Ripple Effects of UK’s Brexit Referendum

Britain’s exit (Brexit) from the European Union (EU) is teed up for a United Kingdom (UK) referendum on June 23, 2016.  While it may seem like an insular European issue, Britain’s longstanding cultural, military and trade relationship with the US makes the outcome a matter of potential importance for US consumers.

The UK joined the European Economic Community (EEC) in 1973.  The EEC gradually evolved into a tighter integration of the members and was renamed the European Union (EU) in 1993. EU citizens normally travel and trade freely across member’s internal borders.  Brussels became the center for the EU’s high volume of new regulations that apply to the 28 members.  Harmonizing the disparate existing regulations has caused frictions and occasional returns of nationalist sentiment.

UK citizens have had 40 years without a say on the oppressive alien-seeming regulations.  Recent immigration trends and immigrant entitlement expectations made the discomfort acute.  British voters want a say in the rules they must live under and the subsidies they must offer to newcomers.

Some of the EU irritants that UK voters resent include: EU creates difficulty in negotiating trade deals with major opportunities like China; the UK’s obligation to remit 350 million in sterling per week to Brussels; lack of control over employment, health and safety regulations; and weak control over immigration.

British Prime Minister David Cameron initially called for the referendum in a period when sentiment looked to favor staying in the EU.  Earlier this year, he negotiated with the EU on some minor regulatory issues, but the concessions were not enough to impress the UK voters.  Recently Cameron has shown signs of desperation, saying that Putin and ISIL would both favor Britain’s exit from the EU.  UK public sentiment over “stay” or “leave” currently runs at 55% stay, 37% leave, but polling reveals sentiment is too volatile to predict the outcome.

Endorsements of favoring either side come from within and from outside UK.  The Queen of England favors exit.  President Obama favors stay.  Donald Trump favors exit and the EU favors stay hoping to thwart other EU members starting referenda of their own, or trying to negotiate a better deal for themselves.

The Bank of England (a stay proponent) says a win by the leave faction could trigger two quarters of UK GDP contraction, i.e. a technical recession, and it argues “either families would face lower incomes because inflation would be higher, or the economy would be weaker with a hit to jobs and livelihoods. This is a lose-lose situation for Britain. Either way, we’d be poorer.” The OECD estimates that “leaving” would cause a 3.2 billion pounds sterling reduction in UK GDP. For comparison, we note that the US Senate is authorizing about half that for Zika virus control, and the 350 million pounds weekly tribute to Brussels costs the UK 17 billion pounds per year.

The UK is a large trading partner with the US.  Major economic changes in the UK, such as a reduction in UK’s exports to the EU or drop in the value of sterling will have some impact in UK’s trade with the US.  However, UK’s improved economic vitality from a reduced EU regulatory drag could help both of us.

Some experts estimate that EU membership costs the UK 10% of its GDP because of compliance costs for Brussels regulations.  Those costs could be shed after Brexit.  The US could devise new trade pacts with the UK very quickly.  On the other hand, after Brexit, the EU may reduce the dominance of the City of London in EU’s financial affairs.  That and other frictions may cause an economic drag on UK GDP of between 2.5% and 10% in the short run.

On balance, the US should feel only a modest impact from Brexit.  The Richmond Fed’s President Jeffrey Lacker said, “My sense is the likely effects on growth in U.K. are highly uncertain, but most of those estimates seem in a range that wouldn’t cause a recession here.” There should be no material impact on EU security because that is handled through NATO, and the NATO arrangements are expected to continue.

The referendum will take place in a few weeks. If the outcome is to “stay,” those looking to leave will begin a campaign that is more convincing for the next referendum.  Voter sentiment in a stay or leave referendum is likely influenced by events exogenous to the UK – such as terrorism attacks in the EU, overwhelming migrations, and financial collapse of the EU’s southern and eastern members.

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