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Tuesday, 19 May 2015

Should I stay or should I go? The Ghosts “Brexit” May Call

The victory of the Conservatives at the general elections in the UK two weeks ago was not a big surprise as such, as there was no real alternative to the current government. If anything, the clear win for Prime Minister David Cameron was also partly due to the fact that he promised to hold a referendum about the future stay of the UK in the EU, if he got re-elected. 

Cameron originally scheduled the referendum for 2017, though it could even happen earlier, in 2016. The question is not if the UK should hold a referendum or not, or if it is applicable, but what the consequences would be, if the UK decides to leave the EU. This could mark the end of the membership of the UK to Europe, after it had joined the European Economic Community (EEC) in 1973. Such a scenario has been popularly discussed under the term “Brexit” (Britan + Exit; similar to the scenario of Greece leaving the Euro-Zone – “Grexit”). 

The Legal Basis – Not as Easy as it Seems
According to Article 50 of the Treaty of the European Union, a member state has the right to leave the EU. Nevertheless, it is not a step that can be done overnight. The provisions laid down in the Treaty of the European Union state that the future relations between the EU and the quitting member have to be discussed and formalized. These relations refer to future bilateral agreements between the EU and the country in question, such as trade agreements, political cooperation, matters of security policy and any cross-border cooperation. Such a case has, however, never occurred before. 

This is a matter of years, and if political realism teaches one lesson, then that no decision can be done within a few days and then undone straight afterwards. Assuming the theoretical concept that, if the UK decides to re-join the EU a couple of years after its withdrawal, it will need to go through the entire accession process, like a normal membership applicant. 

For the time being, quitting the EU sounds like a popular, if not populist tendency in order to win votes for the election. If this was Cameron’s main purpose to win the elections, then it definitely worked for him. But it is more likely that the halo effect will be over soon and that the planned referendum will be hold, but not change anything whatsoever. There are various, mostly economic reasons, why it is improbable for the UK to leave the EU. 

Schrödinger’s UK – Part of the EU, and Not Really
On a first glance, it seems like the UK has little to lose when it decides to leave the EU. Unlike the majority of all EU countries, the UK has never dropped its own currency, the Pound Sterling, for the Euro, as it refused to transfer monetary competencies to the European Central Bank (ECB). As a result, it is monetarily independent from the Euro-Zone and it is also not part of the European Exchange Rate Mechanism (ERM II). 

Secondly, the UK is not part of the Schengen Area as it has decided to opt-out of the common free movement of people, goods, and services. However, the UK is not the only EU Member State that is not part of the Schengen Area. Ireland also has an opt-out, while the remaining non-Schengen EU members Cyprus, Romania, Bulgaria, and Croatia will eventually join the Schengen Area in the next years – as soon as they have met the necessary criteria.

In addition, the UK pays less into the EU budget than it actually should according to its GDP performance due to an agreement between the EEC and the British government under Prime Minister Margaret Thatcher in 1984, called the “UK rebate”. The reason for this was the high proportion of the EU budget for the Common Agricultural Policy (CAP), which benefits the UK less than other member states like France or Germany. Because of the low benefits and the fact that the UK back then was the second poorest of all 10 EEC members, Thatcher managed to get a deal. The rebate is calculated as approximately two-thirds of the amount by which UK payments into the EU exceed EU expenditure returning to the UK. Currently the rebate is worth around € 3.8 billion euros per year. Nevertheless, the UK is one of the largest net contributors. In order to compensate this British gap capped to 25%, the other member states need more to pay into the EU budget. 

Cutting Off Your Own Arm
Assuming the outcome of the referendum in 2017 (or even in 2016) would lead to a withdrawal for the UK from the EU by 2018, the long-term economic consequences would be quite severe. Even though, there are some chances in such a withdrawal. According to a briefing by the Open Europe think tank, the UK would be able to make new trade agreements with other countries more easily than within EU membership. As such, the UK could also draft lighter regulations on export goods than under common EU trade regime. This would make the UK more independent in global exports.

However, there are some significant risks which would also have long-term impacts. 

The UK, as a goods exporting nation, will have to face new tariff regimes for their exports to the EU – to which it no longer belongs. One of the benefits of being an EU member is the absence of tariffs for trading within EU member states. Trading goods like cars, machinery, chemicals, food and beverages would suffer an immediate high risk of disruption and would be hit by import tariffs between 4.7% for cars and over 20% for food, beverage and tobacco. Specifically in this sector, the trade deficit with the EU would be more than 22.8 billion Euros – taking into consideration that 60% of all food, beverage and tobacco goods are exported to the EU. 

Although the service sector would probably benefit from a “Brexit” – the financial service would even make a surplus of approximately 22.1 billion Pounds, the impact would still be severe as new and tighter access regulations to the European finance market would elevate the barriers. 

Three Scenarios for “Brexit”
The German Bertelsmann Foundation and the ifo-Institute have both analysed the economic effects of “Brexit” and drafted three possible scenarios: 

First, a “soft exit” from the EU, with the UK obtaining a similar status as the non-members Switzerland or Norway. Though no longer an EU members, it would be part of a trading agreement and not be hit by tariffs, though other non-tariff barriers might apply. 

Second, a so called “deep cut” without a trading agreement. This will lead to higher import tariffs and trade barriers with the EU. The tariffs would possible reach the same amount as between the EU and the US. 

Third – as a worst case scenario, an isolationist approach by the UK. In this scenario, the UK would lose all its privileges with 38 other countries, which do have a trading agreement with the EU – from which the UK currently also benefits. Even though the UK could draft individual trading agreements with every single country, it would be a long and exhausting process and the UK would find itself in a weakened position on the global market in comparison to the entire EU. 

In addition, the real GDP per capita could drop statically by 3% compared to an EU membership of the UK, if the worst case scenario should occur. Dynamically, the GDP loss could be even far more dramatic: up to 14% GDP losses, leading to dynamic losses of more than 300 billion Euros. 

A “Brexit” would also hit the other remaining EU members. With the UK no longer a member, other country’s GDPs would also suffer from higher export regulations. Above all, Ireland’s GDP would severely drop by more than 2%. In comparison, Germany’s GDP would drop by 0.33%; the EU-27’s total GDP performance (without the UK), would drop by 0.36%. 

Furthermore, the other EU member states would need to pay more into the EU budget in order to compensate the (already rebated) UK contribution. For example, Germany would need to pay an additional 2.5 billion Euros into the EU budget and a country in debt crisis like Italy would even need to pay an additional 1.3 billion Euros. 

Political Consequences – Opening the Floodgates
Economic consequences of “Brexit” will inevitably lead to political consequences – for both the EU and the UK. For Europe, a UK withdrawal would not only be unique in the history of the European integration process, it could lead to other member states to consider leaving the EU. Apart from the UK, even Ireland is silently thinking of this option, and so does the Czech Republic, or even Greece – in case that it defaults and leaves the Euro-Zone. 

Consequently, the entire EU would be weakened politically as the whole concept of European integration will be drastically questioned. This will raise national distrust against the EU system boost nationalism in its member states. More than 50 years of European integration would fall apart and throw the continent back to a state of national rivalry. Some might consider this as regaining national competencies and independence from a Euro-centric, non-transparent and hyper-bureaucratic system, but it would inevitably lead to a sudden loss of freedom within Europe, which younger generations have taken for granted. 

For the UK, “Brexit” also implies the chance of another Scottish referendum for independence. Since Scotland is more “pro-European” than England, a “Brexit” could boost a Scottish independence movement even more. The very recent success of the Scottish National Party (SNP) at the election proves that the independence movement has not vanished – despite the non-independence vote at last year’s referendum. 

Better an Itchy Blanket than no Blanket
From a realistic perspective, the UK will most likely continue to stay with the EU – though most British consider the EU as an itchy blanket. British exceptionalism has its limits and for real-political reasons – and above all for economic reasons – the UK cannot afford a withdrawal, as it would lead to more serious issues than it already has. The UK currently finds itself in a rather comfortable position: it pays less into the EU budget than other EU members, it benefits from the free trade inside the EU and through the EU’s trading agreements with other countries, and it is a vital export market for the own industry. Even though most of the UK population doesn’t like the EU as a political system, economically it is still very convenient. 

However, loudmouths like Nigel Farage from the notorious Anti-EU United Kingdom Independence Party (UKIP) shout against the EU and declare it an undemocratic totalitarian system and people will go on listening to him, especially as he was the cause for Cameron to offer a referendum on UK’s EU membership in order to pull votes away from UKIP. Fortunately, the British electoral system only brought one UKIP MP into the House of Commons, despite of having received 12.6% of the total votes.

If UKIP had won, the UK would have left the EU by last Tuesday the latest.

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