28 April 2016

Franz Nauschnigg: Economic consequences of Brexit - Austria and Switzerland as potential counterfactuals

The different integration strategies of Austria and Switzerland, which is sometimes mentioned as a model for the UK, could serve as potential counterfactuals that show the economic consequences of leaving the EU.

Most studies [about the economic consequences of Brexit] point towards significant economic costs for the UK, in a range of several percent of GDP, mostly because of higher tariff and non-tariff barriers to trade as around half of the UK’s trade is with the EU, its by far most important trading partner. The leave camp counters with studies that claim that the UK, freed from EU regulations and net contributions to the EU budget, would do even better outside the EU. The economic costs of Brexit for the UK will depend to a large degree how fast a new comprehensive legal framework for EU/UK relations can be negotiated. So one should take all these studies with a pinch of salt, but one thing is clear, the longer the uncertainty lasts, the higher the costs.

Here the different integration strategies of Austria and Switzerland, which is sometimes mentioned as a model for the UK, could serve as potential counterfactuals that show the economic consequences. Not all growth differentials however should be attributed to the integration strategies; also other factors played a role, e.g. opening up of Central and Eastern Europe. Also the causality of parallel events is open to discussion. Despite these qualifications they offer interesting real world examples.

Both countries, small open and rich economies in the centre of Europe, where founding members of EFTA in 1960, as were the UK. In the 1970s both concluded free trade agreements with the EU and at the end of the 1980s both wanted to participate in the EU single market through the European Economic Area (EEA) linking the EFTA countries into the EU single market. I still remember the good cooperation with our Swiss colleagues in the EEA negotiations. After finishing the EEA negotiations the Swiss had a referendum on the EEA in 1992 which they lost.

Already before the referendum uncertainty in Switzerland increased and a lot of firms considered to relocate to Austria to have a secure access to the EU single market and some did it. The increased uncertainty also impacted on investment decisions and contributed to problems in the Swiss housing market. My Swiss colleagues had been initially relatively optimistic to conclude quite fast bilateral agreements with the EU instead of the EEA, covering access to the EU single market in most areas. They said we just take what we have agreed in the EEA negotiations. In the end it took them several years to conclude these bilateral agreements and they had to take over practically all EU regulations and pay substantial net contributions to the EU budget.

Austria joined the EEA and in 1995 the EU because we wanted not just to follow EU regulations but have a vote on them. Also the EEA countries have to pay net contributions to the EU Budget, currently Norway, Iceland and Liechtenstein pay around 400 Mio. Euro annually.  Switzerland sometimes implements EU regulations faster than Austria.

The following chart about the growth performance of Austria and Switzerland shows a clear picture. In the 1970s and 1980s Austria was growing only a bit faster than Switzerland as it was poorer and therefore catching up.

Swiss growth was weak for several years in the early 1990s around the negative EEA referendum and a huge growth differential with Austria opened up. Swiss growth was only catching up to Austria after they had concluded the bilateral agreements giving their economy nearly full access to the EU single market.

Since Switzerland has good access to the EU single market its growth rate has converged with Austria again, but they never recovered the losses they had before. In theory however Switzerland should grow faster, as it was and is much more competitive than Austria. In the latest global competitive rankings of the World Economic Forum for 2014 - 2015 Switzerland was in the first place and Austria only in the twenty-first; the UK is on the tenth place. So the UK would have to be very good indeed, to do better outside the EU as some claim.

And Switzerland was always in a much better position than the UK with a huge current account surplus and a much better fiscal position. The UK with a huge current account and fiscal deficit is very dependent on capital inflows. Recent experiences in Eastern Europe and in the Euro area periphery have shown how fast capital inflows can stop or even go into reverse. The Bank of England rightly worries about the financial stability risks of Brexit.

After a referendum in favor of Brexit the uncertainty could be extended for a prolonged period. Britain needs the EU market more than the EU needs Britain’s, so the bargaining power would be asymmetric. The EU and especially several member states with a very limited economic impact of Brexit, for political reasons, or in order to gain business from the UK would most likely drive a hard bargain. This to deter other countries from contemplating exits of their own, so that Brexit doesn't become a possible trigger for further disintegration in the EU.  

© Franz Nauschnigg