Keith Savard
Adjunct Fellow
Banking and Capital Flows and Capital Markets and Finance and Global Economy and Public Policy and Systemic Risk
Keith Savard is a fellow at the Milken Institute. He has extensive executive management experience with expertise in evaluating the interrelationship between economic fundamentals and activity in global financial and commodity markets. He also has a background in sovereign risk analysis and applying a disciplined economic approach to investment-portfolio decision-making.
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Brexit: What Price Sovereignty?

By: Keith Savard
April 11, 2017

British Prime Minister Theresa May’s government publicly believes that a smooth transition from the European Union is possible without excessive costs or dislocations.

Critics regard the government’s view, initially set out in a February white paper, as overly optimistic if not downright delusional. However deep the flaws in May’s vision, Brussels faces its own set of dilemmas at the outset of negotiations. Not the least of them is the pressure to deal with Brexit in a way that strengthens the integrity of the union without inflaming conservative nationalist movements simmering across the continent.

Some analysis of how Brexit might play out supports the government position. Open Europe, a nonpartisan, independent think tank, forecasts a limited net impact on the UK’s economy. This conclusion stems in part from the investment stimulus created by eliminating a plethora of EU regulations which, in turn, will help offset the cost of stricter immigration rules.

But from a practical standpoint, the price of regaining full and unconditional sovereignty will likely be high. Having only two years to complete the withdrawal leaves little time for UK officials to negotiate a satisfactory resolution of many complex issues. This raises the likelihood of a “hard” exit lacking agreements on trade and access to financial markets. Moreover, the amount of time available to complete Brexit will be figuratively squeezed by tough negotiating by the EU.

The costs of a hard exit are highly speculative at this point. The UK Treasury warns that it could cost Britain 66 billion pounds a year. GDP might fall by as much as 9.5 percent over 15 years if trade with the EU reverts to World Trade Organization rules. An MIT study shows a similar outcome with the increased cost of trade with Europe — which accounts for roughly half of all UK trade — reducing the level of commerce as well as foreign investment.

Less attention has been paid to the price that the European Union may face as a result of Brexit. The cost of trade for the EU could be significantly higher than for the UK, according to the think tank Civitas. Manufacturers and farmers would likely be hit the hardest, with tariffs reaching as high as 40 percent. In aggregate, EU exporters potentially could pay twice as much in post-Brexit tariffs, £12.9 billion, than UK exporters would pay for goods entering the EU. In addition, the accounting and consulting firm PWC has warned that the cost of fragmenting financial services as a result of a hard exit could be significant for the EU. According to PWC, the EU imported 31 billion euros worth of financial services from the UK in 2015. This flow represents a reasonable approximation of Europe’s financial reliance on the UK. Although a great deal of these services could probably be replicated within the EU, the time and costs involved could mount quickly.

While history is replete with examples that show the cost of achieving and maintaining sovereignty for a nation state, the past offers little guidance when a supranational organization like the EU is part of the calculation. Faced with questions of its own usefulness and benefit to its members, the EU is likely to take a hard line with the UK to deter other countries contemplating a break with the union. However, being excessively uncompromising could create economic and financial problems for the EU itself. This may embolden right wing political parties who have capitalized on discontent by arguing that the EU leadership and their apparatchiks are more interested in their own welfare and power than the citizens they serve. In an Ipsos Mori survey published earlier this year, respondents in France, Italy, Belgium and Hungary scored higher than Britons in nativist sentiment and were more likely to say the “system” is broken. They also were more worried about the impact of immigration on jobs and social services. If the EU mishandles Brexit, we will likely hear louder discussions of Frexit, Itexit and more.


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