David Cameron’s unexpected majority in the May elections thrust the UK into the spotlight, and his promise to hold a referendum on the UK’s membership in the EU by the end of 2017 prompted uneasy speculation about consequences for business. Fears of a “Brexit” have been exaggerated by comparison to the current Greek exit (“Grexit”) negotiations. However, for most businesses, this analogy is misleading. Brexit is neither as likely nor as threatening as Grexit.
Rather than a consequence of economic conditions, the push for UK separation from the EU is driven by voter perception that EU membership restricts sovereignty. During the financial crisis, this message was championed by newly emerged populist parties that campaigned on an anti-EU, anti-immigrant platform, thereby taking advantage of Britons’ economic insecurity.
FSG considers a Brexit unlikely, but the very uncertainty surrounding the referendum will lead to delays to non-essential investment in the near term, which may in turn reduce economic growth. For most companies, this may be the primary worry.
However, companies that operate in heavily regulated industries, or that are highly dependent on trade between the UK and EU should carefully assess the consequences of Brexit. This particularly applies to firms in industries such as manufacturing, pharmaceuticals or finance. Such companies can engage in a scenario planning exercise to gauge and communicate the impact of a Brexit to major business functions well in advance. Good planning will limit disruptions and encourage better decision-making as a result of institutional clarity on next steps should the unexpected occur.
Staying in the EU: Minor EU concessions make an “in” vote likely, resulting in a return to the status quo in 2017
As part of his strategy to co-opt demands for EU exit, Cameron pledged to renegotiate the UK-EU relationship in the run up to the proposed referendum. While campaign-headline issues such as a Parliamentary say on EU decisions are too contentious for the proposed 2017 time frame, Cameron and EU leaders could easily settle on smaller “wins”. Agreements on restriction of immigration from future enlargements, integration of service markets, or reduction of red tape would be straightforward. While some easy wins may actually boost trade, on balance, there is little reason to believe that any concession will meaningfully affect business in the UK.
In the event of small concessions, or especially with a plan to make more substantial treaty changes, an “in” vote is likely, given the dominance of pro-EU actors. Polls show that voters – as well as a strong majority in Parliament, the ruling Conservative party, and the business community – largely favor staying in the EU, particularly with a renegotiated UK-EU relationship. Such a vote should lead to a rapid recovery of investment spending in the short term, and continued muddling through towards EU harmonization in the longer term. A return to the status quo ante is expected.
Brexit: Drawn out negotiations risk an “out” vote
Despite being business-friendly, the Conservative party does not uniformly support EU membership. In fact, about one third will pressure Cameron for a hardline stance on issues such as immigration. Moreover, he will have to be careful when selling any accord to euroskeptic voters and MPs to ensure support for his desired “in” vote.
Unfortunately, any delay is a threat to business planning stability. National elections in France and Germany loom in 2017, and will significantly reduce EU leaders’ ability to offer concessions. Ineffective negotiations will draw out the period of uncertainty, but worse, could lead to a referendum being held before any concessions can be offered. In such a vote there is a real chance of Brexit.
Implications of an “out” vote
An out vote is unlikely not only because the upside is so minimal, but also because the downside is both so uncertain and so potentially troubling. Because the UK has maintained its own currency, the primary concern in lengthy exit negotiations would be regulation and commercial access to the single market. Given the UK’s position as a major trading partner for the continent (approximately half of exports), agreements on maintaining low tariffs and non-tariff barriers are likely, whether through the European Free Trade Area or a new bilateral accord.
In an optimistic scenario, trading relations between the UK and EU stay relatively constant, and regulations remain comparable going forward. Still, the lengthy period to arrive at the new status quo would create uncertainty about the new rules and regulations, reducing investment and export. Economic growth would be reduced by as much as 1% per year in the process.
In a pessimistic scenario where less favorable trade terms are reached, the UK would see companies move their operations to the European continent as a result of reduced harmonization between the two currency areas. Hardest hit would be automobile and heavy manufacturing, pharmaceuticals, and financial services, which account for large proportions of UK trade. In these scenarios, losses from diverted trade and reduced productivity would bear a substantial portion of the loss.
In addition, leaving the EU could undermine the cohesiveness of the UK itself. The Scottish National Party (SNP), which took an overwhelming majority of Scotland’s votes in the May election, strongly favors EU membership, but is less keen on staying within the UK. Separation from Europe could prompt a separation of the United Kingdom itself, creating additional difficulties for business planners.
Actions to take
Although a Brexit is unlikely, companies can act now to ensure that a turbulent negotiation period does not disrupt their business. FSG is recommending that its clients take the following actions now:
- Contingency plan: Companies active in the industries most impacted by UK-EU trade – automobile and heavy manufacturing, pharmaceuticals, and financial services – should began preparing now for any infringement on the benefits of free trade
- Maintain good UK-EU relationships: Executives should ensure that their teams are maintaining and improving good relationships with partners and customers on both sides of the English Channel. This can help to preserve sales even as broader political economic conditions deteriorate
- Keep calm, and manage expectations: Companies outside of the industries most impacted by trade should still take note. The uncertainty that impending negotiations will inflict upon business planning and investment decisions will reduce economic growth in the lead-up to 2017. Executives should manage expectations for economic and sales growth targets in the UK, which has otherwise outperformed Europe