Britain’s divorce from the EU: economic impact

The United Kingdom has filed for divorce from the European Union, but before talks over its departure can begin, the European Union must decide how it wants to proceed. This is the worst setback ever for the process of European integration that started with a six-nation coal and steel community in 1952. Politically speaking, the split from the European Union could empower independence movements in Scotland and Northern Ireland and lead to squabbles over repatriated powers.

From 1958 to 1972, the United Kingdom stayed outside the European Economic Community (EEC). As the EEC members traded more with each other, the United Kingdom lost market share fast. The ratio of German imports from the United Kingdom relative to its imports from fellow EEC members fell by more than half. Trade diversion hurt the United Kingdom so badly that it began to ask to be let into the EEC five years after staying aloof in 1958.

After rejecting two United Kingdom applications to join in 1963 and 1967, the EEC finally opened its door to the United Kingdom in 1973. As a result, the United Kingdom’s share of the German import market rebounded strongly. Beyond Prime Minister Theresa May’s mellifluous rhetoric in her last month Lancaster House speech, there are some harsh realities that determine United Kingdom’s negotiating path in which she is either deliberately overlooking or making light of.

Economic analysts strongly argued that there is no significant evidence that EU membership has held back the United Kingdom in an economically meaningful way. Instead, the United Kingdom economy has done well within the EU, even somewhat better than Germany or Sweden on many counts. The notion that the United Kingdom could turn itself into Europe’s Singapore, a rich free-wheeling low-tax service and trade center at the edge of the continent, is largely fantasy.

According to analysts, the United Kingdom is simply in the wrong time zone to be the services center of Asia. It needs Europe as a major market. The more the United Kingdom deviates from European norms, the more the EU will regulate and restrain its imports from the United Kingdom. Whatever the economic merits of tax dumping, the more the United Kingdom tries to be an offshore tax haven, the more will the EU see to it that the goods and services the United Kingdom offers will also stay offshore. That means they cannot be sold easily in the EU.

The United Kingdom needs trade with the much bigger EU27 more than vice versa. As recent EU economic data indicates, whereas the United Kingdom earns 12% of its GDP by exporting goods and services to the EU27, the reverse flow accounts for just 3% of EU27 GDP.

Geography is destiny. For all the talk about limitless globalization, the actual conduct of trade is amazingly region-based. This means that nations end up doing most of their trading with nations nearby and not those very far away.

For the EU27, preserving its own cohesion is the absolute priority. Preserving preferential access to the United Kingdom market is nowhere near the top of priorities. The EU27 will take a hard line without wanting to genuinely punish the United Kingdom. If “Brexit means Brexit” as said by Theresa May, then “out means out” as said by Wolfgang Schauble.

Losing the United Kingdom’s 12 billion Euro net contribution to the EU budget would be somewhat unfortunate for the EU27. But, according to EU high level officials, relative to the size of the EU27 economy which is about 12 trillion Euro, the sum is small. With its fiscal surplus, Germany could easily take a little more than its fair share of that.

If the United Kingdom wants to preserve any element of preferential access to the EU market, it will have to pay into the EU budget in return, just like Norway and Switzerland do. To argue that the EU27 will suffer more from Brexit and that the EU would thus want to offer the United Kingdom a sweet deal in order to reduce the supposed damage to the EU27 is a typical “tail wags dog” delusion.

A Donald Trumpian “great trade deal” with the United States will do little more than to preserve the access to the United States market which the United Kingdom enjoys at the moment. Thus, it has no positive economic effect. Quite a number of British economists seriously argued that the Brexit plan devised by Prime Minister Theresa May will hurt the British economy. The United Kingdom could offset some of the Brexit damage through pro-growth reforms. However, the United Kingdom is already lightly regulated in many areas. Thus, the scope for further liberalization is very limited.

Also, the political climate in the United Kingdom with its strong populist streaks of the likes of UKIP, Jeremy Corbyn, Boris Johnson, etc, does not suggest that the United Kingdom will embark on a massive deregulation drive soon, reducing “workers rights” and the like on a major scale.

The very fact that the EU27 finds it difficult to agree makes it unlikely for the United Kingdom to get much of a “bespoke” deal. It is indeed easy to have a guess who would dictate most of the terms. That would leave a tough choice for the United Kingdom between accepting whatever Europe offers and going for a long and contested divorce battle.

Of course, the United Kingdom would still trade with the EU even after a messy divorce. But its access would be restricted in those fields in which it does not fully abide by all EU regulations. The United Kingdom would be at a disadvantage, as it had been when it had remained outside the EEC 1958-1972. We know how that ended for the United Kingdom.