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Preface

In a world struck by enormous issues, countries look to fight wars on the basis of strength of
their economies. Various situations are witnessed across the globe almost every day. These
include poverty, illiteracy, unemployment, population growth, gender inequality, poor health
facilities, environmental abuse, and lack of harmony amongst different communities. Such
economic problems might lead to unexpected events. An example of one such event has been
the recent BREXIT (Britain Exit from the European Union).

My research entirely comprises on this issue that has affected a huge number of global
economies. The primary reason for working on this project is because I’ve always been
interested in pursuing business studies which specifically includes my passion for economics.
Hence I wanted to apply my knowledge of economics to practical scenarios and working on a
research project was one of the best ways to do it.

Brexit has had various economic, social, and political impacts. The particular influence on the
United Kingdom and the European Union has been discussed in detail. I hope that you find this
research useful when it comes to analysis and understanding of different economic decisions.

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Contents
Causes
Political…………………………………………………………………………………………………………………….3

Economic………………………………………………………………………………………………………………….3

Religious…………………………………………………………………………………………………………………..4

Social………………………………………………………………………………………………………………………..5

Sovereignty……………………………………………………………………………………………………………….6

Referendum Voters……………………………………………………………………………………………………8

Effects on the UK
Political………………………………………………………………………………………………………………………10

Economic……………………………………………………………………………………………………………………11

Immigration……………………………………………………………………………………………………………….15

Effects on EU
Political………………………………………………………………………………………………………………………17

Economic……………………………………………………………………………………………………………………17

Effects on other countries……………………………………………………………………………20

Future Prospects………………………………………………………………………………………….24

References…………………………………………………………………………………………………..25

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Causes
Political:

UK joined the EEC (European Economic Community), which was later changed into the
European Union, on 1 January 1973 under the leadership of their Prime Minister, Edward
Health who was also the leader of the Conservative Party at that time. Soon after the decision
was taken, the opposition Labour Party, led by Harold Wilson, contested the October 1974
general election with a commitment to renegotiate Britain's terms of membership of the EEC
and then hold a referendum on whether to remain in the EEC on the new terms. Although it
initially failed to convince the public but later on it changed its policies and kept on resisting
UK’s membership of the EU. Another Eurosceptic political party known as the UK Independence
Party (UKIP), emerged in 1993. It too continued to challenge UK’s decision of continuing to stay
in the European Union. Eventually the British Prime Minister, David Cameron, announced a
referendum date of 23 June 2016. Several campaign groups were formed including the Vote
Leave, Leave.EU, Grassroots Out, Better Off Out, and Commonwealth Freedom of Movement
Organization.

Economic:

The UK did pay more into the EU budget than it got back. The British government spends about
772 billion pounds ($1.1 trillion) a year, but no item in the budget gets people more angry and
divided than the 10 billion pounds it pays to the European Union.

The EU has its own small budget to cover the cost of supporting farmers, depressed regions,
and some businesses. All 28 member countries contribute to the budget, and 11 -- including the
U.K. -- are net contributors, paying in more than they receive in EU-funded programs.

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The Treasury's European Union Finances release provides the best figures for the UK’s
contributions to the EU budget, according to the ONS. The figure above demonstrates that the
net contributions made by the UK were steadily rising in the past few decades and eventually
reached a total of 8.5 bn pounds in 2015.

The Treasury and ONS both publish figures on the subject, but they're slightly different. The
ONS also publishes other figures on contributions to EU institutions which don't include all our
payments or receipts, which complicates matters. The ONS figures ultimately come from the
Treasury, and the numbers aren't the same because they categorize and account for the
payments differently. The European Commission is still another source of information which
shows lower contributions.

The contributions are determined by a number of factors, including the size and health of
national economies, and tax receipts. Based on the formula, the U.K. should have handed 18.7
billion pounds to the EU in 2014, the latest year for which actual numbers are available.
However, the country gets a special discount, or rebate, which was negotiated by Prime
Minister Margaret Thatcher back in the 1980s.

In 2014, this discount was worth 4.4 billion pounds, which brought the U.K. contribution down
to 14.3 billion. But the U.K. doesn't just give money to Europe; it also receives funds from the
budget. The country gets subsidies to support farmers, as well as funds for investment,
research and other items. Overall, the U.K. got 4.6 billion pounds in 2014, meaning its net
contribution to the EU was 9.8 billion. That amounts to about 188 million pounds a week -- far
less than the 350 million a week claimed by some campaigners trying to persuade Brits to vote
to leave the EU in a referendum on June 23.

Vote Leave, the lead 'Brexit' campaign group, was reprimanded by the independent watchdog
for official statistics for using the higher figure and suggesting the money could be spent in full
elsewhere. Britain was the fourth highest net contributor to the EU behind Germany, France
and Italy. However, the economic and other benefits it received cannot be ignored.

Religious:

Both Muslim and Christian communities within the UK have shown diverse stances when it
comes to remaining within the European Union. The campaign by “Muslims for Britain” pushed
the idea that the country should exit the EU. Its rationale was that if the UK does so, there will
be increased and freer trade with Commonwealth nations like India, Pakistan and Bangladesh.
On the other hand, there were Muslims who insisted that the UK should remain. Their rationale
was that Muslims are much safer when they live within a diverse community and any leave

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decision means more growth of Islamophobia. Proponents of Brexit argued that only by staying
outside the EU can the UK effectively restrict immigration and control borders. The anxiety of
unbridled immigration is not only being afraid of losing employment opportunities to
foreigners, but also the fear of terrorist attacks being carried out by Muslim extremists having
EU citizenship. Many of these terrorists went to Syria to do jihad and then returned to the EU
and its travel freedoms. The last is restricted by the refusal of Britain to join the Schengen
passport-free zone. It means that any foreigner who wishes to enter the UK is liable to be
checked. However, it is seen that most terrorists from inside the EU can enter Britain with ease.

Like the Muslims, there was also a schism among Christian communities. The “remain” vote
was favored by Roman Catholics. The “leave” vote was favored by most Protestants. According
to Alison Milbank, a professor of theology, the origin of the EU is divine as it promotes
cooperation among nations. In contrast, Lord Carey, the past Archbishop of Canterbury
provided biblical evidence of the UK leaving the EU. He quoted from book of Exodus, comparing
the liberation of Israel from Egypt, adding that this situation will permit Britain to govern its
own borders and enact laws suited to Britain. The debate on religion on the subject of Brexit is
simply not concerned with theology or faith. It also reveals a number of concerning issues like
diversity, fear, unity and safety. These concepts formed the core of arguments of both sides .

Social:

Immigration was another deciding factor. Since remaining in the EU meant that citizens could
freely move to different member countries so UK was faced with the problem of a huge inward
migration because it was a country with a number of opportunities to be explored. People
primarily came for employment which not only reduced jobs for the locals but also increased
the amount of unemployment benefits the UK had to pay every year. Moreover, some of the
migrants did not add value to the economy. Since they were from a certain ethnicity; they
found it difficult to adjust. Language barriers existed and as mentioned before, the ease of
movement facilitated crime from different communities. Increased population put additional
pressure on public services that resulted in difficulties for the local population.

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As shown in the diagram above, there has been an increase in the rate of inward migration
since the gradient of the curve has continued to rise. This led to proponents arguing on how UK
could control the net immigration particularly from the EU member states if it decides to leave.
The Vote Leave campaign didn't say so overtly, preferring to talk of a Leave vote helping Britain
"take control" of the rate of immigration rather than how far they could cut it by. Their
campaigners cast a vote to Remain as a vote for "uncontrolled immigration", making hay with
the Prime Minister's struggle to fulfill his net migration pledge and implying that Leave would
rein it in. Boris Johnson did as such back in March, warning that Mr. Cameron's failure to get it
under control was "deeply corrosive of public trust". At the end, Lord Ashcroft's Election Day
poll of 12,369 voters also discovered that 'One third (33%) (Of leave voters) said the main
reason was that leaving “offered the best chance for the UK to regain control over immigration
and its own borders.

Sovereignty:

The United Kingdom is considered a conservative society by many. Though many countries have
managed to preserve their culture despite of being in the EU, UK felt left out. Britons’
comparatively less European self-identity and lower trust in the EU may have come about for
the following reasons. First, Britain is the only allied European power not to have
been occupied during the Second World War. Second, Britain has its own common law legal
system, which contrasts with the civil law system of continental Europe. Third, because Britain
has an established church, most British Christians have historically owed their allegiance to a
national institution headed by the monarch, rather than to an international institution headed

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by the Pope. Fourth, Britain is an island whose surrounding waters have partially isolated it
from cultural developments on the continent.

On the day of the referendum Lord Ashcroft's polling team questioned 12,369 people who had
completed voting. This poll produced data that showed that 'Nearly half (49%) of leave voters
said the biggest single reason for wanting to leave the European Union was “the principle that
decisions about the UK should be taken in the UK”. The following graph is a representation of
how the UK population felt as being a part of the European Union.

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Despite of having freedom to trade; a separate language; currency; religion; and cultural
identity, a high percentage of UK population were still not convinced and were ready to vote for
independence.

Referendum Voters:

A referendum - a vote in which everyone (or nearly everyone) of voting age can take part - was
held on Thursday 23 June, to decide whether the UK should leave or remain in the European
Union. Leave won by 52% to 48%. The referendum turnout was 71.8%, with more than 30
million people voting. It has been argued that the result was caused by differential voting
patterns amongst younger and older people. According to Opinium, 64% of eligible people aged
18–24 voted, whereas 90% of eligible individuals over 65 voted.

This is an important aspect that needs to be discussed since there is clear evidence that a
higher percentage from the 65 year plus age group voted. This means that the older segment
was a little more inclined to leave the EU rather than stay. This might be due to various reasons.
National identity is a powerful force in all this – and it comes into play when thinking about why
older people seemed more inclined to vote to leave the EU. The immigration issue is primarily
about threats to identity and culture resulting from people coming into the country without any
apparent controls. Most people saw Brexit as a way of tackling that – which trumped economic
concerns.

When it comes to the costs and benefits of the EU, perceptions vary according to whether or
not you are someone who wins or loses in the global system. Surveys showed 64% of graduates
were planning to vote to remain compared with only 25% of people with no formal
qualifications at all. Some 58% of people in professional and higher management jobs wanted
to remain compared with only 27% of people in unskilled jobs. Not surprisingly, high-status
individuals with marketable skills favored UK membership of the EU, whereas people who
lacked these skills and were vulnerable in the labor market were opposed.

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The same applies across the regions of the country. People in relatively prosperous regions such
as London supported remain, whereas people in poorer areas such as the North-East of England
opted to leave. The evidence is pretty clear that reducing tariff barriers and harmonizing
regulations across countries stimulates trade and creates jobs and prosperity. But if most of the
gains from this go to the affluent and skilled and many of the rest are left behind, then the
losers in the globalization process will challenge the whole idea.

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Effects on UK
Political:

The political scene in the UK went through substantial change and shock after the referendum.
After the result was declared, David Cameron announced that he would resign by October. In
the event, he stood down on 13 July, with Theresa May (leader of the Conservative
Party) becoming Prime Minister. George Osborne was replaced as Chancellor of the
Exchequer by Philip Hammond, Boris Johnson was appointed Secretary of State for Foreign and
Commonwealth Affairs, and David Davis became Secretary of State for Exiting the European
Union. Labour leader Jeremy Corbyn lost a vote of confidence among his parliamentary party
and a leadership challenge was launched, while on 4 July, Nigel Farage announced his
resignation as head of UKIP.

In terms of British officials in EU institutions, commentators agree that mid-level officials on


permanent contracts would probably be able to continue in their roles. However, according to
Pierre Bacri, president of the European Civil Service Federation, director generals and UK
officials in top management positions would likely have to leave (which may explain why some
British officials are looking into Belgian citizenship). That might well apply to Commissioner Hill
as well. Article 50 says nothing on the matter.

Furthermore, although there is no legal reason why the UK cannot hold the EU presidency in
2017, our speakers considered this politically untenable. A House of Lords report notes that
Article 50 disqualifies the UK ‘from chairing any Council meetings on the withdrawal
negotiations – meetings that would no doubt form a significant part of the Council’s activities’.
A re-allocation of the presidency could cause some practical difficulties for the EU, given that a
plan set for 2007– 20 ensures each member state holding the presidency once, for six months.
Hix predicts that a reshuffling of EP committee chairs would occur during the withdrawal
negotiations. It would be deemed unacceptable for British MEPs to chair committees as
relevant to the withdrawal negotiations as those on the Internal Market (trade and access) and

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Civil Liberties, Justice and Home Affairs (free movement). By contrast, Kenneth Armstrong
argues that, aside from the loss of British judges, Brexit will not significantly affect the Court of
Justice.

Economic:

Before the referendum, economists were in near-unanimous agreement that a vote to Leave
would hit the economy. And as predicted, the first three weeks turned out to be torrid. The
pound fell by one-tenth against the dollar; the FTSE 250, an index of domestically focused firms,
went down. Alongside the now-familiar turmoil in financial markets, there is growing evidence
that the real economy is slowing.

Figure 1 Figure 2

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The two graphs shown above (labeled as figure 1 and figure 2) demonstrate the reasons behind
depreciation of pound after the Brexit. Depreciation occurs when the value of a currency in
terms of another currency falls. This means that after Brexit, the value of pound, in terms of
other currencies such as dollar and euro, fell. This depreciation as shown by the graph was
caused due to two factors. The first as shown by Figure 1 is an increase in the supply of pounds
(from S1 to S2) whereas the other shown by Figure 2 is a decrease in the demand for pounds
(from D2 to D1). An increase in supply is indicated by a shift in the supply curve towards right.
According to the basic laws of economics, an increase in supply or a decrease in demand for a
commodity causes the price of that good to fall. In this case, that commodity is the currency or
the UK pound. The increase in supply of pounds means that the pound is available to a greater
number of consumers. Both these changes might be a result of different factors such as:

 Uncertainty. Leaving the EU created uncertainty amongst investors. This discouraged both
portfolio flows and inward investment. Therefore, there would be less demand for buying
Pound Sterling to invest in the UK.
 Fall in exports. Since the EU countries were major importers of UK goods, the decision of an exit
discouraged some of those members to trade leading towards a fall in exports and a decrease
in the value of pound.
 Lower domestic investment. The uncertainty over the change in trading conditions discouraged
domestic firms from investing, leading to lower economic growth.
 UK current account. The UK has a large current account deficit, which is financed by net capital
inflows, such as portfolio investment and capital investment flows. If these inward flows
decline, the Pound falls to correct the imbalance on the current account.
 Loss of access to Single Market. One of the attractions of the UK as a place to invest was access
to the Single Market, which enabled foreign companies to be able to export from UK to Europe
without tariffs and non-tariff barriers. Since UK left the Single Market, it made more attractive
for companies to choose a country which is in the Single Market. This possibly led to a relative
decline in UK inward investment and reduced demand for Sterling.
 Speculation. Speculators, who felt that the value of UK shares would fall after the Brexit, might
have sold their shares which lead to an increase in supply of pounds.

Despite of all these factors, it must be considered that a depreciation of currency is usually
followed by appreciation. This is because the decrease in value of pound will mean that exports
of UK become cheaper and hence more competitive. This means that demand for UK exports
shall increase in future causing an eventual increase in the demand for pound. As a result, the
value of pound will be expected to rise in the long run. Moreover, it is possible that the UK
remains in the single market after negotiating attractive trade deals with Europe.

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The depreciation of currency was followed by a contraction of the GDP growth (as shown by the
graph above) since the growth rate fell from 0.6% to 0.2% after Brexit as stated by the National
Institute of Economic and Social Research (NIESR). All EU countries lose income after Brexit. The
overall GDP fall in the UK is £26 billion to £55 billion, about twice as big as the £12 billion to £28
billion income loss in the rest of the EU combined. A fall in GDP growth means reduced
economic activity. This further means that people decrease their demand for goods and
services. Since businesses suffer from reduced sales, in order to maintain the same level of
profits or for profit maximization, they need to cut back on costs. Hence, businesses reduce
their costs by cutting back on the demand for labor which leads towards a rise in
unemployment. Similarly, the rate of unemployment rose after Brexit because of the fall in
economic activity. An increase in the level of unemployment might lead towards a number of
problems such as payments of unemployment benefits, a fall in the amount of tax received
from the employed, and an increase in the crime rate.

Furthermore, the situation of imports and exports might worsen due to the imposition of trade
barriers such as tariffs, quotas, embargoes, and different rules and regulations. Earlier the UK
could trade freely with any country that was a part of the EU but now either side is eligible to
restrict trade through barriers. The first case would be that of a tariff, a tax on imports.

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The effect of a tariff is clearly shown in the diagram above. When an economy levies a tax on its
import, it causes the price of those imports to rise (in this case from Pworld to Ptariff). The rise
in price causes a movement along both demand and supply curves. Since the demand
decreases and the supply increases, the overall quantity demanded decreases and hence the
imports are reduced from Qs1Qc1 to Qs2Qc2. A similar situation might take place if the EU or
the UK imposes a tariff on its imports.

Similarly quota is a limit on imports. Hence if a quota is imposed with a lesser quantity limit, it
will certainly cut back on the quantity of imports. An embargo, a ban on imports, and rules and
regulations will have the same effect leading towards a rise in trade costs and a decrease in the
quantity of imports.

But Brexit would not necessarily mean that the UK would make zero contribution to the EU
Budget. In return for access to the single market, EEA members such as Norway make
substantial payments to the EU. On a per capita basis, Norway’s financial contribution to the
EU is 83% as large as the UK’s payment (House of Commons, 2013). Therefore, in the
optimistic case we assume that the UK’s contribution to the EU budget falls by 17% (that is,
0.09% of national income). These effects on UK’s living standards are summarized in the table
below.

Optimistic Pessimistic
Trade Effects -1.37% -2.92%
Fiscal Benefits 0.09% 0.31%
Total change in income per -1.28% -2.61%
capita
Income change per -850 pounds -1700 pounds
household
Source: CEP calculations (see Dhingra et al, 2016, for technical details)

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Immigration:

Although the effect of Brexit on immigration cannot be determined in a short time span of a
few months, it is likely that the number of EU residents entering the UK will decrease. About
3m EU nationals are in the UK and they make up about 6.6 percent of the workforce. David
Cameron told EU nationals living in Britain there would be “no immediate changes in your
circumstances” in his resignation speech on Friday and Boris Johnson made a similar statement.

Even in the longer term, experts say it is likely that those already here will be allowed to stay.
For a start, 71 percent of them have been here for five years or more (based on 2015 data),
which means they qualify for permanent residence. The rest will probably have their rights
“grandfathered” so they can stay too, according to comments made by prominent Leave
politician during the campaign. However, there will still be tricky questions to resolve about
whether EU residents in the UK will have the right to bring over family members, for example.

Similarly, the Brexit debate has caused profound unease among Britons living in the rest of the
EU. Whether on Spain’s Costa del Sol or in the villages of southern France, UK nationals fear
that many of the services and privileges they enjoy-such as easy access to the public health
service and pension portability-will come under scrutiny now that Britain is set to leave the EU.

Mariano Rajoy, the Spanish Prime Minister, had also warned, “leaving the EU would mean that
British citizens would lose the right to move freely, work and do business in the largest
economic area, the largest market in the world”.

As indicated by the graph above, the number of EU citizens entering the UK has been on the
rise but UK’s withdrawal is likely to put question marks on the trend.

Establishing some form of free trade agreement is vital to offset some of the cost of
withdrawal. However, the Norwegian and Swiss models of EU association (which are the most
advanced trade arrangements the EU has with any non-members) illustrate that accepting the
principle of EU free movement of people may be the ‘price’ the UK has to pay in order to gain

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liberal access to the single market. UK could potentially adopt different immigration policies to
alter the mix of imported skills, nationalities and enforce border control, such as a new visa
regime or rules on intra-company transfers.

From a trade policy perspective, placing restrictions on the movement of labor is likely to be
negative since restricting the potential labor supply would mean that the UK economy would
react differently to future growth opportunities. For example, limiting labor supply could make
the UK less competitive by raising wages and prices. If this happened at the same time as the
UK opened up to free trade and new low-cost competition from emerging markets in India and
China, some UK-based businesses could find it even harder to compete.

Another way to increase the UK labor supply is to boost the numbers of UK-born people in
employment – through better education and skills. This is another policy lever already available
to the UK – one which has very little to do with the EU.

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Effects on the EU
Political:

Brexit would set a new and awkward precedent. It could trigger chain reactions, such as a
backlash against any notion of ‘ever closer union’, even where this makes obvious sense, as in
the areas of defense, foreign policy, defending the external boundaries of the EU, and certain
aspects of environmental policy. Brexit could also encourage national exit movements
elsewhere. The anti-EU mood in many EU member states, as reflected in the growing strength
of nationalist, nativist, and populist parties in the EU, should not be underestimated. There
could also be a rise in regional separatism (e.g. in Flanders, Catalonia, the Basque country or
Northern Italy). The rejection of any form of supra-nationalism exemplified by Brexit could also
further increase cross-border bail-out fatigue in particular in the Eurozone.

The Scottish are threatening to hold their own referendum to separate from the UK and remain
in the EU. Scottish independence is one thing, but to remain in the EU is to surrender their
independence and become subservient to Brussels. Ireland wants a referendum to unite North
and South. That will probably only result in civil war.

When the markets crash in Europe as Brussels tries to outlaw short selling to prevent markets
from going against the politicians, Britain will remain the place to do business and the euro will
suffer. The banks were just doing what the establishment told them to do. The threats that
banks would leave makes no sense whatsoever.

As a result, there would be a material risk that the terms of access of the UK to the rest of the
EU following Brexit (as regards the movement of goods, services, capital, enterprises, and labor)
would be much worse than those of Norway, Iceland, and Switzerland. This would not just (or
even mainly) be because a non-EU member wanting closer relations with the EU is likely to be
treated better than a former EU member that has seceded from the EU. The need to prevent
the UK’s exit from the EU from creating a precedent would likely produce tough and damaging
terms of access of the UK to the rest of the EU. ‘Pour decourager les autres’, the rest of EU
would want to make it abundantly clear that it is not possible for an existing EU member state
to exit and continue to enjoy most of the benefits of EU membership but none of the costs.

Economic:

Although we have focused on the UK, the fall in trade also affects other countries. Figure 1
shows the distribution of changes in income per capita across countries in the optimistic and
pessimistic scenarios. All EU members are worse off: Ireland suffers the largest proportional
losses from Brexit, alongside the Netherlands and Belgium. Countries that lose the most are
those currently trading the most with the UK. Some countries outside the EU, such as Russia
and Turkey, gain as trade is diverted towards them and away from the EU.

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Altogether the EU loses between -0.12% and -0.29% of its GDP which is offset by a 0.01%
to 0.02% gain for non-EU countries. These seem small percentages, but the rest of the
world’s GDP is, of course, much bigger than that of the UK. So whereas the UK loses
between £26 billion to £55 billion from Brexit the rest of the EU is collectively £12 billion to
£28 billion worse off.7 The ‘Brexit shock’ is almost half as big in the rest of the EU as it is in
the UK. The graph below illustrates these effects.

Along with the US and China, the UK is currently one of the most important trading partners for
the other EU states. In 2010-2014, total exports to the UK were 2.9% of EU’s GDP, and total
imports from the UK were 2.4% of GDP. Trade in goods such as cars, machinery, and chemicals
dominates the EU’s trade volumes with the UK, constituting about 70% of total exports and
imports of goods and services. In goods trade, most EU’s member states are running a sizeable
surplus with the UK, in total 0.6% of EU’s GDP in the past five years (see Figure 1). This surplus
almost disappears, however, when accounting for foreign value added in exports, which was
30% in 2011 for EU’s goods exports to the UK and 23% for UK goods exports to the EU’s,
according to OECD data. In services trade, most EU’s countries are running deficits with the UK,
amounting to a total of 0.2% of GDP. This is almost entirely driven by financial services, while
deficits of the EU’s in other parts of services trade are offset by surpluses in tourism.

Leaving aside indirect effects and temporary bumps during the negotiation period, a symmetric
10% one-off decline in exports to and imports from the UK would lead to a one-off reduction of
EU’s GDP by 0.05% (based on current account data), with negative effects from goods trade
outweighing net positive effects from services trade. Subsequently, trade growth would likely
be lower than otherwise, increasing the potential losses over time. The damage would be a bit

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more severe in the manufacturing hubs in central and eastern Europe as well as in the tourism
hotspots in the Mediterranean.

To minimize potential economic losses, the EU might focus its post-Brexit negotiation strategy
on free trade for all goods and some services like tourism, where it is running a surplus. By
contrast, limiting UK-based financial firms’ access to the EU’s internal market for financial
services might set in motion an import substitution process which may eventually benefit at
least some EU’s member states. However, financial services trade barriers would still be
disruptive at least in the short run given the UK’s near-monopoly in some sectors. If the rest of
EU states fail to replicate the UK’s financial services productivity, they would end up
permanently worse off when ignoring the short-term Keynesian (demand-driven) benefits.

One lesson from the turbulence of the past eight years is that financial links transmit economic
calamities from one country to another almost instantaneously and often amplify the original
shock. Avoiding a financial crisis is also likely to feature high on the list of the EU’s negotiation
priorities. In the case of Brexit, the stakes look particularly high, with the UK exposures of EU’s
banks, companies, governments and households dwarfing those to Greece in 2012. And even
those were sufficient to throw the Eurozone economy into extended turmoil. With UK assets
held by EU’s residents worth nearly half of the EU’s GDP (based on ONS international
investment position data), a complete breakdown in relations could easily reduce EU’s wealth
by a few percentage points of GDP and, in some cases, put additional strains on already-
challenged financial systems.

A financial crisis remains unlikely in our view and the economic cost-benefit calculus of Brexit
might not even be entirely negative for the EU’s. For example, EU’s member states may try and
usurp the UK’s position as the EU’s most popular destination for foreign direct investment. Over
the past 15 years, the UK has received more than 20% of inward EU FDI, but without full access
to the EU’s internal markets, future FDI flows into car factories or financial services hubs that
would have gone into the UK had it remained a member of the EU might be redirected and
create jobs elsewhere in the EU’s.

The Brexit impact on the rest of the EU via trade and finance will depend on the follow-on
agreement between it and the UK. A number of models exist: Norway’s, Iceland’s, and
Liechtenstein’s membership of the European Economic Area (EEA) or Switzerland’s European
Free Trade Area (EFTA) agreement come close to full membership of the EU’s internal market.
Only EEA membership would guarantee free mobility of labor, while EFTA membership can
include it (and in the case of Switzerland, does). A Turkish-style customs union would cover
most goods trade sectors, but the Swiss and Turkish models crucially exclude financial services.
Free trade agreements such as those with Mexico or South Korea would also establish free
access to the EU’s internal market, at least for goods trade. The extension of such agreements
to the UK may face political obstacles, but at least the economic damage could be minimized.

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Effects on other countries
A few immediate consequences seem highly likely:

• The flight to safety away from the epicenter of this British-EU divorce will push capital away
from the region and toward key safe-haven markets including the U.S.—especially Treasuries—
and to Japan. This will further lower market interest rates and raise relative currency values.

• A higher U.S. dollar and Japanese yen are negative to both economies’ export sectors. In the
case of Japan, this is particularly unhelpful to its efforts to reinflate and reinvigorate the
economy after decades of deflation.

• The higher U.S. dollar also triggers additional pressure on China to float the Yuan lower, as it
is caught in the divergence between its two largest export markets—the EU and the U.S.

• For the U.S., the negative impact on exports is relatively small compared with trends in
domestic demand, but the deflationary pressure on tradable goods will widen the divergence
between reasonably strong inflation in the services sector vs. reasonably strong deflation in the
goods sector.

• The European Central Bank will be compelled to raise its level of intervention yet again, as risk
premiums across the region rise. Among the larger Eurozone members, Italy is in a particularly
vulnerable position—now made more vulnerable. Each blow to members of the Eurozone
periphery also further make Germany’s outperformance in the Eurozone even more
unsustainable.

• While no one could have foreseen the exact sequence of events, especially those of a
fundamentally political and social nature, the general arc of the global macro economy
continues to follow a basic configuration, and we will continue to use that pattern as the guide
for our global base case scenario. Among the key elements of our base case scenario as they
are affected by the Brexit vote:

• The U.S. remains the most stable major global economy, but the uncertainty spread between
the U.S. and the EU has now increased. This further tilts macro conditions to the favor of the
U.S. market vs. the EU. But this relatively bullish view (emphasis on the word “relatively”) is
tempered by the signs of an increasingly mature economic cycle. Stability means the U.S. may
expand longer than the other major economic regions, but it will not remain immune from
negative global pressures that have just become more negative. The uncertainty may create
additional incentives for the Fed to reconsider any nearer-term rate hikes.

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• The Eurozone’s expansion cycle has been relatively weak and has mainly benefited from
coming off a low base. We had earlier cautioned that this cycle is likely to be relatively short.
The Brexit vote will probably chill European banks’ appetite for risk, supporting the notion that
this expansion cycle may be cut short.

• The Eurozone (and now the broader European Union) faces profound fractures in the
structures that hold it together. We continue to expect some level of Eurozone breakup over
the medium term (i.e., not next year, but before 10 years) in our base case scenario for the
region. Underlying this thesis is recognition of the shearing forces to the Eurozone macro
economy, but the overlay of the political and social environment potentially fills in the narrative
of how an economic potentiality may become reality.

• China faces further negative pressure on growth rates. The bulk of deceleration pressures are
intrinsically of domestic origin. However, the likely need to counterbalance an even bumpier
global environment will further slow progress toward a new, slower but stronger economic
model. The inward turn of the Chinese economy that we anticipated in our base case scenario
may be facilitated or accelerated by similar inward turns implied by the emerging political and
social climate in other parts of the world.

• Businesses in some major Asian economies - particularly India and Japan- will be hit. Japan
Inc. employs around 140,000 people in the UK and has about $59bn (£40bn) invested there. Big
Japanese car manufacturers like Toyota have already said a Leave vote may lead to 10% duties
on UK-made cars being sold in the EU. Currently, Toyota exports almost 90% of the cars it
manufactures in the UK - and three quarters of those go to the EU.

• Asian companies which have set up operations in the UK to gain access to EU markets will also
have to reassess. Japanese electronics firm Hitachi, for one, has said it will rethink its UK
operations in the event of a Brexit. Over in India, the focus is on technology firms. Together, the
UK and Europe account for over-a-quarter of the country's IT exports, worth around $30bn.
We've also heard from one of India's most prominent t business houses - the Tata Group -
which has been operating in the UK since 1907. In a statement to the media, it said there are
currently 19 independent Tata companies in the UK, with diverse businesses. It also said that
"access to markets, and to a skilled workforce will remain important considerations".

• As world markets endure uncertainty after Brexit, analysts are predicting that the UK’s vote to
leave the EU will have a relatively small impact on Pakistan’s economy. Yet in the immediate
aftermath of the UK’s decision to leave the EU, Pakistan’s stock markets fell by over 1400
points, spurred by panic in the country’s auto and textile sectors. The EU is the
most important trading bloc for Pakistan, accounting for 21.2 percent of Pakistan’s total
exports. The UK additionally is the source of almost 20 percent of total remittances into
Pakistan, while the rest of EU accounts for 3 percent of total worker remittances. A weaker
pound means bad news for migrants working abroad as well as their families living at home. So

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far, both countries enjoy favorable bilateral relations and there is a good chance that Pakistan
will be able to extract a promising trade agreement with a post-EU UK. However, during this
transition period, both Pakistan’s businesses as well as the government will face challenges as
the picture of UK and the EU remains blurry.

• Only a few economies in Asia would see a noticeable effect on growth, Martin said. Examples
include Cambodia, Vietnam and particularly Hong Kong, which have stronger trade ties with the
U.K. Nevertheless, Asian business leaders are watching the process of how the UK transitions
out of the EU very closely. If there is a material impact on EU economies, Asia won't escape
unscathed.

• In general, this recent event reinforces our view that we will continue to be in a period of
heightened political volatility reflected everywhere from Russia to Spain to the U.S. in the
upcoming election run-up.

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The picture above shows an article published in the MORE magazine which discusses the
negative impacts of Brexit on Pakistani freelancers.

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Future Prospects
As we see it, the impact on global growth and inflation on the cyclical horizon is likely to be
relatively small – and almost certainly not large enough to push the global economy into
recession. Even if the UK fell into a recession, which is a distinct possibility, the direct knock-on
effect on global GDP through lower UK import demand would be minimal as the UK accounts
for only 3.6% of global imports of merchandize goods and 4.1% of global imports of commercial
services.

In addition to the direct trade effect, business investment around the globe is likely to be
dampened somewhat due to the heightened uncertainty about the global implications of Brexit
and the tightening of financial conditions. If in doubt, companies will delay investment projects
to assess how Brexit could affect them. For the Eurozone, which would obviously be most
affected by Brexit after the UK, Nicola Mai estimates a negative impact on GDP of around 0.3%.
The effect on the U.S. and other regions would likely be smaller.

However, the long term effects of Brexit will largely depend on how the UK reacts to the
situation. Its economic policies will be the deciding factor; if it manages to negotiate with the
European Union on proper trade terms such that the GDP and the total value of goods traded
does not fall by much, the economic impact will prove to be nominal. On the other hand, the
situation might also worsen in case both the UK and the European Union fail to agree on the
same terms.

UK is still in the process of leaving the EU so it needs to ensure that decisions are taken based
on the global economic situation. The same will apply to the European Union. Overall, the
world would be better off if drastic changes do not occur and resources are utilized in the best
possible way.

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