In this study, Open Europe primarily examines the economic impact of Britain leaving the EU.
Open Europe’s study draws on detailed economic modelling, showing that the economic impact of Brexit is not as clear cut in either direction as most previous analyses have suggested. Instead it will depend on a number of tough decisions in the UK and Europe. This includes whether the EU itself will embrace reform and British politicians and voters are willing to accept ambitious deregulation and new levels of competition through expansion of free trade.
Based on economic modelling of the trade impacts of Brexit and analysis of the most significant pieces of EU regulation, if Britain left the EU on 1 January 2018, we estimate that in 2030:
- In a worst case scenario, where the UK fails to strike a trade deal with the rest of the EU and does not pursue a free trade agenda, Gross Domestic Product (GDP) would be 2.2% lower than if the UK had remained inside the EU.+
- In a best case scenario, where the UK strikes a Free Trade Agreement (FTA) with the EU, pursues very ambitious deregulation of its economy and opens up almost fully to trade with the rest of the world, UK GDP would be 1.6% higher than if it had stayed within the EU.
- However, these are outliers. The more realistic range is between a 0.8% permanent loss to GDP in 2030 – where the UK strikes a comprehensive trade deal with the EU but does nothing else; and a 0.6% permanent gain in GDP in 2030 – where it pursues free trade with the rest of the world and deregulation, in addition to an EU FTA.
The tough choices facing Britain outside
In none of our scenarios would the cost of leaving the single market and the EU customs union be off-set by merely striking a new trade deal with the EU. Britain will only prosper outside the EU if it is prepared to use its new found freedom to undertake active steps towards trade liberalisation and deregulation. It faces a series of difficult choices:
- Beyond the border: Opening up the UK economy to trade with the rest of the world – including the USA, India, China and Indonesia – is essential to economic growth post-Brexit. However, this would mean exposing UK firms and workers to whole new levels of competition from low-cost countries, and would therefore be politically very sensitive.
- On the border: In order to be competitive outside the EU, Britain would need to keep a liberal policy for labour migration. However, of those voters who want to leave the EU, a majority rank limiting free movement and immigration as their main motivation, meaning the UK may move in the opposite direction.
- Behind the border: EU rules have largely been incorporated into UK law, and would remain in force until the UK Parliament decided to amend or scrap them. Outside the EU, we estimate that a very liberally inclined UK government could in theory cut the cost of the most burdensome EU regulations by an amount equivalent to between 0.7% and 1.3% of GDP. However, on current evidence, Britain is likely to keep many of these EU rules, for example on climate change where it has gone further than the EU standard.
The choices for Europe
The economic advantages and disadvantages of Brexit will depend to a large extent on the future relative economic dynamism of the EU. If it manages to overcome its current economic problems, and liberalises internal and external trade, then the cost of Brexit relative to remaining within the EU will be higher.
The process of leaving
Article 50 – the only established legal way to leave the EU – is a major liability. Once triggered, there is no turning back, it excludes the UK from key decisions as well as the final vote and it leaves the EU in charge of the timetable during two years of negotiations, following which the UK could be presented with a ‘take it or leave it’ deal. Our results show that leaving without a preferential trading agreement would dent UK GDP significantly.
After initial disruption, there is a high likelihood that the UK and the EU could conclude preferential trade deals covering goods sectors, but with new border and administrative costs due to rules governing foreign content in their products. For many sectors, a deal may involve adhering to the EU’s high regulatory standards.
For the remaining services sectors, and financial services in particular, guaranteeing seamless access to EU markets for UK businesses will be more difficult, not least because the UK has a deficit with the EU in goods, but a surplus in services.+
Say over the rules
Though some standards are set globally, most sectors would suffer from the UK’s loss of voting rights in the EU – the financial services sector in particular.
Open Europe judges alternatives to full EU membership on four tests – EU market access, say over the rules, gains in independence and negotiability – concluding that none of the existing models are suitable for the UK.
- Instead, the UK would likely have to negotiate a tailored deal for itself. Based on our tests, a “Single Market-Lite” arrangement – staying inside a very tightly defined EU single market – would be the most beneficial for the UK. Unlike the EEA, this must also involve voting rights over the rules governing the single market, which would be very difficult to negotiate.
- A politically more realistic alternative is a comprehensive Free Trade Agreement, differing from the “Swiss model” by including better access for financial services and a fair say over how rules and standards are implemented.+
- The UK could also pursue unilateral liberalisation, which would involve minimum negotiations with the EU but difficult domestic political decisions. However, our modelling suggests that a strategy of agreeing FTAs with the EU and other states, followed by unilateral free trade with the rest of the world would produce the greatest benefit.+
Given the difficulty in leaving the EU and the extent of the political and economic challenges the UK would need to overcome to make Brexit work in its long-term interests, it would be foolhardy to leave without first testing the limits of EU reform. Limiting the areas of EU interference and further market liberalisation would be the most beneficial option for both the UK and the EU.