A new eBook: Brexit Beckons

Richard Baldwin

The 23 June 2016 Brexit vote saw British voters reject membership in the European Union. This column, which was first published in August 2016, introduces a VoxEU eBook containing 19 essays written by leading economists on a wide array of topics and from a broad range of perspectives.

Editor's note: This column was first published on 1 August 2016.

The 23 June 2016 Brexit vote saw British voters reject membership in the European Union. This column introduces a new VoxEU eBook that presents 19 essays written by leading economists on a wide array of topics and from a broad range of perspectives.

Download - Brexit Beckons: Thinking ahead by leading economists

Before turning to a quick review of the chapters, it is instructive to deconstruct the Brexit vote.

UK citizens were asked, “Should the United Kingdom remain a member of the European Union or leave the European Union?” This was a multiple choice test, and the possible answers were: “Remain a member of the European Union” or “Leave the European Union”.

About 72% of eligible voters cast a ballot. 52% of these chose ‘Leave’. According to a poll conducted on the day of the vote (Ashcroft 2016), the young and employed preferred Remain:

73% of 18 to 24 year-olds voted Remain;

60% of over-65s voted Leave;

A majority of the voters with jobs voted Remain; and

A majority without jobs or retired voted Leave.

This was not a vote along party lines. Among the Leave voters, 40% declared themselves as Tories and 20% as supporters of the Labour party. Among the Remain voters, 30% said they were Tories and 40% said they were Labour-leaning voters.

There was also a great deal of difference between the two groups in terms of how serious they thought the decision was. Among the Remain voters, 77% thought “the decision we make in the referendum could have disastrous consequences for us as a country if we get it wrong”. Among the Leave voters, 69% thought the decision “might make us a bit better or worse off as a country, but there probably isn’t much in it either way”.

What did they vote for?

Separating Britain from its deep entanglement with the EU will force the government to confront many irritating issues and tricky trade-offs. In navigating these choices, it will be important to know what exactly it was about the EU that voters rejected. In short: What did the Leave voters vote for?

Unfortunately, this question was not on the ballot, so no one can know the answer. During the campaign, the Leave campaigners at first refused to clarify what would come next, and then provided conflicting answers. As a consequence, voters could not possibly be sure of what they were voting for – only what they were voting against.

Some instant econometrics, which is the best we have to date, shows that their motives were complex. Clarke (2016) reports analysis that combines data on the characteristics of people living in 378 of Britain’s 380 local authorities with district voting patterns. The econometric methods are not clear from the report of the result, but he seems to have controlled for district-specific effects and all the characteristics on which he had data.

He finds that living standards, demographics, migration (especially recent increases in migrants), culture, and a feeling of community cohesion were all significant factors in explaining the leave vote. Surely more solid research is needed to identify what voters wanted on 23 June 2016, and what they want going forwards.

The chapters by Diane Coyle and David Miles look at these issues. Coyle considers how the impact of globalisation seems to have played in shaping voters’ views of EU membership. Miles addresses the oft heard assertion that economists failed to be heard, or believed, by voters. He notes that part of the problem is that economists do not really have a handle on the most important relationship, namely, the link between EU membership and productivity growth. In his chapter, Nauro Campos assesses the quality of the advice offered by economists in the run up the referendum. He argues that while gaps in knowledge may have hindered forecasts, Brexit can essentially be put down to three things: an unnecessary manifesto pledge by David Cameron, a lack of engagement by the City in the Remain campaign, and the pro-Brexit stance of some of the UK's major newspapers.

The fact that voters went for ‘out’ when almost all economists said that ‘in’ would be the better option economically is hard to interpret. One possibility is that economists were ignored, but another is that voters felt the economic costs were worth paying in return for the gains in national control over some policies.

Kevin O’Rourke points out that the last two decades of economic development have left behind a specific slice of the electorate. The Leave vote was at least in part a backlash against this failure to share the gains of progress more widely. This is indeed one of the firmest lessons of history: too much market and too little state invites a backlash. Markets and states are political complements, not substitutes.

Economic policy implications for UK and EU

UK policy in many areas has been made at the EU level for decades. Leaving the EU therefore means that the UK will have to replace EU policies, rules and agreements with British policies, rules and agreements. This will prove a massively complex task. Consider the shape of the EU’s new relationship with the EU, starting with trade policy.

Trade policy

The UK’s trade policy today is crafted in Brussels under the political guidance of all EU leaders, one of which is the British prime minister. As this has been the case for the past four decades, Brexit means that almost every scrap of existing British trade policy will have to be reconstituted. As Jim Rollo and Alan Winters put it in their chapter, “[t]he UK now needs to debate and define its ambitions for international trade and then negotiate them with its partners”.

This will be a challenge along many dimensions. To start with, trade policy in the 21st century is not only, or even mostly, about the trade. We left behind long ago the world where trade meant goods made here and sold there. Most modern manufacturing involves a complex international network of design, financial, manufacturing, and marketing tasks. The UK is no exception; British industry is deeply embedded in what might we called Factory Europe. The main point is that making things today involves back-and-forth – international flows of goods, services, capital, knowhow, and people.

The challenges can be useful slotted into three categories:

Reconstructing UK-EU trade relations;

Disentangling the UK’s and the EU’s WTO memberships; and

Reconstituting the EU’s trade agreements with third nations.

The first is by far the most important economically, since something over half of the UK’s trade in goods and services is with the EU, and the same is true of the UK’s foreign investments.

The chapters by Angus Armstrong, Swati Dhingra and Thomas Sampson, Jim Rollo and Alan Winter, Nicolas Crafts, and Simon Evenett all address various aspects of these three challenges.

Watch Angus Armstrong discuss the UK's new trade priorities in the video below

Watch Nicholas Crafts discuss whether history can tell us anything about the likely impact of Brexit in the video below

Although nothing is certain at this point, and views differ, the authors discuss three options for the new UK-EU relationship:

First is the so-called Norway option, which entails almost full participation in Single Market, where this means free movement of goods, services, capital and people. 1

Second is the so-called Canada option, which means free trade in most industrial goods, and some liberalisation of services and investment flows, but no passporting, and no automatic right for Brits to work in the EU or for EU citizens to work in Britain.

Third is the so-called WTO option, which would see the imposition of tariffs against UK goods and a rise in barriers to UK service exports (including the loss of passporting).

Are these really the only options?

Many pro-Leave analysts, including many in the UK government, are hoping that the EU will create a special Norway-lite deal where Britain would accept a reduction in Single Market access in exchange for some control over immigration from EU members. Many of the authors in the eBook are sceptical of this.

As Paul De Grauwe (2016) points out, it is unlikely that the EU would allow this sort of ‘cherry picking’ of the Single Market policies. The main problem, in my view, is that the Single Market developed over decades and is now a finely balanced package of compromises. If the EU allowed the UK to pick and choose among Single Market measures, the integrity of the Single Market would be threatened as each of the remaining EU members sought to craft their own deal. The Single Market would become 28 single markets. To avoid Brexit disrupting its core economic integration, access to the Single Market will almost surely require acceptance of all four freedoms: goods, services, capital and people.

Moreover, many of the sitting EU governments – each of which will have a veto over the likely future UK-EU trade deal – will wish to avoid creating a comfortable halfway house that might incite their own anti-EU fringe parties.

Given the importance of financial services in the UK economy, two of the chapters deal directly with Brexit and the City. The chapters by Patricia Jackson and Michael McMahon both address the prospects under the three scenarios. They agree that maintaining full access to the EU market – incuding passporting rights – would be the best option for protecting the City’s role as a hub for European financial. This would imply the Norway option. They note, however, that the City is also a global hub so it would thrive even without passporting rights; only some activities and jobs would migrate to be inside the EU.

Labour issues

The chapters by Jonathan Portes, Brian Bell and Stephen Machin, and Barbara Petrongolo take a look at labour market issues raised by Brexit. Portes focuses on immigration policy that is likely to be part of the government’s negotiating stance with the EU. He notes that retaining all or most of the privileges of membership of the Single Market while also achieving significant restrictions on people coming from the EU will be legally, economically, and politically complex, but it is worth trying. Bell and Machin show that areas with relatively low median wages were substantially more likely to vote Leave, and discuss the likely implications of Brexit for wage inequality in the future. Petrongolo argues that immigration has had a positive impact on net fiscal receipts without hurting the labour market prospects of UK-born workers, who are therefore unlikely to benefit from any restrictions imposed on immigration from the EU.

Scotland and Northern Ireland

The chapters by Ian Wooton and by John FitzGerald and Patrick Honohan look at the thorny issues surrounding Brexit and Scotland and Northern Ireland. Both voted to Remain. The issue for Scotland is simply that they like being in Europe and they are lukewarm on the UK. Although setting up Scotland as an independent state inside the EU would entail real costs if the rest of the UK were outside the EU, this is plainly an option that cannot be dismissed. The UK-EU relationship that would be most likely to avoid succession would be the Norway option, as this would give Scots and Scottish-based firms almost as much access to Europe as they have now.

Watch Ian Wooton offer a view on Brexit from north of the border in the video below

The Northern Ireland issue is even more complex since it turns on the politics of the peace process that put an end to decades of armed conflict. In particular, a key element of the peace deal was that there would be no physical border segmenting the island. Since Ireland is not leaving the EU, Brexit would, in the normal course of affairs, set up just the sort of barrier that would threaten the peace process. FitzGerland and Honohan suggest that a compromise could be found where technology would create a virtual but not a physical border.

What it means for the EU

The chapters by Thorsten Beck and Charles Wyplosz look at what Brexit means for EU reform. Wyplosz takes the view that the Leave vote reflects an overreach of the EU and that the referendum in the UK should be a wake-up call for EU leaders. They should take the opportunity to rethink the allocation of competencies between the EU level and national levels. Beck likewise views Brexit – and the impending loss of British voting rights – as an opportunity to fix the institutions of the Eurozone.

Concluding remarks

The future is an unknowable place, as the old saying goes. No can anticipate where the Brexit vote will take the UK and the EU. The alternative that seems most sensible from an economic perspective is the Norway option. It may well be that the UK government could make this palatable, despite the free movement of people, by bundling it together with a very thorough set of policies to help the UK citizens who have been left behind by globalisation, technological advances, and European integration. Maybe we could call it the ‘EEA plus anti-exclusion’ option (EEA+AE).

If this came to pass, the main economic policy outcome of the Brexit vote would be simple. The UK would end up with more influence over its trade, agricultural, and regional policies, but less influence over the rules and regulation governing its industrial and service sectors. Brexit, in other words, would end up as a ‘sovereignty own-goal’ on economic policy. It is also possible that even the Norway option would lead to the break-up of the United Kingdom. Scottish political leaders may exploit the opportunity to achieve their long-time goal of independence. In short, even the best outcome is likely to be problematic.

Is there any way back from Brexit?

Watching UK politics over the last month should make everyone hesitate before proclaiming what is and is not possible politically. Things that seem obvious today may sound crazy in two years and vice versa. But leaving aside the politics, would it be a good idea to revisit the Brexit vote?

The key flaw in the June 2016 vote from a public policy perspective was that it allowed people to say what they were against without forcing them to say what they were for. When Norwegian voters rejected EU membership in 1994, they knew that the alternative was the EEA (now known as the Norway option). Why shouldn’t UK voters decide whether EU membership is better or worse than whatever the government is able to negotiate over the next two years?

Indeed, once the realities of the best alternative to membership firmly displace the wishful thinking that currently surrounds much Brexit analysis, the sitting UK government may decide that it should present the UK voters with a slightly more sophisticated multiple choice question – one that would allow them to choose between EU membership and territorial integrity of the UK on the one hand, and the best alternative arrangement available to the UK on the other. This might seem wise if the alternative were going down in history as the prime minister who broke apart a union that has been in place since 1707. The other EU members would have to play along with this, but it might suit them as a means of dampening the anti-EU parties in their own nations.

Making the best of it

But all this is speculation that may be relevant years down the road (or not). In the meantime, Brexit means Brexit. I believe it is important for economists to help the UK government respond to the many challenges that the Brexit vote has raised and to work towards achieving the best possible alternative to EU membership.

Brexit Beckons: Thinking ahead by leading economists

Contents

Introduction

Richard E. Baldwin

Brexit: The vote and the voters

1 Brexit and globalisation

Diane Coyle

2 Brexit realism: What economists know about costs and voter motives

David Miles

3 Lousy experts: Looking back at the ex ante estimates of the costs of Brexit

Nauro F. Campos

Trade policy and the City

4 The UK’s new trade priorities

Angus Armstrong

5 UK-EU relations after Brexit: What is best for the UK economy?

Swati Dhingra and Thomas Sampson

6 The Ten Commandments of an independent UK trade policy

Simon J. Evenett

7 Negotiating Britain’s new trade policy

Jim Rollo and L Alan Winters

8 Brexit: Lessons from history

Nicholas Crafts

9 Brexit – what happens to banking?

Patricia Jackson

10 The implications of Brexit for the City

Michael McMahon

Labour issues

11 Immigration – the way forward

Jonathan Portes

12 Brexit and wage inequality

Brian Bell and Stephen Machin

13 This backlash has been a long time coming

Kevin H. O’Rourke

14 How to prevent Brexit from damaging the EU

Paul De Grauwe

15 Brexit and labour markets

Barbara Petrongolo

Scotland and Northern Ireland

16 Brexit – a view from north of the border

Ian Wooton

17 Ireland and Brexit

John FitzGerald and Patrick Honohan

Issues for the EU

18 A month after the Brexit vote: More turmoil to come

Thorsten Beck

19 The EU must adapt to survive

Charles Wyplosz

References

Ashcroft, M. (2016), “How the United Kingdom voted on Thursday… and why", 24 June.

Clarke, Stephen (2016), “Why did we vote to leave? What an analysis of place can tell us about Brexit,” Resolution Foundation,

Endnotes

[1] The Norway option does not include free trade in food, participation in EU agriculture subsidies, or in the EU’s regional policy, nor does it require Norway to adopted EU trade policies with respect to non-EU nations.