Brexit Worries Already Hurting UK Economy As Uncertainty Hits Business Confidence

According to the vast majority of economists, a British exit from the European Union would be a calamity, knocking down growth for years to come. And some of them now say the mere idea of it is already exerting a negative influence on the United Kingdom’s economy.

The avenue for the debate over “Brexit,” as a British departure from the EU has become known, is business confidence. How can business plan for the future if the country is seriously discussing how it might shred one of the organizing principles behind the 21st century British economy?

“There are tentative signs that uncertainty related to the EU referendum is already having an effect,” said Daniel Vernazza, an economist with UniCredit in London.

U.K. consumer confidence is stable, but business confidence has ebbed recently, Vernazza pointed out. Investment intentions have also eased in recent months, and nonfinancial companies are hoarding cash. And finally, the trade-weighted exchange rate of the British pound has declined for the last three months and the Bank of England is starting to turn up anecdotal evidence that the referendum is one factor in the slide, Vernazza noted.

The uncertainty isn’t going away anytime soon.

Prime Minister David Cameron, who leads the Conservative Party, has embarked on the biggest gamble over Britain’s role in Europe since the country voted in 1975, in a referendum, to stay in what later became the European Union. At a mid-February meeting, other EU chiefs will pass judgment on a package of changes to the U.K.’s rights and responsibilities within the union, a sweetener that Cameron hopes will persuade Britons to endorse continued membership in a referendum, probably later this year.

If voters reject British membership, a mixture of domestic law and European rules will create a two-year window in which the country can renegotiate the terms of its relationship with the union. Polling suggests the vote will be close, with a slight advantage for the pro-EU faction.

“The British electorate has on balance generally been more pro- than anti-EU, particularly over the past couple of years,” Peter Dixon, an economist with Commerzbank in London, wrote in a research note.

A rejection of the European Union would open a Pandora’s box of self-inflicted problems for Britain, first by exacerbating existing economic problems. Then, it would shred the legal framework behind Britain’s international trade in goods — currently 40 percent of GDP, according to the World Bank — and the financial services that are central to London’s role in the world economy. And the country would stand little chance of recreating these advantageous relationships outside the European Union.

UniCredit estimates that an exit would cost Britain 6 percent of its GDP, the equivalent of a searing recession, even if spread out over several years. The advantages of Brexit, such as the end of contributions to the EU budget, would be “small beer” by comparison, according to UniCredit.

The British economy is currently recovering from a long phase of tepid growth and government-imposed austerity, with the Bank of England contemplating the timing of higher interest rates. It has avoided tighter credit thanks to inflows of foreign capital, and is particularly dependent on trade with the 19 countries that use the euro, who are collectively its largest trading partner. And immigrants, whether they moved to Britain for work — thanks to the EU’s freedom-of-movement rules — or simply to buy an expensive London townhouse, have brought to the U.K. purchasing power and an expanding workforce.

“Every element of Britain’s economy is vulnerable if Brexit is added to the conversation,” said Carl Weinberg, chief economist at High-Frequency Economics.

The effects of leaving the EU would fall most heavily, from a policy perspective, on international trade rules.

Brexit, Vernazza wrote in a research paper, “would tear up the U.K.’s current economic and political ties with by far its closest and largest neighbor, the EU, but also with the rest of the world too.”

Countries that join the EU delegate trade policy to Brussels, which wields a sway in international negotiations that’s comparable only to the United States, and perhaps China, because it represents 28 countries. Those countries share the same set of obligations, such as tariff levels, as part of a customs union. A widget shipped from China to Athens faces the same tariff as one coming through London.

So, by departing the EU, Britain would have to design and negotiate with other countries — without the weight of 27 other European countries — new trade agreements with virtually every other country in the world.

In short, the notion that Britain can leave the EU — but still benefit from the “single market” that binds the countries together — isn’t a realistic option. Charles Grant, president of the Center for European Reform, has pointed out that Britain doesn’t even have its own trade policy staff. And the politics of a negotiation with 27 other countries would be hazardous at best.

“In none of our scenarios would the cost of leaving the single market and the EU customs union be offset by merely striking a new trade deal with the EU,” Open Europe, a think tank in London and Brussels, wrote in a recent analysis of Britain’s options.