25 Years IWH

UK’s “No” to EU will be costly for both sides

On Thursday 23rd, the British people have decided to leave the European Union (EU) Their vote not to remain in the European community was surprisingly clear. UK’s exit will have both political and economic consequences which are far-reaching for the country itself as well as the rest of Europe. “The reactions of the remaining member states are the crucial key now, especially France’s and Germany’s” says Reint E. Gropp, President of the Halle Institute for Economic Research (IWH) – Member of the Leibniz Association.

Authors Reint E. Gropp

Financial market reactions to poll data before the referendum showed strong financial dislocations in the short-run (see IWH Online 5/2016). For the financial markets, the vote must have been surprising. Within the past two weeks, the British pound has actually been revalued by 3% compared to the euro. This development will probably reverse now. Many companies already announced to reduce investments in the UK or even skip them completely because the access to the European market is no longer assured. In particular, London as the financial centre of Europe could suffer from the British vote: Previously, bank stocks have reacted substantially on a higher likelihood of a negative vote both in the United Kingdom and the euro area. In the medium term, from a British point of view, many developments will depend on how the negotiations about UK’s leaving will proceed. “In the end, hopefully, every party will realize the benefits of a fast agreement,” Gropp emphasizes. To “punish” the UK by protracting the negotiations would be inappropriate and, furthermore, not in the interest of the remaining member states. It is still unclear, however, whether the current government will stay in office, which adds a political uncertainty to the already existing economic one.

To what extent will a Brexit impair the economic prospects of the EU? The euro did not react on a higher likelihood of a negative vote and hence seems to stay stable. It depends on the upcoming negotiations to what extent the markets for goods and services, the labour and capital markets inside the EU will stay open for British business. The vote itself will not lead to an exit, but it initiates a leaving process which has to be confirmed by the British Parliament. Generally, there is a high like-lihood that at least in the short-run, both sides will suffer deadweight losses. 45% of the overall exported goods and services from the United Kingdom end in the member states of the European Union – contrary to goods and services of the EU where just 6% are exported to the UK. Germany holds a percentage of 7%, which is just slightly higher.

In the end, hopefully, every party will realize the benefits of a fast agreement

On the long-run, a less economic-friendly climate is expected in terms of a higher number of regulations in the EU. It is currently unclear how the economic relations between the UK and the EU will develop. So far, there are many options (European Free Trade Association EFTA or bilateral agreements), but the decisions will need time. One of the major problems for Great Britain are the trade relations with about 60 countries (e.g. USA, India, China, Japan and Australia) which are up to now based on EU agreements. Hence, they have to be renegotiated individually while the UK is situated in a quite weak bargaining position.

From an EU point of view, there is a risk of further disintegration among the member states. On the basis of article 50 of the Treaty on European Union which regularizes the voluntary exit, every member state is free to leave the union since 2009. After Great Britain decided to withdraw from the EU, the anti-European attitude of other countries could be strengthened. They could even follow the British example. This is why the reactions of the remaining countries, in particular Germany and France, are so essential. A wise and reliable strategy needs to be established and communicated which should be stated collectively by the big member states, namely Germany and France, in a convincing manner. To become sustainable with or without Great Britain, the EU should work on a more intensive democratic legitimation of the European Union’s institutions, less regulations in labour and product markets, a reduction of bureaucracy in the EU as well as their member states, the implementation of a capital market union as well as a new prioritisation of EU expenses.

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Verknüpfte Publikationen

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Brexit (Probability) and Effects on Financial Market Stability

Thomas Krause Felix Noth Lena Tonzer

in: IWH Online , 5, 2016

Abstract

On 23 June 2016, there will be a referendum in the United Kingdom (UK) on the stay of the country in the European Union (EU). Based on recent poll data, the share of supporters and opponents of an exit varies around 50%. Opponents of the UK breaking up with Brussels („Brexit“) refer to high costs in terms of stagnating economic growth if the UK leaves the EU. The risk of reduced trade, declining foreign direct investment, and a lower degree of financial market integration is high following an exit of the “single market”.

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