The full blow of Brexit

The subjects of the United Kingdom of Great Britain and Northern Ireland will vote yes or no on June 23 to the question: ‘Should the United Kingdom remain a member of the European Union?’ The politics of why Britain’s political classes have allowed this moment to arrive are irrelevant. What matters is what will happen in the event of a yes vote, and, being a little parochial about it, I’m concerned about the citizens of the Republic of Ireland.

The polls are incredibly close, and indicate a significant number of undecided voters.

Brexit fears have already had a strong impact on the British economy. British factory output recorded its biggest annual fall since 2013, partly due to the collapse of its steel industry, and partly as a result of Brexit fears. The Treasury has confirmed it expects the British economy to slump post-Brexit, with the highly respected National Institute of Economic and Social Research using words like “clobbered” to describe just how bad things could get for Britain.

There will likely be five major effects of a Brexit on the British economy in the short term of, say, one to three years. There will be a realignment of the terms of trade, and this realignment will take place through the interest rate and the exchange rate channels, as the banking system, the Bank of England, and sterling all try to cope with the immediate outflows of cash a Brexit would cause. Sterling could fall by as much as 20 per cent post-Brexit. There would almost certainly be a recession in Britain and potentially in Ireland, a reinstigation of ‘soft’ border controls between the North and the Republic, and the beginning of the renegotiation of free travel movements and trade flow agreements dating back, in some cases, to the 19th century.

There would be a decoupling of business to business, and business to consumer, processes currently handled across jurisdictions. Payment systems and procurement systems which just work today will be reformulated in the light of these new borders.

In the longer term of three years or more, we can expect to see a reinstigation of ‘hard’ border controls, especially as Britain faces the refugee crisis across Europe, and a slide of sterling close to parity with the euro – or roughly a 25 per cent drop from where it is now.

We can expect alterations to British law and regulations. This will affect manufacturing and services and, of course, compatibility between jurisdictions. Expect to see changes in financial regulation – and who knows where that will end. Expect Britain to become much more financialised, meaning the importance of the financial system to the country becomes much more pronounced. Regional variations within the country itself will deepen. They are already deeply ingrained. To see this, simply note the recent survey results on Brexit by region. Voting yes, to leave: Northern Ireland, 48 per cent; Scotland, 33 per cent; south of England, 38 per cent, north of England, 41 per cent; Wales, 28 per cent. Only 24 per cent of the young across the entire sample want to leave, while 41 per cent of the old wish to go.

Swati Dhingra from the London School of Economics, and colleagues, looked carefully at how Brexit would affect the average household. Expressed as percentages of national output, their model posits the following impacts, based mainly on a trade model. Trade will always fall, but there’s a benefit to the nation’s finances, because it isn’t contributing to the EU anymore. The negative trade effects outweigh the positives in all scenarios. There are two basic scenarios: optimistic and pessimistic. In the optimistic scenario, GDP drops by 1.28 per cent, or £27 billion, and, in the pessimistic scenario, it drops by 2.61 per cent, or over £53 billion. Over half of all British exports go to the rest of the European Union – this corresponds to almost 15 per cent of its national output (GDP), and it is this drop which pushes the negative welfare changes onto British households.

It is important to note that negative outcome is just for Britain. Writing for Bloomberg Intelligence, Jamie Murray and Dan Hanson did a simpler modelling and forecasting exercise for Britain, showing the likely path of interest rate changes with and without a Brexit. With a Brexit, interest rates don’t get back-up to their long-run averages for five more years, so monetary policy stays weirder for longer. Every modelling exercise I’ve seen shows Britain experiencing large losses in output, even when dynamic effects are modelled explicitly.

For Ireland, Alan Barrett and colleagues at the Economic and Social Research Institute (ESRI) estimated that in the event of a Brexit, bilateral trade flows would fall 20 per cent between our countries. Individual sectors such as merchandise trade and geographical regions such as the south west would be badly affected. Lower foreign direct investment to Britain would imply lower growth there which would affect Ireland.

The ‘substitution’ effect of British FDI to Irish FDI would not be enough to balance the drop in output. Energy interconnection between the islands would suffer. For example, if Britain left the EU, it would no longer be subject to EU regulatory measures to deal with a possible crisis situation in the case of a gas or oil shortage. Ireland would then have to consider how best to provide protection from very unlikely, but potentially catastrophic outcomes.

Migration to and from Ireland by Irish citizens and British subjects would be curtailed, though with the strong political power of the IFSC here and the City of London there, it is unlikely capital mobility will be impaired.

Brexit is more likely to be as damaging for Ireland as for Britain and, because we are a tiny open economy with no independent monetary policy, Brexit may well hurt Ireland harder, for longer.