The AQA Business Studies A level Buss 4 exam is coming up, and Section B (a 50 minutes essay) is rumoured to perhaps contain a Brexit question. Jim Riley, former businessman and consultant turned on line business academic, runs the excellent Tutor2U website with his twin brother. It covers business and humanities subjects and as well as briliantly assembling a knowledge bank offers sound advice on structuring exam question responses. He lists the various subjects covered already in the Section B past papers – margers, integration, planning, innovation etc. – and points out that European business is one of the few subjects not covered yet. It’s time may have come.
With that in mind I constructed – and answered myself – a possible Brexit question using Jim’s recommended layout of intro – 3 points (2 for 1 against) – conclusion. Here it is:
“In the event of a vote to leave the EU, would the risks of economic shock for the U.K. outweigh the benefits of controlling our borders to reduce immigration?”
In the upcoming Referendum the people of the U.K. will vote on whether to remain in, or leave, the European Union. The E.U. is a collection of 27 independent countries with a population of 500 million. Trade within the EU is governed by the Single Market, in which there are very few trade barriers or tariffs between members, and where trade agreements are negotiated on-bloc to the rest of the world. Any reduction in Single Market access is likely to affect trade and cause uncertainty in financial markets, which may in turn diminish public finances. In the EU there is free movement of goods and services, and also people for employment. This means that a dis-benefit of membership is reduced control over who settles in Britain, leading to an increase in net migration in recent years, which both changes the nature of the U.K. and itself puts pressure on public services. In this essay we will examine some of the possible economic shocks of Brexit, and balance that against benefits of getting back control of our borders.
First let us examine trade barriers associated with Brexit and their effect on individual companies. The medium term economic risk of leaving the EU will be to reduce U.K. firms’ access to the Single Market. The impact will be to inhibit trade and increase trade barriers, in three respects. First financial tariffs, which U.K. firms may have to pay to export to EU countries; second the complexity and uncertainty of doing business with Europe would increase; and third inability for a prolonged period to strike new trade deals to replace EU deals as they unwound. If we examine Porter’s 5 competitive forces, new entrants to markets find it difficult to compete against existing companies if high barriers to entry exist. Brexit would create these barriers. This would reduce the ability of U.K. firms to compete against for instance German and French rivals, specifically new growth business would be difficult to secure, and existing business exports lost. Decisions on investment size and location would be at risk.
What evidence have we that trade might be more difficult? At a high level, the German finance minister has confirmed that Britain would be excluded from the Single Market, while President Obama of the U.S.A. has said that Britain would be at the “back of the queue” in developing a U.K. independent agreement with the U.S.A. At a very local level, the former leader of the Republic of Ireland has said it is likely that trade tariffs would have to be introduced for products coming across the Northern Irish (UK) border into Eire. Tariffs vary – for instance 32% on wine, 4% on gas, and around 10% on cars and wheat, but typically they might average around 5% which would make UK products 5% more expensive when selling into Europe. Companies would either increase their prices accordingly to maintain profit margins – but this would risk losing sales volumes – or cut costs by 5%; for instance their labour costs. An example of the increased complexity of doing business post Brexit is the risk to the “financial passport” which the UK financial services sector has by being in the EU. This would put at risk the attractiveness of London as a financial centre for banks, insurances and currency trading.
So in summary the threat to individual companies of Brexit would come through trade barriers, tariffs and market access which would make individual UK firms un-competitive. Collectively, this would produce an economic shock to the UK.
If the economic case against Brexit is compelling, why as we approach Referendum Day is the Leave campaign pulling ahead in the polls? The answer lies in one word – “immigration” – and one phrase “get back control of our borders”. Net immigration is running at about 300,000 each year. This means that the difference between gross immigration (600,000) and emigration i.e. people leaving, around 300,000, is about 300,000 net and has been increasing since the end of the 2008 recession as demand for labour has picked up. Free movement of labour is legally binding in the EU and so when David Cameron tried to win concessions from the EU before the vote, all could he achieve was a restriction on immigrants claiming benefits rather than a restriction of numbers per se. The attraction of the UK has increased to migrants as the minimum wage (the lowest wage employers must pay to employees) has risen. The rise of EU immigration has had economic, business and social effects. First, economically, more immigrants have increased pressure on social services like the NHS social housing and schools, at a time when budgets are already under pressure. Businesses need a supply of labour and are tempted to take the cheapest labour from Europe, and this in turn has a social effect. Namely communities especially on the East Coast are changing, with many different nationalities for instance Polish beginning settle and open their own supermarkets. The Leave campaign asserts that a way of addressing these issues is to “get back control of our borders” by leaving the EU, thus eliminating the requirement to accept immigrants without a proper assessment of their skills and suitability. This will be especially important as the EU expands in future, possibly taking in countries like Turkey and Albania which are nearer trouble spots in the Middle East. This security issue makes it ever more important to control our borders.
In summary the case for controlling our borders and hence immigration rests on difficulty in providing social services, a desire to preserve the UK’s ethnic mix, and worries about the future security of the UK. The Leave Campaign argues that the only way to address these issues is to leave the E.U. This is so important that any short term economic problems, if they arise, are insignificant especially if we no longer have to pay our EU membership fee of around £350 million a week, as advertised on the Leave Battle Bus.
Now let us use this membership fee to compare against macro-economic risks and assess whether a U.K.–wide economic shock would occur. The fee amounts to £18 billion a year. A rebate of £5 billion occurs immediately leaving a net £13 billion payment. Our public expenditure is £750 billion a year so this represents 1.7% saving. Our Gross Domestic Product (GDP, the sum of all economic activity in the U.K.) is around £2000 billion so the saving would be 0.7%. Both of these savings are significant but how certain are the savings and would they be offset by economic risks of EU withdrawal? We have argued above that individual companies would find it more difficult to trade with the EU post Brexit. This in turn would reduce sales revenues and hence profits of U.K. companies, collectively meaning less corporation tax would be paid to the Government, and that jobs would be lost and unemployment would rise. This fall in Government revenues coupled with increased demand for unemployment benefit would lead to inability to balance the UK finances, which would require public national debt to rise, unless income tax rose or services like welfare or health care were cut. The evidence to support this is that several independent economic forecasting bodies such as the Institute of Fiscal Studies (IFS), the International Monetary Fund, the Organisation of Economic Development and the Bank of England, have been warning of the economic effect of “Brexit”. There will be a short term shock and long term permanent shrinking of the economy. For instance the IFS have estimated that the negative effect of Brexit will create a £20 billion – £40billion fall in available public finances. This more than offsets the £13 billion gain. Taking a £30 billion midpoint, the net loss would be £17 billion, or 2% of public spending and 1% of GDP – indicating a recession. The Chancellor has claimed he will need to propose a short term emergency budget to increase taxes and lower public spending in reaction to these forecasts. He also has said that long term by 2030 the economy would be 6% smaller than otherwise would be the case, meaning a £4,300 loss of GDP per person. Other evidence for a shock very close to the date of the referendum is that share prices on the FTSE 100 index and value of the pound have fallen in correlation with the polls favouring Brexit, which leads to uncertainty in the markets. Finally it is not certain how much of, or when, we would get the $13billion back, especially if some savings were maintained to preserve trade deals.
Summarising, the collective impact of companies’ difficulty in trading post Brexit would be both a short term shock and long term drag for the UK, which would offset the benefits of regaining the membership fee.
In conclusion I believe that on balance the high risks of economic shock following Brexit outweigh the benefits of reducing immigration for the following reasons. Leaving the EU would create barriers to trade for companies from a variety of factors like tariff increase and loss of trade agreements and this would in turn diminish competitiveness and restrict investments. The collective sum of these difficulties would mean a diminishing of the total public finances which the majority of economists agree would significantly outweigh the savings of the membership fee. Forecasts are difficult and vary but the common factor of most is the sign – “negative”. The impact will be tax rises or spending cuts or increased debt – none desirable. However, this does not mean that staying in the EU should proceed without change. If immigration continues at its current level forever then clearly the U.K. would eventually, literally run out of space, and so I recommend that if the U.K votes to stay in the EU it uses its 2017 Presidency of the EU to continue the case for reform. The most important argument for remaining is to avoid a recession and more austerity, caused by financial uncertainty and inability of companies to trade as they did before in Europe.