By Rohit Dhalaria

This article is the second part of a series of two articles by Rohit Dhalaria. Find the first part here.

United Kingdom: The Brexit Shock

The decision to leave the European Union will reshape UK’s relationship with its largest trading partner, the European Union. Based on recent data, 27 member nations of the EU account for 45% of UK’s exports. Membership of EU has certainly benefited the UK by boosting its trade and economy, among the innumerable other benefits.

Through this membership, the UK was able to access the single market. When United Kingdom opted to leave the EU, it relinquished all the benefits accruing from being a part of the single market system. There are a number of reasons as to why Brexit can cause an economic turmoil in the United Kingdom discussed henceforth.

Redesigning The Rules

Firstly, as soon as the United Kingdom ceased to be a member of EU, it no longer remains a part of the single market system. This, in turn, raises the cost of trade i.e. tariff on goods and services. This hike in the cost of trade due to regulatory divergence will hamper the bilateral trade relations between UK and EU nations. Since such costs of trade barriers are generally borne by the consumers and the suppliers, decrement in the volume of trade between UK and EU will hit the UK consumers and business firms.

At the other end of the spectrum, consumers will now have access only to the limited highly priced domestically produced goods and services. On the other hand, UK firms might be reluctant to sell their goods and services across the border due to the trade restrictions, which further hampers their profit margins.

Thus such trade restrictions decrease the output, incomes and living standards in the United Kingdom.

Secondly, until now, UK has been successfully attracting significant amounts of Foreign Direct Investment (FDI), particularly from EU member nations. However, it is highly unlikely that the scenario remains the same in the post-Brexit era. Firms who intend to sell their goods and services to other EU members will start finding the UK less attractive for two reasons. First, since the UK is no longer a participant in the single market system, the firms will now have to bear the cost of tariff and non-tariff barriers when exporting to the rest of the EU. Second, due to the uncertainty over the type of trade relations that UK and EU share in future, the business firms will now be discouraged to invest in the UK. Such reduction in foreign investment means lower employment opportunities for Britons thereby, adversely affecting income and lifestyle choices.

Thirdly, the pre-Brexit time comprises of a majority of UK labour and workforce who are immigrants. They are young, able and willing to work.

These immigrants are the net contributors to UK’s public financing and thus, they help in sustaining the economy of an aging nation, which has a very little native workforce.

These immigrants are the net contributors to UK’s public financing and thus, they help in sustaining the economy of an aging nation, which has a very little native workforce. However in the present times, since UK has ceased to be a part of EU, it has restricted the freedom of movement of labour into its own country. This means that workforce in the UK will now see a major reduction that will further hamper the industrial output. Also, a considerable chunk of government revenue, which was derived from taxing the immigrants, is now lost. In order to restore the balance, UK would now either have to reduce the government spending or increase the tax rates for the native population.

The domino that Brexit began | Photo Courtesy: Google Images

Brexit and the Chinese slump have the influence to initiate a domino effect across the world which can spiral into a global slowdown. | Photo Courtesy: Google Images

A Case of Wishful Thinking?

The propagators of Brexit claim that UK can reach an amicable agreement with EU in order to sustain the British economy. However, analysts have predicted that regardless of the trade agreement adopted by the UK, regulatory divergence and reduced access to the EU market will certainly trigger a process of reduction in industrial output, income, and living standard in the UK, finally leading to a financial slowdown in the nation.

The fact that UK economy is shrinking at the fastest rate since 2009 is an early sign of the impending turmoil.

Connecting The Dots

The world has never been so closely knit. In the present day scenario, no economy can function in isolation. Recession in one country can result in all its trading partners experiencing a similar economic meltdown.

A financial slowdown in China and UK, which are the two major economies vastly connected with the world, can trigger off a domino effect. It could all culminate into a worldwide crisis.

A financial slowdown in China and UK, which are the two major economies vastly connected with the world, can trigger off a domino effect. It could all culminate into a worldwide crisis. This domino effect was exemplified when the Chinese turmoil at the start of 2016 gave the world stock the worst start to the year since the 2008 crisis. Since China accounts for 15% of the global output, it slowing down will impact countries around the world. The countries in South American countries were entirely dependent on Chinese exports are already on the verge of a major economic crisis. Brazil, which is the largest trading partner of China, has seen a 60% fall in Chinese exports in 2016 alone.

The IMF has issued warnings that not only South America but even the Asia-Pacific region would experience an economic shock due to the Chinese slowdown. Countries like Taiwan, Japan, and Australia, which are heavily dependent on commodity exports to China, are facing a slowdown in their own economy due to the decrease in Chinese demand. In the light of China’s economic troubles, Taiwan has slashed down their forecasted growth rate by 1.35% in September 2015. While on the other hand, Japan’s GDP also contracted by 0.4% last year.

The sheer size of the Chinese economy worries economists that the entire world might have to pay for the spillovers of the Chinese recession.

And, We All Fall Down

On the other hand, with UK’s exit from EU, various European countries that were engaged in high volume trade with the UK are bound to get affected. According to various economic analysts, Brexit could lower the Eurozone GDP by 0.03 percent each year. Stock markets in Spain and Italy have already fallen by almost twice as much as in the UK. Future of Europe’s economic stability is in jeopardy.

Larry Summers, former head of the US national economic council also acknowledged the threat posed by Brexit when he said “ Dramatic exchange rate fluctuations tend to portend upswings in protectionist pressure. And problems in European banks could as in 2009 lead to a drying up of trade finance.” This wave of turmoil, which has been set off due to Brexit, is not just limited to Europe. Many Asian countries like Singapore and Vietnam, which derive 6 to 7 percent of their GDP from exports to the EU, are also in for adverse economic effects. The IMF has cut down its global growth forecast for 2017, in light of Brexit and the atmosphere of economic uncertainty that it brings along.

The world had just started on its path to recovery from the horrors of 2008 crisis when Brexit gave a big jolt to this recuperation process. The biggest fear of the economists around the world is that with two of the world’s major economies slumped into a slowdown, this already fragile global economy is at best waning and at worst collapsing.

Rohit Dhalaria is an undergraduate law student at the National University Of Juridical Sciences, Kolkata.

Featured Image Source: Pixabay

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Posted by The Indian Economist