The UK has voted to leave the EU by 17 410 742 votes (51.9% or 37.4% of the electorate) to 16 141 241 votes (48.1% or 34.7% of the electorate). But what will be the economic consequences of the vote?
To leave the EU, Article 50 must be invoked, which starts the process of negotiating the new relationship with the EU. This, according to David Cameron, will happen when a new Conservative Prime Minister is chosen. Once Article 50 has been invoked, negotiations must be completed within two years and then the remaining 27 countries will decide on the new terms on which the UK can trade with the EU. As explained in the blog, The UK’s EU referendum: the economic arguments, there are various forms the new arrangements could take. These include:
‘The Norwegian model’, where Britain leaves the EU, but joins the European Economic Area, giving access to the single market, but removing regulation in some key areas, such as fisheries and home affairs. Another possibility is ‘the Swiss model’, where the UK would negotiate trade deals on an individual basis. Another would be ‘the Turkish model’ where the UK forms a customs union with the EU. At the extreme, the UK could make a complete break from the EU and simply use its membership of the WTO to make trade agreements.
The long-term economic effects would thus depend on which model is adopted. In the Norwegian model, the UK would remain in the single market, which would involve free trade with the EU, the free movement of labour between the UK and member states and contributions to the EU budget. 
The UK would no longer have a vote in the EU on its future direction. Such an outcome is unlikely, however, given that a central argument of the Leave camp has been for the UK to be able to control migration and not to have to pay contributions to the EU budget.
It is quite likely, then, that the UK would trade with the EU on the basis of individual trade deals. This could involve tariffs on exports to the EU and would involve being subject to EU regulations. Such negotiations could be protracted and potentially extend beyond the two-year deadline under Article 50. But for this to happen, there would have to be agreement by the remaining 27 EU countries. At the end of the two-year process, when the UK exits the EU, any unresolved negotiations would default to the terms for other countries outside the EU. EU treaties would cease to apply to the UK.
It is quite likely, then, that the UK would face trade restrictions on its exports to the EU, which would adversely affect firms for whom the EU is a significant market. 
Where practical, some firms may thus choose to relocate from the UK to the EU or move business and staff from UK offices to offices within the EU. This is particularly relevant to the financial services sector. As the second Economist article explains:
In the longer run … Britain’s financial industry could face severe difficulties. It thrives on the EU’s ‘passport’ rules, under which banks, asset managers and other financial firms in one member state may serve customers in the other 27 without setting up local operations. …
Unless passports are renewed or replaced, they will lapse when Britain leaves. A deal is imaginable: the EU may deem Britain’s regulations as ‘equivalent’ to its own. But agreement may not come easily. French and German politicians, keen to bolster their own financial centres and facing elections next year, may drive a hard bargain. No other non-member has full passport rights.
But if long-term economic effects are hard to predict, short-term effects are happening already.
The pound fell sharply as soon as the results of the referendum became clear. By the end of the day it had depreciated by 7.7% against the dollar and 5.7% against the euro. A lower pound will make imports more expensive and hence will drive up prices and reduce the real value of sterling. On the other had, it will make exports cheaper and act as a boost to exports.
If inflation rises, then the Bank of England may raise interest rates. This could have a dampening effect on the economy, which in turn would reduce tax revenues. The government, if it sticks to its fiscal target of achieving a public-sector net surplus by 2020 (the Fiscal Mandate), may then feel the need to cut government expenditure and/or raise taxes. Indeed, the Chancellor argued before the vote that such an austerity budget may be necessary following a vote to leave.
Higher interest rates could also dampen house prices as mortgages became more expensive or harder to obtain. The exception could be the top end of the market where a large proportion are buyers from outside the UK whose demand would be boosted by the depreciation of sterling.
But given that the Bank of England’s remit is to target inflation in 24 month’s time, it is possible that any spike in inflation is temporary and this may give the Bank of England leeway to cut Bank Rate from 0.5% to 0.25% or even 0% and/or to engage in further quantitative easing.
One major worry is that uncertainty may discourage investment by domestic companies. It could also discourage inward investment, and international companies many divert investment to the EU. Already some multinationals have indicated that they will do just this. Shares in banks plummeted when the results of the vote were announced.
Uncertainty is also likely to discourage consumption of durables and other big-ticket items. The fall in aggregate demand could result in recession, again necessitating an austerity budget if the Fiscal Mandate is to be adhered to.
We live in ‘interesting’ times. Uncertainty is rarely good for an economy. But that uncertainty could persist for some time.
Articles
Why Brexit is grim news for the world economy The Economist (24/6/16)
International banking in a London outside the European Union The Economist (24/6/16)
What happens now that Britain has voted for Brexit The Economist (24/6/16)
Britain and the EU: A tragic split The Economist (24/6/16)
Brexit in seven charts — the economic impact Financial Times, Chris Giles (21/6/16)
How will Brexit result affect France, Germany and the rest of Europe? Financial Times, Anne-Sylvaine Chassany, Stefan Wagstyl, Duncan Robinson and Richard Milne (24/6/16)
How global markets are reacting to UK’s Brexit vote Financial Times, Michael Mackenzie and Eric Platt (24/6/16)
Brexit: What happens now? BBC News (24/6/16)
How will Brexit affect your finances? BBC News, Brian Milligan (24/6/16)
Brexit: what happens when Britain leaves the EU Vox, Timothy B. Lee (25/6/16)
An expert sums up the economic consensus about Brexit. It’s bad. Vox, John Van Reenen (24/6/16)
How will the world’s policymakers respond to Brexit? The Telegraph, Peter Spence (24/6/16)
City of London could be cut off from Europe, says ECB official The Guardian, Katie Allen (25/6/16)
Multinationals warn of job cuts and lower profits after Brexit vot The Guardian, Graham Ruddick (24/6/16)
How will Brexit affect Britain’s trade with Europe? The Guardian, Dan Milmo (26/6/16)
Britain’s financial sector reels after Brexit bombshell Reuters, Sinead Cruise, Andrew MacAskill and Lawrence White (24/6/16)
How ‘Brexit’ Will Affect the Global Economy, Now and Later New York Times, Neil Irwin (24/6/16)
Brexit results: Spurned Europe wants Britain gone Sydney Morning Herald, Nick Miller (25/6/16)
Economists React to ‘Brexit’: ‘A Wave of Economic and Political Uncertainty’ The Wall Street Journal, Jeffrey Sparshott (24/6/16)
Brexit wound: UK vote makes EU decline ‘practically irreversible’, Soros says CNBC, Javier E. David (25/6/16)
One month on, what has been the impact of the Brexit vote so far? The Guardian (23/7/16)
Questions
- What are the main elements of a balance of payments account? Changes in which elements caused the depreciation of the pound following the Brexit vote? What elements of the account, in turn, are likely to be affected by the depreciation?
- What determines the size of the effect on the current account of the balance of payments of a depreciation? How might long-term effects differ from short-term ones?
- Is it possible for firms to have access to the single market without allowing free movement of labour?
- What assumptions were made by the Leave side about the economic effects of Brexit?
- Would it be beneficial to go for a ‘free trade’ option of abolishing all import tariffs if the UK left the EU? Would it mean that UK exports would face no tariffs from other countries?
- What factors are likely to drive the level of investment in the UK (a) by domestic companies trading within the UK and (b) by multinational companies over the coming months?
- What will determine the course of monetary policy over the coming months?
Many of the arguments used by both sides in the referendum debate centre on whether there will be a net economic gain from either remaining in or leaving the EU. This involves forecasting.
Forecasting the economic impact of the decision, however, is difficult, especially in the case of a leave vote, which would involve substantial change and uncertainty.
First, the effects of either remaining or leaving may be very different in the long run from the short run, and long-run forecasts are highly unreliable, as the economy is likely to be affected by so many unpredictable events – few people, for example, predicted the financial crisis of 2007–8.
Second, the effects of leaving depend on the nature of any future trading relationships with the EU. Various possibilities have been suggested, including ‘the Norwegian model’, where Britain leaves the EU, but joins the European Economic Area, giving access to the single market, but removing regulation in some key areas, such as fisheries and home affairs. Another possibility is ‘the Swiss model’, where the UK would negotiate trade deals on an individual basis. Another would be ‘the Turkish model’ where the UK forms a customs union with the EU. At the extreme, the UK could make a complete break from the EU and simply use its membership of the WTO to make trade agreements.
Nevertheless, despite the uncertainty, economists have ventured to predict the effects of remaining or leaving. These are not precise predictions for the reasons given above. Rather they are based on likely assumptions.
In a poll of 100 economists for the Financial Times, ‘almost three-quarters thought leaving the EU would damage the country’s medium-term outlook, nine times more than the 8 per cent who thought the country would benefit from leaving’. Most fear damage to financial markets in the UK and to inward foreign direct investment.
Despite the barrage of pessimistic forecasts by economists about a British exit, there is a group of eight economists in favour of Brexit. They claim that leaving the EU would lead to a stronger economy, with higher GDP, a faster growth in real wages, lower unemployment and a smaller gap between imports and exports. The main argument they use to support their claims is that the UK would be more able to pursue trade creation freed from various EU rules and regulations.
Then, less than four weeks before the vote, a poll of economists who are members of the Royal Economic Society and the Society of Business Economists came out strongly in favour of continued membership of the EU. Of the 639 respondents, 72 per cent thought that the most likely impact of Brexit on UK real GDP would be negative over the next 10 to 20 years; and 88 per cent thought the impact on GDP would be negative in the next five years (see chart: click to enlarge).
Of those stating that a negative impact on GDP in the next 5 years would be most likely, a majority cited loss of access to the single market (67%) and increased uncertainty leading to reduced investment (66%).
The views of the majority of economists accord with those of various organisations. Domestic ones, such as the Bank of England, the Treasury (see the blog Brexit costs), the Institute for Fiscal Studies and the National Institute for Economic and Social Research (NIESR) all warn that Brexit would be likely to result in lower growth – possibly a recession – increased unemployment, a fall in the exchange rate and higher prices and that greater economic uncertainty would damage investment.
International organisations, such as the OECD, the IMF and the WTO, also argue that leaving the EU would create great uncertainty over future trade relations and access to the Single Market and would reduce inward foreign direct investment and the flow of skills.
But the forecasts of all these organisations depend on their assumptions about trade relations and that, in the event of the UK leaving the EU, would depend on the outcome of trade negotiations. The Leave campaign argues that other countries would want to trade with the UK and that therefore leaving would not damage trade. The Remain campaign argues that the EU would not wish to be generous to the UK for fear of encouraging other countries to leave the EU and that, anyway, the process of decoupling from the EU and negotiating new trade deals would take many years and, in the meantime, the uncertainty would be damaging to investment and growth.
The articles linked below looks at the economic arguments about Brexit and reflect the range of views of economists. Several are from ‘The Conversation’ as these are by academic economists. Although some economists are in favour of Brexit, the vast majority support the Remain side in the debate.
Articles
EU referendum: Pros and cons of Britain voting to leave Europe The Week (4/5/16)
The fatal contradictions in the Remain and Leave camps The Economist (3/6/16)
Four reasons a post-Brexit UK can’t copy Norway or Switzerland The Telegraph, Andrew Sentance (10/6/16)
What will Brexit do to UK trade? Independent, Ben Chu (2/6/16)
Leavers may not like economists but we are right about Brexit Institute for Fiscal Studies, Paul Johnson (9/6/15)
Why Brexit supporters should take an EU-turn – just like I did The Conversation, Wilfred Dolfsma (8/6/16)
The economic case for Brexit The Conversation, Philip B. Whyman (28/4/16)
Fact Check: do the Treasury’s Brexit numbers add up? The Conversation, Nauro Campos (20/4/16)
Which Brexit forecast should you trust the most? An economist explains The Conversation, Nauro Campos (25/4/16)
Why is the academic consensus on the cost of Brexit being ignored? The Conversation, Simon Wren-Lewis (17/5/16)
How Brexit would reduce foreign investment in the UK – and why that matters The Conversation, John Van Reenen (15/4/16)
The consensus on modelling Brexit NIESR, Jack Meaning, Oriol Carreras, Simon Kirby and Rebecca Piggott (23/5/16)
Reports, Press Conferences, etc.
Economists’ forecasts: Brexit would damage growth Financial Times, Chris Giles and Emily Cadman (3/1/16)
The Economy After Brexit, Economists for Brexit
Economists’ Views on Brexit Ipsos MORI (28/5/16)
Inflation Report Bank of England (May 2016)
EU referendum: HM Treasury analysis key facts HM Treasury (18/4/16)
Brexit and the UK’s public finances Institute for Fiscal Studies, Carl Emmerson , Paul Johnson , Ian Mitchell and David Phillips (25/5/16)
The Long and the Short of it: What price UK Exit from the EU? NIESR, Oriol Carreras, Monique Ebell, Simon Kirby, Jack Meaning, Rebecca Piggott and James Warren (12/5/16)
The Economic Consequences of Brexit: A Taxing Decision OECD (27/4/16)
Transcript of the Press Conference on the Release of the April 2016 World Economic Outlook IMF (12/4/16)
Macroeconomic implications of the United Kingdom leaving the Euroepan Union IMF Country Report 16/169 (1/6/16)
WTO warns on tortuous Brexit trade talks Financial Times, Shawn Donnan (25/5/16)
Questions
- Summarise the main economic arguments of the Remain side.
- What assumptions are made by the Remain side about Brexit?
- Summarise the main economic arguments of the Leave side.
- What assumptions are made by the Leave side about Brexit?
- Assess the realism of the assumptions of the two sides.
- If the UK exited the EU, would it be possible to continue gaining the benefits of the single market while restricting the free movement of labour?
- Would it be beneficial to go for a ‘free trade’ option of abolishing all import tariffs if the UK left the EU? Would it mean that UK exports would face no tariffs from other countries?
- If forecasting is unreliable, does this mean that nothing can be said about the costs and benefits of Brexit? Explain.
On 20 February, the UK Prime Minister, David Cameron, announced the date for the referendum on whether the UK should remain in or leave the EU. It will be on 23 June. The announcement followed a deal with EU leaders over terms of UK membership of the EU. He will argue strongly in favour of staying in the EU, supported by many in his cabinet – but not all.
Two days later, Boris Johnson, the Mayor of London, said that he would be campaigning for the UK to leave the EU.
In the meantime, Mr Johnson’s announcement, the stance of various politicians and predictions of the outcome of the referendum are having effects on markets.
One such effect is on the foreign exchange market. As the Telegraph article below states:
The pound suffered its biggest drop against the dollar in seven years after London Mayor Boris Johnson said he will campaign for Britain to leave the European Union [‘Brexit’].
Sterling fell by as much as 2.12pc to $1.4101 against the dollar on Monday afternoon, putting it on course for the biggest one day drop since February 2009. Experts said the influential Mayor’s decision made a British exit from the bloc more likely.
The pound also fell by as much as 1.2pc to €1.2786 against the euro and hit a two-year low against Japan’s yen.
This follows depreciation that has already taken place this year as predictions of possible Brexit have grown. The chart shows that from the start of the year to 23 February the sterling trade weighted index fell by 5.3% (click here for a PowerPoint).
But why has sterling depreciated so rapidly? How does this reflect people’s concerns about the effect of Brexit on the balance of payments and business more generally? Read the articles and try answering the questions below.
Articles
Pound in Worst Day Since Banking Crisis as `Brexit’ Fears Bite Bloomberg, Eshe Nelson (21/2/16)
Pound hits 7-year low on Brexit fears Finiancial Times, Michael Hunter and Peter Wells (22/2/16)
Pound in freefall as Boris Johnson sparks Brexit fears The Telegraph, Szu Ping Chan (22/2/16)
Pound falls below $1.39 as economists warn Brexit could hammer households The Telegraph, Peter Spence (24/2/16)
Why is the pound falling and what does it mean for households and businesses? The Telegraph, Szu Ping Chan (23/2/16)
Pound heading for biggest one-day fall since 2009 on Brexit fears BBC News (22/2/16)
Cameron tries to sell EU deal after London mayor backs Brexit Euronews, Guy Faulconbridge and Michael Holden (22/2/16)
EU referendum: Sterling suffers biggest fall since 2010 after Boris Johnson backs Brexit International Business Times, Dan Cancian (22/2/16)
Exchange rate data
Spot exchange rates against £ sterling Bank of England
Questions
- What are the details of the deal negotiated by David Cameron over the UK’s membership of the EU?
- Why did sterling depreciate in (a) the run-up to the deal on UK EU membership and (b) after the announcement of the date of the referendum?
- Why did the FTSE100 rise on the first trading day after the Prime Minister’s announcement?
- What is the relationship between the balance of trade and the exchange rate?
- What are meant by the ‘six-month implied volatility in sterling/dollar’ and the ‘six-month risk reversals’?
- Why is it difficult to estimate the effect of leaving the EU on the UK’s balance of trade?
Interest rates are the main tool of monetary policy and crucially affect investment. There has been much discussion since the end of the financial crisis concerning when UK interest rates would eventually rise. Uncertainty over just when, and by how much, interest rates will rise affects business confidence and hence investment. Businesses therefore listen carefully to what the Bank of England says about future movements in Bank Rate. But Mark Carney has now spoken about another cause of uncertainty and its impct on investment. This is the uncertainty over the outcome of the referendum on whether the UK should leave the EU.
By 2017, the Prime Minister has promised a referendum on staying in the EU, but Mark Carney has urged for this to be held ‘as soon as possible’. Whether or not the UK remains in the EU will have a big effect on businesses and with the uncertainty surrounding the UK’s future, this may soon turn to a lack of investment. 
As yet, businesses have not responded to this uncertainty, but the longer the delay for the referendum, the more inclined firms will be to postpone investment. As Mark Carney said:
“We talk to a lot of bosses and there has been an awareness of some of this political uncertainty – whether because of the election or because of the referendum … What they’ve been telling us, and we see it in the statistics, is they have not yet acted on that uncertainty – or to put it another way, they are continuing to invest, they are continuing to hire.”
Leaving the EU will have big effects on consumers and businesses, given that the EU is the UK’s largest market, trading partner and investor. With a referendum sooner rather than later, uncertainty will be more limited and any reaction by businesses will take place over a shorter time period. There are many other factors that affect business investment, some of which are related to the UK’s relationship with the EU and the following articles consider these issues.
EU referendum should be held ‘as soon as necessary’, says Mark Carney BBC News (14/5/15)
Business want an early EU referendum, Mark Carney indicates The Telegraph, Ben Riley-Smith (14/5/15)
EU poll should take place ‘as soon as necessary’, says Bank of England Chief The Guardian, Angela Monaghan (14/5/15)
Threat of business leaving the EU is fuelling business ‘uncertainty’, says Bank of England governor Mark Carney Mail Online, Matt Chorley (14/5/15)
Bank of England’s Mark Carney urges speedy EU referendum Financial Times, George Parker (14/5/15)
Questions
- Why is the EU important to the UK’s economic performance?
- If the UK were to leave the EU, what impact would this have on UK consumers?
- What would be the impact on UK firms if the UK were to leave the EU?
- Consider an AD/AS diagram and use this to explain the potential impact on the macroeconomic variables if the UK were to leave the EU.
- Why is uncertainty over the UK’s referendum likely to have an adverse effect on investment?
One of the key battle grounds at the next General Election is undoubtedly going to be immigration. A topic that is very closely related to EU membership and what can be done to limit the number of people coming to the UK. One side of the argument is that immigrants coming into the UK boost growth and add to the strength of the economy. The other side is that once in the UK, immigrants don’t move into work and end up taking more from the welfare state than they give to it through taxation.
A new report produced by University College London’s Centre for Research and Analysis of Migration has found that the effect on the UK economy of immigrants from the 10 countries that joined the EU from 2004 has been positive. In the years until 2011, it has been found that these immigrants contributed £4.96 billion more in taxes than they took out in benefits and use of public services. Christian Dustmann, one of the authors of this report said:
“Our new analysis draws a positive picture of the overall fiscal contribution made by recent immigrant cohorts, particularly of immigrants arriving from the EU … European immigrants, particularly, both from the new accession countries and the rest of the European Union, make the most substantial contributions … This is mainly down to their higher average labour market participation compared with natives and their lower receipt of welfare benefits.”
The report also found that in the 11 years to 2011, migrants from these 10 EU countries were 43 per cent less likely than native Britons to receive benefits or tax credits, and 7 per cent less likely to live in social housing. This type of data suggests a positive overall contribution from EU immigration. However, critics have said that it doesn’t paint an accurate picture. Sir Andrew Green, Chairman of Migration Watch commented on the choice of dates, saying:
“If you take all EU migration including those who arrived before 2001 what you find is this: you find by the end of the period they are making a negative contribution and increasingly so … And the reason is that if you take a group of people while they’re young fit and healthy they’re not going to be very expensive but if you take them over a longer period they will be.”
However, the report is not all positive about the effects of immigration. When considering the impact on the economy of migrants from outside of the EEA, the picture is quite different. Over the past 17 years, immigration has cost the UK economy approximately £120bn, through migrant’s greater consumption of public benefits, such as the NHS, compared to their contributions through taxation. The debate is likely to continue and this report will certainly be used by both sides of the argument as evidence that (a) no change in immigration policy is needed and (b) a major change is needed to immigration policy. The following articles consider this report.
Report
The Fiscal effects of immigration to the UK The Economic Journal, University College London’s Centre for Research and Analysis of Migration, Christian Dustmann and Tommaso Frattini (November 2014)
Articles
Immigration from outside Europe ‘cost £120 billion’ The Telegraph, David Barrett (5/11/14)
New EU members add £5bn to UK says Research BBC News (5/11/14)
UK gains £20bn from European migrants, UCL economists reveal The Guardian, Alan Travis (5/11/14)
EU immigrant tax gain revealed Mail Online (5/11/14)
Immigration question still open BBC News, Robert Peston (5/11/14)
EU migrants pay £20bn more in taxes than they receive Financial Times, Helen Warrell (5/11/14)
Questions
- Why is immigration such a political topic?
- How are UK labour markets be affected by immigration? Use a demand and supply diagram to illustrate the effect.
- Based on your answer to question 2, explain why some people are concerned about the impact of immigration on UK jobs.
- What is the economic argument in favour of allowing immigration to continue?
- What policy changes could be recommended to restrict the levels of immigration from outside the EEA, but to continue to allow immigration from EU countries?
- If EU migrants are well educated, does that have a positive or negative impact on UK workers, finances and the economy?
Where practical, some firms may thus choose to relocate from the UK to the EU or move business and staff from UK offices to offices within the EU. This is particularly relevant to the financial services sector. As the second Economist article explains:
If inflation rises, then the Bank of England may raise interest rates. This could have a dampening effect on the economy, which in turn would reduce tax revenues. The government, if it sticks to its fiscal target of achieving a public-sector net surplus by 2020 (the Fiscal Mandate), may then feel the need to cut government expenditure and/or raise taxes. Indeed, the Chancellor argued before the vote that such an austerity budget may be necessary following a vote to leave.
