Change: Brexit – is the worst still to come?

The EU referendum vote on 23 June 2016 represented the biggest political decision British voters have made in their lifetime. The British public in turn delivered a result that can easily be classified as one of the biggest shocks to the political elite, to its European neighbours and to the global economy as a whole. Professor John Ryan, LSE Ideas, shares his thoughts


It is clear from the result that British society suffers from an identity crisis not unlike those that have hit other Western countries in the wake of globalisation and the 2008 financial crisis. Fragmentation is spreading everywhere as nations become more inward-looking and worried about how the world is changing.

The UK in particular faces another political complication: the rise of nationalism in Scotland and the effect of Brexit on the survival of the UK. In 2014, Scotland voted in its own referendum to remain in the UK, but the nationalists won almost all of Scotland’s seats in the general election eight months later. With Scottish opinion much more pro-European than in England, Nicola Sturgeon is seeking a mandate to protect Scotland’s place in the EU.

David Cameron announced the day after the referendum, on June 24, that he is going to step down as Prime Minister. He, in fact, may well be remembered as the Prime Minister who not only facilitated a possible breakup of Europe but also a breakup of the UK. His political career tails into ignominy it will go down as one of the worst instances of political opportunism and mismanagement in living memory.

Meanwhile, Bank of England Governor, Mark Carney, highlighted in his statement that it will take some time for the UK to establish a new relationship with Europe and the rest of the world. As volatility hits financial markets, the Bank of England is ready to take additional measures as required and as markets adjust, he added.

Arguably the Brexit result raises more questions for the opposition Labour Party than it does for the ruling Tories. What it shows is that the Labour heartlands outside London are taking matters into their own hands because people there no longer believe the party can deliver the better future they want. The weakness of Labour may prompt the Tories to call a general election in order to take advantage. Labour MPs voted on 28 June in a secret ballot 172 to 40 to back a motion of no confidence in party leader Jeremy Corbyn.

It is highly uncertain what the UK’s future will look like outside the EU, which makes Brexit a leap into the unknown. After Brexit, the EU will continue to be the world’s largest market and the UK’s biggest trading partner. A key question is what will happen to the three million EU citizens living in the UK and the two million UK citizens living in the EU? There are economic benefits from European integration, but obtaining these benefits comes at the political cost of giving up some sovereignty. Inside or outside the EU, this trade-off is inescapable. Britain has a number of options to consider for a post-Brexit relationship with the EU.

The EU has made clear to non-members such as Norway and Switzerland that they can have full access to the single market only if they accept most of its rules, including the free movement of people, and contribute to the EU budget. In other words, a Britain outside the Union will gain little in terms of 'sovereignty'; on the contrary, it is likely to lose its vote and influence over the terms of its participation in the single market. Meanwhile, rival financial centres such as Paris and Frankfurt will get ready to seize the chance to establish rules that will help them win back business from London.

A further option is going it alone as a member of the World Trade Organization (WTO). This would give the UK more sovereignty at the price of less trade and a bigger fall in income, even if the UK were to abolish tariffs completely. Brexit could allow the UK to negotiate its own trade deals with non-EU countries. But as a medium size country, the UK would have less bargaining power than the EU. Canada’s trade deals with the United States show that losing this bargaining power could be costly for the UK.

An obvious casualty of Brexit could be the City of London and its status as the principal financial center for Europe and the euro currency. The EU and eurozone governments could actively seek to 'repatriate' as many financial activities related to the single currency (and jobs) as possible from London. It is not unfeasible to think that they could be successful within a short period of time. It is quite likely that the European Central Bank will force clearing houses to move their euro-denominated operations from London to the eurozone.

Most non-UK-headquartered large financial institutions have actively worked on Brexit contingency plans. The 'out' vote will plunge the UK into a prolonged period of high uncertainty. An order of magnitude, up to one-fifth of activity potentially relocating outside of the UK does not appear far-fetched.

On 24 June, Moody's cut the UK's credit rating outlook to negative. On 27 June, the UK lost its top AAA credit rating from ratings agency S&P following the country's Brexit vote.

S&P said that the referendum result could lead to "a deterioration of the UK's economic performance, including its large financial services sector". Rival agency Fitch lowered its rating from AA+ to AA, forecasting an "abrupt slowdown" in growth in the short term.

With a recession and a possible election looming, the Conservative Government and Labour opposition are concentrating on possible party leadership contests. It would be wise for any business, large or small, to update or start developing a Brexit contingency plan in order to take stock of what business you currently do with the EU. Are there material operational risks or threats likely to arise from Brexit? Companies should analyse different scenarios and how they will affect their business to ensure sufficient flexibility to react to ongoing negotiations with the EU over the next two years or more.

The UK will have to trigger Article 50 of the EU Treaty to get the exit process started. The economic consequences, in all likelihood, will be hugely disruptive. A huge body of national law will need to be revised. The negotiations with the EU will have to bring decisions and insights into what “out” actually means in terms of trade relations.

Professor John Ryan, LSE Ideas

Opinions expressed in this article are personal to the writer so should not be interpreted as being those of the CISI or anyone else.

Published: 30 Jun 2016
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