Calculating an UK Exit from the EU – Questions and Answers

Last week the Global Economic Dynamics project, together with the Ifo-institute in Munich, released its policy brief paper on the potential economic consequences a Brexit – the UK leaving the EU – could have on both Britain as well as on the rest of Europe. Our findings were that the risks of such a move were immense and that the UK in particular would potentially face sizeable GDP losses from 2030 onwards (-0,6% to -3%), which even in the best case scenario would outweigh the theoretic EU-Budget savings that would come with a Brexit (ca. 0,5% of GDP). All parties involved should therefore, in our eyes, try everything in their power to avoid a UK – EU separation. While our paper was generally well received, there were some critical voices raising questions on the extent and validity of our findings. This article shall therefore serve to answer those questions, clarify our findings and correct some misunderstandings.

Brevity is the Soul of Wit – Especially When it Comes to Policy Briefs

Among those critical voices one main concern was the briefness of our paper. Some felt the eight pages of our paper failed to adequately deal with such a complex topic as is the proposed UK exit from the EU. To those voices let us say fear not, for, as the keen observer of our paper’s title page might have spotted, what our team released last Monday was intended as a policy brief only and not yet as the full study. We are at the moment still putting some finishing touches on said complete study (around 60 pages) and fully expect to be able to deliver the study to you by the beginning of next week. The full study will of course go into more detail talking about the various underlying assumptions used for our models and how these are applied. It will also cover some new aspects, not mentioned or only slightly touched upon, in our earlier policy brief such as the role of foreign direct investment and migration to the UK and the resulting risks of a Brexit. So don’t forget to check back on our website for the study’s release, as it will definitely be worth the read.

Dynamic Effects Have the Potential to Make UK’s Losses Catastrophic

Another aspect our paper was criticised for was the credibility of our worst-case figure of a 14% GDP loss for the UK from 2030 onwards once dynamic effects were taken into consideration in our model. Let us clarify a bit what we are talking about here. The previously mentioned effect range of GDP losses from -0,6% to up to -3% in the UK only describes economic effects of a static nature. Such results deal with direct trade effects only and can thus be calculated more easily and to a greater level of precision. They do, however, only represent one side of the coin. In order to get a full picture one also has to look at the dynamic effects of a possible Brexit. Dynamic effects look at, for example, how the general openness of a country, and the resulting changes in access to foreign markets and international capital mobility, affect future growth of investments and innovation in a country. The ultimate effect on GDP is calculated using our already existing worst case, static results and plugging them into regression results from existing literature that estimate the general effect of overall openness of a country on its GDP per capita. Our findings are not far off from those of other studies either. LSE’s Centre for Economic Performance for example finds a Brexit with dynamic effects to result in a 2030 GDP loss of nearly 10% in a worst case scenario. All this will of course also be dealt with, much more in-depth, in our upcoming Brexit study.

Leaving the EU Would Deal UK a Weak Hand in Future Negotiations

Finally, let us address the likelihood of the different scenarios described in our paper. Critics have pointed out we would focus too much on the negative scenarios of an UK-EU separation, while the described best case scenario, looking only at static effects and taking into account the savings from EU-Budget payments, would only result in minimal losses for the UK economy. While that is true, we do not see this most positive Brexit scenario as the most likely one, just as we are not saying that the other extreme, the absolute worst case scenario, will probably take effect. The most positive scenario sees the UK negotiating a kind of deep FTA with the EU granting it a similar role to Norway or Switzerland. The UK will not however have the best hand when it comes to such negotiations. Our study clearly shows that effects of a Brexit will be much more significant for the UK than for the rest of Europe. While the EU makes up about 45% of the UK exports, only about 10% of the EU’s exports are directed to the United Kingdom. What this means in short is that the UK is much more dependent on the EU trade wise than the EU is on the United Kingdom. As with most interval estimates, a result somewhere in the middle of the two extremes can most likely be expected. And bear in mind, this result will not yet include the earlier mentioned dynamic effects. It is therefore quite reasonable to suggest that a move to separate the UK from the EU will bring no good to any of the parties involved and especially not to the UK itself. For more on how a Brexit would weaken the UK’s negotiation position, you might also want to take a look at our last blogpost: UK at the Crossroad.

We hope this article was helpful for all those seeking answers for their questions on our policy brief and we of course also hope you will read our full study on the topic when it comes out next week in order to really give you the full picture on our findings and positions.