Brexit enters the final stages

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Brexit enters the final stages

Last Friday David Cameron reached a deal with EU policymakers concerning special treatment for Britain and its EU membership. After a hard battle that ended with only modest achievements, we are now entering the final stages of the Brexit debate, which will culminate in June with a referendum to ask the Brits whether they want to stay or leave the EU. As there is still no clear winner, investors are assured of a wild ride in sterling markets. The FTSE may also suffer and lag behind European markets, particularly if Mario Draghi expands the current asset purchase programme. Whether Britain will be better off staying or leaving remains to be seen, as many of the potential implications of a ‘No’ vote are difficult to foresee.

Now that the negotiations with the EU have ended and that the referendum has been assigned a date, we can expect huge volatility for the pound and British markets, as both sides line up with arguments and counter-arguments on the pros and cons of leaving the EU. The battle will be particularly fierce in terms of economic, immigration, and security matters.

While leaving the EU would allow the UK to regain its full sovereignty by pushing the decision centre back to Westminster, it would also cease the participation of the UK in the European construction, meaning that the UK would no longer have its say on Europe’s future but instead have to accept decisions as exogenous, as does Switzerland. Rather than an active role, the UK would enjoy a passive role in the second biggest bloc in the world.

Many believe that by leaving Britain can avoid the hassle of having to comply with EU law regarding the single market, being then able to secure new bilateral trading deals without having to comply with tight rules. But that is an illusion. First of all, no one has access to the single market without complying with the rules. Second, negotiating bilateral deals may prove more tedious than relying on simplified common rules. Third, the UK is already one of the least regulated countries in the world, at par with the US, Canada and Australia. That being the case, what exactly does Britain stand to gain in terms of de-regulation?

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More than 50% of UK exports go to the EU. It’s hard to understand how the country plans to benefit from leaving the market where it places half of its exports, especially given that the said market would not allow British products to enter without complying with the same strict rules as before. Leaving means having to comply with the rules imposed by others instead of complying with rules that were co-built. Re-focusing exports towards America, China and other countries could be an alternative solution to the problem. But that is really quite unlikely to happen fast enough, especially given the geographical proximity of the EU.

Many also claim that Britain contributes too much money to the EU budget. By leaving the country could stop sending around £350 million every week that could serve to finance part of its education system or healthcare budget. But that is a naive argument because it ignores the benefits the country collects from accessing the single market. It is by no means clear that at the point when the country ceases to contribute money to the EU, it would continue to reap the same market benefits as before. It is difficult to estimate the exact cost-benefit relationship, but it has many times been pointed out that despite contributing billions of pounds each year, the UK still gets benefits in excess of the cost. The main problem here relates to the distribution of the benefits, which are certainly uneven and benefit some sectors of the economy at the expense of others. Future efforts should be spent on making sure that the benefits aren’t concentrated in Financial and Insurance activities at the cost of others like Agriculture, Forestry and Fishing activities.

The immigration issue is now one of the most sensitive matters, as the EU has failed to manage the humanitarian issue that rose from the inability of the world to deal with the Syrian crisis. The truth is that the UK is one of the most attractive EU countries for immigrants, but it is also true that until today no study was able to establish a negative link between this immigration and real wages or jobs left for existing British citizens.

One last issue is influence. Some believe the UK has lost influence due to its EU membership. But that membership is in effect a call option the British government retains in the European construction. Whenever the European policymakers go the wrong way, the British government can exercise its call. That has been the case with Margaret Thatcher in the past regarding the Common Agriculture Policy (CAP). The British PM contributed to an improvement in efficiency at the EU level by severely opposing CAP. In leaving, the UK loses that call option and takes European decisions as final without having any material influence on them. In my view this represents a massive loss of influence for the country. Besides, the UK is often represented twice in international organisations: once as the UK and once as part of the EU. That will end. An additional point to make is related to the influence that the City has in global economic and financial affairs. Will the EU behave passively while the City retains its influence in an exit scenario? I believe not. EU policymakers will do everything in their power to create a new financial centre within the EU’s borders, which could have serious implications for London’s economy. But that’s something that doesn’t seem to scare Boris Johnson, London’s Mayor, who just came out in favour of an exit.

I believe The Economist very well describes the importance of the EU for the UK and vice-versa:

“In fact Britain has influenced the EU for the better. The European project it joined in 1973 had obvious flaws: ludicrously expensive farm and fisheries policies, a budget designed to cost Britain more than any other country, no single market and only nine members. Thanks partly to British political clout, the EU now has less wasteful agricultural and fisheries policies, a budget to which Britain is a middling net contributor, a liberal single market, a commitment to freer trade and 28 members. Like any club, it needs reform. But the worst way to effect change is to loiter by the exit.” (The Economist, Jan 15th 2016)

Faced with the prospects of an exit, the pound has been on a downtrend since the end of 2015 and will likely face increased volatility during the next four months.

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But, in four months’ time, if the “In” vote wins, the pound would regain most of its prior strength. I’m betting on increased volatility in the near term with the potential for a huge comeback in the second half of the year, because I believe that, regardless of the polls, when the time really comes, the British voter will refrain from voting for the exit.

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