The Conservative party is committed to holding a referendum on the UK’s membership of the European Union (EU) in 2017 – and many voters seem keen on having the opportunity to express their opinion. So what would be the consequences of a majority vote in favour of leaving? ‘Brexit’ is likely to have a significant negative impact on the UK economy, writes Joao Paulo Pessoa.
Eurosceptics emphasise greater national sovereignty from Brexit while Europhiles tend to focus on the importance of ever greater unity to reduce the risks of the political conflicts that ravaged Europe in the first half of the twentieth century. These are important matters, but we focus on the more mundane (but quantifiable) economic issues.
Leaving the EU would bring home the equivalent of about half a percentage point of national income, since the UK would transfer fewer resources to subsidise poorer EU members. This would be the main economic benefit of Brexit.
The most important cost would be in the form of lower trade. There are three possible reasons why trade costs may increase after leaving the EU:
Our analysis uses a state-of-the-art quantitative model of international trade to estimate the effects of Brexit on trade and quantify the consequences for national income.
Our initial ‘static’ calculations suggest that even in the most optimistic scenario, there would be an overall loss of national income of 1.13% driven simply by current and future changes in non-tariff barriers. In a pessimistic scenario, the overall loss swells to 3.09%, with most of the impact coming from higher non-tariff barriers (2.55%). These far outweigh the fiscal saving. In cash terms, the loss is £50 billion in the pessimistic scenario and still a substantial £18 billion in the optimistic one.
But these numbers do not take account of several other ‘dynamic’ forces, for example, the effects of trade on growth. Trade could increase productivity via more competition, innovation and adoption of technologies.
Using a different approach that factors in more realistic dynamic losses from lower productivity growth, a conservative estimate would double losses to 2.2% of GDP even in the most optimistic case. In the pessimistic case, there would be income falls between 6.3% and 9.5% of GDP. To put these numbers in perspective, during the 2008/09 global financial crisis, the UK’s GDP fell by around 7%.
There are several other potential economic effects of Brexit. These include the effects of regulation, immigration and foreign direct investment (FDI).
The UK received the most FDI of any European country in 2011, and was second only to the United States in terms of the stock of inward FDI around the world. Part of the attraction of the UK is as an export platform to the rest of the EU, so if the UK is outside the trading bloc, this position is likely to be threatened. This matters because foreign multinationals tend to be high productivity firms and they bring new technologies and management skills with them.
Outside the EU, the UK could restrict immigration from the rest of the EU and vice versa. In economic terms, migratory flows act much like trade as people tend to move to where they can be more productive and earn higher incomes, increasing total welfare. Other studies find that restricting this mobility will, just like restricting trade, reduce UK overall welfare. Moreover, other evidence suggests that there have been no negative effects on jobs and wages of native Britons from the waves of EU immigration. So even on distributional grounds, immigration does not seem to have been damaging.
Currently the UK is able to influence the rules and regulations governing the EU single market. Even if the UK maintained full access to the single market, it would be in the same situation as Switzerland: UK exports would have to follow these regulations without being party to agreeing them.
In sum, our current assessment is that leaving the EU would be likely to impose substantial costs on the UK economy and would be a very risky gamble. The dream of splendid isolation may turn out to be a very costly one indeed.
For more details see: ‘Brexit or Fixit? The Trade and Welfare Effects of Leaving the European Union’ by Gianmarco Ottaviano, Joao Paulo Pessoa, Thomas Sampson and John Van Reenen
Joao Paulo Pessoa works at Centre for Economic Performance, part of the London School of Economics