June 23, 2016 will be marked as a historical event that would have a far reaching global impact. Almost 110 years ago in 1805, Napoleon Bonaparte banned the entry of British goods in mainland Europe through a so called continental blockade policy.
Since then, the clock has turned 360 degrees and in 2016, the UK decided to break its four and half decades of very close economic ties with the European Union (EU), although, it had not been a part of the euro zone.
Brexit is an event that measures equal and opposite proportion of the fall of the Berlin Wall in 1989. The fall of the Berlin wall is a metaphor for integration and Brexit will become a metaphor for disintegration. The world economy has witnessed sharp turmoil from the Nikkei to Wall Street as the global market lost USD 2.1 trillion in the equity market and the UK Pound sank to its lowest level in the last 30 years. There are many questions – What alternatives would Britain have? What is the likely long term impact of Brexit? I will share my views through this article.
To gauge the impact of the British vote to exit the EU, we need to know the current level of integration of the British economy to the European Union. In 2014, the EU accounted for 44.6 percent of British exports (amounting to UK Pound 364 billion as compared to only UK Pound 43 billion worth of trade with China) and 53 percent of British imports, 43.6 percent of foreign assets of Britain are held in the EU (UK Pound 450 billion). Britain’s trade deficit with the EU is about UK Pound 77 billion.
Foreign assets held by British banks in the euro zone bank were 70 percent higher than ones held in the USA. It is quite evident that despite the recent fall in its level of economic ties with the EU, the UK is still highly integrated with the EU. Many believe that this divorce is likely to be turbulent and chaotic. Yet, Euro-skeptics believe that this divorce is timely and Britain stands to benefit by expanding its trade with emerging economies.
After Brexit, Britain’s trade relationship with the EU will be determined by the process of negotiation. The process of negotiation may result into three possible scenarios:
Scenario 1 (worst case scenario): Britain is denied membership of the European Free Trade Agreement (EFTA) and European Economic Area (EEA). It is highly unlikely that after Brexit, the EU will consider working out a bilateral arrangement with Britain as it has done with Switzerland. In this case, Britain being member of the WTO would still get Most Favoured Nation (MFN) status in Europe and will not be penalised with discriminatory tariff.
Although, MFN tariff rates in the EU have declined steeply, the British exports will become less competitive in the EU market and this impact will differ significantly across sectors. British trade in services would be adversely affected by non-tariff barriers such as domestic laws and regulations of EU member states.
Britain may face difficulty in accessing the EU’s market for services as well as it will also not benefit from the greater liberalisation of trade in services that the EU would undertake in future.
In this situation Britain will have to look beyond Europe towards emerging economies, NAFTA and a possible move towards Commonwealth free trade areas.
In such a scenario, Britain will have an option to negotiate Free Trade Agreements (FTAs) on bilateral basis with different countries. Such a process of transition will be slow and until such trade negotiations are carried out, British international trade will possibly see a downturn.
Scenario 2: Britain is able to negotiate a membership of EFTA, which allows it to be a member of the free trade area which consists of four European countries—Iceland, Liechtenstein, Norway and Switzerland. Being a member of EFTA will also give Britain a freedom to undertake free trade agreement with third parties. EFTA offers greater flexibility to its member states to exercise their independent policies and protect their economies. In my opinion this is the best option for Britain. Its benefit would be far less than being a member of the EU but certainly much better than being left out completely.
Scenario 3 (highly unlikely): Britain also joins EEA as it joins EFTA. EEA enables EFTA members to be a part of the EU in terms of free movement of goods, services, persons and capital without having to accept common trade and agriculture policy and also not being a part of custom union. This can happen only if the EU still agrees to the British proposal. German Chancellor Angela Merkel has already conveyed that separation from the EU will not be a cherry picking exercise hence it is highly unlikely that the EU will accept such a proposal. This option will also go against Britain’s ability to bring about fundamental change in its immigration policy. I do not think that Nigel Farage (the one who led the Brexit movement) can afford this.
Brexit should not be viewed as an isolated event. It brings to the focus the challenges thrown open by closer integration of disparate economies. The EU and even more so, the euro zone requires a high degree of uniformity in various policies—trade, fiscal and monetary.
The onus of maintaining a given set of policies that are incongruent with the needs of individual economies tend to become burdensome which can be easily used to arouse public opinion against such integration.
From the Greek ‘sovereign debt’ crisis to immigration related issues in Britain, all reflect growing conflict of interest in maintaining such untenable integration. Strong nationalistic interests always overtake super-national or regional interests.
EU type integration of economies is unlikely to be successful or even attractive to anyone. Without adequate policies and institutions that brings the equity issue at the centre of discussion, efforts to integration would only highlight inherent conflict of interest and would promote nationalistic forces.
Regional integration in regions with the environment of political distrust and conflict of geopolitical interest will be taken forward with great caution. The speed of integration will slow down considerably not only in South Asia and Africa but also in more advanced regional blocks like ASEAN and NAFTA.
Bilateral arrangements for free trade is likely to become a popular instrument and regional integration may take a back seat. The nationalistic and anti-globalisation forces will become more vociferous and omnipresent.
Failure of national governments to tackle unemployment, inflation and extend wider and deeper social protection nets would also mean an end of the dream of greater regional integration and also globalization.
We can witness such tendencies right here in Bhutan—opposition to the BBIN (Bhutan Bangladesh, India and Nepal) initiative only reflects precedence of national interest over regional interest.
Fredrick List would definitely be smiling in his grave.
Professor of Economics
Royal Thimphu College