BREXIT: Stay or Leave? An Economic Analysis Part 1
Next March, Britain will almost certainly be leaving the European Union, after an unexpected result from a referendum on June 23, 2016. A slim majority of British citizens (51.9 percent) voted to leave the European Union, and with it, all of its trade deals, membership fees, and laws. Brexit will affect the UK for years to come, and will have long-lasting economic and political consequences for British citizens. But the cost of leaving the EU may be greater than voters anticipated. Theoretical and empirical economic evidence suggests that leaving the EU would cause a decline in the average living standard of UK citizens. (Van Reenen, 2016) Brexit would lead to loss of beneficial trade deals with the rest of Europe, decline in the productivity of the labor market, and decline in foreign investment. The UK has two primary options regarding their removal from the EU: they could remain in the single market but remove themselves from the EU (a “soft” Brexit), or they will fail to reach a deal and revert back to the laws of the World Trade Organization (a “hard” Brexit). The decision they make will create vastly different effects on the UK economy. This is the first of a two-part piece on Brexit: what it is, what it means for the UK, and the options Britain has to mitigate the economic ramifications. The economic losses of leaving the EU will almost certainly lead Britain into a recession. The best scenario for Britain to save their economy would be to remain in the EU, and if that is no longer an option, to be open to the single market. This first part will provide an introduction to the different kinds of market options Britain has available to them. The second part will primarily be an analysis of how UK trade will change after Brexit and be an essential cause of their economic decline.
The first trade agreement the UK could employ is simply a Free-Trade Area (FTA). Alan Griffiths and Stuart Wall (2012) define an FTA as a region that has zero/preferential tariff rates for goods and/or services produced, while member countries keep their own external tariff rates and commercial policy. An FTA requires border checks to prevent re-exporting, and participating countries set rules on documentation and origin of the goods (Griffiths and Wall, 2012). An FTA increases competition and lowers prices, while increasing foreign investment. One FTA model is the Swiss model, which would guarantee tariff-free access to non-agricultural goods between the UK and EU. However, the Swiss model does not include free trade of services, and also includes the free movement of labor, a contentious issue for Brexiteers.
The second important agreement the UK could make is to remain a part the EU’s customs union. A customs union is an agreement where members have zero or preferential rates for goods and/or services, and also the same external tariff rates. Goods move more freely inside the EU’s customs union. Having the same product regulations further reduces need for CU member border checks. (Griffiths and Wall, 2012) If Britain left the CU, exporters would be required to demonstrate that the goods they are exporting originated in the UK, to avoid paying tariffs. This would create a nontariff barrier to trade, increasing trade costs.
Lastly, the UK could decide to remain in the EU’s single market but leave the customs union, much like Norway, Iceland, and Liechtenstein. The single market includes free movement of goods, services, people, and capital between the member countries, with no borders and common product regulations. (Griffiths and Wall 2012) These “four freedoms” are the hallmark of the EU trade agreement, and are the source of much of the contention surrounding the decision to stay or leave. If Britain followed in Norway’s footsteps, the UK would have no tariffs with the EU, and could work with the EU to minimize non-tariff barriers. If the UK were to remain in the single market and customs union, not much would change economically. However, it is unlikely that the UK will agree to stay within the single market, as many Brexiteers are against the free movement of labor.
If the UK is unable to reach one of these deals, and reverts to its WTO trade rules (a “hard” Brexit), the economic ramifications would be severe. A hard Brexit would cut off any beneficial trade deals with the EU, causing a decline in labor market productivity due to restrictions on free movement of labor and decreasing foreign investment, limiting UK revenue in foreign markets. A soft Brexit would minimize the change in trade costs between the UK and the EU, allowing a significant portion of their current trade with Europe to continue. Upon review of the economic evidence, it is clear that, at least on economic grounds, the UK’s best bet is to remain part of the single market. It is uncertain whether this is a viable option, as this would not be attractive to Brexiteers. It would also not provide much in terms of benefits compared to what the UK currently enjoys as a full member. But one thing is clear: what the Britain decides next March will affect Britain’s economy to such a large degree that it could even cause a domestic recession. We can only speculate what this might mean for the rest of the world, but with increased strain in global international trade and increasing interest rates, we can only hope this is not the straw that breaks the global economy’s back.
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