The economic impact of Brexit on the UK economy

This assignment critically evaluates the long-term economic impact of Brexit on the UK. It contends that the short-term economic effects are established as being largely negative due to the uncertainty created, but that the long term impact will be dependent on the views and actions of politicians. This argument is made by using recent relevant economic analyses and arguments from the academic literature and reliable media reports.

In general, there is broad consensus that despite some increases in investment and activities in the second quarter of 2016, the Brexit decision is likely to harm economic growth in the UK in the short term (Fichtner et al., 2016). Forecasts from academic publications have indicated that the economic fall-out from the Brexit vote will result in the UK’s economic growth over the next two years falling by one per cent – from an estimated 2.3% to just 1.3% per annum (Economic Outlook, 2016b, p. 1). Other analysis indicates that the pound sterling may fall by fifteen per cent from its pre-Brexit peak by the end of 2016 (Economic Outlook, 2016a, p. 5). However, the analysis presented in support of these arguments is largely based on the short-term economic uncertainty the Brexit decision has generated. Over the long term, results may improve once this uncertainty is resolved and details of the UK’s new relationship with the EU and the wider world are established. Thus it is important to analyse the potential nature of this relationship in greater detail and what deal is likely to be negotiated in the two-year period following the UK formally beginning the Brexit process.

The most significant factor likely to influence the economic outcomes of the UK will be whether the UK remains in the EU single market after Brexit. This market represents the world’s largest free trade zone, allowing for the free movement of goods, services, capital and labour within the EU. In theory, remaining in the single market will minimise economic disruption, as the UK will continue to benefit from free trade and investment with the rest of Europe, despite Brexit taking the country out of the EU. This is shown in the graph below, which compares a free trade agreement in the single market with the standard WTO trade agreement which includes some tariffs.

Statista (2016)

However, as noted by Emerson (2016), membership of the single market would require the free movement of labour and the acceptance of EU influence on UK laws. Popular sentiment in the UK may thus militate against this. This is shown in the following graph:

(Ritholz, 2016)

This sentiment thus may result in the UK leaving the single market as part of Brexit, thereby creating trade barriers with the EU and harming the UK economy due to tariffs being imposed on imports and exports until the UK is able to negotiate a bespoke trade deal. However, recent evidence indicates that the UK may be given an exemption from the free movement of people for up to seven years as part of its Brexit deal, which could make it possible for the UK to retain access to the single market whilst addressing some concerns around immigration (Helm, 2016). This would help to ensure the continuation of trade with the EU and mitigate any long term damage to the UK economy in terms of greater costs of imports and exports.

Unfortunately, whilst the UK retaining access to the single market would help in the import and export of goods, access to financial markets may not be as straightforward. In particular, Meager (2016) notes that Brexit may hinder the ability of the London financial markets to continue to act as a financial and clearing hub for the EU as a whole. Even if the UK retains access to the single market after Brexit, being outside the EU may mean that banks choose to carry out more of their transactions within the EU, particularly if the French government continues with its long-term policy of encouraging more banks to operate from Paris rather than London. Indeed, the risks to the financial sector are reflected in the short-term outcomes of the Brexit decision, as seen in the sharp decline in the share price of many banks. According to the Economist (2016, p. 81), this decline was based on ‘the possibility that financial firms will not be able to serve the whole EU following Brexit and the need for freedom of movement in order to access the EU’s single market’. Given the importance of the London financial services sector to the UK as a whole, it is clear that the largest economic risks to the future of the UK are likely to emanate from this sector of the economy. The UK government may thus face the choice of either accepting free movement of labour or reducing the ability of the UK financial services industry to continue to serve the whole of the EU after Brexit.

At the same time, it is important to note that many proponents of Brexit focused not only on the benefits of single market access, but also on the constraints the single market places on economic activity. In particular, the increasing levels of economic integration with the EU have limited the ability of EU member states to differentiate themselves within the union. Common trade policies have traditionally been seen as limiting to the UK and many Scandinavian member states, who believe their economies have been damaged by European integration (Chopin and Lequesne, 2016). In particular, the EU imposes heavy duties on manufactured goods imported from outside the union. It has been argued that these duties, combined with a protectionist agricultural policy, expensive labour and environmental regulations, and limits on trade outside the union, were a driver for Brexit (Tully, 2016). Brexit could thus help drive down the prices of imported manufactured goods, allow the UK access to overseas agricultural markets, and reduce the need for UK businesses to comply with EU regulations even if they do not actually export anything to the EU. Further to this, Chris Grayling, one of the leaders of the Brexit campaign, argues that the EU influences almost sixty per cent of the UK’s laws, which are determined by what is best for the EU as a whole, not what is best for the UK (Grayling, 2016). Whilst an exit from the single market as part of Brexit would thus harm the UK’s trade with the EU, it would also allow the country the opportunity to reduce externally imposed constraints on its economy, potentially providing significant benefits.

Exiting the EU and leaving the single market would also open up significant opportunities for the UK. This would include the potential to negotiate new trade deals with traditional trade partners such as Australia and New Zealand, who have been marginalised by EU protectionism, as well as emerging economies such as India and China (Armstrong and Portes, 2016). In addition to this, the overall Brexit decision and the associated uncertainty has resulted in a dip in share prices and a market adjustment of interest rates, which are now expected to stay low and potentially fall if uncertainty persists (Lim and Tepper, 2016). This indicates that there may be investment opportunities driven by a low cost of debt and fall in the value of companies enabling UK companies to make more investments and earn higher returns from doing so. As such, the long term impact of Brexit could in fact be positive, provided the process can be managed so as to support the needs of the UK economy.

In conclusion, whilst the short term economic impact of Brexit has been challenging and has seen downgrades in forecasts of UK economic performance, the long term impact is less certain. The economic impact will largely depend on decisions around the single market. Should the UK choose to remain in the single market after Brexit, the economic risks are likely to be minimised, although they may still affect the financial services sector. However, if the UK chooses to leave the single market it will suffer significant negative impacts to the economy based on trade with the EU. At the same time, these negative impacts of Brexit may be outweighed by new trade deals and opportunities with emerging economies and countries outside the EU. The most viable long term economic path for the UK may thus involve a full exit from the EU and the single market, although this path would also involve the most short term risk and uncertainty from Brexit and thus would need to be managed carefully.

References

1. Armstrong, A. and Portes, J. (2016) Commentary: The Economic Consequences of Leaving the EU. National Institute Economic Review. 236(1) p2-6
2. Chopin, T. and Lequensne, C. (2016) Differentiation as a double-edged sword: member states’ practices and Brexit. International Affairs. 92(3) p531-545
3. Economic Outlook (2016a) The short-term impact of Brexit. Economic Outlook. 40(2) p5-9
4. Economic Outlook (2016b) World Economic Prospects. Economic Outlook. 40(3) p1-35
5. Economist (2016) From folly to fragmentation. 420(8996) p61-63
6. Emerson, M. (2016) The Economics of a Brexit. 51(2) p46-47
7. Fichtner, F. Steffen, C. Hachula, M. and Schlaak, T. (2016) Brexit decision is likely to reduce growth in the short term. DIW Economic Bulletin. 26/27, p301-307
8. Grayling, C. (2016) Pro-Brexit: Leaving the E.U. Gives Britain the Freedom to Thrive. 188(2/3) p18-19
9. Helm, T. (2016) https://www.theguardian.com/world/2016/jul/24/brexit-deal-free-movement-exemption-seven-years Accessed 26^th July 2016
10. Lim, P. and Tepper, T. (2016) The Brighter Side of Brexit. 45(7) p17
11. Meager, L. (2016) Brexit threatens London’s clearing hub status. International Financial Law Review. 7/18/2016, p1
12. Ritholtz, B. (2016) http://ritholtz.com/2016/06/brexit-meltdown/ Accessed 1^st August 2016
13. Statista (2016) https://www.statista.com/chart/4533/the-economic-impact-of-brexit/ Accessed 1^st August 2016
14. Tully, S. (2016) The European Union Is In Big Trouble. 173(7) p10-12