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Brexit, Stage Left: What is at Stake?

Wells Fargo Economics Group Special Commentary

3 March 2016

“Brexit” fears came to the fore last week as Prime Minister David Cameron scheduled a referendum on the issue for June 23. The British pound subsequently fell to a 7-year low and has since settled around this lower level. This depreciation in sterling likely reflects uncertainty around the implications of a potential British exit from the European Union.

It is impossible to quantify the exact effects Brexit would have on the U.K. economy. However, extensive trade ties, cross-border investment and the free flow of individuals between the United Kingdom and EU member countries could be at risk. London’s status as the financial capital of Europe could also be in jeopardy. Whatever the outcome, there is no precedent for such an event and any negotiations in the aftermath would likely be lengthy and challenging.

Loss of Access to EU’s Single Market Looms

Arguably the most significant issue at stake is Britain’s status as a member of the EU’s “single market,” which allows for the free movement of people, goods, services and money between member states

Norway and Switzerland are not EU members but have gained full or partial single market access.

Norway has gained full access to the EU single market through its membership in the European Economic Area (EEA). However, as a member of the EEA, Norway also must contribute to the EU budget and abide by EU regulations, but does not have a right to vote on these regulations.

Switzerland, on the other hand, has negotiated a series of bilateral agreements with the European Union to gain access only to selected aspects of the single market, including free trade in goods and the free movement of persons across borders.

Investment Outlook at Risk

Given geographical proximity and unfettered movement of capital, goods and services, it comes as little surprise that EU member states account for a significant share of foreign investment in the United Kingdom. Although the share has wavered slightly, EU members have generally accounted for about half of all foreign direct investment (FDI) in the United Kingdom over the past decade or so.

Will London Still be the Financial Center of Europe?

London is often referred to as the financial capital of Europe, and often serves as an attractive offshore base for many foreign banks. Indeed, it is the world’s preeminent foreign exchange (FX) and interest rate derivatives trading hub, having accounted for roughly 40 percent of total daily FX market turnover and about half of all over-the-counter (OTC) rate derivatives turnover as of 2013.

Given the sheer volume of financial services activity that occurs in the City, it comes as little surprise that the financial sector is an important part of the U.K. economy.

What does the United Kingdom have to gain by leaving the EU?

Perhaps the most quantifiable benefit of leaving is that it would no longer have to contribute to the EU budget, at least in theory.

Some proponents of Brexit also argue that it would afford the United Kingdom greater control over immigration from EU member countries, and that perhaps some of the country’s regulatory burden would be eased by leaving the EU.

Plunging into the Abyss

Financial markets have clearly grown increasingly worrisome of the potential for a British exit from the European Union in recent weeks. In our view, this fear is justified. There is little historical evidence we can use as a compass for theUnited Kingdom’s future outside of the European Union. Should Brexit occur, the outlook for economic activity in the United Kingdom is highly uncertain both in the short term and over the longer term. Polls currently suggest a slightly larger share of British citizens favor maintaining membership in the European Union over exiting, and financial markets will likely remain on pins and needles as long as the margin remains narrow.

Read the complete commentary here:  uk-brexit-20160302

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