Uncertainty arising from the UK’s vote to leave the EU has left many investors, businesses and workers feeling nervous and vulnerable. Since the referendum on 23 June, collective heart rates have soared in response to market volatility, talk of another recession and the weakened pound.
Adding to this was political uncertainty over who would lead the Conservative Party following David Cameron’s decision to step down as Britain’s prime minister within hours of the result. Markets were somewhat calmed when his successor, Theresa May, was appointed relatively swiftly. She is now faced with an unenviable task: to stabilise and grow the British economy, and maintain the nation’s position as a global business hub, reassuring investors and trading partners.
How she will achieve these aims if the UK does actually leave the EU is anyone’s guess. For Hélène Rey, Lord Raj Bagri Professor of Economics, and Richard Portes CBE, Professor of Economics at London Business School, May has taken on a huge challenge.
In ‘Brexit and the Global Economy’, a webcast hosted by the AQR Asset Management Institute (AQR AMI), Professors Rey and Portes talk about the likely actions the British government might take. The AQR AMI Academic Directors also discuss how leaving the EU will affect exchange rates, capital flows, monetary policy and foreign direct investment. But perhaps the most critical talking point of Brexit is the potential trade-off between free movement of labour and access to the single market, both defining principles of the EU.
There are questions over whether the UK will still permit free movement of labour should it go ahead with Brexit. Much depends on the trade and labour deals it strikes with European Union members, although May’s rhetoric suggests she wants access to the free market, while placing restrictions on the movement of people.
Professor Rey believes May will struggle to secure trade deals on those terms. “This is something that the EU does not want to unpick, which puts May in a tough bargaining position,” she says. “Therefore, there is a lot of uncertainty around access to the single market and future labour flows into and out of the UK.”
That uncertainty could reduce the UK’s attractiveness to investors, according to Professor Rey. “We are starting to see delays to investment and hiring decisions. Now what, economically speaking, does this all mean in the short run? Rather than a massive decline in aggregate demand, we're seeing things grind to a halt. There are no new projects being financed, which may affect productivity in the future.
“From experience, we know that putting barriers up leads to a decrease in competitiveness over the long term. This then leads to a drop in productivity growth, especially when placing restrictions on labour migration.”
Deal or no deal?
Free trade with other EU countries is likely to end should the UK leave the union. If that happens, the British government needs to strike new deals with members of the single market and countries outside.
One option is to buy and sell goods and services under World Trade Organisation (WTO) rules, although the UK would face tariffs on imports. “We would see a huge disruption to existing trade patterns and a loss of access to the European single market,” says Professor Portes. Another loss would be the preferential trade agreements that the EU has negotiated on our and other member states' behalf with a number of countries in the world.
“The second possibility is a free trade agreement with the EU and elsewhere. These are lengthy, complex negotiations that involve all sorts of technicalities and would take quite some time to negotiate.”
Professor Portes believes the relatively low tariffs for trading under the WTO would be a minor inconvenience. Complying with the laws and standards governing EU products and services in the event of Brexit is a far bigger headache for British companies.
“The real barrier to trade is non-tariff barriers such as regulatory standards for products, which require tremendous amounts of negotiation. Another major problem in these negotiations is intellectual property rights. These issues go far beyond what you can do under WTO, and they are the real barriers for a modern economy.”
He adds that the UK could adopt the Swiss policy of agreeing several bilateral trade deals, giving it partial access to the single market in exchange for a smaller EU budget contribution. Alternatively, it could negotiate a Norwegian-style membership of the European Economic Area to secure full access to the single market, although that would mean accepting most EU laws and free movement of people between member countries.
“The EU would say, ‘Sorry, if you want to stay in the single market, you've got to keep your borders open to labour from the rest of the union.’”
Time is of the essence
Getting nations to the negotiation table is one thing, but striking mutually beneficial deals within two years – the timeframe for the UK to leave the EU – is a different matter. Professor Rey believes it will take far longer than that to establish new trade agreements that benefit Britain.
“Whenever it takes a relatively short period of time to agree on a trade deal, such as the US-Australia one, it’s usually done on a take-it-or-leave-it basis from one of the parties. In that particular case, it was the US making the demands. But trade deals are, on average, very complicated. You need a serious army of trade negotiators who are well trained in order to work on several fronts at the same time.
“Then you need all 27 EU member countries to ratify any trade agreement with the UK and we could end up with no deal after two years. In that scenario, Britain would have to take a ‘hard Brexit’ [leave the EU with no access to the single market]. I don't see there being a great willingness or kindness from the rest of the world to fast-track all these trade deals.
Whether the British government triggers Article 50 to put Brexit in motion remains to be seen. But the uncertainty surrounding the future of the UK’s relationship with the EU, and the broader economic and political implications for the union as a whole, are major concerns for both.