By Rasananda Panda & Prashanta Chandra Panda*, August 7, 2016 : Brexit is a portmanteau of the words “Britain” and “Exit”, the same way the possible exit of Greece from EU was dubbed as Grexit. In the referendum to decide whether the United Kingdom (UK) should leave or stay in the European Union, the people of the UK have decided to leave with a voting margin of 52% to 48%. The exit of UK from EU now depends on invoking the article 50 and the subsequent agreement on a framework for the UK’s withdrawal.

Brief History

The European Economic Community was created after the World War II to foster economic development in the war torn region as well as to create harmony between the European nations and avoid possible wars. The name was later changed to European Union which currently has 28 members. The European Union provided a ‘single market’ for easy trade as well as free movement of people across the member countries.

A single currency- the Euro was also created for easy transaction which is presently used by 19 of the member countries. The European Union has its own parliament and looks after various policies, including climate, environment and health, external relations and security, justice and migration.

Membership in the European Union has been a long debated topic in the UK. A referendum has already been held in 1975 to whether the UK should stay in the EU just two years after joining the European Economic Community (European Union).

The European Union currently includes Austria, Belgium, Bulgaria, Croatia, Republic of Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the UK. Post Brexit, UK will no longer be a member of the Union.

Problems in European Union – The European Debt Crisis and Plunging Euro

In the wake of the Great Recession around 2008, several Eurozone countries (Portugal, Ireland, Greece, Spain and Cyprus) were facing government structural deficits and high debt levels. The crisis was controlled to an extent by financial guarantees by other European countries and the International Monetary Fund (IMF). It has, however led to decrease in confidence for trade and commerce in the Eurozone as well as a decline in the value of the Euro.

It is believed that the Brexit movement gained more support during the European debt crisis. The economic condition of the European Union was compared to an unsalvagable sinking ship and the unfair burden on the developed economies to bail out the countries in crisis was pointed out. In two years time between 2014 and 2016 Euro fallen nearly 20% against dollar.

UK is having trade surplus with  non European economies. With major European partners it has trade deficit to the amount of 60% total exports to this region. We have shared data for 2014 and 2015 for this purpose.

Except China UK seems to have almost equal in partner for exports and imports with its major trading partners. UK may gain more devising independent strategy to gain more from trade with this area and commonwealth economies. For the struggling EU economies the  reorganization and restructuring of government departments to make it  flexible and responsive, and pension reform for long-term sustainability of public finances has limitations in terms of finance and negative effect on the economy. Export buoyancy may be lacking for the period.

Because of controlled  access to credit (together with an initial sharp increase in lending rates) and with  supplyside reforms in the service sectors only Baltic economies  could attempt rebalancing of their economies with relative ease. Now you see them successful in  growth path. The services sector makes up for 74.7% of GDP in the European Union. Debt is rising and at the same time GDP growth rate is slow for some economies. This is putting negative effect on the currency.

Immigration issue 

Developed nations in the EU is also suffering from the rising immigration. European Union allows free movement across the member nations allowing visa free entry to any member country. This has been cited as a problem in the UK as immigrants from economically struggling countries (Ireland, Poland, Romania, Italy, Lithuania etc.) come to the UK in search for jobs and are willing to work for  comparatively lower wages leading to scarcity of jobs for nationals.

Reasons for UK to leave

Many British people believe that Britain is being held back by the EU ,which has imposed a lot of rules and regulations which is hampering the growth of business. Although  EU allows free and easy trade with the member nations, trading with non EU countries comes with lots of regulations and taxes which constraints British firm’s ability to expand to other nations. Also, the hefty membership fees charged by the EU while providing little return is a big issue in the country.

Table 1: Latest Migration Statistics, Year Ending December 2015

(Source: migrationwatchuk.com}

Immigration is also cited as a major issue for Britain’s exit. EU’s “free movement” policy which allows any EU citizen to go and live in any other EU country without a visa has led to a high level of immigration to Britain. The number of immigrants in the UK has doubled since 2012.

The net migration to the UK as per December 2015 was about 333000 out of which 184000 were from EU. Britain’s economy provides higher job prospects and welfare schemes which attracts immigrants from less developed countries which has not only added to population burden but also increased competition for the scarce resources.

The country is also against the idea of “ever closer union” which it perceives as the creation of a “United States of  Europe” thereby endangering the UK’s sovereignty.

It is has however been argued that immigrants provide the UK with the much needed  and highly skilled workforce for the economic development of the nation.

Reasons for UK to Stay

The main advantage for the UK to be in the EU is the ease of trading with other EU countries. The EU’s single market policy allows three major benefits to the member nations. Firstly, it eliminates tariffs on goods. Secondly, companies can sell goods or services to other member states. Third, it allows export-import between member countries without having to comply with 28 different rule books of various countries.

Britain- EU export and import in the month of May 2016 was £11.4 billion and £18.6 billion respectively. The major import-export partners were Germany, Netherlands, France, Ireland- countries which are economically sound and close to proximity as well.

Britain’s status with the European Union countries may get damaged by leaving as Britain enjoyed a healthy trade relationship with EU countries. Also Britain has a much louder say as a member of 28 country group rather than going solo.

Impact of Brexit on UK 

Following the decision to leave European union, major stock markets across the world were in turmoil, especially, the London stock market, which suffered steep losses at the opening, but recovered to finish down 199 points or minus 3.1%. Bank stocks suffered the highest burnt followed by house builders who also suffered huge losses.

It is speculated that trade between Britain and the countries of the European Union will also fall as a result of the exit. The free trade policy with the rest of the Europe under European Union will no longer be applicable and hence UK will have to reestablish trade relationship with the rest of the country from scratch again.

It is also argued that the share of companies in the UK will become less attractive to foreign investors thereby reducing share values. In the longer term, however the share prices are supposed to rise as the companies start to make profits. Export import will be a mixed affair as exporters will gain more, attributing to the weaker pound while the importers will see a slump in their profits.

The British pound suffered its largest one day fall on 24^th June as seen in the figure after the news about Britain exiting the  European Union. The fall in Pound Sterling has incited various speculations in the near future, including slower economic growth, reduction in wage growth and reduced employment prospects.

Impact of Brexit on the World 

The news about UK leaving the EU was not taken well by investors all across the world, resulting in volatility in the markets all over. Investor sentiment was majorly towards avoiding equity and instead going for commodities like Gold as a result of which the value of Gold was considerably appreciated. Also safe havens like the Japanese Yen was preferred by the investors, thereby considerably appreciating Yen.

Impact on European Union

Exit of Britain will have many macroeconomical as well as geopolitical impact on the European Union. Firstly, the European union will lose an influential member, thereby shifting the balance of power towards a few powerful countries. This will make it harder to block illiberal measures in the EU. Post Brexit, there will be tussling of power between Germany and France and will lead to changes in the political dynamics of the region. London is currently considered as the financial capital of EU as it is place of headquarters for most of the companies operating in the EU.

Post Brexit, companies will find it hard to control their businesses in the EU and therefore trade can be disrupted for a short period of time. Also, without the UK, EU will lose its status as an important trading hub and will become a less attractive destination as compared to the USA, Japan and many emerging nations.

Countries like the Netherlands, Ireland and Cyprus, who have strong trade and financial links with  the UK will be most exposed to the aftermaths of Brexit. Spain and France have a substantial direct investment in the UK, which will be a major concern for these countries. Other countries will be closely monitoring the impact of the British exit on the EU budget and their residents in UK. Countries like Greece and France are also not too fond of the European Union and may follow suit and thereby jeopardizing the existence of the EU.

Impact on Advanced Economies

The impact on Advanced economies out of the European union is still not clear enough at the moment. Countries like America who have companies and investors in direct trade with the European countries will likely face credit risk. Also a weak Euro will increase the price of American products and thereby reduce the demands. Japan, a major manufacturing country has many manufacturing units set up in the UK from where it operates across the EU. Brexit will severely hamper the present trade conditions in the EU and the Japanese companies have to rethink on their trade policies in the region. Brexit will also complicate the talks between Japan and EU for an economic partnership agreement. Australia has been trying to hold preliminary talks regarding free trading. This process may be put on hold because of Brexit. Also, Australia would now need to have separate talks with Britain and EU. Specific markets such as the wine markets may be affected but no major effect is predicted for the Australian economy.

Impact on Emerging Market Economies

Emerging economies are currently driving most of the world’s growth. The emerging markets now account for about 58% of the global output. China is currently a $10.98 trillion economy and the world’s second largest economy and is growing at a rate of 7 %. India is now the fastest growing global economy with a growth rate of 8% as per 2016 data.

Although UK is not a major trading partner with countries like India and China, they nevertheless will feel the impact of Brexit. China, which is mainly an export oriented country is currently facing decrease in growth acounting to low global demand. Brexit will only make things worse for China as the demand will decrease in the UK and the EU countries which could have been a good option for China in the near future.

The same can be said about India as the total FDI equity share of the UK in India is a mere 8 percent. The impact till now has been seen only in the equity market which was down for a short time and has risen again to the normal value. Brexit can however be seen as a positive move for India as it will develop a better trade relationship with the UK as well as allow more jobs to the Indian diaspora staying in Britain.

Geopolitically, Brexit can be seen as God sent gift to China as it was wary about a strong Europe as it can join hands with the United States and form a strategic alliance against Beijing dominance. Also the Chinese propagandists are portraying this event as  a dysfunction of democracy.

Geopolitical Issues

Various geopolitical issues have also risen due to the Brexit. Theresa May has been sworn in as the new Prime Minister of UK following the resignation of David Cameroon who was a supporter of the remain campaign in the Brexit referendum. It would be especially hard for the new prime minister to steer the country which has to renew its geopolitical and trade relations with the rest of the world.

A major point of concern is that unlike England and Wales who had a clear majority for leaving the European Union, Scotland and Northern Ireland were in favor of remaining in the European Union. This has created speculation on whether Scotland and Northern Island would like to stay in the European Union thereby disintegrating the United Kingdom.

Another fact to notice is that Britain is considered as the gateway of Europe as many companies from non EU countries first enter Britain as a means to enter the EU markets. Britain’s image as the financial hub with a predictable legal system as well as the language made it the first choice for many companies to establish their business here. This status will however no longer remain as companies will have to look for alternate options to establish business with EU.

What lies ahead for UK?

The UK’s decision to leave the European Union has created a major question on how it will manage to continue to trade especially with the countries of the European Union. Majorly, there are five models that are available in the country.

The first option is to join the European Economic Area which is followed by Norway, Ireland and Liechtenstein. This means banks will be working normally but will require free movement of nationals to the UK.

The second option is to follow the Switzerland option. This will provide UK access to parts of EU market at a certain fee. This also requires free movement of nationals as well as providing of financial services to the European Union.

The third option is to follow the Canada option wherein the market will be only partially open to Britain. This will allow UK the option of not allowing workers from the European Union.

The fourth option is to simply rely on the World Trade Organization (WTO) and its rules and regulations.

The fifth option is to enter into bilateral agreements with some or all of the EU countries. 

Conclusion 

Brexit has led to economic slowdown in the Britain as well as decrease in value of the Pound. Also the geopolitical effect of Brexit on Britain is currently quite profound with the country having to deal with many issues like trade with EU countries, creating bilateral treaties with other countries as well as political stability. It has also given rise to fear of other EU countries following suit and subsequent disintegration of the EU- which is not a good sign for the trade and political scenario of the region.

The macroeconomic effects of Brexit on the world is currently not so sure as it will take time to publish the macro-economic data, the immediate aftermath of Brexit is evident in the form of volatile stock market and currencies in many countries across the world. The effect however is subsiding slowly as the market is gaining confidence. Countries which have trade relations with Britain will be facing problems for some time and will be closely observing the developments in British economic and political scenario.

Another point to acknowledge is growing protectionism and anti-immigrant sentiment world wide which is a point of concern towards world harmony and peace.

*(Dr. Rasananda Panda and Dr. Prashanta Ch. Panda  are faculty in Economics and Khyati Jagani is FPM scholar at MICA)