02 May 2016

PIIE: Brexit Scenarios for June 24

Scenario 1: The UK votes to stay in the EU

If UK voters decide to remain in the EU, the deal forged by Prime Minister David Cameron will take effect quickly. But if most Conservative voters back the losing Brexit side, which seems probable, Cameron is hardly likely to be viewed as a savior inside his party. [...] In other words, a defeat for Brexit is not likely to make the UK government more friendly towards the EU.

Boris Johnson, the mayor of London and proponent of the Brexit, is thus increasingly likely to seek the job of prime minister even before the next UK election. [...]

Scenario 2: UK votes to leave the EU

Cameron's stated intention to launch a UK exit procedure under the EU Treaty's Article 50 was aimed to undercut any pro-Brexit fantasy that a rejection of Europe could be reversed in a subsequent referendum. Yet a vote to leave the EU would not necessarily preclude more discussions with Brussels before any actual legally binding steps were taken.

A "time out" could take a very long time, however. The history of previous referenda suggests that the heterogeneous collection of rejectionists rarely agrees on what to do next. [...] In the wake of the offensive and atavistic comments about President Obama's part-Kenyan heritage and his alleged ancestral hatred of the British Empire, a Conservative government is not likely to be open about trade or immigration. This would greatly amplify any post-Brexit economic and political downside for the UK.

At a practical level it is also difficult to see the allegedly noxious set of growth-and-job-destroying EU regulations that Brexit would unshackle Britain from. The UK already has among the lowest levels of product market regulations in the OECD comparable to levels in the United States. But many of the regulatory practices that surely are problematic in the UK—say land use or licensing and permitting—are domestic in origin, not EU practices. After all, NIMBYism is not something Brussels imposed on Britain. [...]

Meanwhile, the Scottish nationalists in the SNP have already let it be known that they would likely seek a new referendum on Scottish independence if—as appears likely in a Brexit scenario—Scotland were to vote to stay in the EU only to be outnumbered by an English no vote. And as the UK and the EU—being World Trade Organization (WTO) members—could not offer a special deal to Ireland and Northern Ireland, the Green Isle would again be separated by an actual border, including tariffs and likely physical border controls. It does not appear impossible that these prospects could lead to a movement in Northern Ireland to secede from the UK and unify with the rest of Ireland inside the EU. Certainly a vote to leave the EU spearheaded by English voters would unleash very serious centrifugal political forces inside the UK itself, greatly complicating any domestic political process of deciding what the next steps should be. And it would be a mistake to assume that centrifugal political forces unleashed by Brexit would negatively affect only the EU. The UK itself may well not survive Brexit in the medium term.

This will matter greatly, as the rest of the EU—just as the euro area could afford to wait longer for a solution than Greece during the euro crisis—can afford to wait much longer than can the UK for a solution to be found. [...]For the UK, 50 percent of its goods and 35 percent of its services are exported to the other countries in the EU. Yes, Brexit would economically hurt both the EU and UK, but surely the latter far more.

In the face of an exit, the UK should expect the EU to bargain hard. Almost every EU member has a nationalist, anti-EU party in parliament. These parties (together with Vladimir Putin) would love to undo European integration. The incentive for the EU to impose a harsh deal on the UK is obvious. Nor would they have any incentive to speed the negotiations along.

An obvious casualty would be the City of London and its status as the principal financial center for Europe and the euro currency. The EU and euro area governments would actively seek to "repatriate" as many euro-related financial activities (and jobs) as possible from London. In a short time, they would succeed.

The EU would not likely accept anything other than the core components of the “Norway/Switzerland model” for a close economic relationship with the UK. Such an arrangement would require that the UK contribute to the relevant EU program and agency budgets that it wishes to participate in, such as the Internal Market. Such participation is generally guided by a proportionality factor related to the size of the GDP of the non-EU member to the size of the entire European Economic Area (EEA). The UK would lose its EU budget rebate and be compelled to contribute to EU activities on a scale comparable to regular EU members. [...]

In principle, Norway and Switzerland must comply with the EU’s internal freedom of movement rules. They cannot impose unilateral restrictions on EU worker migration. [..]

The EU has stood firm against Swiss restrictions on EU migration. A post-Brexit UK seeking to restrict migration of EU residents would lose access to the EU Internal Market, along with any close economic relationship with the EU. Britain would have to choose between keeping the free movement of workers or abandoning economic ties with the EU.

Given the prominence of migration in the Brexit debate, it seems inconceivable that any Conservative government could agree to simply maintain the status quo on this issue, and the prospects for any meaningful economic agreement and certainly Internal Market access hence look very dim.

Following an activation of Article 50, the UK would hence probably fall out of the EU after two years of futile negotiations, and instead be left to trade with the rest of the EU on similar terms as all other non-EU WTO members. The economic consequences would likely be hugely disruptive. [...]

Full article on PIIE

© Peter G Peterson Institute for International Economics