If the Conservatives win the coming election, there will be a referendum on whether the UK should leave the European Union (EU). Some polls put nearly half in favour of exit, probably because, first, it would save the £11.3bn contribution to the community budget, an average cost of £180 per household (which is more than the £145 BBC licence fee); and second, it would allegedly free business from tiresome Brussels regulation; and third, it would give us back the power to stop immigration from the EU. The possibility of Brexit is all too real.
The benefits of EU membership are considerable, but much harder to quantify than the costs. Ironically, although the EU is often portrayed as an institution that limits the freedom of British businesses, what lies at the heart of the EU project is the four freedoms: the free movement of goods, services, labour and capital.
Free movement of goods and services means the UK is part of a single market covering 28 countries and over 500 million people. Academic studies suggest these benefits are worth, on balance, some 2-3 per cent of GDP – enough to pay the membership fee five times over. But there is no certainty here. Some studies suggest a negative impact of 4 per cent. Others a gain of 5 per cent.
Supporters of Brexit assume the UK can continue to enjoy these benefits after leaving the club. But can it? The all-important exit terms will be decided, in our absence, by the remaining members who might be quite angry at our departure. It is this (considerable) uncertainty that spooks business: what will happen to the four freedoms?
Probably the most important consequence of Brexit would be on the movement of capital. Britain is attractive to foreign investors because it offers tariff-free access, under a single regulatory regime, to the huge EU market. In the boom, annual inflows of foreign direct investment rose to over £80bn, of which over £60bn came from the EU. The annual inflows today are only half that level, but there is still a lot of money at risk.
These inflows come mainly from large international companies based in the UK expressly to serve the entire EU market, which they can do by complying with a single set of regulatory standards. This is the positive aspect of “Brussels red tape”. Goldman Sachs and Nissan have already gone public with their concerns that Brexit would deny them access to the EU market. The solution – relocation – would mean a loss of investment and jobs in the UK.
The alleged offsetting gains – freedom from irksome regulations – are a mirage, because not all regulations come from the EU. The UK has been a leader, not an EU follower, in environmental regulation, signing up early to UN-driven global agreements. Banking regulations are driven by the G20 and originate in Basel, not Brussels. And those regulations that did come from Brussels are now part of UK law. They will not disappear overnight if we leave.
So Brexit could damage Britain’s economy. But, make no mistake, the impact on markets, and investors, would be very different from Grexit.
If Greece leaves the eurozone it will be because the austerity measures, needed to put its public finances in order and restore competitiveness, have proved politically insupportable. A Grexit would be a major crisis for the eurozone, introducing a long period of market turbulence driven by speculation about which currency might be the next to leave.
Brexit, by contrast, has no currency implications, because the pound is not in the eurozone. Nor would it be a sign of weakness. The UK’s public finances are slowly but surely being restored to health, and the economy is growing. UK government bond yields will remain low whether the UK is in or out of the EU.
Nevertheless, Brexit would be unwelcome to businesses, which would hate the uncertainty it engendered. Investment would fall as a result, especially by footloose multinationals who would find the UK a less attractive location. The resulting damage to the UK’s long term prospects for growth in national income, and hence company revenues and profits, could have a negative impact on share prices.
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