Washington Trust Bank Blog | Explaining Brexit

Explaining Brexit

On June 23^rd the United Kingdom will vote on whether to remain within or exit the European Union (EU).  If they vote to leave, will the effect be positive or negative? The EU is independent of the Eurozone (EZ), of which the UK is not a member, hence the British use of the pound sterling (£) instead of the euro (€). The EU, formerly called the European Economic Community (EEC) or the Common Market, was formed in 1957. The group was created post World War II at the urging of Winston Churchill to reconcile France and Germany and to build stronger economic ties. However, Britain did not join the original Union, hoping to preserve bonds with both the US and the Continent. Later, Charles de Gaulle vetoed Britain’s application, twice, but the UK eventually joined in 1973, after de Gaulle had left power.

So from the onset, Britain has had difficulty with membership, and initiatives to leave the Union have sprung up over the years led by both conservatives and liberals at various times. The current vote was initiated by British Prime Minister David Cameron in response to a campaign promise to renegotiate Britain’s EU membership and later hold a referendum. He currently leads the camp to remain within the EU. Joining him are his Conservative government colleagues, as well as the Labour Party, the Liberal Democrats, and the Scottish National Party. They argue that leaving the trading bloc-—and single market access for duty free trade and financial services-—would hurt the economy.

The exit camp led by Michael Gove, the justice minister, and Boris Johnson, the former mayor of London, is supported by nearly 50% of the Conservative members of Parliament and the UK Independence Party. One need only look at the economic trauma within the EZ and the relative strength of the British economy to see why the call to leave has vigor.

However, most economists believe the UK will be weakened by exiting the Union. Even economists who support an exit vote feel the break would initially hurt. Although, they believe Britain would be better off by 2030 due to the reduced regulation on consumers and business. The parting would enable the UK to pursue its own economic and political policies. Britain would also be better able to control its borders, a growing issue because of the European Migrant Crisis. Nevertheless, Britain seems to benefit from European immigration. European immigrants pay much more in taxes than they receive in benefits.

Regardless, there is more to this vote than economics. To many, the vote is about sovereignty. Britain has always viewed itself distinct from the Continent. Historically, the British have fought to keep a hegemony from developing in Europe. Just in the last two centuries it has allied with central European powers against France (Napoleon) and later allied with France against central European powers (WWI and WWII).

So, the June 23^rd vote will determine whether the UK exits the European Union. If the British vote to leave, a two-year negotiation with the EU over terms will ensue. Most of the negotiations will center on trade, where Britain will try to retain favorable access to EU markets. The EU is Britain’s largest trading partner. Brussels, for its part, will probably be less than cooperative in an attempt to dissuade other countries from withdrawing.

For the US, the economic impact from a Brexit would be minor. For the capital markets, a departure would raise uncertainty which could lead to a temporary sell-off in equities and a flight to quality (e.g. Treasuries). More concerning is the potential rise in nationalism and protective trade policies over the long term. This shift could diminish global trade, leading to lower economic growth, which in turn would reduce corporate profits and stock prices— an unwelcomed consequence for investors.

 

Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.

---