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A Brexit recession

18 April 2016 By Hugo Dixon

A vote to quit the European Union could tip the UK into recession. This is no longer an academic possibility. Opinion polls show British people evenly divided on whether they want to remain in the EU or leave; betting odds suggest there is a one in three chance that the pro-Brexit camp will prevail in the June 23 referendum.

Such a vote would trigger political turmoil and acrimonious divorce talks. Investment would grind to a halt as firms wait for the fog to clear. Consumer confidence could also be hit.

The long-term impact of a vote to leave the EU would also be damaging. After all, the EU accounts for half Britain’s trade. It would be impossible to retain full access to that market if the Leave camp sticks to its goal of ending free movement of people between the EU and the UK and stopping budget contributions to Brussels. This “has never happened in Europe”, Klaus Regling, head of the European Stability Mechanism, was quoted by the FT as saying at the International Monetary Fund meetings last week. The UK government is predicting the economy will be 6 percent smaller by 2030 than if it stayed in the bloc.

But it is the short-term impact of a Brexit vote that will be at the forefront of investors’ minds. This is likely to be nasty.

For a start, David Cameron, who is campaigning for Britain to stay in the EU, would probably have to resign as prime minister. Boris Johnson, the popular mayor of London who is campaigning to quit, would be in pole position to replace him.

Wolfgang Schaeuble, the German finance minister, told his British counterpart, George Osborne, at the IMF meetings that the divorce talks would be tough, according to the FT. There are several reasons to believe this.

One is that the UK’s partners wouldn’t want other EU countries to think it was easy to quit. Otherwise, the whole bloc might unravel as, say, the French said they didn’t want to abide by competition law, the Italians said they wouldn’t stick to the budget rules, and so forth.

Another reason is that some countries would want to use Brexit to grab business that until now has been transacted by the UK. The French economy minister has already promised to roll out the red carpet to bankers. The way to do that would be to stop Britain having full access to the EU market.

Yet another reason is the electoral timetable. French presidential elections are held in May next year, while the German federal election is next autumn. Neither government would want to give an inch to Britain before those were out of the way.

The pro-Brexit camp disagrees. It says the EU would be desperate to do a trade deal because it sells more to the UK than vice versa. The snag is that this argument ignores proportionality. Exports to the EU account for 13 percent of UK GDP; exports from the EU to Britain account for just 3 percent of its GDP. As such, the UK needs the EU more than the bloc needs Britain.

What’s more, if worst came to worst, the EU could fall back on World Trade Organisation trading terms. These limit the tariffs Britain could impose on imports of goods from the EU. Unfortunately, the UK’s comparative advantage is in services, including financial services, and the WTO does virtually nothing to protect its exports of these.

If the Leave camp was preparing the electorate for tough times ahead, that would be bad enough. But its wild promises about how easy it would be to clinch a deal with the EU mean the negotiations could be especially bitter.

Britain’s post-Brexit government would be in some ways like the radical left-wing party Syriza just after it took power in Greece last year. It would have made promises it couldn’t deliver. And, because it would be hard to tell the British people that they had been conned, the new administration would probably respond by taking a confrontational approach to the EU and blaming its former partners.

Such a government would also be under tight deadline pressure. The EU’s divorce process is set out in Article 50 of the Treaty. This says a deal has to be done within two years of the article being triggered, or Britain has to leave without any agreement.

If little was achieved in the first year because of the French and German elections, the heat would be on. The deadline could be extended with the unanimous approval of the other 27 countries. But, as the Greeks have discovered, negotiating with one’s back to the wall isn’t fun.

Unsurprisingly, the IMF predicts the divorce talks “would likely be protracted… resulting in an extended period of heightened uncertainty that could weigh heavily on confidence and investment.” Equally, 31 out of 35 economists polled by Reuters think Brexit would hurt the economy. None of them think it would be good. They are right.


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