After Brexit: Will an Economic Goodbye to Europe Mean Hello to the World?
Europe is not the world, and certainly not its most dynamic part.
As with any divorce, Brexit faces its greatest fear, pain and outrage in the initial legal wrangling. Since Britain’s June vote to break with the European Union (EU), a growing list of legal complications seems to have raised more uncertainties than loomed immediately after the results were tallied. It will take a while before anyone knows where Britain or the EU stand. But daunting as all this is, the success or failure of any separation depends less on the initial pains of the break than on how the principals pursue the rest of their lives.
This longer-term strangely has clearer prospects than the immediate future. Effectively, the country has two choices. Britain can continue to pursue the Europe-centered economic orientation it adopted when it joined the union over forty years ago. If it does, its economy will suffer all the disadvantages of dependence on Europe with none of the advantages of union membership. Alternatively, Britain can use its new independence to open itself to the world’s faster-growing economies more thoroughly than it ever could as a member of the EU. Should the country choose this path, its prospects would improve dramatically. It would also offer the world a wonderful irony indeed—that a seemingly inward-looking vote, mostly to secure what some would call a narrow national sovereignty, helped create a more thoroughly internationalized British economy.
***
The vote, of course, had little to do with either economic alternative. If exit polls and subsequent commentary are any guide, British voters considered economics and trade little. Constitutional matters dominated their concerns. They wanted to rid the country of EU dominance—the ability of the European Courts and the EU’s administrative structures to dictate labor, environmental and safety regulations, even law. British voters especially resisted the EU’s insistence that the country keep its borders open to migrants from any union member. Even if British jurists, bureaucrats and representatives would have made the same regulations and laws as Brussels, which is not unlikely, voters clearly wanted the decision made in Britain under British procedures and not by the EU. Those who voted for exit and acknowledged the economic costs of separation saw them as an acceptable price to pay for constitutional principle.
Those costs have now become clear. Until the UK secures new trade agreements with EU members, it seems poised to lose a portion of its huge trade with the continent, half the total at last count. Now that the EU no longer represents British trade to the rest of the world, the economy also stands to suffer until it can secure its own trade agreements with nations outside the EU, including with economic powers such as the United States, China, India, Australia and Canada. Because Britain will no longer have easy access to the huge continental market, it will suffer further as third parties, notably Korean and Japanese interests, rethink their previous practice of using Britain as a base for Europe-wide operations. Perhaps most troublesome is the potential squeeze on Britain’s dominant financial and business services sectors, more than 10 percent of the UK economy. With exit, this sector will lose the ability to serve clients freely throughout Europe, what the EU calls passporting. Many firms in the area, unwilling to wait for new arrangements, have already formulated plans to move parts of their business out of London onto the continent to the immediate detriment of British employment and income.
Estimates of how much economic damage the country will suffer vary from minor to devastating. Her Majesty’s Treasury, noting that exports of goods and services constitute more than a third of Britain’s economy, has calculated that exit could cost it some 7.5 percent in real income between now and 2030, about half a percent of growth a year. Those on the “leave” side have come up with more moderate estimates, while some on the “remain” side have arrived at more frightening figures. Much depends on how quickly London can make new trade arrangements with the rest of the world and the EU, including passporting facilities for its financial sector. In the interim, however, much should mitigate the worst of these effects.
For one thing, Britain has become less dependent on European business in recent years. Some ten years ago the EU absorbed about 12 percentage points more of the country’s trade than it does now. Nor would the absence of agreements impose tariff barriers as onerous as it once might have. With no special arrangements, EU-British trade would fall under what the World Trade Organization calls “most-favored-nation” rules. Tariffs under these have already fallen to only 4 percent on average, well down from 7 percent twenty years ago and nearly 10 percent before that.
Promising to mitigate Britain’s economic strains further is the clear need of continental European business to sustain trade. The British market absorbs almost 8 percent of German exports, over 7 percent of French exports, over 5 percent of Italian exports and almost 10 percent of exports from the Netherlands. Business leaders in these countries hardly want to lose even a portion of this business. Other impediments notwithstanding, these economic interests will push hard to protect such sales by clarifying trade relationships as quickly as possible.
At the same time, British financial services are well-positioned to overcome ill effects should they lose passporting privileges. Firms in this area have dominated the union for so long that many on the continent will demand access or will take their business independently to the City of London, as the British call this sector, regardless of any possible passporting restrictions. Larger players will continue to require the special expertise and deep pools of financial capital more readily available through British financial sources. What is more, the liquidity, expertise and connections of British finance will almost surely prompt continental financial firms to seek joint ventures with British counterparts or make other arrangements that could sidestep passporting restrictions.
***
Still, Britain looks unlikely to gain any relief from a speedy resolution of exit terms, much less a quick settlement on new trade arrangements. All such matters are tied in legal knots from seemingly every quarter. Britain’s high court has delayed any settlement prospects with its decision that the referendum was insufficient to settle the matter. Parliament must debate the issues and vote before any negotiations can begin. No doubt the judges are right. Britain’s constitution identifies parliament as the only body that can undo what parliament did. But the court’s decision nonetheless will sustain economic uncertainty even though there is little doubt about the conclusion. Meanwhile, the European side has recently brought up the question of some €25 billion that Britain owes the union. It seems that the EU over the years has shifted some €200 billion in loans to members for various reasons, what it refers to as the “reste a liquider.” EU sources claim that the €25 billion is Britain’s share and the country must discharge this liability before it can settle anything else.
These matters, complex as they are, seem like a minor glitch compared with the problems surrounding actual negotiations for post-exit trade arrangements. London’s new foreign minister Boris Johnson and UK International Trade Secretary Liam Fox, recognizing Britain’s economic need for a quick settlement, have expressed a desire to combine negotiations on Britain’s exit from the union, under Article 50 of the Lisbon Treaty, with subsequent trade arrangements. On the EU’s side, however, Danuta Hubner, chair of the European Parliament’s constitutional affairs committee, insists that Britain will first have to negotiate withdrawal, a process that could take two years or more, before it can begin negotiations on future agreements. Adding to the complications, other influential EU officials have remained coy on the matter.
Ambiguities also surround coming negotiations with trading nations outside the union. The EU has established 33 preferred or free trade agreements (FTAs) with 62 countries, covering some 13 percent of British exports. While Britain remained an EU member, these agreements allowed it to enjoy tariff reductions from 7.4 percent on average before the treaties were signed to some 2.4 percent presently. Now these arrangements are in doubt. Adding still another complication, the EU seems to have negotiated two very different sorts of treaties. Some it signed alone for all its members in what the legal jargon refers to as treaties established with its “exclusive competence.” But some treaties were established under what the lawyers refer to as “mixed competence.” In these, both the EU and each member state signed. Legal opinion is confident that Britain will need to re-negotiate the first sort of treaty. It might claim the “mixed competence” arrangements for itself even after separation, except that the lack of precedent makes a final settlement on even these arrangements ambiguous.
If all this were not unsettling enough, it has become increasingly clear that Britain can use neither the Norwegian nor the Swiss model to guide its new relationship with the EU. These two nations stand apart from the EU but nonetheless have negotiated special trading rights. Many had hoped that Britain could establish similar relationships after exit. That now seems unlikely. Both these countries have secured their trading positions by bowing to EU strictures and rules. Norway, for instance, pays dues to the EU up to 87 percent of full membership. Both Norway and Switzerland have agreed to open their borders to unfettered migration by EU residents. For Britain to follow a similar path, it would have to go against the wishes of its voters.
***
However severe, immediate economic pressures of one kind or another look unavoidable. Even after that uncertain date when arrangements with the EU are settled, ill effects would continue if Britain retains the largely European economic orientation that it assumed when it joined the EU. Without union membership, its economy cannot help but face ongoing disadvantages if it retains its bias toward seeking business on the continent, dealing with third parties as a member of a European unit and selling itself to investors as a place of access to that trade zone. The “leave” camp was so concerned about exit because it implicitly assumed Britain would carry on in this way. But, as indicated, Britain has other options. Even as it tries for the best deal possible with the EU, it could improve its economic prospects dramatically by leveraging its new, separate status to gain a more complete exposure to the world’s most dynamic economies, something it could not do as an EU member.
Such a global approach would seem to have promise. Europe, as important as it will remain to the United Kingdom, is, after all, not the world, and certainly not its most dynamic part. The EU has grown only 1.2 percent a year in real terms during the past three years and an even slower 1.1 percent if the calculation excludes the UK economy. Contrast that to the United States, which has grown almost twice as fast at 2.1 percent a year. Canada, growing at 2.0 percent a year during this time, and Australia, growing at 2.4 percent, have also outpaced Europe by a considerable margin. All three countries have shown a willingness to reach agreements with Britain. India, though less vocal, looks like a promising partner; it grew at a 7.0 percent annual rate. China grew 7.3 percent a year during this time. And these are only the larger players. Many smaller countries, all of which could trade more with Britain than they do presently, are showing considerable economic dynamism. Indonesia, for instance, has averaged a growth rate of 5.1 percent a year, Malaysia 5.2 percent, Singapore 3.8 percent and Vietnam 6.0 percent. The European Commission itself forecasts that in the next fifteen years, fully 90 percent of the world demand will emerge outside of Europe.
Britain might also do better negotiating for itself with these alternative, fast-growing economies than EU negotiators have done for it. Brussels, after all, has failed to sign treaties with most of these important economies. Its muddled approach no doubt has interfered. It claims to have pursued FTAs as a substitute for the failed general efforts at trade liberalization, most particularly the stalled Doha round of negotiations overseen by the World Trade Organization (WTO). But even as it makes such claims, it admits to a political agenda beyond trade. Unlike the United States, for instance, which has kept trade negotiations on trade, modelling them on the North American Free Trade Agreement (NAFTA), EU negotiators, by their own admission, have pursued FTAs mostly to encourage stability and regional integration along the lines of the EU in Europe. EU literature claims to have followed this guiding principle in negotiations with regions as diverse as Eastern Europe, the Mediterranean, the Balkans, Latin America and Southeast Asia. Though such objectives do not necessarily contradict the objective of trade liberalization, neither are they particularly well-suited to the interests of each EU member.
In addition to muddling matters with mixed objectives, the EU has failed Britain in two areas especially, agriculture and financial services. Though the EU claims that its FTAs seek to remove tariffs on some 90 percent of trade among signatories, it nonetheless has consistently protected agriculture. The treaty signed with South Africa, for instance, excludes tariff reductions on 280 agricultural lines. Since farming is a small part of the British economy—a mere 0.7 percent in fact—the country has hardly benefited from such protections, certainly less than France, for instance, where agriculture is almost three times as important. What is more, EU insistence on agricultural concessions has certainly made it harder to get concessions from these other countries in areas such as financial services that matter more to Britain. To be fair to the EU negotiators, agreements on investments and financial services are notoriously difficult. But the EU’s insistence on protecting agriculture can only have impeded headway.
On its own, Britain could alter the balance of these FTA negotiations. A greater British willingness to make concessions on agricultural trade might have great appeal to those many fast-growing developing economies that depend on agricultural exports. And for such concessions, these potential British trading partners might well make concessions of their own, perhaps in financial and business services. Canada, Australia and the United States, though each has a fully-developed financial sector, might well accommodate Britain anyway because agriculture exports remain important to each of them. Of course, the UK, by leaving the union, would give up the EU’s major negotiating advantage, which is size. At one-sixth of the EU, its offer of access is much less compelling than such an offer from Brussels. Still, as one of the largest ten economies in the world, interaction with Britain is hardly something any potential trading partner would lightly dismiss.
***
Now that its people have voted for exit, the country would seem to have more room to maneuver than most recent commentary admits. If it fails to use that room, if it maintains the European economic focus that its former EU membership effectively imposed on it, it will pay an economic price for the sovereignty that its voters have demanded. But if it takes a more global approach, it can make trade arrangements that enable it to gain from more rapid growth in the Americas, Asia, and Australia. Since London can pursue European arrangements at the same time that it looks further afield, it is only a lack of imagination, energy or will that could cause the country’s leadership to ignore non-European vistas. History suggests the additional effort should come naturally. Britain has long sought economic strength outside Europe even while pursuing active interests on the continent.
Mr. Ezrati is chief economist for Vested, a New York-based communications firm, a contributing editor at The National Interest, and an affiliate of the Center for the Study of Human Capital at the University at Buffalo (SUNY). His most recent book, Thirty Tomorrows, describing how the world can cope with the challenges of aging demographics, was recently released by Thomas Dunne Books of Saint Martin’s Press.
Image: British twenty-pound notes. Pixabay/Public domain