Brexit and Beyond

21 Jul 2016

On 23 June the United Kingdom voted to leave the European Union. The full consequences of that decision will not be known for years, and arguably decades. Indeed, at this early stage it is not even certain that Brexit will happen – it is at least theoretically possible that the UK may ultimately remain within the EU. Markets cannot wait for all the uncertainty to be resolved. Prices have already started to adjust to the new economic and political reality. This article will discuss the likely domestic ramifications of Brexit. There are almost certainly economic and political consequences for the rest of Europe too – both good and bad – but these are beyond the scope of this article. To be clear from the outset, I will not express a view on the merits of Brexit: the people have already spoken on that issue, for the moment at least.

End games

One of the curses of modern life is the spoiler: those who record their favourite HBO series and plan to watch it at their convenience are forever at risk of having their 60 minutes of TV heaven being ruined by some well-meaning friend blurting out the twist in the tale. With Brexit it’s the exact opposite. If you want to figure out what the vote means for the economy or asset prices in the long run then the one thing you really need to know above all else is what the final settlement between the UK and the EU will look like. There are an almost countless number of possibilities but we shall focus on three distinct scenarios.

Option one is Remain, despite the outcome of the referendum. The most plausible route to this scenario is via a second referendum. In order to get a second referendum there likely has to be a lot of economic, political and democratic pressure on the Government – that is, if the outcome of the first vote is clearly having a negative impact on the standard of living of the electorate, if opposition parties are able apply pressure on the Government and if there is clear public support for a second vote. This scenario starts to look less likely once the UK triggers Article 50, and formal exit negotiations begin, although in theory it is still possible for the UK to change its mind after this point.

Option two is Norway – that is, the UK chooses to leave the European Union but stay within the European Economic Area (EEA). This option would allow the UK to retain near complete access (n.b. not full access) to the single market and to negotiate its own trade deals with countries in the rest of the world and to regain sovereignty in a couple of key areas (agriculture, fisheries). However, the quid pro quo of the Norwegian option is the UK would have to accept near complete freedom of movement of labour across its borders, would continue to make (smaller) financial contributions to the EU budget and would have to accept EU regulations without any significant say on how those regulations are calibrated.

Option three is out, out – that is, the UK does not remain within the EU or the EEA. In this scenario, the UK regains control over migrant flows from the EU but loses preferential access to the single market and will therefore have to negotiate a new free trade agreement with the EU. It is impossible to be sure what that new deal will look like or the conditions that will be attached to it, but there appears to be a double lock on the UK being able to have its cake and eat it too. First, if the EU allows the UK to continue enjoying the perceived benefits of EU membership (the free movement of goods and services) without having to continue paying what is perceived to be by some the major cost (free movement of labour) then that could prove problematic: other members might start to question their membership of the club. Second, even if the UK is able to strike such a good deal with the key political figures in Europe it will still have to be ratified by every national parliament of the EU.