Brexit: What does it mean for Europe?
TextileFuture is presenting today a timely evaluation what economic effects the voting of June 23, 2016 of Great Britain might have on the development of Europe
We are well aware that Brexit is a political decision of the people of Great Britain, nevertheless the economic and political effect will influence the further development of Europe. If the vote is for Brexit, the decision will act as brake on Europe’s economy. This is why TextileFuture presents a report by Euler Hermes Economic Research, among the many publications available, we feature this one, because we think it is close to what might become an economic reality, if the Brexit is voted positively, and these might affect your and your company’s further planning.
The authors of Hermes Economic Research are: Ana Boata, Economist for Europe, Thomas Cardiel, Junior Economist, Irène Herlea, Junior Economist and Ludovic Subran, Chief Economist. Here are their major findings:
– In a soft leave scenario, UK real GDP growth could be cut by -2.8 pp percentage points between 2017 and 2019 and 1500 additional bankruptcies are expected. In a hard leave scenario, the cumulated impact would be -4.3 percentage points of real GDP growth and 1700 insolvencies. The peak is expected in 2019. Brexit fears are nonetheless already affecting the UK: -GBP 34 billion in portfolio outflows.
– For the Eurozone, real GDP growth could fall by -0.4 pp by 2019 in a soft leave scenario, where a Free Trade Agreement is in place. Cumulated export losses would be EUR17.4 billion for goods and services, EUR18.2 billion for Foreign Direct Investments (FDIs) i.e. 1.9 % of total and +1.0 pp in business insolvencies growth. In a hard leave scenario, the impact will be higher: -0.6percentage points p of real GDP growth, EUR23.5 billion for exports (i.e. 0.5 % of total), EUR 29.7 billion for FDIs (Foreign Direct Investment i.e. 3.1 % of total) and +1.5 pp in business insolvencies growth.
– The Netherlands, Ireland, and Belgium would be the most affected through their exports and cross-investment positions. Germany, France, and the United States would also see a significant impact. Biggest losses will be concentrated in sectors such as financial services, automotive, machinery and equipment, chemicals and agri-food.
Fears of Brexit already affected the attractiveness of the UK
The last six months have confirmed that the risk of Brexit is already affecting the economy.
In the UK, portfolio investments from abroad suffered from the economic slowdown, the increasingly dovish stance of the Bank of England, and the fears of Brexit. We estimate that the latter accounts for 40% of the fall, i.e.-GBP 34 billion out of the total -GBP 85 billion (see Figure 1).
Rising uncertainty around the June 23, 2016 referendum will peak in Q2. Overall, 2016 growth could decelerate to +1.9 % (from +2.3 % in 2015). Also, note that the Bank of England will keep interest rates on hold until the end of the year given the subdued inflation – and what a Brexit would mean in terms of monetary policy stance (exchange rate effects and financial stress).
Brexit: A scorecard for the impact on the UK
Last November, Euler Hermes published a first estimate of the cost of a Brexit for the UK (Brexit me if you can: Companies to suffer the most). Additional transmission channels are presented in Figure 2:
In the soft leave scenario, an exit with a Free Trade Agreement (FTA) with the EU post 2019, we estimate a -2 pp cumulative impact on nominal GDP growth (-2.8 pp in real terms) between 2017 and 2019. In 2019, the peak year, real GDP would stagnate, the GBP depreciate by 10 %, firms’ turnover growth slow down to +1.2 % and margins should lose 1 pp. Overall for 2017- 2019, as much as 1500 additional bankruptcies could be attributed to Brexit (on top of ~20300 per year on average).
In the hard leave scenario, no FTA with the EU (and subsequently with the 50 non-EU markets currently under FTAs), the impact would be much stronger: UK export losses could reach GBP 30 billion in 2019 (i.e. 8% of total UK exports). The overall impact on nominal GDP growth is estimated at -4 pp over 2017-19 (-4.3 pp in real terms) and 1700 bankruptcies. The UK is expected in recession in 2019 (-1.3%), the GBP could depreciate by 20 %, firms’ turnover would be down -1 % and margins will decrease by -2 pp. In this scenario, the risk of capital flight and resulting financial stress is deemed very severe as the UK is running a large current account deficit (-7 % of GDP vs. -2 % of GDP on average since 1984).
For the Eurozone the impact of Brexit should remain moderate
For the Eurozone as a whole, we forecast a moderate impact of -0.4 pp for real GDP growth in 2019 in a soft leave scenario. On the contrary, in a hard leave scenario, the impact could climb to -0.6 pp (see Figure 3).
There are three main transmission channels for Brexit to the rest of the world: (i) trade in goods; (ii) trade in services; and (iii) divestment costs from the UK by European companies and from British companies operating in Europe (including dividends repatriated):
Trade in goods: The GBP depreciation and lower GDP growth would trigger a fall in UK imports. We estimate that in the case of a soft leave, the combined effect of a slowdown and GBP depreciation (at least 10 %) would cause UK imports’ growth to slow down. In 2019 the peak year, imports will increase by +0.5 % instead of +3 % (baseline). In a hard leave scenario, additional tariffs could even cause a contraction -1 % of UK imports in 2019.
As a result, cumulated 2017-19 export losses for the Eurozone could reach EUR 15.2 billion (i.e. 0.5 % of total Eurozone goods exports) in a soft leave scenario and EUR19.9 billion in a hard leave scenario (i.e. 0.6 % of total Eurozone goods exports).
Trade in services: Changes in regulation and additional administrative costs could imply lower activity for European companies operating in the UK. The local market would shrink, notably for financial services, and foreign businesses would be looking for new markets. Finally, a Brexit would mean a jeopardized business model for the City of London. Access to the London Marketplace would be more complicated, namely due to higher cost of passporting rights. Also, UK-based subsidiaries in the financial sector will no longer access euro financing through the ECB as they do today.
As a result, export losses for the Eurozone could reach EUR2.2 billion (i.e. 0.2 % of total Eurozone exports of services) in a soft leave scenario and EUR 3.6 billion (i.e. 0.3 % of total Eurozone exports of services) in a hard leave scenario.
Investment: The UK is very dependent on inward investments, but it is also an important investor abroad. EU countries would be inclined to invest less in the UK post EU-exit and conversely.
Britain has a positive net investment position vis-a-vis countries such as France, Italy, and the Netherlands. Yet its balance is significantly negative with the US. Most British investment in the EU ends up in financial services, and the chemicals, retail, and ITC sectors. An estimate of the investment losses in case of a Brexit (see Figure 3) finds that the United States (-EUR13.5 billion for a soft leave), the Netherlands (-EUR8.2billion), France (-EUR3.2 billion), Germany (-EUR2.1 billion), China region (-EUR1.9 billon), Spain (-EUR1.8 billion) and Ireland (-EUR1.2 billion) would be the main losers.
In the medium-term however, there could be increasing opportunities for EU countries to attract lost UK investments – as well as new inflows. Possible winners: the pharmaceutical, electronics and financial sector in Ireland; the automotive sector in Spain, Slovakia and Poland; machinery and equipment in Germany, Italy and Czech Republic; financial services, high tech and transportation sector in the Netherlands; aeronautics in France.
The Netherlands, Ireland and Belgium to be the most impacted by a Brexit, followed by Germany, France and the United States.
The Netherlands, Ireland, and Belgium will be the most impacted under both scenarios (soft and hard leave). Biggest losses will be concentrated in sectors such as automotive, machinery and equipment, chemicals and agri-food.
Belgium and the Netherlands are major European trade hubs and have a high exposure to the UK market. For the Netherlands in particular, the overall impact of Brexit will be high: -1.5 pp of GDP growth in a soft leave scenario and +2 pp for business insolvencies growth. Most of the impact would come from important financial linkages (holding structures) but also from lower exports of chemicals, agri-food and electronics.
In the case of Ireland, the UK is the second biggest market for exporters, with a high concentration on oil and higher value added products (electronics, chemicals, machinery and equipment). The impact is estimated at-0.9 pp for GDP growth and will trigger an additional increase in business insolvencies by +1.5 pp in the soft leave scenario. In the hard leave scenario, the fall in GDP growth will be bigger (-1.4percentage points) and will be a higher drag on business insolvencies (+2.0 pp).
The UK imports mostly intermediate goods from Germany, notably vehicle components and machinery. In a hard leave scenario, we expect a loss of –EUR 2.0 billion for German automotive exporters and of –EUR 1.0 billion for machinery exporters (see Figure 4). The German chemical sector is also relatively exposed to the UK, and the authors expect a loss of –EUR 1.1 billion by 2019 in a hard leave scenario. Overall, the impact on real GDP growth by 2019 is expected to range between -0.3 pp and -0.4 pp; the impact on business insolvencies growth could be as much as +1.2 pp additional turbulence.
France will be impacted in a similar way as Germany, although to a lesser extent. The sectors that are likely to suffer the most are machinery, agri-food and chemicals that are expected to lose –EUR 0.5 billion each by 2019 in a hard leave scenario.
Outside Europe, the United States appears to be one of the most impacted countries, notably given its investments in the UK as a gateway to Europe. The interconnection between the US and the UK markets for financial services is significant: 26 % of total UK exports of financial services go to the US and 30 % of total UK’s imports come from the US in this sector. In total, we expect a loss of –EUR 13.5 billion of FDIs in the case of a soft leave scenario and up to –EUR 22 billion in a hard leave scenario.
The UK is the US’s fifth trade partner for goods. We estimated cumulated losses by 2019 to reach –EUR 2.2 billion in a soft leave scenario and –EUR 2.9 billion in a hard leave one. Biggest losses will come from machinery and equipment (-EUR0.7 billion) and chemicals (-EUR0.4 billion) – see Figure 4.
In total, -0.1 pp of GDP growth should be lost in a soft leave scenario vs. -0.2 pp in the hard leave.
The hidden costs of a Europe à la carte
1. Uncertainty and legal cost
Legally, a Brexit would prove burdensome. Article 50 of the Lisbon Treaty only briefly outlines the procedure for exit negotiations. As details are yet to be defined, legal costs and more importantly uncertainty on its final status should not be underestimated.
2. The risk of a spillover to other EU countries
On the one hand, a Brexit could boost centrifugal forces and slow down the integration process. The transfer of competencies to Brussels, especially in the political and social fields, could come to a halt resulting in a so-called Europe à la carte. Scandinavian countries, Poland and Austria, have already advocated for less political integration. On the other hand, Brexit could also be an opportunity for Europe to opt for a one-speed model of integration including faster reforms towards federalism.
3. Productivity puzzle
The UK is the second biggest recipient of EU research funding. EUR 8.8 billion were granted between 2007 and 2013, with funds going to key projects such as the Joint European Torus in Durham, and nuclear research. What is more, UK universities coordinate one-third of the projects funded by the EU’s 80 billion Euro Horizon 2020 research program. If the UK were to leave the EU, economies of scale for R&D will be limited at a time when productivity is stagnating. Access to cutting-edge science, reduced scientific cooperation, and cross- border cooperation is a must and often a forgotten side benefits of trusted trade relationships.
4. Mobility
In 2015, around 1.2 million foreign workers were employed in the UK. Many of these are posted workers from Eastern Europe whose presence is permitted and regulated under an EU directive. If the UK were to exit, working visas and benefits would have to be redefined.
Euler Hermes is a company of German Allianz Group.