15 April 2015

Brexit would alter the political balance within the EU

While our recent report focused on the economic impact, as does this post, it is also important to mention the significant political change caused by Brexit. Politically, the costs of Brexit to the EU would be substantial. The loss of the UK – one of Europe’s largest economies and one of its only two military powers – would not only be a major blow to the EU’s international prestige, but losing the most prominent advocate of liberal, free-trade policies could also fundamentally alter the power dynamics within the EU.

As the graph below shows, the UK’s absence from the EU’s qualified majority voting arrangements would hand a French-led protectionist bloc large sway over future decision-making in the EU as it would be able to command a blocking minority (35% of the voting weight), while the UK’s natural allies such as Germany, the Netherlands, Sweden, Ireland and others would no longer be able to.

150414_Open_Europe_graph_ itemprop=

How this change to the balance of power would affect the future economic performance of the EU is difficult to quantify. But it is fair to assume that, without the UK, there is a high chance that the rest of the EU would become more inward-looking and less globally competitive.

Meanwhile, depending on their levels of trade with the UK, Brexit will have a larger immediate economic impact on some countries than others. Perhaps unsurprisingly, given the geographic proximity and high levels of trade, our modelling suggests that Ireland would be hit the hardest by a Brexit.

What is the economic impact of Brexit on Ireland?

As the table below shows, in a worst case scenario, where the UK leaves the EU without a free trade agreement in place and falls back on World Trade Organisation (WTO) rules, Ireland could see a permanent loss to GDP of 3% in 2030. This means Ireland would actually be worse off than the UK in such a scenario. (NB – all the details on the modelling and scenarios can be found in the annex to our report here).

Even in the best case scenario for the UK outside of the EU, where the UK successfully negotiates an ambitious free trade agreement with the EU, deregulates significantly and opens up to global trade, Ireland would still be worse off to the tune of 1% of GDP in 2030. So, even in a scenario where the UK economy is better off after Brexit, Ireland could still lose out.

150414_Open_Europe_table_ itemprop=

What explains the impact of Brexit on Ireland?

Significant amount of UK-Irish trade: The impact of Brexit on Ireland is so large due to the significant amount of Anglo-Irish trade. While the importance of UK trade to Ireland has fallen, Ireland still exports 16% of its manufactured goods and 19% of services to the UK. It currently imports 34% of its goods from the UK and 18% of its services. As a small, open economy, trade in goods is equivalent to almost 80% of Irish GDP. Any barriers which disrupt that trade will involve significant costs.

Tariffs: In the worst case scenario, trade in goods between the UK and Ireland would be subject to tariffs. While the EU’s tariffs are generally low, in some sectors such as cars and agriculture they remain high and the large volume of trade between the two states means the impact of even low tariffs would be sizeable.

In the best case scenario, where the UK and EU successfully negotiate a free trade agreement, there would be no tariffs on trade between the UK and Ireland. As we note in the full report, there is an incentive for both the UK and the EU to conclude a zero tariff deal for goods manufacturers, while a deal which replicated existing single market access for industries such as financial services could be harder to strike.

New border costs: According to our analysis, the majority of the costs of Brexit would stem from the imposition of a new customs border with the UK. Again, due to the significant amount of trade between the two countries, this represents a large cost to Ireland. Border costs are lasting and take the form of time lost at the border or out of pocket administrative costs of complying with customs procedures. Unlike tariffs, this is also a deadweight cost rather than a transfer.

Even in the ‘best case’ scenario where the UK strikes a free trade agreement with the EU, there would still need to be a customs border. New costs would include demonstrating adherence to so-called ‘rules of origin’ – the rules products need to comply with in order to benefit from zero duty under free trade agreements. In our model we have assumed that under the ‘best case’ scenario, the Irish-UK border would be similar to that of Switzerland’s border with the EU, which requires exporters and importers to comply with administrative procedures but does not result in shipments being held up for hours at the border.

EU budget: It is also worth noting that, while some of the impact of Brexit on the UK is offset or bolstered by a significant saving from the EU budget, Ireland would actually find itself with an additional budget payment to make – other member states would need to cover the loss of UK net contributions. In 2030, Ireland’s additional payment could total roughly €177m per year (0.1% GDP).

Foreign direct investment (FDI): The economies of Ireland and the UK exhibit a number of similarities and both attract high levels of foreign investment, particularly in services sectors. While FDI flows are captured by our model the wide variety of outcomes may not be fully factored in. It is possible that FDI which previously flowed into the UK could instead flow to Ireland. This could happen if the UK was unable to secure the access to EU markets that it currently enjoys and foreign firms were looking for alternative gateways to into the EU’s single market.

If, on the other hand, the UK significantly deregulates and liberalises to become an even more open economy following Brexit, it could be an even more attractive location for investment. The effect on FDI in both the UK and Ireland is therefore likely to depend on the policies adopted in both countries. Nevertheless, some change in FDI flows is likely.

What could the UK and Ireland do to reduce the impact of Brexit?

Our analysis suggests UK withdrawal from the EU would pose a significant economic challenge for Ireland. There are also likely to be political implications, particularly in Northern Ireland, which would also need careful consideration.

The most important issue to address would be the arrangements for a new border. There is no reason why the UK and Ireland could not retain the Common Travel Area and so avoid the need to introduce passport controls, which would enable the continued free movement of people between the UK and Ireland. For example, the Schengen passport-free travel area currently straddles EU and non-EU members.

Arrangements would also need to be made to minimise the impact on cross-border trade. The Swedish-Norwegian border could provide a model. The two countries share a vast land border and Sweden is in the EU, while Norway is within the European Economic Area but not in the EU (both states are within the Schengen passport-free zone). Therefore the Norway-Sweden border is a customs border even if it is not a passport border. Norway can and does set its own trade policy which differs to that of the EU.

In practice the customs procedures on the Sweden/Norway border are governed by a 1960 Sweden/Norway/Finland cooperation agreement that eliminates duplication in customs administration. This means that either state can check goods out and into the neighbouring state, which ensures minimal costs for traders.

It’s in Ireland’s interests to back UK efforts to reform the EU

It is important to note that the UK does not yet face a binary choice between In and Out. If David Cameron is re-elected he will seek reform of the EU before membership is put to a referendum. Just as policies adopted after Brexit are likely to determine the UK’s fate outside the EU, if the EU illustrates it is capable of reform the attraction of Brexit will be reduced.

On reform, there is a huge overlap of interests. Like the UK, Ireland would benefit greatly from the greater liberalisation of services trade across the EU long advocated by the UK (and Open Europe). According to the European Commission, Ireland could see a boost of up to 1.78% to its GDP if barriers to trade in services were further removed within Ireland and across the EU. Ireland also has much to benefit from concluding a free trade agreement with the US. This could potentially boost Irish GDP by 0.5% of GDP in 2030. Likewise, all member states would benefit if the EU were to become more accountable to national electorates.

The likely economic and political impact of Brexit on Ireland illustrates that it’s very much in Ireland’s self-interest to back UK efforts to reform the EU. Ireland will no doubt seek to retain its distinct voice within the EU but its membership of the Eurozone and its deep relationship with Britain means it is well-placed to act as an honest broker in negotiations between the UK and other EU member states. Not only would reform benefit the entire EU, including Ireland, the polling evidence suggests it would make it far more likely that the British public would vote to remain inside.