Brexit: Will It Ever Happen?

by Elliott Morss, Morss Global Finance

Introduction

A United Kingdom (UK) departure from the European Union (EU) would generate important changes in global finance and trade. International financial markets do not as yet reflect these changes, suggesting they don’t think Brexit will happen. Will it ever really happen?

Please share this article – Go to very top of page, right hand side, for social media buttons.

The key question is whether the protagonists – the UK and the EU – can work out a deal that will satisfy both of them. It will be difficult. There is considerable bad blood. The EU, and particularly Germany, is angered by the UK’s wish to get out. Below, they key issues are identified and supplemented with data.

Background

Table 1 indicates that the UK’s GDP is second only to Germany’s in the EU. Germany’s share of the EU’s GDP is 21% and the UK’s is (16%). Clearly, the UK’s departure would reduce the EU’s negotiating power significantly. Brexit is not the only problematic issue facing EU countries. Terrorism and the EU’s intra-country open borders are seen as a real problem to all members. And the apparent German decision to support construction of the Nord Stream 2 pipeline is not sitting well with neighboring EU countries.

Table 1. – European Countries, Socio-Economic Data

Sources: IMF, Eurostat, SIRI

Key Issues

While the ongoing UK/EU negotiations are extremely complex, there are a series of issues that stand out.

a. Trade Between the EU and the UK

Table 2 provides data on trade between the UK and the EU. The UK runs a trade deficit with both the EU and the world. And of greater importance to the Brexit negotiations, exports to the EU are far more important to the UK (47% of its total exports) than are UK exports to the EU (6%). EU negotiators are well aware of this and will certainly negotiate to reduce the unfettered trade that now takes place between the UK and other EU countries.

Table 2. – Trade Between the UK and Other EU Countries (Mil. US$)

Source: UNCTAD

b. Investments

One of the great attractions of being in the EU is that a company situated in any EU country can sell to other EU countries without having to pay normal inter-country tariffs and clear other restrictions. And at least some companies have invested in the UK knowing that being located there will provide them with free trade access to other EU countries. Brexit will mean this direct access is cut off to some degree, and some foreign investment will be lost. Table 3 provides data on foreign direct investment in the UK for the 2012 – 2016 period. Brexit can be expected to reduce this. One already hears that some financial companies are talking of relocating on the Continent.

Table 3. – UK Foreign Direct Investment Inflow (mil. US$)

Source: UNCTAD

Needless to say, foreign companies that located in the UK with the intent of selling from there to other EU countries will be lobbying hard against Brexit.

c. Immigration

Immigration has become a problem for all EU countries and could ultimately lead to the complete breakup of the EU. With the growth in terrorist acts, all EU countries would like control over who is allowed in. I quote from a well-informed German friend:

“Prime Minister May stressed over and over again that two motives dominated the British decision: The British do not want to be controlled by foreign courts and they want to control their borders. The latter means that they do not want to live together with thousands of Polish and other Eastern European people. This is a very strong force that awakens all over Europe. The individual European nations do not want to live together with millions of immigrants from cultures that are alien to them. This is Chancellor Merkel’s policy. She wants centralization and harmonization all over Europe and wants to impose the cultural conditions of German economic and financial policy on the other European nations. This will fail.

President Trump once predicted that Merkel’s refugee policy will trigger a civil war in Germany. It may not cause civil war but tensions are rising rapidly and a new nationalistic party is rising rapidly in Germany. Refugees cost Germany $34 billion last year and about the same this year. Crime by foreigners is rising rapidly as are attacks on refugee camps. Five million Muslims, primarily Turks, are now living in Germany. Another two million Arabs have arrived since 2014. Germans are beginning to feel as foreigners in their own country.”

And there are a host of other problematic immigration issues. For example, what will happen to EU citizens living in the UK and UK citizens living in other EU countries? As Khalid Koser has suggested, what become the real problems will depend on the negotiations:

“As is the case for Norway and Switzerland, for example, it is perfectly feasible that the UK will maintain the free movement of EU labor, in exchange for access to the EU market, even once it leaves.”

Koser also notes that UK universities are likely to be big losers from Brexit, making them less attractive to students and staff. It will also probably to limit their EU funding sources and research networks. He notes further that many in the UK citizens view having control over asylum seekers and refugees as justification alone for leaving the EU. He claims this is a false sense of relief because

“…the UK already attracts proportionally far fewer asylum seekers than other European countries like Germany and Sweden, and has long and successfully resisted EU efforts to harmonize asylum policy.”

d. Settling Up With the EU Financially

In 2016, the UK paid the EU a membership fee of $17.5 billion. The UK gets back in support a bit more than $5.4 billion, so the net is about $12 billion annually. There are a host of other financial issues that will have to be resolved between the two sides before Brexit is complete. And lawsuits could delay the process for years.

Conclusions

As suggested at the outset, whether or not Brexit occurs will depend largely on the negotiating stances taken by each side. The EU does not want the UK to pull out for a wide variety of reasons. So they will make numerous demands to make the costs appear very high for the UK. The EU’s primary bargaining chip is UK business and citizen access to the EU. For example, the UK now serves as the primary financial center of all of Europe. Will the EU allow this to continue or will they require UK firms to “register” in the EU as non-EU states must? Another example: how will trade in goods and other services be handled? Keep in mind that tariffs are only part of international trading costs: there are a number of other restrictions on imports from non-EU countries that the UK might be asked to deal with.

The UK has very little to bargain with. It will be interesting to see how this all works out. My guess? There will be minor adjustments, but the UK will remain a member of the EU. The UK will come to realize just how problematic its departure would be.

One thing is certain. With the Greek crisis far from being resolved and this matter likely to stretch on for years, Europe remains a very uncertain place for investments.