The Economic Impact of Brexit on the UK Economy

Introduction

Overview

This chapter covers the background to the study, problem statement, research objectives, questions and the significance of the study.

Background to the study

In early 2013, the British Prime Minister declared that the country will vote to decide whether the country should remain or exit the European (Whyte 2015). Most of the UK citizens are more and more becoming discontented with the regional body, its plan to incorporate new members and the extensive influx of EU transients to its labor market (Gallagher 2008; Pinder & Usherwood 2013). Moreover, the conservative party is divided on whether to stay or exit the European Union.

However, the liberals are completely against the move (Baker & Schnapper 2015; Trevena 2013). There is considerable uncertainty about the relationship between EU member states and the UK in the case of Brexit (CEP 2014). Because of the inevitable policy uncertainty, many analysts are considering some options regarding the EU’s future policy relationship with the UK (Dustmann & Frattini 2013).

Statement of the problem

Since the economies of EU member states are currently interlocked at diverse levels, it makes one wonder how the UK economy will get on outside the Eurozone. The political ramifications of the exit have been well debated, yet less consideration is given to the economic impact of the exit. Therefore, this paper will try to explore how the country’s withdrawal would impact its economy based on scenario modeling.

Research objectives

The main objective of the study is to analyze the economic impact of Brexit on the UK economy. In line with this, the specific objectives were:

1. To establish whether the exit from the Eurozone is reasonable from an economic point of view.
2. To explore the possible options available to the UK upon withdrawal and their impact on the country’s economy.

Research Questions

In line with the main objective, the following questions were formulated:

1. Will the withdrawal from the Eurozone negatively affect the UK’s economy?
2. Are there possible options available to the UK and what are their impacts on the economy in the long run?

Justification of the study

This study is vital because of the way that it adds to the accessible collection of learning concerning the economic impact of UK withdrawal from the Eurozone. The outcomes of this study are of great value to policymakers.

Scope of the Study

Since the study cannot analyze all areas of the economy that will be affected by the UK’s withdrawal from the Eurozone, it will concentrate on key areas that seemingly will have expansive economic effects on the UK.

Literature Review

Introduction

The study is set to find out the economic impact of the UK’s exit from the European Union on its own economy. This chapter highlights the work that other scholars and researchers have done and will include theoretical and empirical literature review. The theoretical review will focus on key theories that explain the process of European Integration and rules and regulation that governs the relationship between the member states. In other words, it focuses on two theories, both exact and hypothetical, that are firmly connected to the processes of European integration, its regulations, and powers. On the other hand, the empirical review will entail a review of studies that have been carried out on the impact of Brexit on the UK economy.

It explores previous studies concerning the UK’s withdrawal from the EU and its impact. This section will be divided into two, namely: the impact of Brexit on trade and investment and the impact of Brexit on the labor force. The literature review heavily relied on online academic databases, making use of search phrases and terms, including, but not restricted to, Brexit and economic consequences of EU exit to member countries. To be specific, Google Scholar was used to trace academic journals. The literature review was mainly based on books and academic journals.

Theoretical Review

Intergovernmentalism

This is a theory eyeing to clarify the procedure of European integration instead of the European way. The theory depends on realism presumptions about the role of government and along these lines expresses that states are exceptionally commanding institutions in the international sphere. Subsequently, the nature and operations of the European Union greatly depend on the member states, who, one by one, try to safeguard and advance their interests. Therefore, regional bodies only have powers that have been granted by the member states, who believe they will work in their best interest (Frank 2008). For this reason, the UK government is a key actor, who looks to advance domestic interests as a matter of priority. This viewpoint can also be used to foretell the undertakings of other EU member states (Frank 2008).

Fiscal Neoliberalism

Fiscal Neoliberalism is a theory that advances nominal authority by utilizing fiscal effectiveness consideration, rather than ideological thinking. The theory accepts that in a free market, casual signs moving through the economy decide market costs (Blanchard 2009). State impedance is deemed as upsetting since its agencies can foresee and destabilize the socially optimum equilibrium level taking into account its desires.

The well-being of the economy is dictated by the level of consumption enjoyed by every buyer and, therefore, the definite objective is production efficiency, which is accomplished when the economy can’t expand yield of one commodity without lessening that of another (Blanchard 2009). This theoretic point of view enables the study to recognize the key actors and systems in business sectors and to break down the impacts of impediments to trade and constraints on labor and money-related markets.

Empirical Review

Impact of UK withdrawal on trade and investment

The Eurozone provides the UK with a great prospect to trade without any restriction such as import charges or tariffs, or a wide range of protocols (World Bank, 2015, p. 11; Hix 2008). In 2015, the UK exported more than $230 billion worth of goods and services to the Eurozone, which was more than 45 percent of the aggregate UK exports and 15 percent of the total GDP. At the same time, it imported goods and services worth more than $290 billion, which represents 53 percent of the aggregate imports (Webb, Keep and Wilton 2015). For this reason, the European Union is the UK’s principal partner in terms of trade (Burrage 2014; Office of National Statistics 2015, para. 8).

The main benefit of taking part in a single market and customs union is the business creation and enhanced fiscal well-being (Rosa 2012). The reduction of trade impediments results in lower prices of goods and services, which subsequently shift consumption to low-cost manufacturers. This leads to increased output and the creation of more jobs. Also, under the customs union, there are extra advantages from improved transfers and trades as other member states get rid of or reduce their tariffs (Rosa 2012; Barrell & Pain1998).

Therefore, should the UK decide to withdraw from the Eurozone, there will be economic implications (Bloom, Bond & Van Reenen 2012). The national revenue may surge although the change in producer excesses will hinge on the variance between the foreign exchange lost through export duty charges and salvaged local market shares. Nonetheless, should the country’s export volume reduce as a result of withdrawal from the Eurozone, it will not be capable of make the most of the comparative advantages to a similar level as in the past.

As a result, it will be very difficult to achieve economies of scale due to increased average costs, which will subsequently lead to high industrial fixed costs. Moreover, increased protection of the local industry due to high tariff charges will reduce competition. As a result, companies will have fewer motives to minimize cost and enhance efficiency, hence leading to product and service deficit (PWC 2016).

In a case where the UK continues to trade with the EU after withdrawal and it does not negotiate terms of trade with the regional body, they will be bound by an obligation to WTO agreement due to their membership (Miller 2015). According to the World Trade Organization, the Eurozone is regarded as a customs territory and is handled as a lone contracting party. The WTO operates on a twofold principle, namely: National Treatment and Most Preferred Nation principle.

Nation Treatment principle prohibits any member state from discriminating against other member states in support of their merchandise or companies. In contrast, Most Favored Nation principle states that any trade benefit given by a member of a given regional federation to another member of the same group for its products must do the same for WTO members producing a similar product (Bootle 2015). For this reason, the UK will be eligible to export goods to the Eurozone based on the Most Favored Nation principle, under the conditions set by the EU for its members. However, the two principles do not apply to services and that’s where the UK will encounter numerous challenges (Botha 2015; Bootle 2015).

While impediments to trade in products have been minimized under the World Trade Organization (WTO), small progress has been made in enhancing trade in services (Bloom, Bond & Van Reenen 2012). In reality, many studies have found out that it is very hard overall to liberalize services in transnational treaties, including treaties on the General Agreement on Tariffs and Trade (GATT). GATT only covers export commodities and that’s why the General Agreement on Trade in Services (GATS) was created to complement it (Bootle 2015).

Unlike in GATT, Nation Treatment is not compulsory for General Agreement on Trade in Services. Whereas Most Favored Nation is hypothetically compulsory, numerous exclusions make it redundant in the real world (Frank 2008). WTO member states can decide on the segment they want to submit and whether they want to permit access to their markets and Nation Treatment principle for said segment. Also, EU member states hold a considerable freedom of choice when it comes to service control and management, which the EU alludes to in their GATS responsibilities. As a result, non-members may face different guidelines and policies when exporting services to the Eurozone (Miller 2015).

Trade-in services are normally affected by non-tariff obstacles, for instance, internal rules and regulation. These barriers are usually meant to conform to social targets or rectify supply failures; yet, practically speaking they likewise have a profoundly prohibitive impact on business sector access for non-member states (Miller 2015). Therefore, the UK access to the Eurozone markets will be restricted. Consequently, this will adversely affect the UK’s balance of trade with the European Union as long as the trade-in commodities stay liberalized and trade in services turn out to be constrained (Lester, Mercurio & Arwel 2012).

Lack of an inclusive WTO treaty on investment is also another area of concern, even though there are provisions in the General Agreement on Trade in Services and General Agreement on Tariffs and Trade (CER 2014). For example, for segments committed to the General Agreement on Trade in Services, investments are covered if they are identified with services with on-location ventures. The trade-associated investment dimension is a clause under the General Agreement on Trade in Services, but it only protects investments associated with merchandise and, therefore, it is not a solid or extremely pertinent clause. The UK would need to depend on reciprocal bargains for enabling EU investment (Lester, Mercurio & Arwel 2012).

Impact of UK withdrawal on labor force

In the past twenty years, there have been constant inflows of migrants into the UK (Caramani 2008; Pemberton & Stevens 2010). The net long-run migration to the United Kingdom stood at 280,000 in 2015. The growing gap between net emigrants and immigrants is mainly contributed by the free movement of the workforce within the Eurozone. For this reason, the inflow of migrants has considerably expanded the UK’s workforce and aggregate output, as well as growth in overall demand and aggregate consumption in the economy. Besides, the majority of the migrants are highly educated and skilled than the locals (Whyte 2015, para. 9).

Withdrawal from the Eurozone does not certainly mean there will an end of European immigrants in the UK. The country can decide to authorize entry into the local labor market. However, given the key agendas of the referendum, it is extremely improbable that the free inflow of EU migrants will carry on. If the UK does not reach an agreement with the EU on the movement of labor, the European migrants will likely be subjected to the same rules and regulations as the non-EU migrants (Podmore 2008).

One of the repercussions for discontinuing the free flow of migrants from the Eurozone would be a reduced workforce, which will subsequently lead to a decreased aggregate output, and ultimately, the demand for workforce may as well decrease. The UK labor market will be less elastic, and job loss might increase in some sectors while some sectors may suffer from underemployment (Whyte 2015, para. 6).

Conclusion

The studies presented in this chapter were chosen to establish and provide facts on the impact of Brexit on the UK economy. One main reason why the UK joined the EU was to enhance trade among the member countries. At the moment, the integration has surpassed its main ambition. The possible effects of the exit are very hard to predict since exiting the EU will impact the UK economy in numerous ways. The referendum matter on its own is putting a lot of pressure on the regional body just a couple of years after it struggled very hard to retain Greece in the Eurozone. Therefore, it would not make any sense for the EU to lose its key member.

The current bodies of literature have considerably explored the impact of Brexit on both the UK and the EU member states, but less consideration is given to the economic impact of the exit. Nonetheless, nearly all the reviewed literature concur that the UK withdrawal would lead to an uncertain relationship between the UK and the EU and that the possible impact of the exit is hard to predict. The key areas that are likely to be affected include trade and movement of labor.

However, one of the major gaps of these studies is that most of them assume that the UK will act unanimously, but a country like Scotland that form the greater United Kingdom has pledged to remain in the EU. The economic and political impact of losing Scotland and other states that constitute the greater United Kingdom would certainly form a fascinating area for forthcoming studies.

Methodology

The methodology is the procedure of directing the techniques of carrying out the study. It is, subsequently, helpful for leading the exploration and for breaking down the research questions. Methodology demands that much care ought to be given to the sorts of procedures to be followed in fulfilling a given plan or an objective (Blanchard and Cathy 2002). The reason for this study is to make a space for further research that will examine the impact of Brexit on the UK economy. Therefore, the study is exploratory. Exploratory research gives others a chance to survey zones that have not been widely scrutinized (Saunders, Thornhill, and Lewis 2009).

For this reason, participating in exploratory studies add extra information on the issue or phenomenon under scrutiny. This has been accomplished by probing the specified hypotheses. To embark on this study, a wide-ranging methodology has been assimilated, which includes the research design, and the methods that were used in gathering information. It also contains the data analysis methods, validity and reliability of data and the limitation of the study.

Research Design

There are three types of research design: exploratory research, descriptive research and causal research (Saunders, Thornhill, and Lewis 2009). However, this study will apply for exploratory research. Exploratory research mainly explores the nature of the problem to draw inferences. In this scenario, the researcher is in a good position to understand the problem under investigation. The flow of exploratory research involves identifying the problem and seeking to find the appropriate solutions and new ideas. Exploratory research is mostly applicable in circumstances where the structure of the research problem is not definite (Saunders, Thornhill, and Lewis 2009).

Research techniques

Two principal techniques are popular in the field of research. These approaches are the deductive approach and inductive approach (Bryman & Cramer, 1999, p. 93). The distinguishing factor between the two approaches relates to the building of the theories. In the deductive approach, the hypotheses and theory are constructed after exploring the available relevant literature. In the inductive approach, the theory is constructed after the data has been explored and analyzed. This study used the deductive approach; whereby the theory and the hypotheses were formulated after going through the relevant literature.

Data Collection

In any research that is conducted, there are basic stages that are involved in regards to the shaping of the research, namely: understanding the research problem, the framework of the research, data collection, data analysis and interpretations, and drawing of inferences. The study mainly relied on secondary sources. Saunders et al. (2009, p. 99) characterize secondary sources as all the distributed and unpublished information accessible and gathered for some reason other than the current issue. In Chapter 2, the study surveyed the writing on the subject under study with the direction of the study targets.

The utilization of exploratory examination is supported because the scientist picks up a sociology setting of the effect of Brexit on the UK economy. Second, the use of the writing survey is legitimized because the scientist can consolidate the mind-boggling nature of the subject under smaller subtitles and areas inside a brief span (Saunders, Thornhill, and Lewis 2009). Third, the utilization of writing survey is defended based on the fact that the studier can access past illustrations in the range under study.

The study depended on work area research, which is an arrangement of existing data accessible in the optional sources, that is, government information, private information and web database (Saunders, Thornhill and Lewis 2009). The secondary information was gathered from course books, diaries, important articles, and the web.

While gathering secondary information, especially from online sources, the accompanying strategies were utilized: to begin with, online searches depended on watchwords and equivalent words; second, titles and features were filtered to assess the helpfulness and significance of the data discovered; third, every information sources were bookmarked and grouped as per goals that had been set before the information accumulation process; fourth, the studier connected the trump card methodology keeping in mind the end goal to minimize writing long inquiry strings; ultimately, the prescribed connections to the website were gone by at the start.

Credibility and Generalisability

Credibility and Generalisability issues should be taken seriously when conducting quantitative research. Regardless of the way that there are tried and true slants to a particular level amid the data amassing strategy, the examination must direct the procedure to give a steady and believable result at the end of the study (Saunders, Thornhill and Lewis 2009). For this study, the level of generalisability was upgraded through point by point reporting and selecting materials on the premise of averageness. In any case, more weight was set on point by point answer to give the studier satisfactory subtle element to understand the circumstance. The validity issues were managed by drawing materials from their unique source, for example, state distributions and EU commission’s sites.

Ethical Concern

The scientist considered all parts of the moral issues. The analyst had a moral commitment to watching and legitimately translating the results, which implies maintaining a strategic distance from individual inclination to impact the result of the study. The scientist’s part is consequently limited to watching and breaking down the accessible data without pointless results.

Analysis

The analysis was based on scenario modeling where the impact of two possible scenarios on the UK economy was assessed. The first scenario is where the UK withdraws from the EU but arranges a free trade agreement with the European Union in light of tax organized commerce in merchandise. The second scenario is where the negotiations become challenging and lengthy and, therefore, forces the UK and the EU to operate under the WTO’s most favored nation principle.

Study Limitation

There were worries about whether the collected information was authentic or not and whether there might be an unequivocal conclusion when deciphering and analyzing the data. In addition, the study only employed a qualitative approach and ignored the quantitative approach due to time and budgetary concerns.

Summary

This section has given the framework of the study procedure, method, and outline. Since the examination included a contextual analysis, the studier embraced an exploratory methodology. The studier likewise embraced a positivist technique to deal with the current studies. Moreover, a subjective methodology was favored over quantitative methodology since it catches every one of the variables, along these lines, creating dependable results. There were potential impediments to this study in the range of believability and generalisability. Be that as it may, they were minimized by utilization of reasonable exploration methodologies and procedures. Moral issues influencing this study procedure are highlighted with suitable moderation set up at whatever point.

Analysis and interpretation

Scenario modeling

The examined the possible economic effect of the UK withdrawal under two probable scenarios consolidating a scope of good and less positive suppositions. The first scenario is where the UK withdraws from the EU but arranges a free trade agreement (FTA) with the European Union. The second scenario is where the negotiations become challenging and lengthy and, therefore, forces the UK and the EU to operate under the WTO’s most favored nation principle. Under the FTA, the UK would need to actualize EU standards on merchandise delivered to the Eurozone. On the other hand, it would not be tied to the freedoms of a single market.

The inflow of lowly gifted immigrants from the Eurozone would stop. However, this situation mirrors a situation where the Government can secure a more notable adaptability over its migration arrangement. The UK will claim all the current unhindered commerce agreements that the European Union hosts with countries that have not formally joined the EU after its withdrawal. For that reason, the UK will utilize this opportunity to seek after its external exchange approach by arranging an FTA with other global economies.

We suppose that the UK would likewise have more noteworthy control over administrative policies, which could lead to a few administrative cost reserve funds. Be that as it may, there could likewise be some policy dissimilarity between the UK and EU, prompting an increase in non-tariff trade obstacles.

Under the WTO’s most favored nation principle, the country will no more enjoy a duty-free trade in merchandise with the European Union. Nevertheless, unlike the FTA situation, we assume that there will be no more relaxation in migration policies for highly gifted immigrants. The country will have more noteworthy control over administrative policies, which could lead to several regulatory cost savings.

However, there could likewise be some policy disparity between the UK and EU, prompting an increase in non-tariff trade obstacles. We presume that the commercial treaties between the EU and countries that have not formally joined the EU will not apply to the United Kingdom upon withdrawal. That means trade between the UK and the thirty-party states will revert to WTO’s most favored nation principle until new agreements are made. Nonetheless, the UK will utilize the freedom to seek after its external exchange approach by arranging an FTA with global economies.

Impact on the UK economy

Based on the two scenarios, economic experts believe the country’s real GDP will shrink by 1.3 percent under the FTA situation and 3.5 percent under the WTO most favored nation scenario by 2030. The long-run effect on real GDP is attributed mainly to trade and migration. Restrictions on free access to the Eurozone market and policy difference between the UK and EU leading to non-tariff barriers would decrease the UK exports and GDP. On the other hand, the migration effect would lead to a decreased labor force, which would affect the country’s level of productivity. The table below shows the percentage differences in real GDP under the two scenarios.

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