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Can Brexit Bring Back Growth?

Jul 8, 2016

It is now more than a week since the shocking Brexit referendum. A lot is still unclear. Who will lead the country? What is the long-term economic impact? What is the future of the EU?

In the era of global prosperity, it was easy to sell the idea of open markets and globalisation. There was enough cake to go around. The last few decades have seen increased integration and trade between countries. Developing economies have benefitted from this trend.

Today, however, we are seeing the rise nationalism in many parts of the world. The outlook for growth is poor. And the middle class is wary of a technological shift. It is natural to view open borders and trade deals with skepticism.

The history of the EU dates back to 1993. The idea of a united Europe was very relevant in a post-war world. It was thought to reduce the risk of political tensions and create a large trading area where goods and services could move freely. It would also provide a single currency - insulating consumers from exchange risk in this region. The tradeoff was the free movement of labour, loss of monetary control, and adherence to a common framework of trade regulations.

The union today consists of 28 countries. Countries such as Norway and Switzerland do not use the euro but have a special status in the union.

The key drivers of the Brexit debate were (and still are) trade and immigration. The 'Remain' camp believes that leaving the EU will cut access to a large market and hurt trade. The 'Leave' camp is disgruntled by open borders and the perceived loss of jobs to immigrants.

The Norwegian model

The 'Leave' campaign has highlighted the Norwegian and Swiss models as the next step. This choice is hard to understand. This model retains access to the free market, but it has to adhere to a smaller subset of EU laws.

However, it still allows the migration of people within the Schengen area. In other words the access to the EU market comes with the price of free movement of people. Not ideal for the 'Leave' camp. More importantly, Norway has no vote in the framing of trade laws, which the UK does (or at least currently does).

Setting a precedent

The indications are that UK will lose access to the single market. It would be harmful for the EU to go easy on Britain. Any concessions regarding the free movement of people will result in similar requests from other members.

The very idea of the EU - free movement of goods, services, people, and money - would be in jeopardy.

What next?

The UK will go through a protracted period of uncertainty - to negotiate the divorce. But Brexit is hardly the panacea that people are expecting. The stemming of immigration will not create jobs, and the loss of the single market is temporary. The UK can still negotiate terms (albeit worse) with the EU and other countries to ensure that they can still participate.

And ultimately, Brexit alone will not determine long-term growth. Productivity drives growth. The productivity of capital and labour will decide the economic future. Technological innovation, a young and educated work force, and policies that spur entrepreneurship will decide long-term growth.

Access to markets and control over borders will have an impact - but nowhere near the impact of the fundamental drivers...

This column is authored by Nitin Gregory. Nitin, who graduated from IIM-Calcutta, is currently pursuing a finance role with an automotive major. He has a deep interest in Macroeconomics and pens a blog at Gregonomics.

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