The UK’s EU referendum does not, at first glance, seem like a suitable case for the Long Finance Pamphleteers treatment. By the time this piece is published, we shall be counting down the days till the 23 June 02016 vote itself. Further, the debate between the remainers and the leavers has tended to revolve around relatively short-term issues. Yet, I am motivated to write this short pamphlet now, precisely because this extremely important, long-term decision has become mired in tit-for-tat exchanges, short-term speculation about markets, houses prices and the like, even wild conspiracy theories about political carve-ups. The debate deserves some logical, longer-term thinking.
In any case, the result of the EU referendum will impact on issues central to the Long Finance initiative, not least environmental, social & governance (ESG) issues central to the London Accord Programme. The decision will also have significance to Financial Centre Futures; to that end I have written a specific piece for Foreign Policy Magazine. Whatever the result, I think the aftermath of the EU referendum is a subject that merits attention; I want to get some of my thoughts into the public domain before the vote and the result.
I should declare my personal view on the referendum. To quote my own words from that Foreign Policy Magazine piece, I believe that a vote to leave the EU “would be a collective act of commercial and geopolitical suicide.” Yet many people seem genuinely to be struggling with deciding how to vote. I believe that struggle is partly connected with the disappointingly poor quality of debate in the official campaigns for both sides, but is also connected with the inherent difficulties humans have in making complex long-term decisions.
There is a solid body of academic work illustrating how difficult it is for individuals to handle even relatively simple temporal choices and intertemporal decision making. Early in our book, The Price of Fish: A New Approach To Wicked Economics and Better Decisions, Michael Mainelli and I provide a brief tour d’horizon of such work. Later in the book, we reflect those difficulties onto complex problems requiring long-term decision making, such as sustainability, global warming, over-fishing, overpopulation and pensions crises.
The EU referendum as a decision has some additional, confounding difficulties, making it an especially messy, circular and aggressive problem upon which to make a simple, binary “remain or leave” decision:
Because of the temporal asymetry described above, there is little merit in setting out medium and long-term qualitative factors and consequences of a remain vote. For example, if the EU were to renege on the deals it has struck with the UK government (an assertion often made by leave campaigners), the UK government could choose to put the matter to referendum again. There would be opportuinities for the UK to participate in further reform of the EU if the UK votes to remain, but those matters, while important, are short and medium-term matters; not the purpose of this paper.
So what does the next 25 years or so hold in store, comparatively, if the UK votes to leave the EU? Probably not much would happen overnight. There would be some turmoil in the UK government, but that is likely whatever the vote. However, in the event of Brexit, there would quite rapidly be moves from Scotland for a second referendum on Scottish independence. Interestingly, last year’s Scottish independence referendum is a recent, good example of an asymetrically temporal decision. It will be diffiuclt for the UK government to deny the Scottish people that “second bite” if the UK has voted to leave the EU despite a large majority of Scots voting to remain. It is quite likely that Scotland would vote to leave the UK if the UK votes to leave the EU. There are likely to be similar independence noises from Wales and Northern Ireland, especially the latter, which seems likely to vote very heavily to remain in the EU. The worst-case scenario is a return to troubles in Northern Ireland; perhaps not very likely but certainly reasonably foreseeable and/or quite likely.
As for the UK’s negotiated exit from the EU, the leave-advocates’ argument that the UK would be in a strong negotiating position is almost laughably fanciful. The European Commission would, in truth, be in a fearfully difficult position over Brexit. If it is too draconian towards the UK it risks stifling trade and commerce throughout Europe at a fragile time, but the Commission will need to be sufficiently draconian “pour encourager les autres”, as our French colleagues/former colleagues might put it. And there would be “autres” in need of encouragement from the EU; Denmark, for example, is a likely candidate for a similar exit referendum if the UK votes to leave.
So nothing would actually get decided about the UK’s exit deal in a hurry, not least because nothing in Europe ever does happen in a hurry. To be fair, the EU wouldn’t even be entirely sure who or what it was negotiating with. The UK government would be in a state of turmoil for quite a while and the UK would potentially be breaking up. So the UK’s trading status with the EU would be in a state of limbo for many years.
For the medium term, at least the next five to ten years, the UK’s trading status with the EU would be subject to change and uncertainty. That uncertainty would have an adverse effect on the UK’s ability to sell goods and services to EU countries to a greater extent than its ongoing ability to buy goods and services. EU vendors will want to continue to supply their UK customers of course, whereas EU buyers would at the very least seek alternative vendors within the EU/EEA as a fallback plan to maintain supply in the event that UK goods and/or services became non-compliant.
There would also be financial uncertainty, not just for the UK but for Europe as a whole. Beyond Denmark, which like the UK retains its own currency, there are also countries within the Eurozone where exit campaigns on the back of a UK exit are quite likely. Greece is an obvious example, Austria slightly less obvious but still foreseeable. Those moves would have significant effects on the Euro as well as the knock-on commercial effects resulting from the uncertainties.
Fairly rapidly after Brexit there is likely to be a significant fall in sterling’s value on global currency markets. The Euro will probably also be weakened but not as much as sterling. It is difficult to imagine rapid circumstances that mightlead to a significant rebound, so these would probably be medium term (five to ten years at least) economic factors. Imports into the UK would become more expensive but would remain necessary for the UK economy. Exports from the UK would become cheaper (thus potentially more competitive) but also more likely to be subject to increasing regulation and protectionist tariffs.
In short, the notion that international trade effects are symmetrical and balance-out is overly simplistic and simply wrong. The UK, given its physical size and population, is an especially poor candidate for autarky (economic self-sufficiency), so the UK will need to continue its international trade. UK’s balance of trade, already seriously adverse, is likely to get significantly worse, at least for the medium term, in the event of Brexit.
For example, in financial services, it seems quite likely that the UK would eventually lose its financial European passporting rights as a result of an eventual exit deal, as the European Economic Area (EEA) requires the same freedom of movement of people as EU membership. Financial institutions are likely to repatriate such EU-oriented services away from London to financial centres unquestionably in the EEA, such as Frankfurt or Zurich, in the short and medium term, to insure against such a change in the UK. While the direct effects might only be modest, they would be negative. It is hard to imagine what alternative trade in goods and services might replace the jobs and tax revenues (direct and indirect) that would be lost to the UK as a result of such changes.
25 years from now, I think historians would look back on the Brexit vote as a tipping point, from which the rest of the world’s commercial, financial and geopolitical attention migrated away from Europe. In particular, I envisage commercial attention in the Americas (especially the USA) shifting to the Asia Pacific region more than Europe for trade and finance. There are signs of it already, regardless of Brexit. Large Asian financial centres, such as Hong Kong, Singapore and Tokyo, even Seoul and Shanghai, already have the scale and infrastructure to grow as global financial centres. Indeed, over the 10 years or so, the most interesting trend in the Global Financial Centres Index (GFCI) has been the rise of Asian financial centres in the rankings.
Further, the US is closer to progressing the Trans-Pacific Partnership (TPP) deal with major Asian nations than the nascent Transatlantic Trade and Investment Partnership (TTIP) deal with the EU. But Brexit and its knock-on consequences would, I believe, tip the balance markedly in favour of American/Asian commercial and financial alliances, from which a shift in political alliances would no doubt follow.
While the UK is currently in a relatively happy geo-political position straddling the EU and the US, benefiting from its current “in the EU but not entirely in Europe status”, on Brexit the UK might end up in the worst of both of those worlds; alienated from the EU and blamed by other nations (fairly or unfairly) for any subsequent turmoil in Europe, such as the further break-up of the EU, disputes between European nations and/or proxy international conflicts perceived to be European at heart.
Advocates of leaving the EU argue that the UK will be in a better position to trade with other partners, such as the US, if the UK leaves the EU. Possibly so, possibly not, but those advocates should beware the things they wish for; especially those advocates who claim that the EU benefits only giant corporations, not smaller businesses. If the UK were to rush into the arms of the US by signing something like the TTIP as it is currently framed, much of the UK’s commerce would be more strictly and unaccountably governed by the USA than is currently the case with EU standards and regulation. The EU, of course, might also feel pressured into signing an unsatisfactory version of the TTIP in an attempt to reverse the adverse economic effects of Brexit and the subsequent uncertainties and consequences. In any such circumstances, standardisation in international trade will continue to apply to the UK if it wishes to trade with other nations. Such international trade standardisation (de facto global standardisation) is likely to increase in scope and apply to UK exports of goods and services, regardless of the UK’s status within the EU, but the UK’s influence over the setting of those standards would probably, if anything, be diminished if the UK were to leave the EU.
The long-term environmental, social and governance impact of the medium-term uncertainties and horse-trading that would result from Brexit are the hardest of all to predict and yet deeply worrying. I would love to read a credible, well-argued paper on how Brexit might genuinely improve the long-term prospects for extra-financial and social global issues. I struggle to envisage what such a paper might say, beyond some glib, simplistic statements about the EU being a bad thing and the world being better off without it.
In reality, environmental, sustainability, extra-financial and social concerns are likely to take a back seat, not just in the UK but in the EU and elsewhere, in the medium-term economic and political turmoil that would result from Brexit. It would become that much more difficult to reach international agreements around tricky subjects such as climate change. The UK would find itself in an especially awkward position; either positioning itself on the outside of international agreements (a relatively large, somewhat iffy, offshore financial and trading centre) or it will be dragged along by international agreements having had little or no influence on their content. Europe’s influence on international affairs would be diminished and it is unclear from where (if anywhere) compensating influence might emerge.
Of course, my concerns about these aspects of long finance and geopolitics subsist regardless of the EU referendum result, They are abiding, wicked problems. But the outlook is that much more messy, complex and aggressive if the UK were to leave the EU.
So if you read this pamphlet as a UK voter in the days running up to the EU referendum, I hope it has helped to explain why your choice is difficult and helps you to make a wise choice.
If you are reading it after the referendum, I hope against hope that it sits as a thought experiment about what might have panned out over the medium to long term, not as a prophetic “I told you so” pamphlet charting the medium to long term financial, commercial and geopolitical drama that would follow a leave vote.