Britain and the EU: The Brexit delusion

David Cameron will struggle to win a referendum on Britain’s EU membership. If he loses, the result will be messy at best and at worst disastrous

THE referendum on Britain’s membership of the European Union that David Cameron has called for June 23rd will be not only the most crucial event in this parliament but the most important in Europe in years. It will determine the prime minister’s future, for a start: it is hard to see him staying in office if he fails to win his campaign to remain in the EU. It may be decisive for the future of the United Kingdom, as Scottish Nationalists have said a Brexit would trigger another vote on Scottish independence. And the departure of one of the heavyweight members would have a huge impact on the future of the EU.

The referendum was called after Mr Cameron completed his promised renegotiation of the terms of Britain’s membership at a marathon EU summit in Brussels that ended late on February 19th. In all four areas where he demanded change, he won concessions that could prove useful, even if they do little to swing the result of the referendum (see article).

Yet it is hard to portray these relatively small reforms as the fundamental change in Britain’s relationship with Europe that Mr Cameron once promised. Nor did he secure the “full-on” treaty change he once said he needed. As a result, his deal suffered a predictable trashing in Britain’s Eurosceptic press and from many backbench Tory MPs. This was a blow to Mr Cameron. But the referendum will be decided not on the details of his deal but on the far bigger issue of whether voters believe that Britain is better off in or out of the EU.

On this, a heavier blow for the prime minister came when six of his 29 senior ministers confirmed, after a special cabinet meeting on February 20th, that they would campaign to leave. Besides such usual suspects as Iain Duncan Smith, the work and pensions secretary, their number included Michael Gove, the justice secretary and a close friend of the prime minister. And on February 21st came the biggest setback to Mr Cameron, when Boris Johnson, the popular mayor of London and aspirant to the Tory leadership, announced that he too would campaign to leave (see article).

Even before these leading Tories had come out, opinion polls suggested the outcome of the referendum would be close. Since Mr Cameron first promised an in/out referendum in a speech at the London office of the Bloomberg news agency in January 2013, there has usually been a clear lead for staying in (see chart 1). As worries have grown over Europe’s economic woes and its migration crisis, the gap has narrowed. The adverse reception of Mr Cameron’s Brussels deal and the decision of Mr Johnson to throw his weight behind the leave campaign may shift opinion further.

Belatedly business and the financial markets have woken up to the rising danger of Brexit. This week sterling slid to its lowest level against the dollar in eight years. Bosses of many of the biggest companies in Britain have come out strongly in favour of remaining in. Yet the chances that Brexit may happen look greater than at any time in the past five years. And that makes it worth dwelling on what Brexit would entail—and how it measures up to the promises of would-be leavers.

An infernal article

The merits of the claims of the leavers are hard to judge because nobody can be sure what relationship a departing Britain would have with the EU. There is no precedent aside from Greenland. It left the club in 1985, but it is tiny and remains a dependency of Denmark, which is still in the EU. The assumption, now confirmed by Mr Cameron, is that a vote for Brexit would trigger an application to withdraw under article 50 of the Lisbon treaty.

Article 50 provides that the EU will negotiate a new agreement with the withdrawing country over two years. That can be extended, but only by unanimous agreement. The article also specifies that, when agreeing a new deal, the EU acts without the involvement of the country that is leaving. To get a feel for the negotiating dynamic, imagine a divorce demanded unilaterally by one partner, the terms of which are fixed unilaterally by the other. It is a process that is likely to be neither harmonious nor quick—nor to yield a result that is favourable to Britain.

Indeed, the incentive for other EU countries is not to act with generosity. A decision to leave will be seen by many as a hostile and destabilising act for a union that is already in deep trouble. Voters across Europe are disillusioned with Brussels. Populist parties in France, the Netherlands, Italy and elsewhere are watching the Brexit debate closely. The EU will be desperate to show that a decision to leave does not have a painless outcome.

The immediate effects of a Brexit vote are likely to be bad. Prolonged uncertainty over Britain’s new relationship with the EU will discourage investment, especially foreign direct investment, of which Britain is the biggest net recipient in the EU. This is particularly worrying for a country with a large current-account deficit that must be financed by capital inflows. Fears about the current account, Britain’s credit rating and Brexit have been drivers of the pound’s recent fall (see chart 2).

The longer-term effects of Brexit are also likely to be adverse. Most studies suggest that economic growth would suffer. A detailed analysis from the Bank of England in October found that EU membership had benefited the British economy. Attempts to model the consequences of Brexit point to economic damage. Two American banks, Goldman Sachs and Citigroup, recently warned that growth and the pound would fall further after a vote to leave the EU.

The trickiest issue for a post-Brexit Britain would be how to maintain full access to the EU’s single market, the world’s biggest. This is crucial since almost half Britain’s exports go to the rest of the EU. It matters greatly for the fastest-growing component of exports, services (including financial services). It will not be simple.

Norway and Iceland have access to the single market through their membership of the European Economic Area (EEA). But they are obliged to observe all the EU’s single-market regulations without having a say in them, to make payments into the EU budget (in Norway’s case, around 90% of Britain’s net payment per head) and to accept free movement of EU migrants. As a Norwegian minister once put it, “if you want to run Europe, you must be in Europe. If you want to be run by Europe, feel free to join Norway.”

Switzerland, which is not in the EEA, has negotiated bilateral agreements that give access for goods but not most services. It has to keep to most single-market rules, contribute to the budget and accept free movement of people. The Swiss have been warned that, if they try to implement a 2014 referendum demand for limits on the latter, their trade agreement with the EU will lapse.

Countries such as South Korea and, now, Canada, have free-trade deals with the EU that do not require observing all its rules, paying into the budget or accepting migrants. But such deals do not circumvent non-tariff barriers, nor do they cover financial services. Moreover, the EU has or is negotiating free-trade deals with America, China and India, from which a post-Brexit Britain would be excluded. The EU has 53 such deals. Britain would have to try to replicate them, a huge challenge given its lack of trade negotiators and the length of time even simple trade talks take.

Heading for the Brexit

The Brexit lobby responds with three arguments. The first is to assert that both sides have a strong interest in a free-trade deal. This is true but any deal is unlikely to cover services. The second is to claim that, because Britain runs a big trade deficit with other EU countries, they need the British market more than Britain needs theirs. This is a fallacy: Britain accounts for only 10% of EU exports, while the EU takes almost half of Britain’s. Moreover, most of the British trade deficit with the EU is with just two countries, Germany and Spain—yet a trade agreement must be endorsed by the other 25 members too.

The third argument is that a post-Brexit Britain could strike new free-trade deals swiftly. Yet experienced trade diplomats are doubtful. Tough negotiators like the South Koreans are unlikely to offer Britain the same deal they gave the EU. America, China and India have made clear that they would be more interested in a deal with the EU than one with Britain alone. When it comes to opening China to more trade, say, the negotiating clout of the world’s biggest market far outweighs Britain’s alone.

The next issue is regulation. The leave campaign claims that EU red tape hobbles Britain’s firms and strangles growth. Yet studies by the OECD, a rich-country club, find that, despite being in the EU, Britain’s product and labour markets are among the rich world’s least regulated. Moreover, a post-Brexit bonfire of market-unfriendly rules is fanciful. Britain led the charge for environmental rules, for example. The biggest interventions in the market, such as tight planning laws and a new living wage that will reach £9 ($13) an hour by 2020, are home-grown.

Immigration policy, on the other hand, would surely change post-Brexit. Although libertarians who want to leave favour more, not less migration, most Brexiters do not. Indeed, the big selling-point of their campaign is to restore British control of the frontiers by stopping free movement of people. It will be hard to do this and keep full access to the EU’s single market; it may also compromise the position of 2m British citizens who live in other EU countries. But the bigger point is that immigration curbs would do economic damage. Studies find that immigrants are net contributors to the economy because they pay far more in taxes than they take out in benefits.

Brexit would also have implications for the survival of the United Kingdom. The Scottish National Party is campaigning to stay in. If the leave side wins thanks to English votes, which is quite possible, the SNP will demand another independence referendum, which it expects to win. Northern Ireland is also troubled by Brexit: Britain’s economic, trade and political relations with Ireland depend heavily on both belonging to the EU. This helped underpin the peace process in Northern Ireland.

Then there are the implications for the EU’s place in the world. As opinion polls have shown, voters in other EU countries agree with their governments in wanting Britain to stay in. Besides its size, global reach and free-trade instincts, Britain is a useful counter to the dominance of Germany and France. And, as the biggest military power in the EU, it is central to the club’s foreign-policy and security clout.

Less clout if it’s out

The growing role of the EU in global diplomacy, ranging from the imposition of sanctions on Russia through a nuclear-weapons deal with Iran to action against piracy off Somalia, would be severely diminished were Britain no longer in the club. The fight against terrorism would also be harder. It may be possible to try to replicate the police, security-service and judicial co-operation built up within the EU to fight terrorism, but it would take time and might not work as well.

Brexiters answer that NATO, not the EU, is the guarantor of the West’s security. A post-Brexit Britain could still co-operate with the EU on security issues, including the European arrest warrant and exchanges of information. They also see no reason why leaving the EU should upset either Northern Ireland or the union with Scotland. Mr Cameron disagrees. In Brussels he said firmly that Britain would be safer and stronger, not just more prosperous, in the EU. In the coming weeks, he will make domestic and national security a large part of the argument for remaining in.

The strongest argument for Brexit is that it is the only way to restore sovereignty to Parliament and escape the jurisdiction of the European Court of Justice. Mr Cameron’s plan to counter this with an act that reasserts parliamentary sovereignty will not convince many, for the ECJ would still stand supreme. In a world with a network of international treaties and obligations, sovereignty is not a completely binary matter; as Mr Cameron put it this week, it would be possible to regain the illusion of sovereignty but without real power.

The conclusion is that the purported benefits from Brexit are uncertain and may prove illusory, while the risks are much greater if voters choose to leave. Similar sentiments led Britons to vote to stay in the European project in 1975, and Scots to remain in the union in 2014. And yet the outcome in June seems more uncertain.

That is partly because the leave side has had a good few weeks. But it is also because voters will be influenced not by a cool calculation of costs and benefits but by their general view of Europe. And in the midst of a huge refugee crisis and stuck in the economic doldrums, Europe does not look inviting. Referendums are always unpredictable: a sudden shock in the markets, or even a terrorist incident, could swing voters. There is all to play for.

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