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Brexit – The Impetuous Exit!

Published on August 26, 2016 by Gaurav Rulhan

The UK voted to leave the European Union (EU) on June 23, 2016. British Prime Minister David Cameron stepped down leaving his successor, Theresa May, to decide when to invoke Article 50, which triggers a retreat from the EU.

Young UK understands global competition

Brexit polling numbers showed young voters favored to stay in the EU. However, with the final decision in favor of Brexit, they will now have to live with the consequences. Those aged 18-24 years (of which only 19% wanted to leave) will have to live with the decision for an average of 69 years, while those over 65 years (majority pensioners) will have to live with the decision for an average of 16 years.

Going by these numbers, it is unfair for the future generation to live with a decision they did not make, and they are likely to go to any extent to reverse the decision for a better future.

In addition, the result of the EU referendum is not legally binding, so, in theory, the parliament has the power to reject the will of the people by deciding to stay in the EU. Moreover, Brexit was the result of an “advisory referendum” as opposed to a “binary one,” which has a fixed outcome.

However, the government has an obligation to follow through on the electorate’s will.

Furthermore, young voters are aware about the various ways Brexit would impact the country, primarily economically and politically. The impact of Brexit is discussed below.

Economic stagnation

The simplest way to analyze an economy’s GDP growth trend is to split growth into the following:

  1. Growth in labor input comprising:

    • Growth in the size of potential labor force

    • Growth in the participation of actual labor force

  2. Growth from labor productivity comprising:

    • Growth from capital input and

    • Total Factor Productivity growth (i.e., growth from an increase in productivity in using capital inputs)

The economic trend growth rate is likely to be relatively low (may be negative), as labor growth could be constrained by the country’s immigration policy.

Immigration helps address issues like skill shortages and consequences of an aging population. Free movement allows firms in the UK to access specialist skills, which are increasingly important to high-value-added industries, which is an advantage for the economy.

The UK is the biggest beneficiary of foreign direct investments (FDI) in the EU, and its decision to exit the EU could reduce its appeal as a gateway to Europe, leading to lower investments (capital inputs) from the rest of the EU, the biggest source of FDI for the UK. Following the decision, it may also become difficult for the UK to attract corporates to set up their headquarters in the country. For instance, JPMorgan CEO Jamie Dimon said the bank could move a large number of staff out of Britain if it lost its automatic right to sell financial services to the EU.

Brexit could have a huge impact on the UK and may push it toward recession, as overall investments and labor productivity could take a hit, and the country may never recover from this.

Political isolation

In Scotland, around 60% of the population voted in favor of the UK’s staying in the EU, which is reeling for a second referendum in two years after the final results. Granting Scotland a referendum on independence in order to join the EU could evoke similar national sentiments in Northern Ireland, further disintegrating the wider political environment and isolating England.

In addition, London’s future as Europe’s financial center would face a challenge from cities such as Frankfurt and Paris.

The road ahead – Uncertainty

Currently, the UK does not have a leader to negotiate a favorable deal with the EU. Politicians are playing the blame game. For instance, EU Commission President Jean-Claude Juncker accused Brexit campaigners Boris Johnson and Nigel Farage of quitting when things got out of control.

There is still a lot of confusion as Britain’s government decides whether and how to actually exit the EU. This uncertainty alone could lead to a significant economic turmoil. Moreover, this uncertainty has shattered the confidence of investors.

May, who declared that she would lead the nation out of the EU, has emerged unscathed from the uncertainty and chaos surrounding the referendum. However, many doubt her ability to negotiate a favorable deal for the UK.

The negotiation

A key demand during negotiations should be the retention of access to the single European market, as this protects the industrial base and services industry (particularly London’s vital financial services industry) in the UK. Going by prior events/cases in Norway and Switzerland and the statements of Angela Merkel (German Chancellor), Francois Hollande (French President), and other eastern EU states, the UK will need to give up its desire to impose migration restrictions in order to acquire full market access.

If the UK disagrees, it may be heading for a long recession, and if it agrees, it would defeat the purpose of the referendum (and people who voted to “leave” would feel betrayed).

Brexit may not happen – Second referendum

The only objective of a second referendum would be to conduct a poll on the final deal obtained by the UK in the Brexit negotiation (as suggested by Health Secretary Jeremy Hunt). This course of action, however, could be unfavorable for the UK, as it would upset the UK electorate – the promises by the Brexit campaigners that had lured the Britons into voting for Brexit on June 23 would turn out to be just “castle in the air”.

After that maybe the pensioners believe in age old proverb “United we stand, divided we fall”

The final result of Brexit is clearly uncertain until Article 50 is invoked and the exit is complete. Until then, the UK remains a part of the EU and is subject to the laws of the EU.


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About the Author

Senior AVP, Investment Research

Gaurav is part of the Investment Research / Credit Research team at Acuity Knowledge Partners. He is responsible for managing an investment research team for a leading asset management company.

He has nearly 10 years of experience in investment research, conducting research for asset managers/private equity firms across all stages of an investment lifecycle. In his previous stint at Acuity Knowledge Partners, he led a team serving distressed opportunity funds of a private equity firm and a team for a bulge bracket investment bank.

Gaurav is a CFA Level III candidate and holds a Master of Business Administration (Finance).

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