The EU referendum has sent shock waves through the country and its political establishment. However, Brexit will neither be an apocalypse nor will it be an utopia. The growing economic evidence suggests that there would be a small negative economic result from Brexit, probably in the region of 0.5% – 1.5% of GDP in the long run, presuming a reasonable trade agreement is struck between the UK and the EU. The question is whether the UK can use its new found freedoms to offset the cost of Brexit or reverse it to a positive outcome.

We believe it is possible, but the path to prosperity outside the EU lies through: free trade and opening up to low cost competition, maintaining relatively high immigration (albeit with a different mix of skills), and pushing through deregulation and economic reforms in areas where the UK has historically been sub-par compared to international partners. There is no doubt that such an approach would disappoint a number of people on the ‘Leave’ side and whether there is appetite for such changes in the UK is unclear. One thing that is clear is that Brexit cannot be all things to all people.

Our Brexit guide outlines the key priorities for a UK Government (click here to access the full report):

Trade

a) The first step would be to try to strike a Free Trade Agreement with the EU and to maintain the FTAs Britain has with other states via the EU. As we outlined in our previous report, this is not an easy task and could take many years. The emerging consensus is that – taken by itself – there would be a small negative economic impact from leaving the customs union and the single market in the long run.

b) The second step would be to build FTAs with other states to try to offset this effect.

  • Contrary to popular belief, countries don’t only strike free trade agreements with large states or economic blocs. Medium-sized economies such as Norway (80%), Australia (77%) and Canada (69%) have managed to strike FTAs covering a significant proportion of their trade – more than the UK at 63%. For Norway and Canada this is reliant on having reached an agreement with their largest trading partner – the EU in the UK’s case. However, Australia and New Zealand have proven a more diversified approach can also work. Striking deals with US and China would bring the UK’s share of trade covered by FTAs to over 81% – slightly higher than Norway’s.
  • Evidence suggests this will take some time. Globally, trade deals have usually taken anywhere between four and ten years to negotiate. The EU is not uniquely sluggish.
  • There is a trade-off between speed and scope. A more complex agreement addressing services and non-tariff barriers (NTBs) does seem to take longer. Basic agreements focusing on goods tend more towards the four year end of the scale while more comprehensive deals tend towards ten years.
  • One option for the UK to speed up this process would be to dump the EU’s all or nothing approach. That way, the UK could strike initial agreements on removing tariffs on goods and revisit negotiations on services and NTBs at a later date. This would make sense for emerging market economies where tariffs are relatively high and the majority of UK trade is in goods – China, India and Brazil fit this category.
  • Striking a series of FTAs with Asian economies (China, India, Japan and ASEAN) could deliver a boost of up to 0.6% of GDP for the UK, going some way to offsetting the negative impact of leaving the EU customs union and single market. Alternatively, a unilateral free trade approach could deliver a boost of around 0.75% of GDP in the long run.
  • A case study of the agricultural sector highlights the tension between opening up to the rest of the world or continuing protectionism and subsidies. There are potential savings for both taxpayers (£1.5bn) and consumers (between £400m and £1.4bn) from liberalisation. However, this would mean creative destruction and would see a number of farms going out of business, not least because 19% of British farms do not currently make any profit. So far, comments from politicians suggest they are not willing to take on the established interests in this sector. How much more widely would this apply post-Brexit?
  • Recent controversies, particularly around the steel sector, highlight the potential political challenges to opening up trade with emerging markets and particularly non-market economies such as China. Striking trade agreements with such countries may well face significant grassroots opposition.

c) The third step could be revisiting and updating older agreements.

  • Only eleven of the 33 EU FTAs currently in force cover services. Often the biggest difference between trade agreements does not come from the size of the negotiating parties, but whether it is a first generation agreement (basic, focused on tariffs and goods) or a more comprehensive second generation agreement (dealing with services, NTBs and regulation).

Immigration

a) While there would be political pressure to reduce immigration following Brexit, there are several reasons why we believe headline net immigration is unlikely to reduce much:

  • The business case for maintaining a flexible supply of labour. The evidence suggests that, with a record high employment rate, the UK’s labour market is already tightening;
  • the political and economic challenge of finding policy alternatives to relieve pressure on the public finances caused by ageing demographics, where immigration can help smoothen the path to fiscal sustainability;
  • the effects of globalisation on migration flows, which the UK is not alone in experiencing;
  • and the likelihood of some constraints on UK immigration policy under a new arrangement with the EU.

b) Nevertheless, free from EU rules on free movement, the UK would likely pursue a selective policy more geared towards attracting skilled migration, which could be more politically acceptable.

c) Open Europe would recommend a system seeking to emulate the points-based systems of Canada and Australia. The system could be weighted strongly towards those with a job offer, but also offer a route for skilled migrants seeking work. Such a system could give priority to UK industries and employers suffering skills shortages but also allow a flexible supply of skilled workers to enter the UK labour force subject to a cap which could be varied depending on economic circumstances. However, there is likely to be a continued need for migrant labour to fill low-skilled jobs. Therefore, the UK would also need a mechanism to fill low-skilled jobs or meet labour shortages where employers have recently relied on EU migrants.

d) However, there is likely to be a trade-off between the depth of any new economic agreement with the EU and the extent to which the UK will have to accept EU free movement. The evidence from the precedents of Norway and Switzerland suggest that the deeper the agreement, the more likely the UK will need to accept free movement. This might mean building in preferential treatment for EU citizens in the UK’s new points system, which would give EU nationals priority over non-EU nationals, or it could create a separate temporary migration scheme for migrants from the EU.

e) The UK is far from alone in its migration experience in terms of developed economies. Between 2000 and 2015 the UK received 3.7 migrants for every thousand people, which puts it just above the average but below countries such as Canada, Australia, Norway and Switzerland. If the UK had experienced the same level of immigration as Canada or Australia there would have been an additional 3 million or 4.4 million migrants respectively coming to the UK over the past decade – though of course the UK is a more crowded country.

Regulation and competitiveness

a) There is certainly scope for deregulation outside the EU, though maybe not as large as assumed. We estimate a politically feasible deregulation agenda could lead to permanent gains of 0.7% of GDP – with savings coming mostly from three areas: social employment law, environment and climate change and financial services. But even such a scenario would involve difficult choices such as scrapping renewable energy targets and deregulating social and employment laws.

b) More broadly, the UK remains one of the most competitive developed economies, particularly in areas such as: labour market, business environment and product market regulation. Yet there are of course potential gains, especially in areas such as: education, skills, infrastructure and costs of certain services. There is little evidence that the EU holds us back in these areas, but their reform and the ensuing competitiveness boost will become increasingly crucial in the case of Brexit.

Implications

These findings have important implications for the type of relationship the UK should seek with the EU post-Brexit. Realising the potential economic gains we’ve identified – notably via immigration and deregulation – means a relatively high degree of flexibility from the EU. The confines of a Norwegian or Swiss-style arrangement would not deliver this. As such, the best option would be for the UK to pursue a comprehensive bilateral free trade agreement, aimed at maintaining as much of the current market access as possible while also adopting a broader liberalisation agenda over the longer term. Of course, this is easier said than done.

This paper is not an endorsement of Leave or Remain, but an attempt to flesh out some of the policies which we believe the UK may reasonably have to adopt in the event of a Brexit in order to offset the costs and maximise the economic benefits.

If you cannot see the PDF reader below, please click here to access the full report.

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