When it comes to the prospect of the UK voting to leave the European Union, it’s hard to keep a balanced view.

I am privileged to trust Erik F. Nielsen highly. As this Open Thinking did on another occasion (that time we were debating rating agencies and a little bias they might have against Italy), we love to let Erik’s “Sunday Wrap” of 24 April 2016 speak clearly, about why the so-called Brexit would be a much worse prospect for the UK than it would be for the EU.

“The number one topic – by a mile – among investors, policymakers and anyone else I come across these days, in London and across the Continent, is the issue of Brexit. The key questions I hear are: Will they or won’t they? And what happens if they leave?  Let me summarise:

 

(i)       I still think the UK will vote to remain in the EU.

While I worry about the impact of the Panama Papers on Cameron’s ability to persuade people on the issue of Europe and prevent the vote becoming about him, on balance, I continue to think that the Brits will vote to stay in the EU. This past week, the “Remain” campaign received what ought to be a big boost from Obama. 

Opinion polls continue to suggest a close race, but with a large number of undecided voters. Interestingly, when the undecided voters are asked which way they are leaning, they tilt quite heavily towards staying, they say. 

But we have seen several referenda on European issues turn into a de facto vote on the sitting political leadership (in Denmark it has happened virtually every time, as it did in the Netherlands and France), so if Cameron has been more severely damaged by the Panama Papers, we may have a problem. Comfortingly, the UK bookmakers keep making odds with an implied probability of staying in the EU of about 70%.

More fundamentally, while the Brits still struggle with their perception of their own place in today’s world, I just cannot believe that a majority is so deluded that they think they would be better off outside the EU, thus ignoring the opinions of practically all the UK’s foreign allies as well as the vast majority of UK business leaders and UK and international economists.

Latest, this week President Obama killed any claim by the “Leave” campaign that there would be an easy way for the UK outside the EU to a trade agreement with the US. As he said, the US would want to negotiate with the bigger economies, like the EU, while the UK would be “at the end of the queue” (note his use of the British version of what they call “the end of the line” in the US – either because he wanted to be sure the Brits understood him, or maybe because he used a line suggested by Cameron?) He later suggested that it might take about 10 years to get to such a trade agreement. That seems a reasonable (if not even optimistic) estimate when you recall that it took seven years for the EU to get a trade agreement with Canada – and no free trade agreement in the world comes close to the Single Market for services, which is crucial to UK trade and the City of London.

Obama’s clarification of trade, as well as his elegant response to Boris Johnson’s claim in a newspaper column on Friday that the placement in the White House of a bust of Winston Churchill somehow reflects Obama’s anti-British bias, left the London mayor, and leading Brexit campaigner, on the back foot as poorly informed – and that’s to put it politely. If you are interested in a more robust rebuttal of Boris Johnson’s attack on Obama, Nick Cohen’s piece in The Spectator (which Johnson used to be the editor of) is worth reading: http://blogs.spectator.co.uk/2016/04/barack-obama-wants-boris-johnson-prefer-gutter/

That said, a YouGov poll after Obama’s and Cameron’s press conference (curiously asking what people thought of Obama’s “intervention in the EU referendum campaign”, rather than e.g. “how the US thinks of the issue” or “how the US would react to Brexit”) suggested that 41% of Brits were “angered” or “annoyed” by Obama’s “intervention”, while 28% were “pleased” or “inspired” (22% didn’t care and just 3% hadn’t noticed.) However, I suspect the 41% “angered” or “annoyed” are those who anyway had decided to vote to leave.

After having had a nice cup of tea with the Queen and the royal family to celebrate her 90th birthday, Obama continued today to Hannover, Germany, where he’ll join Merkel tonight when they open the 2016 Hannover Messe – the world’s biggest industrial technology fair. I suspect the conversation on Airforce One on the short flight today will have been along the lines of “now we have helped pull Cameron’s political chestnuts out of the fire, let’s get down to the more important, forward looking, business in Germany.”

(ii)      But what if it all does go wrong, and the UK votes to leave the EU?

 

To be sure, nobody knows for sure what exactly will happen following a vote to leave, but here is our best guess:

Cameron will announce his resignation, which will trigger a Conservative leadership election, which will take 3-6 months to complete. (Cameron will remain during this period as caretaker PM.) The next leader could be Boris Johnson, who’ll claim he won (after having switched from being generally pro-Europe to lead the Brexit campaign), or it could be Theresa May (who used to be quite anti-European, but switched to the “Remain” side, after a similar considerations as Boris Johnson’s – but with the opposite outcome.) Or it could be someone else, less well known.

The new government will face a dilemma on how to start the exit negotiations. 

On the one hand, they may be keen to get down to business and would therefore probably invoke Article 50 of the Lisbon Treaty very quickly after taking office; i.e. formally notify the EU that they want to leave, which starts a clock allowing two years to negotiate what will surely be very complex withdrawal agreement with the remaining (now probably not very friendly) 27 EU member states. If they don’t manage to complete negotiations within the two years, it’ll require a unanimous agreement by all 27 EU states to extend the talks. This would put the UK in a very difficult – and indeed commercially and economically dangerous – position because without an agreement it would well leave the UK on their own with no arrangements for trade and other commercial interactions with anyone. (EU legislation will continue to apply to the UK during the time it takes to negotiate a new agreement, or for two years after Article 50 has been invoked, whatever comes first.) 

 

Alternatively, the new UK government could delay Article 50, while trying to start exit negotiations on a technical level, and only invoke Article 50 when they are confident that an agreement is in sight. But then again, the rest of the EU would know this game just as well, and might very well refuse such “theoretical” negotiations until Article 50 has been invoked. My point is this: Whichever way the UK plays it post-Brexit vote, they’ll be in a very uncomfortable spot, and de facto at the mercy of every single other 27 EU member state.

Our UK Lead Economist – and laser-beam focused Brexit Watcher – Daniel Vernazza argues that the outcome of exit negotiations will likely leave the UK trading under World Trade Organization (WTO) rules; that is, outside the European Single Market where goods and services trade freely. As he notes, access to the Single Market is incompatible with the “Leave” campaign’s desire to end the free movement of people, contributions to the EU budget, and EU regulation. The only two large non-EU countries with access to the Single Market, Norway and Switzerland, both have free movement and both pay into the EU budget.

So there you have it: Huge uncertainty for years – my guess would be a massively weaker pound (20% down in trade-weighed terms – probably less against the euro?), massively weaker UK equities (10%-20% down?), lower house prices in London – and a big sell-off of gilt, which would be countered to some extent by a new dose of QE, which, with the inevitably larger budget deficit, would come about as close to helicopter money as you’ll ever see. The wealth destruction would almost certainly send the UK back into recession (which means that the fear of Brexit leading to other countries wanting to follow the UK out seems widely off the mark to me.)

 

The long-term economic impact for the UK of leaving the EU is surely negative. We estimate it would be a net cost to the UK economy equivalent to around 6% of GDP over the next 10-15 years, a similar magnitude to that of the UK Treasury’s estimate.  If you don’t think that’s a lot, then I encourage you to suggest realistic policy measures, which would lift GDP by that amount in perpetuity.

 

I hear a lot of suggestions that the rest of Europe would suffer significantly as well, and maybe even as much as the UK – although this is an argument more often heard in the UK than on the Continent. I don’t buy it. Europe would be hit by volatility for sure, but the longer-term negative effects would disappear in noise. After all, the EU would maintain all its external trade agreements (apart from with the UK), and possibly trade at a weaker euro. The UK would left for maybe 7-10 years with no trade agreements with anyone, which is not easily compensated for by a weaker pound.”

Thank you Erik.

Tommaso Arenare

http://www.twitter.com/tommaso_arenare