UK Voters: To Brexit or not to Brexit
To inform the decision that voters in the United Kingdom will make later this month in a referendum on whether their country should remain a member of the European Union, Her Majesty’s Treasury released a report providing an analysis of the impact over a two-year period of a vote to leave.
The analysis doesn’t pull any punches. “A vote to leave would cause an immediate and profound
economic shock creating instability and uncertainty which would be compounded by the complex and interdependent negotiations that would follow,” the report concluded. “The effect of this profound shock would be to push the UK into recession and lead to a sharp rise in unemployment.”
The immediate economic impact would be driven by three key factors, according to the report the first of which it call the “transition effect” of the UK becoming less open to trade and investment. The two other immediate effects are the “uncertainty effect” and the impact of uncertainty on economic and the “financial conditions effect” which predicts financial market volatility.
The transition effect projects that “the UK would become less open, less productive, and poorer as a country in the long term following a vote to leave the EU.”
The transition effect, the report warns, would be felt immediately. Businesses will reduce investment and cut jobs, in the expectation of lower external demand and investment in the future.
The degree to which this transition will lead “to a permanent reduction in trade, foreign direct investment and productivity in the long term” will depend on the sort of relationship the UK would seek with the EU going forward.
“The impact of the transition effect would be considerably larger if the UK did not seek participation in the Single Market, as would be cthe case if it fell back on World Trade Organization (WTO) membership,” said the report.
Aspects of the uncertainty effect include the necessity of the UK entering a new trading relationship with the EU as well as the rest of the world. There are over 50 countries with which the UK would need to negotiate new trade arrangements, according to the report.
“In the immediate aftermath of a vote to leave, financial markets would start to reassess the UK’s economic prospects.” Hence, the financial conditions effect. “The UK would be viewed as a bigger risk to overseas investors, which would immediately lead to an increase in the premium for lending to UK
businesses,” the report said.
The combination of the three effects would have a damaging effect on both the demand side and supply side of the economy, the report posits. An impact in advance of the referendum is already being seen as the value of the pound has fallen in international currency markets. Recent data also shows weaker expectations for business investment and a sharp fall in commercial real estate transactions. Purchasing managers indexes for services, manufacturing, and construction output are all at their lowest levels for three years.
In a more extreme severe shock scenario GDP would fall six percent over two years lower, the unemployed would increase by around 800,000, the pound would depreciate by 15 percent, and inflation would increase by 2.7 percentage points after a year.
On the other hand, a vote to remain in the EU “would see uncertainty fall back rapidly with little lasting impact on the economy,” the report concluded. If the voters decide to remain, the report projects “growth to start to recover in the second half of 2016.”