Word in the New$: Brexit

Jun 25, 2016 05.00PM |
 

by Ryan Ong

YESTERDAY, Britain voted to leave the European Union (EU), in a narrow and historic referendum. The Leave camp won by a slim 51.9 per cent, showing that despite the victory, the issue is far from over. In its wake, Brexit leaves behind a dis-United Kingdom, deep uncertainty about its economic future, and a currency that has plummeted to a 31 year low.

This is the first time a country has left the EU in almost 60 years. Britain’s decision to go alone means it has flipped a reset switch on its own economy. It will have to find new trading partners and rebuild previous relationships, as well as re-establish trust in the British pound and the country’s growth prospects.

This dangerous gamble is likely to see Britiain sink into recession, at least in the coming year. It also poses a threat to the EU, which now has to take strong steps to maintain the cohesion of its remaining 27 members.

How it happened

The main cause of the referendum was a promise made by British Prime Minister David Cameron in 2015.

Facing a tough election in 2015, Prime Minister David Cameron promised that, if his political party was elected, he would hold a referendum on whether Britain should stay in the EU. This has turned out to be a fatal miscalculation on his part.

The British PM pointed out repeatedly that Britain has the best advantages of being in the EU, with few of the drawbacks. For example, Britain did not have to sign the Schengen Agreement, which allows free movement of EU citizens between member states. Britain also did not have to contribute to EU bailouts, such as during the Greek Financial Crisis.

However, Britain has long been a bastion of Euroskepticism. This is the belief that the EU represents a deficit in democracy. Euroskeptics hold that Brussels (the de-facto capital of the EU) has too much power to interfere in the domestic business of EU member states. For example, the EU gets to regulate on decisions such as whether certain corporate mergers are allowed, what products can be sold, and the movement of peoples between member states.

Prominent British figures, such as London Mayor Boris Johonson, and United Kingdom Independence Party (UKIP) leader Nigel Farage, were able to convince much of the public that the EU infringed on British independence.

The British public had also been bombarded by their media (minus the country’s notorious low-grade tabloids), by the ruling labour party, and even by celebrities to remain in the EU. This allowed individuals like Mr Farage to frame the referendum as a struggle of “the little people” versus a powerful and oppressive establishment.

This effective storytelling appears to have trumped facts.

The second reason is a mix of racism and anti-Muslim sentiment. The Paris attacks made the British public paranoid about a similiar occurrence on their soil. The leaders of the Leave party insisted that the EU’s approach of accepting large numbers of refugees, many from Islamic countries, would invite precisely such incidents. This was compounded with suspicion that EU migrants stole jobs from British citizens (Anyone who bothered to check, however, would have realised British unemployment was at a 10 year low as of April 2016).

Better reasoned branches of the Leave camp feared that, economically, the EU was a sinking ship and Britain was going down with it. The fear mongering centered on highly indebted EU states, such as Greece, Portugal, and Italy – the Leave camp harangued the public about the Britain being made to bear the weight of such financial burdens, when their own social welfare system was already struggling. Leaving, it was promised, meant that Britain could forge a better economy without the bureaucratic tangles of the EU.

The consequences

The British pound has fallen to a 31 year low, pulling several other currencies along with it. The Singapore dollar is currently down 1.7 per cent against the US dollar, the biggest drop since November 2011. Brexit signifies high volatility and the probability of a weaker global economy, thus causing investors to flee to safe haven currencies such as the Japanese yen (up 3.3 per cent, at 102.69 yen to 1 USD. This is the highest since 2013).

Another safe haven asset, gold, has risen by more than eight per cent, to US$1,358.54 per ounce.

The flight to safety is likely to continue, at least until after Britain concludes new negotiations with the EU (and even then, there is no assurance that volatility will not continue). On the back of the falling pound, and rising uncertainty, Standard & Poor has also threatened to downgrade Britian’s AAA rating.

This is just the beginning.

Under the EU rules, Britain must inform the group of the intent to leave at least two years in advance. The current referendum does not count as notification, so the earliest Britain will be out of the EU is 2018. What Britain now hopes for is a Norway-style deal, in which it can maintain the free trade of goods with the EU without being an actual member.

But this is improbable, as the EU needs to make an example of Britain. In order to convince other members such as France not to leave, it’s likely the EU will drive a hard bargain. They may impose tariffs on British businesses, or demand that existing trade deals be renegotiated on tougher terms. It would seem Britain is in for a volatile two years…and then things could get really bad.

Normally, when a country’s currency falls, its exports become more competitive. But around half of Britain’s exports go to the EU, putting them in a lose-lose situation. It’s estimated that 3.1 per cent of the EU’s GDP depends on trade with Britain, whereas 12.6 per cent Britain’s GDP is dependent on trade with the EU. The impact of Brexit has thus been estimated, by the British Treasury, to contract their overall GDP by 3.8 per cent.

This projection assumes migration rates do not fall. Should a more isolationist government replace PM Cameron’s party, restrictions in migration will likely cause an even greater contraction. The UK has, over the years, become quite dependent on the EU for labour. The UK currently has 2.1 million EU migrants, constituting 6.8 per cent of their workforce. Many of these migrants will be forced to return to the EU in the aftermath of Brexit. The subsequent labour crunch is likely to impede business expansion across the UK.

The cohesion of the UK itself could also be under threat. Scotland is very much in favour of staying within the EU, as they see the EU as a check against British authority. The Scottish have long disliked the degree of dominance Britain maintains over their politics, and Brussels was their defence against it. There is a risk that Scotland won’t feel comfortable having Britain loom over it forever, and this could affect future independence votes.

On the upside, it should be a lot cheaper to holiday in London, or study there. And the weaker pound means fewer British tourists, so Orchard Road can be even emptier and more spacious.

 

Featured image European Flag by Flickr user Rock CohenCC BY-SA 2.0

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