What next after Brexit?

Britain exits. But the question remains, what next. What does it imply for the European Union's future, what does it imply for the global economy and what does it mean for Indians in UK?

Indeed the immediate effect of 52% of British voters choosing to go out of the EU was quite evident in financial market turmoil everywhere in the world. Pound has reached its 30 year low, as confidence, which is a key factor in boosting growth in short-term, has declined. In the short and medium-term the weakening of sterling and euro against $ will create major setbacks to the global financial market. Bank stocks also went down, with the British banks hit the worst - Royal Bank of Scotland declined by 34 percent and Deutsche Bank fell by 17 percent. But these are short-term effects, and the long-term effects are still unclear.

The process of British moving out of the EU will start as per the norms of Article 50 of the EU, which is likely to start in early October. Until the divorce process is complete, the UK is still a full-fledged member of the EU, and it can enjoy all the EU member benefits. Given that the British prime minister David Cameroon has decided to leave the office, the British conservative political party will have to choose a new leader – obviously one who is anti EU –, and the initiation of the EU leaving process will be the responsibility of the new leader. UK will then have 2 years to complete the process, and to negotiate with the EU, on how its future relationship with the EU will shape. If the conservatives fail to get consensus on choosing a right and able leader, it might damage the relationship between London and other EU capitals.

The impact of the Brexit can be divided broadly into political and economic. The political impact of Brexit is more far-reaching than it’s still unclear economic impact.

European politics after Brexit

A likely political consequence is the increased acceptance for the right wing political views among Europeans. France's Marine Le Pen and Netherlands' Geert Wilders both cheered the Brexit, whereas Germany's Angela Merkel's party sees it as the biggest catastrophe in the EU integration history. For the UK it puts the country into a constitutional crisis, as the Scotland already expressing the need for another referendum for leaving the UK. Obviously, the Scottish independence will come back to discussion. As the right wing populist nationalist movements will gain more support and confidence across the Western Europe, the opportunism and nationalism may dominate over the wider interest of the region as a whole, disregarding the need for respecting diversity. This can lead to more disintegration. On the other hand, it is also likely that the remaining countries in the EU realize the need for a stronger and unified EU, now with stronger influences from France behind Germany. Nevertheless, this is challenging given the political complexities and bureaucracy with which Brussels operates.

The far right extremists will now be more active and will gain more support and inspiration from Brexit. As was the case during the Brexit campaign, populist perceptions may dominate over expert and educated opinions. Even though it is unlikely that the extreme right will come to power in any of major European countries in the immediate future, they will indeed gain political support to be a strong force to influence governments' decision making. For instance, the Dutch freedom party – which is one of the most aggressive anti-immigrant political organizations in the Netherlands - has helped block the EU's association agreement with Ukraine. In a democratic setting, we are bound to accept such shift in perceptions, as it is a reflection of the change in the perceptions of citizens. However, the other side of the story is that much of these populist gains are built on a large number of lies. If you look at the amount of lies that has been spread around during the Brexit campaign, it is amazing even in this age of free information. For instance, a survey suggested that most British think that the EU born people living in the UK consists of 15 percent of British population. Immigration has been one of the hot issues in this referendum. Interestingly, the Brexit campaigners inflated this number to 20% and the anti-Brexiters deflated it to 10%. All these numbers are wrong; the actual figure is 5% (based on Ipsos MORI survey of UK perceptions of the EU). A post-Brexit google analytics suggests that British citizens started googling about what EU and Brexit means, but only after the poll is closed! It clearly suggests that they were ill-informed about what they are voting for. Perhaps all that they were concerned was that ‘the migrants are coming to take over their jobs’.

Impact on economy

The economic impact of Brexit could accrue via risking three freedom of movement - people and workers, goods and services and capital. The EU was built on principles of free movement of workers, but in reality the free movement started at massive scale only since 2004, when Central and Eastern European countries joined the EU. But these EU migrants are young, better educated, have higher employment and activity rates, and contributes more in taxes and to the UK public finances, than they take out in benefits, compared to the British citizens. Even after Brexit, it is unlikely that migration – be it from EU or outside – will be cut down to zero, as the country would need workers from outside to sustain its growth. Also there is no evidence to argue that immigrants reduces wage. Data does not support this claim. Currently, unemployment rates in the UK are low, and given the declining working age population in several European economies including the UK, the demand for skilled workers will intensify in the coming years. This might lead to a tighter labour market in the U.K, in fact necessitating promotion of immigration. A recent estimate of the Conference Board suggests the UK is one of the countries that will see stronger wage growth in the next decade.

There are several estimates out there on the potential impact of Brexit on the economies of the EU and the UK. The consensus suggests a larger GDP loss for the British economy in the longer-term compared to the rest of the Europe. An estimate of the London School of Economics suggests that Brexit would cause a GDP loss by at least 2.2 percent for the UK in the most optimistic scenario, and between 6.3 to 9.5 percent in its pessimistic scenario. The EU is UK’s largest trading partner, with almost 15% of UK’s GDP consists of exports to EU. The EU exports primarily goods to UK (e.g. transport equipment, food and beverages and electrical and optical equipment). Services are more important than goods for the British exports to the EU, in particular financial services. There is also a large segment of transport equipment exports from the UK to the EU. This segment will also have impact on Indian companies (for instance Tata), with significance presence in the UK. The Brexit will make trade barriers higher. It is easy to negotiate tariff barriers, but it is tough to negotiate non-tariff barriers, and it becomes even difficult when it comes to financial services. These negotiations may take longer time, as they will have to be built on a number of compromises. And the long-term effect of lower trade would be slower productivity growth in the UK. The United Kingdom is already suffering from a productivity puzzle, and this scenario would further trigger it, which will eventually impact its progress in standard of living.

However, the ultimate economic impact are hard to predict, as it depends upon how the negotiations with the EU evolve in the coming days, but it is quite evident that the impact of Brexit through trade and investment would be harsher on the UK, rather than on the EU. It is likely that the trade negotiations between the UK and the EU will be tedious and complex. Moreover, from the EU perspective, since the rest of the EU would now feel that the UK did let down the unity of the continent, any attempt from Brussels to offer a generous deal for the UK in the coming years will only harm the unity of the EU, and will therefore be suicidal. It is quite obvious from the experience of TTIP negotiations that aimed to create a trade relationship between the EU and the U.S, agreements on non-tariff barriers could be particularly time consuming. In any case, both the UK and the EU will have to work on regaining the investor confidence, which is a global issue as reflected in the volatility in the financial market, as it will delay several investment decisions. The potential political uncertainty will also influence the financial markets in the Eurozone. The Eurozone financial markets will be more sensitive to vulnerabilities, as investors will be more skeptical about the ability and political willingness of Eurozone governments to strengthen the European monetary union. Europe has been long debating on establishing a common banking union, and a single service market. Damages could happen to these ambitious plans as well.

Even though the overall economic impact on the EU could be minimal, there could be substantial variation across member states. This author lives in the Netherlands, a country which might be severely influenced by Brexit. Dutch investors own Euro 230 billion worth of assets in UK, which is more than 1/3rd of Dutch GDP. The potential depreciation of British currency, in the post-Brexit era, will severely impact the value of these assets. In the worst case of UK falling into a recession, countries like Germany which is one of the biggest exporters to the UK will be hit hard. The net impact will be even higher on Ireland and Malta, where nearly 5 percent of jobs and production relies on trade with the UK. Netherlands also has strong trade ties with the UK.

US after Brexit

United States also will be suffering from the Brexit, and it did anticipate it in advance, which made Obama come in open support for staying in the EU. While the debates within the UK and among other anti EU supporters hovers around sovereignty, jobs, boarders and financial contributions, the interest of the U.S is the loss of a strong and open large single EU market.

Will it bring financial crisis in EU?

It is unlikely that Brexit will cause a financial crisis in the EU, and the European Central Bank has committed to step in with additional liquidity to save the EU markets. Yet, it is quite sure that there will be a period - how short or longer it is yet unclear - of uncertainty and more importantly transition and adjustment, both for the UK and for the EU. Brexit indeed will affect the EU's confidence and international reputation, and more importantly, it will harm Europe’s image as a liberal political and economic entity. Politically, the EU lost an influential member, a 1 percent loss of its global population and employment share, nearly 2.5 percent decline in its share of Global GDP, and nearly 3.5 percent decline in its relative per capita income level compared to the global average (GDP as measured in purchasing power parity terms, as of 2015) (based on The Conference Board Total Economy Database, May 2016). Also the share of EU in global exports will be lowered by 4 percent (based on World Bank, World Development Indicators). Yet it is unlikely to have London losing its space in the financial world, as it has its inherent advantages and large networks, but it will be harder for London to work with European regulations in the coming days. Some business, including Indian firms, may have to move to Eurozone financial centers to ensure their accessibility to the larger EU market.

India’s trade with Britain

In 2016, the bilateral trade between India and Britain was more than 14 billion US$, and this volume has been relatively stable over the last five years, whereas India’s total trade with the EU as a whole has been declining. Therefore, it is unlikely that Brexit will have a major impact on India’s trade ties with UK. Some argue that in fact it will be beneficial for India, which is also an unlikely scenario; given that even now there is no significant EU imposed hindrance for UK to improve its trade ties with India. However, for Indian businesses in the UK, Brexit does not seem to be good news, as it affects their ability to see UK (more precisely London) as the entry point to Europe. They may have to operate in different headquarters in the UK and in the EU, and face different regulatory policies, which may affect their business. The U.K houses a large number of Indian born workers. As far as these Indians working in the UK are concerned, Brexit is unlikely to have major impact, as most these workers are high-skilled young IT professionals or health sector professionals. The demand for these, in particular, healthcare professionals are likely to increase in comparison with their supply within the UK.

Why did students vote to stay in EU?

A less discussed impact of Brexit is on students. As is evident from the poll results, most young and educated people voted for staying in the EU, whereas old people preferred an exit. Brexit could lead to a reduction in job opportunities, and for these youngsters who are exploring their work opportunities across Europe, it creates a concern. In addition, several academic research funded by the EU will be suffered, and the ability of students – particularly of poor back ground – to travel abroad for their education will be limited, as tuition fee for non-EU students is substantially higher.

Global integration

Globally, Brexit might evoke a shadow over the prospects of global integration, and may lead to the re-emergence of protectionist policies and anti-immigrant sentiments across the globe. This will further hamper already declining productivity in times of looming labor shortage due to ageing population in the West (and also in countries like Japan and China). The segment of population who benefit from the integration and globalization in general are middle class, young and high-skilled, and they largely voted against the Brexit. The largest concern over Brexit in particular and the right-wing opportunism in general, is anti-migrant, which is now mixed up with the threat of terrorism. Obviously, the Brexit campaigners could use EU as an easy scapegoat for triggering racism and anti-immigrant views of the right-wing parties. The problem of such opportunistic, short-term oriented approach is that it diverts attention and resources from real issues, and thus damages the long-term prosperity. Europe failed in realizing that austerity and globalization are not policies that you can implement simultaneously, and the first is a huge mistake.

The pro-EU campaigners also contributed to this in some way. Perhaps the emotional engagement of average British citizens in the EU was more of an economic one, as they seem to have conceived it as a fully economic union, whereas the EU seemingly went beyond that and emerged as a political union, thus conveying a wrong signal to member states that it might threaten their sovereignty.

Job security, inequality…

Moreover, as is the case with globalization policies in general, the concern over the job security of poor people was undermined, and the question of inequality was less considered. The leave campaign made use of these sentiments effectively, even though their way is not necessarily the long-term answer to these problems. A likely consequence of this in the global politics in general would be that opinions of knowledgeable experts will become irrelevant, and populist blunders will dominate the scene everywhere in the world. The emergence of such potential right-wing threat is spreading across the European continent, and elsewhere, including in India, perhaps the only country to have a group celebrating Donald Trump’s birthday.

Destruction is easier than construction, and economists often talk about creative destruction. 60 years of effort after the Second World War, since the Treaty of Rome in 1957, was destroyed overnight - UK is the first country to leave. It is indeed something new to Europe, and Europe will have to go through a new set of actions, which they are not exposed to in the past. Time will show if this destruction of European unity is a constructive one. Theoretically, it does not look one, as it directly impacts the benefits of a single largest market, the exposure to competition and efficiency gains, the mobility of ideas, investment, and skills, increased research cooperation and innovation. This exit was primarily a result of the ability of the populist politicians to easily create paranoia that 'the migrants are coming to take your jobs, to threaten your security, to make your life worse'. In the context of Europe, statistics suggests that many of the Central and Eastern European countries already seeing tighter labour market and upcoming labour shortage problem, as the working age population is declining. In the longer term, the challenge for Europe in general, regardless of whether you are in the West or East, and for the UK is in finding enough skilled workers, and it will be difficult to avoid allowing free movement of workers, if they want to get their jobs done. The challenge is in converting migrants, including refugees, into economic migrants, and in integrating them with the rest of the society – Europe has been a failure in doing this so far.

(The views expressed are personal. Abdul Azeez Erumban is a senior economist with the Conference Board Europe, Brussels, Belgium and Assistant Professor at University of Groningen, the Netherlands )