Life after Brexit: The UK’s Options Outside the EU

Yves here. As much as articles like this are instructive in laying out some of the choices the UK would need to make in the wake of a pro-Brexit vote, I have yet to see one that looks at the question of Brexit in terms of the fate of the Eurozone. While the mechanics, particularly involving bank information technology, make of reintroducing a new currency almost impossibly hard, the centrifugal forces in the currency union may reach the level where a country nevertheless makes the break. Indeed even though Brexit would be far easier, it would play into the idea of leaving if nothing else by illustrating that voters prefer national sovereignity to growth, particularly now that the benefits of growth seem to accrue mainly to a small cohort of top earners.

So even though analysts consistently argue that a Brexit would impose costs on the UK economy, one question worth including in the mix is: would a Brexit increase or lower the cost of dealing with a shock like the exit of France from the Eurozone?

By Swati Dhingra and Thomas Sampson, Assistant Professors, Department of Economics, London School of Economics. Originally published at VoxEU

On 23 June 2016, the UK will hold a referendum on whether to remain part of the EU. Suppose the UK votes to leave the EU. What happens next? Unfortunately, no one knows.

A vote to remain in the EU would be a vote to maintain the status quo. But a vote in favour of Brexit would be a leap into the unknown. Leaving the EU would not mean Britain could wash its hands of dealing with the rest of Europe. As UK Prime Minister David Cameron noted in his 2013 Bloomberg speech committing the Conservative Party to holding a referendum, “If we leave the EU, we cannot of course leave Europe. It will remain for many years our biggest market, and forever our geographical neighbourhood” (Cameron 2013). Yet neither the government nor the campaign to leave the EU has put forward concrete proposals for what comes after Brexit. In a recent report (Dhingra and Sampson 2016), we shed light on the possible aftermath of Brexit by considering the options for Britain outside the EU and analysing the costs and benefits of each alternative.

Leaving the EU

In the event of Brexit, the UK and the EU would need to make decisions in five main areas. First, what happens to UK citizens and businesses resident in the EU and to EU citizens and businesses resident in the UK? Second, how would UK law be changed in areas covered by EU legislation? Third, what policies would the UK adopt in areas that currently fall under the authority of the EU. Of particular importance would be regional and agricultural policies since these are the biggest components of the EU budget. Fourth, would there be a transition period during which the UK’s rights and obligations as an EU member are gradually phased out or would the change happen abruptly? Fifth, and probably most importantly, what would be the future of Britain’s relationship with the EU. Would free trade between Britain and the EU continue? Would labour mobility between Britain and the EU continue? Would British companies continue to have the right to establish subsidiaries and do business in the EU?

The key trade-off Britain would face outside the EU would be the same trade-off that has always dominated Britain’s European policy. There are economic benefits from integration, but obtaining these benefits comes at the political cost of giving up sovereignty over certain decisions. Inside or outside the EU, this trade-off is inescapable. The different options described below provide alternative ways of resolving this trade-off.

European Economic Area – The Norwegian Model

The European Economic Area (EEA) comprises all members of the EU together with Norway, Iceland and Liechtenstein. EEA members are part of the European Single Market, meaning there is free movement of goods, services, people and capital within the EEA, but EEA membership does not require deeper political integration. Research on the consequences of leaving the EU finds that, although Brexit would undoubtedly harm the UK’s economy, the cost is smaller when the UK remains more economically integrated with the EU (Ottaviano et al. 2014).

Are there downsides to the EEA? Yes. Non-EU members of the EEA must accept and implement EU legislation governing the Single Market without having any part in deciding the legislation. Therefore, leaving the EU to join the EEA would reduce the UK’s control over economic policy. Also, EEA members such as Norway do not belong to the EU’s customs union. Consequently, Norwegian exports must satisfy rules of origin requirements in order to enter the EU duty free and the EU can use anti-dumping measures to restrict imports from Norway, as occurred in 2006 when the EU imposed a 16% tariff on imports of Norwegian salmon. Finally, EEA members effectively pay a fee to be part of the Single Market. In 2011 Norway’s contribution to the EU budget was £106 per capita, only 17% lower than the UK’s net contribution of £128 per capita (House of Commons 2013). Becoming part of the EEA would not generate substantial fiscal savings for the UK.

Bilateral Treaties – The Swiss Model

Switzerland is not a member of the EU or the EEA. Instead, it has negotiated a series of bilateral treaties under which it adopts EU policies in specific areas such as insurance, air traffic, pensions and fraud prevention, among many others. The bilateral treaty approach allows Switzerland the flexibility to choose which EU initiatives it wishes to participate in. Through European Free Trade Association (EFTA) membership and an agreement covering technical barriers to trade, Switzerland has achieved a similar level of goods market integration with the EU as EEA countries. Currently, there is also free movement of people between Switzerland and the EU.

In return for its participation in EU programmes, Switzerland must adopt EU policies and legislation, meaning Switzerland also trades integration for sovereignty. Switzerland and the EU have not reached a comprehensive agreement covering trade in services. Consequently, Swiss financial institutions often serve the EU market through subsidiaries based in London. Like the EEA countries, Switzerland makes a financial contribution to the EU, which in recent years has averaged around £53 per capita, 60% lower than the UK’s net contribution per capita (House of Commons 2013). Overall, it is likely that the Swiss model would result in less economic integration between Britain and the EU than EEA membership leading to higher economic costs of Brexit.

Looking Away from Europe

If Britain leaves the EU without putting in place any alternative arrangements, then Britain’s trade with both the EU and almost all the rest of the world would be governed by the WTO. As a WTO member, Britain’s exports to the EU and other WTO members would be subject to the importing countries’ most-favoured nation tariffs. Britain’s services trade would also be subject to WTO rules. Since the WTO has made far less progress than the EU in liberalising trade in services, this would mean reduced access to EU markets for UK service producers. The WTO has no provisions for free movement of labour, so under this scenario free labour mobility between Britain and the EU would cease.

After leaving the EU, Britain would no longer be bound by the EU’s common trade policy, but could set its own import tariffs. Since the average tariff charged on imports to the EU is only 1% (World Bank 2015), there is limited scope for further tariff reductions. There is also limited scope to lower non-tariff barriers through unilateral action since reducing non-tariff barriers often requires international agreement to harmonise policies. Following Brexit, the UK would be free to negotiate trade agreements with countries outside Europe. But since the UK is a much smaller market than the EU, it would have less bargaining power in trade negotiations than the EU has. Whether the benefits from greater autonomy in trade negotiations would outweigh the costs from reduced bargaining power is hard to predict. And whatever agreements Britain reaches with countries outside Europe, the most important decision facing the UK would still be its relations with its largest trading partner, the EU.

The pay-off for the lack of economic integration provided by the WTO would be greater sovereignty over economic policy and regulation. Being outside of the Single Market could enable the UK government to better adapt economic policy to Britain’s needs. However, any divergence in regulation between Britain and the EU would also act as a non-tariff barrier to trade and raise the cost of doing business with Europe. The OECD has found that, even as a member of the Single Market, Britain’s labour and product markets are substantially less regulated and more flexible than those of other EU countries (Koske et al. 2015). This implies the Single Market does provide scope for countries to choose the flexibility of economic regulations to suit national preferences.

Conclusions

A vote in favour of Brexit will fire the starting gun on a two-year renegotiation of Britain’s place in Europe and the world. This renegotiation could, if Britain opts to cut ties with the rest of Europe, fundamentally change the political, economic, and legal foundations of British life that have built up since the UK joined the EU in 1973. Alternatively, if Britain chooses to remain part of the EEA, the economic and legal changes would be relatively small. During the renegotiation Britain will face an unavoidable trade-off between economic benefits and political sovereignty. The UK benefits from closer economic integration with the EU, but the price for this integration is allowing the EU control over some areas of policy. Leaving the EU will not free Britain from this fundamental trade-off.

At present, there is no consensus within the UK over what should follow Brexit. This reflects the fact that all of the alternatives to EU membership have their own drawbacks and would negatively affect the British economy. To make an informed decision about the merits of Brexit, voters need to know more about what would follow Brexit.

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10 comments

  1. Jeff

    In theory, one could leave EU but keep the Euro – Kosovo and Montenegro do this now.
    So most of the IT problems would not be urgent, but all other -exit issues, as illustrated here, would remain. On the other hand, an -exit does have a cost, and does not bring back sovereignty if the euro is kept, so what would drive a country out – or rather, what would make the political class of a country work towards an -exit with so little to show in immediate returns?

  2. grayslady

    Other than the common currency issue, which doesn’t apply to Britain, this is the first article I’ve seen that points out why the EU was never really necessary in the first place. Schengen seems to be totally separate from the EU, and appears to be collapsing anyway with the migrant crisis. As the authors point out, treaties could have sufficed in place of a lumbering Brussels bureaucracy that angers citizens by taking away their self determination and ignoring their individual cultures and economic strengths.

    The whole EU fiasco reminds me of Obamacare. The few benefits provided by Obamacare (eliminating premium discrimination against women, eliminating preexisting conditions limitations, covering contraception) could have been achieved as a small set of mandatory federal changes without forcing people into more costly and restrictive insurance plans than they had before.

    A friend of mine says he’s seeing an increasing number of articles on Geert Wilders in the Dutch press, and that Wilders is gaining more citizen backing than ever before. Wilders, for those who don’t know, is a very nationalistic politician who wants Holland to leave the EU.

  3. HotFlash

    Fifth, and probably most importantly, what would be the future of Britain’s relationship with the EU. Would free trade between Britain and the EU continue? Would labour mobility between Britain and the EU continue? Would British companies continue to have the right to establish subsidiaries and do business in the EU?

    Why the hand-wringing? Isn’t the whole point of Brexit to make these exact questions subject to Britain’s wishes? So, free trade, labour mobility, and trans-Union corporations would be subject to British law only, or to treaties established one-to-one rather than the current one-size-fits-none solutions imposed from Bruge.

    For instance, British labour would be welcome in the EU *iff* the EU agreed to welcome them and Britain permitted them to go, and vice versa. Britain would not be required to accept floods of Eurolabour, and could resist skill drain to the EU, if they wished. More importantly, they could unilaterally change the policies to suit British conditions as they change.

    1. dw

      unless your thinking just do the total break from the EU, then you need to consider what the rules will be after the break. today the UK can trade very easily with the rest of the EU. but if its just sudden break, that no longer will be the case. you would need to negotiate separate treaties to cover all of the trade you do now, and if the EU didnt want to participate in some or all of them, you would be just another external trade party wouldnt you? while the whole point of BREXIT is to remove the UK from the EU, so they can make their own choices, it also means that going forward that the EU will decide whether it wants or cares to participate in trade with the UK.
      course then the next question is whether Scotland will stay in the UK too huh?

    2. clinical wasteman

      I’d like to see them try (ok, no I wouldn’t) to ‘resist skills drain to the EU’. The ridiculous ‘net migration’ statistic already used to conjure a ‘social integration’ crisis as cover for top-down class warfare more or less begs for such a policy: just stop UK nationals emigrating and the detested ‘net migration’ falls!
      More or less every EU treaty currently in force is a management-school abomination, but dictatorship of the Middle England ‘Green Belt’ would be worse. To say that the multi-‘ethnic’ proles [the Green Belt’s word, not ours] of London, Liverpool, Bristol, Glasgow etc would gain nothing from this arrangement stretches the (underward) limits of understatement.
      It’s a wonder that the Little Englanders keep a straight face when they occasionally talk about ‘turning towards’ the rest of the world. As soon as they have their feudal manor back they’ll come after the never-Europeans in the cities mentioned above. Then once they have a more efficient system of indenture than the current (Labour govt.-brokered) gangmaster-led ‘sponsorship’ in place, they’ll start taking Gastarbeiter again, leaving the ‘ethno’-demographic breakdown much the same but the understanding of WHO IS BOSS so much clearer. All the more so because under the almost certain (or actually default, given that the UK is already a member?) EEA arrangement, the purge of former ‘fellow Europeans’ will amount to nothing much. Anyway, given an existing £35,000 annual income baseline for new non-EU permanent residency applications, the ‘skills drain’ (including all those non-lucrative skills already not counted as such by immigration rules, eg nurses) will burst all the pipes, and not just those leading Europe-ward.
      Apologies to all those in other continents to whom this may seen an insane string of extrapolations: admittedly it’s visceral as much as analytical, but in order to fear and loathe them adequately you’d really have to see what I’ve called the ‘Green Belt’ — not even strictly a capitalist but more and landlord (and latterly financial) class — in action. I guess you’ve already seen some of their media, which is almost all of it that comes from here.

  4. JW

    The lack of knowledge of the EU , the EZ and the UK’s relationship of both is remarkable. Almost as bad as the typical european lack of knowledge of what really makes US politics/economics work.
    The UK is not in the EZ. The ‘core’ members of the EU are focused on a federal union to support the EZ. The UK will either leave the EU or eventually be consumed into the EZ.
    No one knows the slight positive or negative effect on the economy of Brexit over time. But what is certain is that this is the last chance for the UK to remain an independant nation.
    Whether you are a Democrat or a Republican in the US , faced with this choice, which way would you vote?

  5. Brooklin Bridge

    It is not simply sovereignty at stake, it is democracy and not simply for Britain, but also for members of the EU who are ultimately drawn into the EZ which is essentially finance and bureaucrats taking the place of legitimate democratic political institutions in a manner that is far too blunt to be fair or durable.

    What people are being asked to vote on, however, is only subliminally related to this. The question being posed is, “Do you want a lot of useless pain with your nose in the air or business as usual with a small ding to national pride?”

    The deeper issue is in play, it is, after all, what puts a negative cloud over the whole, but is not going to be addressed by this referendum.

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