Brexit Is a Bad Trade

June 3, 2016

On June 23, the United Kingdom holds a referendum on whether to walk away from the European Union. A look at the island nation's tangled web of global trade relationships highlights just how damaging a potential "Brexit" could be.

Rising from the ashes of World War II, the European Union is among the most successful efforts at sustained international cooperation in human history. It has also resulted in major economic benefits to the United Kingdom during its 43 years of membership.

A look at the island nation's tangled web of global trade relationships highlights just how damaging a potential ‘Brexit’ could be.

As part of Britain's proposed exit from the European Union, the United Kingdom would be leaving a successful free trade agreement in order to pursue something else. A question that should be contemplated by all of the "Leave" voters in favor of Brexit is: What might that something else be?

Consider this question in two parts, since about half of current UK exports go to the EU market and the other half go to the rest of the world.

First is the United Kingdom's future relationship with the European Union. The most likely outcome has the United Kingdom negotiating a new free trade agreement to be able to continue to export to the European Union. The prototype agreements are those that other EU nonmembers Norway and Switzerland have negotiated with the continent.

The downsides of this approach for the United Kingdom are what should give pause to Brexit voters. Despite choosing not to be EU members, Norway and Switzerland enjoy only small cost savings relative to the United Kingdom, as they also make sizeable fiscal payments into the EU budget in order to obtain duty free access to the European common market for their goods and services. The same would be expected of the United Kingdom.

More importantly, and unlike what the United Kingdom currently enjoys as an EU member, Norway and Switzerland have no say in the European Union's internal rulemaking process. For example, they have no role in determining what standards are necessary to protect EU consumers from harmful products, employees from harmful working conditions, or the environment from degradation. Equally importantly, this also implies that Norway and Switzerland have no ability to stop proposed regulations that are unnecessary.

For their part, Norway and Switzerland are also required to adopt many of the regulations and standards legislated in Brussels simply for the right to export duty free to the EU market. In an increasingly integrated global economy, the political sovereignty that these countries "enjoy" from being outside of the EU turns out to provide them little practical freedom to regulate outside of the norm.

Furthermore, and again unlike the United Kingdom's current situation, Norway and Switzerland also have no influence on the decision of which EU standards should be exported globally. This is important because the scope of European influence is at the heart of the European Union's current trade negotiating agenda with the rest of the world.

The first major problem with Brexit is that the United Kingdom ends up trading coveted influence over future standards-setting—both in Brussels and globally—for a scenario in which it is excused from the regulatory conversation and simply becomes an adopter of the standards that are determined elsewhere.

Second, consider the United Kingdom's future trading relationship with the rest of the world. Even outside of Europe, modern trade agreement negotiations are centered around high-income countries seeking to influence the process by which these product standards, environmental protections, and worker rights are being determined.

Take the United States—the United Kingdom's single largest export market. The current US negotiations with the European Union under the Trans-Atlantic Trade and Investment Partnership (TTIP) are focused almost entirely on the redundant or sometimes contradictory regulations that proliferate across these two "high-standards" jurisdictions. For their parts, the United States and the European Union have managed to achieve substantial progress in reducing barriers to trade within their own respective markets; the United States and the European Union are now negotiating over how to do this across the Atlantic. These negotiations are hard. But if an agreement is reached, due to the size of the combined market, many of the standards and ways in which future market conditions are regulated under the deal are expected to be exported globally.

Somewhat ironically, at the same time that some in the United Kingdom are asking out of the European Union, the rest of the world's top negotiators are saying now is the time to engage more!

Finally, in the event of Brexit from the European Union, would the United Kingdom be able to negotiate a separate trade deal with the United States? Any such agreement is unlikely in the near term, as Washington already has two major trade initiatives in the pipeline. In addition to the negotiations with the European Union, it is navigating the politics of congressional ratification of the Trans-Pacific Partnership (TPP)—an almost equally "high standard" agreement—signed in February with Japan, Canada, and nine other Pacific rim countries. Indeed, as President Barack Obama stated in a joint press statement with Prime Minister David Cameron during his recent visit to London, because any trade agreement at this stage is such a "heavy lift" politically, any potential for a UK-US trade deal in the event of Brexit would involve the United Kingdom having to get "at the back of the queue."

Unfortunately, a fundamental law of economics is diminishing marginal returns. Applied to international economic cooperation, this principle implies that additional meaningful acts of cooperation that the United Kingdom is seeking from EU partners are both harder to achieve and are likely to result in smaller improvements than past efforts at reform.

This is surely part of the frustration facing UK voters contemplating Brexit. Being an integral part of the EU project—where so much success has already been achieved—also makes it more difficult to push forward. However, there is a substantial difference between unrealized (but small) gains from failures to achieve more progress when compared to the potentially large losses to the United Kingdom from abandoning international cooperation as under Brexit.

In the modern global economy, going at it alone is an unproductive path.

For in the modern global economy, going at it alone is an unproductive path. Brexit would involve the United Kingdom giving up a prominent seat at the decisionmakers' table as negotiators resolve exactly how to tackle 21st century trade agreement issues. For what?