with EU; Turkey is an example
  • Follow regular WTO rules
  • Strike a preferential agreement with EU, which provides the free trade option without any limitations of the present system (more a case of unfounded enthusiasm as the relations between the two sides will be strained – UK will be seen as a selfish defector) (Source: The Economist)


The Eagle's Problem

The U.S. has its own worries as its corporations stand in a fix. Being a financial hub, UK is a European entry door for most big companies, not only from U.S. but all around the world. Taking advantages of the liberal immigration policies and free trade zone, MNCs prefer operating in the region from UK. Other than administrative convenience, this also translates into huge cost savings. If Britain leaves, all this is going to change. U.S. is also working on a trans-Atlantic trade deal that stands to lose with the exit and fresh bilateral negotiations are not likely to begin anytime soon. As a result, U.S. exports will take a beating. On the political front, the resulting instability in EU can also destabilize NATO, which is the last thing anyone would want. 

It is in everyone’s interest that England remains a part of European Union, it seems. While both sides have their own arguments, the "for exit" campaign is basing its arguments largely on optimism about everything falling into place neatly and EU bowing to all of UK's demands. The Union’s agenda certainly needs reforms. It is important, though, that the voters see through the propaganda and focus on hard facts before making their choice.

Eurion Constellation is a research and consulting firm serving businesses in U.S., Europe and India. The research services have a global reach with focus on industry / market / economic research, financial analysis, equity research, company valuations and report writing. The consulting wing in India focuses on the startup and SME sectors. Please feel free to get in touch for any business requirements. Visit http://www.eurionconstellation.com

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