Great Britain’s June 23 “Brexit” referendum to leave the European Union has come and gone, but its decision to depart from the 28-nation bloc has had immediate reverberations across the global economy.
Financial markets worldwide spiraled into disarray. The British Pound dropped to its lowest level since 1985, and U.K. Prime Minister David Cameron has subsequently announced he’d resign. To add insult to injury, the European Commission and some of its member countries, such as Germany and France, have made it clear that they do not intend to let the British exit from the pact be a smooth ride.
However long Britain’s exodus takes—Article 50 of the Treaty of Lisbon mandates it be completed within two years—economists and analysts agree that Britain’s unprecedented departure has ushered in an economic future rife with unknowns. Consumers may find themselves paying more for products and services. Younger demographics may find themselves fleeing Britain for good, which may lead to a lack of skilled professionals and a much longer recovery period. Worldwide, costs of capital and credit may exponentially rise, and global supply chains may experience crippling disruptions due to increased costs in compliance and customs tariffs.
According to Dr. Helmi Hamdi, senior economist at the Central Bank of Bahrain, the Brexit means much more than a reshuffling of Great Britain’s financial structures and its place in the financial world—it may prove to be the catalyst for a domino effect resulting in the collapse of the entire European Union.
“Today, many European leaders in different countries call for the exit: Nethexit, Franexit, Italexist, Danexit, and so on,” he says, referring to the Netherlands, France, Italy and Denmark, “and this will definitely make a new financial tornado in Europe which will spread to the rest on the world.”
Hamdi believes such a mass exodus would send markets into a global recession.
“If these events really happen, a global recession would currently be in front of our doors,” he warns.
Echoing concerns of uncertainty in world financial markets, while cautioning investors not to overreact, is Dr. Alex Edmans, professor of Finance at the London Business School.
“Volatility will be very high in the short-term as markets struggle to figure out what a post-Brexit U.K. will entail,” he tells New York Financial Press. “But any long-term, or even medium-term investor should sit tight. The FTSE 100 plummeted 8.7 percent immediately after Brexit, only to recover 5.5 percent of the fall by the end of the day, and actually ends the week higher than it started.”
Besides global stock index volatility, the Brexit also sparks new questions about Britain’s future place in the financial world. The U.K. currently stands as the largest financial hub in the European Union, accounting for 22 percent of European financial services sector activity, and 40 percent of EU financial services exports to the rest of the world, according to an analysis by PricewaterhouseCoopers.
Banks, insurers and investment companies in the U.K. currently authorized to conduct cross-border business in another European Economic Area (EEA) country by exercising the right of establishment via a branch or cross-border services without any further requirements, also known as “Passporting,” would subsequently be required to find a new system that may hinder this passage, and a result, lead to companies having to look at other options that do not include the United Kingdom.
The U.K. has also been a traditional point of access for capital and funding. With the Brexit, the situation could lead to the institution of capital and currency controls that may significantly impact this model. Borrowers and lenders alike may face potentially higher costs for credit, and a result, credit markets worldwide may find themselves without ample liquidity.
To illustrate the Brexit’s adverse effects upon a British economy driven by financial services, the international economic group Organisation for Economic Co-operation and Development (OECD) released a troubling analysis demonstrating a 3 percent decline in Gross Domestic Product (GDP). Borrowers and lenders may therefore decide to seek opportunity in other markets due to a more efficient flow of capital.
The Brexit may subsequently also impact London’s position as the number-one worldwide financial hub, as the current U.K. common financial regulatory framework is based upon EU law. A consequential switch to local regulation or a parallel adherence to a second set of compliance rules would increase cost and complexity and lead financial firms to look elsewhere for investment, leaving the U.K. seriously deprived of one of its major sources of tax revenue.
The Brexit could also mean that funds domiciled in the U.K. may not be available to private investors elsewhere, or may face regulatory actions from European Union officials and re-classified as alternative investments, thus becoming uncompetitive due to its regulatory risks. As a result, U.K.-based UCITS (Undertakings for Collective Investment in Transferable Securities)—referring to any mutual fund in the European Union—funds may decide to relocate to maintain their current operating status and client base.
As it did for so many market watchers around the world, Britain’s vote to leave the EU came as a surprise to Dr. Kaushik Sengupta, chair of the Department of Management & Entrepreneurship and an associate professor at Hofstra University’s Frank G. Zarb School of Business.
“It is completely uncertain right now,” he says of what a post-Brexit world economy will resemble. “This came out of left field.”
Two things for sure, he says, is that Britain’s exodus will not happen overnight, and it will have significant effects on global supply chains, its management systems, and even demographics.
“A lot of this will be figured out as you go, because none of this was planned,” he says. “The devil is in the details. It’s easy to vote and exit, but there was a statement released by the EU leaders saying that they want Britain to leave as soon as possible. Some folks say this will take two to 10 years, and I’m thinking it will be more like that, a more prolonged exit.”
Trade contracts and agreements between companies based in Britain and who do business in Britain will have to be re-worked in order to guarantee a more efficient supply chain, explains Sengupta. “The agreement that a company has with a supplier or distributor who is located in Britain or Europe, it doesn’t matter where, is based on a contractual agreement that ‘This is how the costs, the price, the trade and the customs will work out.’
“Of course, that was there in the in the framework of what was there in the European Union, not Britain,” he continues. “That will change going forward, but we do not know how. It was seamless, until now.”
Voter turnout polls among age demographics revealed a stark generational divide. Younger voters overwhelmingly voted “Stay” on the referendum, while older voters chose the “Leave” option.
“The Millennials overwhelmingly wanted to stay in the Union,” explains Sengupta. “In a way, the 70- and 80-year-old folks have decided how the 20- and 30-year-old folks are going to live their professional lives.”
With the resulting economic isolation comes another ramification to consider, then—the potential for a “brain drain” of younger British workers seeking higher-paying jobs, which would also hinder future economic growth in the U.K. To this effect, it’s worth noting that Google searches “Who will replace David Cameron?” “What is the EU?” and “Getting an Irish passport” spiked in the U.K. following the Brexit vote.
Whatever the true ramifications of the Brexit turn out to be, academics and economists agree one thing is absolutely certain: We’re in unchartered waters.