13 April 2016

With the EU referendum campaign so far providing little more detail on what life might be like outside of the EU, we have today published a new report, ‘Where next? A liberal, free-market guide to Brexit’, which attempts to flesh out what policy choices would confront the UK in the event of a vote for Brexit and how best to respond.

Building on the work of our ‘What if…’ report published last year, which concluded that Brexit could result in a long-run economic loss of 2.2% or a 1.6% gain to UK GDP in 2030 depending on the post-Brexit EU trade deal, trade arrangements with the rest of the world, and future policies on immigration and regulation, this report looks in more detail at the policies we think a UK Government would need to adopt in order to reach positive economic territory.

The UK needs a plan to offset the costs of leaving the EU

There is a growing consensus that withdrawal from the EU is likely to result in a small negative long run economic result, probably in the region of 0.5% – 1.5% of GDP, even presuming a reasonably comprehensive trade agreement is struck between the UK and the EU. So, the question then is whether the UK can use its new found freedoms to offset this cost or reverse it to a positive outcome.

We believe it is possible, but the path to prosperity outside the EU lies through rejecting protectionism and embracing economic liberalism. This means an ambitious free trade strategy and opening up to low cost competition, maintaining relatively high levels of 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.

Economic gains would come from an ambitious UK trade and deregulation strategy

The first step for the UK would be to try to strike a post-Brexit trade deal with the EU and to maintain the 33 agreements with 62 states the UK is party to via its EU membership. As we outlined in our previous report, this is not an easy task and could take many years. However, even striking a relatively comprehensive deal with the EU will not fully make up for the negative impact of leaving the customs union and the single market in the long run.

An ambitious UK trade strategy would be challenging but not unprecedented. Medium-sized economies such as Norway (80%), Australia (77%) and Canada (69%) have managed to strike trade deals 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. Though our research suggests that many of the deals fail to extend into services – a crucial area for the UK.

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If the UK were to strike an Australian-style series of FTAs with Asian economies (China, India, Japan and ASEAN), this could deliver a boost of up to 0.6% of GDP, 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.

There also potential gains to be had from deregulation. 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.

While the UK remains one of the most competitive developed economies, particularly in areas such as: labour market, business environment and product market regulation, there are of course potential gains, especially in areas such as: education, skills, infrastructure and costs of certain services. However, 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.

Such an approach to both trade and regulation would not be without political controversy – as the recent debate about Chinese steel and the Labour Party’s calls for a greater emphasis on ‘social union’ within the EU illustrate. So there are economic gains to be had, but they would not come automatically and difficult political arguments would need to be won.

Could the UK afford a drastic reduction to immigration levels?

For various reasons – business demand for a flexible supply of labour, the need for immigration to offset the challenge posed by an aging population and the effects of globalisation – we think it unlikely that immigration levels would/should be reduced by much. Indeed, the UK is not alone in experiencing high levels of immigration. Between 2000 and 2015 the UK received 3.7 migrants for every thousand people, which puts it just above the OECD average but below countries such as Canada, Australia, Norway and Switzerland – often cited as countries to emulate outside the EU.

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Nevertheless, free from EU free movement rules, the UK would likely pursue a selective policy more geared towards attracting skilled migration, which could be more politically acceptable. We recommend a model 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, the Canadian and Australian, and to some extent the US, experience all illustrate that points based or quota systems are not a magic bullet. These countries all offer alternative migration routes, which also contribute to providing a flexible supply of labour for the economy, particularly for lower-skilled jobs. This type of migration is the most politically contentious and, in the UK, this role has recently largely been filled by EU free movement. Outside of the EU, the UK would likely need to find a new mechanism to attract temporary or low-skilled labour.

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 Norway and Switzerland’s experiences suggest that the deeper the agreement, the more likely the UK will need to accept some degree of free movement.

This should be a debate about the economic and political trade-offs involved in or outside the EU

Both the Remain and Leave campaigns, with some exceptions, have been trading in apocalyptic hyperbole and cliché which pitches everything in black and white, which takes a rather dim view of voters’ ability to hold more than one thought in their heads at the same time.

Most grown-ups are capable of understanding that nothing comes for free in life and this referendum campaign should therefore offer an opportunity to debate the political and economic trade-offs involved in EU membership and those the country might face after withdrawal. It is then up to voters to determine for themselves whether they are willing to take on the challenge of making Brexit a success. We hope this report will help prompt such a discussion.