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Commentary and Updates from Friends First Chief Economist Jim Power
A few weeks before I sat my Leaving Cert exam, Ireland took the bold step of joining the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) without the UK, thereby breaking a long-standing one for one link with sterling. This was a very brave move for Ireland and one that subsequently caused many problems during periods of sterling weakness in particular. Two days after my son finishes his Leaving Cert, another potentially momentous development for Ireland in terms of its relationship with the UK could occur.
On June 23rd the UK electorate will go to the polls to decide if the UK should remain a part of the EU, which it has been since Ireland joined in 1974. If the UK electorate votes to leave the EU, it could have potentially significant implications for the UK, the EU and Ireland.
An interesting question to pose is why David Cameron pledged to hold such a referendum in the first place. The obvious answer is to silence ‘pesky Eurosceptics’. Ever since the UK joined the EU it has had a very shaky relationship with the system. Indeed, the shaky relationship with Europe dates back much longer than that. For the Tory party in particular, the relationship with Europe has been a constant thorn in the side of the party. Indeed it arguably caused the demise of Margaret Thatcher and John Major, and caused massive problems for their successors, including the incumbent Prime Minister.
The fact is that the Tory party has been and continues to be deeply divided by the European question. The anti EU brigade in the Tory party and indeed in broader UK society have a strong sense of the former might of the British Empire and yearn for the country to re-attain its previous position of power in global affairs. They tend to believe that EU membership has weakened the country and hence should be ended. There is also the more real opposition to and antipathy towards the regulations that emanate from Brussels, and the contribution that the UK makes to the EU budget.
It is argued that leaving the EU would allow the UK to become powerful again; free itself from the shackles of EU regulation; and free up money to be used domestically. In reality, it is far from clear that a decision to leave the EU would achieve any of those objectives.
Brexit would not be good for UK trade. It is estimated that 47 per cent of UK exports go to EU countries, and just 7 per cent of EU exports go to the UK. Hence, the EU market is much more important to the UK than vice-versa. The UK makes a gross contribution of £20 billion to the EU budget, but receives £10 billion from the EU in Agricultural and other payments.
If the UK electorate were to vote to leave the EU, a process of negotiation would begin to determine what sort of relationship the UK would have with the EU henceforth. This process could take many years. Options could include agreements similiar to Norway, Switzerland or Canada.
It is not clear what sort of relationship would be negotiated with the EU, but it is clear that if the UK wanted access to the EU market, which presumably it would, it would still be bound by many of the regulations and financial commitments that it is in theory trying to break free from. There is also considerable concern for UK agriculture, as it would lose CAP payments, and this is already causing land prices to decline.
If the electorate does decide to leave the EU, it would cause immense short-term problems for the UK economy. The longer-term consequences would depend on the type of trade deal agreed and how the UK structures its economy. The French in particular would hardly be in a mood to give the British too many concessions. Quite frankly, the Brexit proponents do not make a lot of sense, putting it mildly.
The short-term negative economic impact is playing out already in the UK. GDP growth slowed to just 0.4 per cent in the first quarter of 2016 and the year-on-year growth rate declined to 2.1 per cent, which compares to 2.6 per cent a year ago. While global economic and financial turbulence would have taken their toll in the early months of the year, it is clear that Brexit uncertainty did contribute. Industrial activity is at its lowest level since 2013; commercial real estate transactions are reported to be down 40 per cent in the first quarter; land prices and sales fell sharply in Q1; and the Bank of England has warned that many UK companies are putting business decisions on hold until after the referendum on June 23rd.
For Ireland, any semblance of economic slowdown and uncertainty in the UK is not good news. The reality is that despite the trade diversification that has occurred since 1999 and the advent of the euro, the UK is still a very important trading partner for Ireland, and particularly for indigenous exporters. Last year exports of goods to the UK totaled €15.5 billion, and service exports were roughly the same. The Food & Beverage sector is particularly exposed, as the UK accounts for over 41 per cent of exports from the sector. We imported €17.8 billion worth of goods from the UK, and €10 billion worth of services. These are significant numbers.
The EU is based on the creation of a zone where there is free movement of goods, people and capital. If the UK were to leave the EU, there would be a significant question mark over the future of all free movement, particularly goods. Of more immediate concern however, would be a further slowdown in the UK economy and a further weakening of sterling. Both would damage Irish exports to the UK, increase imports, and damage the attractiveness of Ireland as a destination for UK tourists. Since November, sterling has lost almost 15 per cent of its value against the euro, although it has regained some strength in recent weeks as the markets are betting that the UK electorate will opt for caution and vote to remain part of the EU. If the risk of Brexit were to increase or materialize, sterling could easily fall another 15 per cent. This would not be good news for Ireland.
Other issues of uncertainty would include:
There is a possibility that if the UK left the EU, it could pursue a much more aggressive policy on corporation tax, thereby challenging Ireland’s undoubted primacy in that area. I also believe, that if Britain leaves the EU, Ireland would become much more vulnerable in its efforts to stave off the pressure from France and Germany to increase the 12.5 per cent corporation tax rate.
On the upside, with the exception of Malta, which is not a serious competitor of Ireland’s on the FDI front, Ireland would become the only English speaking country in the EU, which could boost investment from the US. We could also see some movement of financial services activity from London to Dublin.
However, on balance, in the short-term Brexit poses many more risks than opportunities for Ireland. Longer-term, the impact would be heavily determined by what sort of trading agreement is reached between the EU and the UK. It would not be possible for Ireland to negotiate bi-lateral trade deals with the UK, unless every EU member state was to agree. That could be problematical, because the remaining EU countries might not adopt a very conciliatory approach to the UK.
Of course Ireland would adjust and adapt in the longer-term, but in the short-terms the risks are clear. The best outcome would obviously be a vote to stay in, but it might be hoped that in the event of such a vote, the EU would actually reform itself and address the many shortcomings that the flawed EU structure obviously has. In the event of a UK vote to leave, similar reform would be necessary to offset the possibility of other countries following the UK out.
There might just be some upside longer-term regardless of what way the vote goes on June 23rd.
(This publication is based on data available up to 18th May 2016).