Brexit's Consequences for the UK – and the EU

Monday, 6 June 2016

Authors: Steven Blockmans and Michael Emerson

Series: CEPS Commentary

On 23 June 2016, the United Kingdom will hold a referendum on whether it should remain in the European Union or leave. A British exit, or Brexit, could have serious economic and political consequences for both the UK and the rest of the EU. Such an exit is a distinct possibility, with polling demonstrating a close race. 

If Brexit becomes a reality, the UK's post-referendum trajectory will depend on whether the transitional period is a flexible but orderly exit carried out in a spirit of partnership with the EU, or whether the split is acrimonious and messy, without properly tying up all the legal loose ends. In a scenario in which pragmatism prevails over resentment, economic and financial tensions could be limited by London and Brussels negotiating an amicable separation agreement. However, broader political considerations, including the EU's desire to avoid further departures by making an example of the UK, might lead to a far more damaging outcome for all parties.

Impact on the UK

Shortly after a vote to leave, the UK would probably trigger the voluntary withdrawal procedure foreseen in the EU's 2009 Lisbon Treaty, which allows for a two-year period to reach a separation agreement. Without such an agreement, the UK – which currently enjoys unrestricted access to the rest of the EU under the Single Market rules – would revert to the default trade arrangement with the EU, based on World Trade Organization (WTO) rules. 

Under the latter scenario, the EU would apply its external customs duties to UK goods. It could also introduce non-tariff hurdles for goods (such as technical standards) and especially services (including licenses). Brussels would also be able to restrict London’s ability to conduct euro transactions and euro-derivatives transactions, and thereby undermine the position of the city as a financial centre. UK citizens could also lose their automatic right to work in the rest of EU. What's more, the EU’s new external border would divide Northern Ireland from the rest of the island and could thereby jeopardise the peace agreement.

Even in the event of a more amicable separation, there would still be multiple adverse impacts on the UK. Regarding the economic impact, an overwhelming majority of serious analyses from government, business organisations, think tanks and academia from within the UK, as well as from the International Monetary Fund and Organization for Economic Cooperation and Development, converge on the following propositions:

  • Reduced EU market access. The UK’s access to the EU Single Market would be less complete than under the status quo. All existing alternatives to EU membership have drawbacks. The Norwegian model – membership in the European Economic Area – would assure full market access, but is politically implausible for the UK since it would mean a loss of sovereignty due to the need to accept EU legislation without being able to influence the substance of the rules at the EU Council’s negotiating table. Switzerland's model of negotiating multiple separate sectoral agreements with the EU is considered attractive by some Brexiteers, but would simply not be on offer from the EU side. Indeed, the so-called ‘Swiss cheese’ model has broken down over issues of immigration and is severely criticised by politicians and officials in EU circles as ‘cherry-picking’. In addition, both Norway and Switzerland must allow free movement of EU citizens, a primary concern of those in the Leave camp. The enhanced free-trade arrangements like that recently agreed between the EU and Canada offer little under services, which are a major portion of the UK economy.
  • Damage to trade ties. The UK’s trade relationships with the rest of the world, beyond membership in the WTO, would also be subject to huge uncertainties. All of the EU’s existing preferential agreements with other countries around the world would cease to apply to the UK, and it would be a long and messy process to reconstitute them on a bilateral basis. As for the EU’s ongoing negotiations for new trade deals – for example with the United States, India, and Japan – the UK would not benefit from a faster inside track on these bilaterally. US President Barack Obama and Democratic presidential hopeful Hillary Clinton have made it clear that the UK would be sent to the ‘back of the queue’ for trade deals with the United States, an indication of the potential damage to the ‘special relationship’ between the UK and the United States.
  • Risks to London. Domestically, the UK risks damaging all three of its economic ‘crown jewels’, namely London’s position as a financial centre, its large services-sector trade with the EU and its prime location as a destination for foreign direct investment aimed at the EU market. The UK is already suffering a number of negative macroeconomic impacts as a result of the uncertainty surrounding the referendum, including exchange rate depreciation and dented business confidence.

Although the full extent of the economic impact depends on many factors, including the eventual trade arrangement between the UK and the EU, most economists agree that it would clearly be negative. Indeed, eager to avoid setting a precedent, EU member states more inclined towards integration, such as Germany, Italy, Spain, Belgium and Luxembourg, would likely seek to impose tough terms for the separation agreement with the UK.

Regarding the future of the UK itself, a Leave vote could lead to a prolonged period of political instability. Politicians’ heads would roll, beginning with Prime Minister David Cameron, but also including other leaders in the Tory party who campaigned against Brexit. The split in the Conservative party would deepen, and new general elections might be called. Brexit could also undermine UK unity by potentially triggering a fresh referendum over Scottish independence, reinvigorating Welsh nationalism and dividing the more pro-EU London and southeast regions against the more eurosceptic Midlands and north.

From an international perspective, there is not a single voice among the UK’s friends in Europe, the Commonwealth or the world at large that supports the idea of Brexit. The EU has acted as a ‘multiplier’ for the UK’s foreign and security policy interests throughout the world, backed by the weight of the EU’s Single Market and the wide range of EU foreign policy tools, as well as its perceived neutrality. Secession would thus reverse that effect, reducing the UK's global influence.

Impact on the EU

Some argue that Brexit would lead to the collapse of the EU, but this is highly unlikely. The web of socioeconomic ties between the remaining member states has been woven so intricately and deeply over the past six decades that Brexit would not unravel the fundamental post-World War II order in Europe.

But unfortunately for the rest of the EU, the consequences of Brexit would not be limited to the UK. Brexit would fan the flames of growing anti-EU sentiment in Europe, emboldening nationalist and eurosceptic movements, and leading to a retreat from EU-level solutions to cross-border challenges. Brexit may also boost a new generation of nationalist leaders (most likely in France, Hungary, and Poland) to copycat the ‘blackmail tactics’ employed by David Cameron to obtain concessions from the rest of the EU. Hungarian Prime Minister Viktor Orban has already emulated these tactics by calling for a national referendum in the hope of obtaining a popular mandate so as to better resist attempts by the European Commission to accept its quota under a new refugee relocation scheme.

In addition, by removing a major power from the EU, Brexit would increase the already dominant influence of Germany in the Union. This in turn could heighten tensions in countries suspicious of Berlin – including France, where Marine Le Pen and her far-right National Front party have gained strength ahead of the 2017 presidential elections. Germany and its like-minded partners in the EU would nevertheless try to put the house together again with renewed integration initiatives to counter the reputational damage of UK secession. Rhetorical resolve would be immediately forthcoming, but real action would be delayed as Germany will be caught up in its own national election in 2017.

How might Brexit impact on EU policies? There are four likely areas of change: the euro currency system, the EU’s budget and liberalisation, the nexus of immigration and border management and foreign and security policy more broadly.

  • First, in the wake of a Brexit, there is a risk that the euro will depreciate. In the longer run, however, the eurozone would have more power to drive economic and financial policy in the EU. France, Germany and Italy all say they want to make the euro system more robust on the fiscal side, but behind this simple statement lie profound disagreements, with Italy wanting eurobonds, Germany blocking anything that smacks of a transfer union and France making speeches about the need for an EU ‘finance minister’. Progress towards a capital markets union would also continue, although at a slower pace and in a different direction from London’s preferred approach. Some major US banks have already declared that they might relocate their European branches from London to Europe.
  • Second, without the UK, the EU budget would have to do without the UK’s €10.5 billion net annual contribution. This would certainly require a thorough review of budget allocations and revive a debate about raising new resources for the EU. Also, the weight of the ‘economically liberal’ bloc in the EU (currently the UK, the Netherlands, Sweden, Denmark and Estonia) would decline. Because of this, pundits have suggested that a post-Brexit EU would probably become more protectionist, yet there has been a growing consensus across the Union in favour of liberalising internal markets in goods, services and labour.
  • Third, on the immigration front there is much to be done. The refugee crisis of the past year has clearly demonstrated that the EU needs to move towards a centralised border control and asylum mechanism. Although such momentous moves are unlikely in the foreseeable future, the need for common action will only increase as migration pressure from Africa is added to the current movements from the wider Middle East, creating an ever-bigger challenge. At the same time, a Brexit would reduce the EU's ability to tackle cross-border organised crime and transnational terrorism, unless new coordination and cooperation mechanisms can be established with the UK.
  • Finally, foreign and security policy would perhaps be the least-fraught areas. It is undeniable that Brexit would seriously threaten the EU’s global standing and soft power status, its ability to play a greater role on global security issues and the likelihood of concluding the Transatlantic Trade and Investment Partnership (TTIP) deal with the United Sates before the end of President Obama’s term. On the other hand, EU decision-making without the historically ‘unruly’ UK would become simpler and lead to a more truly common Common Foreign and Security Policy. Indeed, without the UK, there would be less opposition to the establishment of a permanent structure for defence cooperation, with more pooling and sharing of capabilities, more cooperation on defence planning and the creation of a single military headquarters in Brussels.

Brexit would not only be bad for the UK, but would also be on balance bad for the EU. Both parties could waste years negotiating a new relationship. At a time when the post-World War II international order is under strain and Europe's societies are increasingly threatened by protectionism, it is abundantly clear that the EU needs more than ever to be able to resolutely face the big global challenges. But if the Remain vote prevails on June 23rd, the EU could be strengthened on multiple fronts – internally, through further liberalisation of the single market, and externally, as a robust pillar of a liberal order in an increasingly hazardous and chaotic world.

Steven Blockmans is Senior Research Fellow and Head of EU Foreign Policy at CEPS. Michael Emerson is Associate Senior Research Fellow at CEPS. This commentary was originally prepared as a Global Memo for publication by the Council of Councils (www.cfr.org/councilofcouncils/global_memos/p37922).

CEPS Commentaries offer concise, policy-oriented insights into topical issues in European affairs. The views expressed are attributable only to the authors in a personal capacity and not to any institution with which they are associated.