Gaming out the British Referendum

16 MINS READJun 20, 2016 | 09:30 GMT
Gaming out the British Referendum
If an 'exit' vote prevails in this week's referendum on Britain's membership in the European Union, expect the effects to reverberate globally. A 'remain' vote will also have an effect, albeit a much less dramatic one.
  • If Britain votes to leave the European Union, it will set off a chain reaction that will fundamentally change how the bloc operates, if not dissolve it entirely.
  • A vote to "remain" will not necessarily save Europe either, since the forces undermining the bloc's unity will keep driving its members apart.
  • No matter how the referendum plays out, conflicting visions of the European Union's future will continue to threaten the bloc's survival.
British voters will head to the polls June 23 to decide whether the United Kingdom will continue to be a part of the European Union. The referendum, which stands to alter the course of country and Continent for decades to come, could go either way at this point. Recent opinion polls show the "leave" and "remain" camps neck and neck for the lead as they compete for the 10-15 percent of the population that is still undecided.
Stratfor is not in the business of calling elections. We do, however, forecast how events will unfold once the outcome of the vote is decided. While a decision to leave the European Union would have sweeping political and economic consequences for both Britain and Europe, a vote to remain would not improve the prospects of Continental integration.

Scenario 1: Britain Leaves the European Union 

If the "leave" camp wins the referendum, the repercussions of the vote will reverberate throughout the world. Even so, several things should be kept in mind in the event of a Brexit:

It Would Not Be Immediate 

Should a Brexit come to pass, it would not automatically take effect. According to Article 50 of the Treaty on European Union, members that want to leave the Continental bloc must first negotiate the terms of their exit and develop a framework for their future relationship with Europe. This process can take up to two years, though the United Kingdom would be able to control when that period begins by choosing when to notify the European Union of its intentions. EU officials have said that the terms of Britain's departure likely could be settled within the two-year time frame but that defining its subsequent ties with the bloc would take longer. Of course, Article 50 is a relatively recent amendment to EU law; it has been in force only since December 2009. Because it has never been invoked, it is unclear how comprehensive a withdrawal agreement would have to be to pass muster.

Until the exit negotiations were concluded, Britain would still be considered a full EU member bound by the bloc's rules and treaties. This means it would continue to be part of the European Union until at least late 2018. Once London and Brussels reach a final deal, it then would have to be put to a vote by the European Council as well as by the European and British parliaments. Though it is unclear what would happen if either EU body voted against the withdrawal agreement, all parties would probably return to the negotiating table to hash out a new deal. In theory, Britain would have the option of unilaterally leaving the bloc, but doing so would make future talks between London and Brussels much more difficult. Considering that Britain would want to pursue a free trade deal with the European Union — the world's largest trading bloc — after renouncing its membership, London would be unlikely to sour its relations with Brussels if it could help it. Article 50 also does not include provisions for countries that want to reverse their decision to leave while talks are ongoing, leaving it unclear how the bloc would proceed if the British government changes its mind.

In the end, the course of Britain's departure talks would be determined by political negotiation, regardless of what the EU treaties say. Recent leaks to international media outlets have suggested that the German government would want to settle talks with London quickly to minimize any financial instability that might come in the wake of a Brexit. France, on the other hand, is allegedly willing to make Britain's departure more difficult to send a message to Euroskeptic parties at home. These conflicting interests could temporarily aggravate frictions among EU members, though the specter of prolonged uncertainty would probably encourage most of the bloc to come to an agreement with London sooner rather than later.

It Would Raise Tough Questions in London 

Once Britain's exit is finalized, the British government would be pressed to address three major issues. Chief among them is trade. Some 45 percent of Britain's goods and services exports go to EU members, and 53 percent of its imports come from the Continental bloc. Consequently, Britain would be highly motivated to preserve its access to Europe's common market. Doing so would require London to negotiate new free trade agreements with the bloc and with the non-EU countries it trades with through the European Union. Based on historical experience, such agreements can take as much as a decade to complete.

Legislation would also become an important problem to resolve. Once EU norms were no longer enforced, the British Parliament would have to reintroduce, amend or abolish the laws currently in place. The Brexit's critics have warned that over time the gap between British and European regulations would widen, hurting British exports to the Continent and making Britain a less attractive destination for investment.

The other issue that would move to the fore is immigration. After leaving the European Union, London would have to decide the status of EU citizens working in Britain, just as Brussels would need to determine the status of British workers living throughout the bloc. Moreover, the British government would have to design an immigration policy to attract skilled laborers and counter the country's demographic decline. To that end, it would likely put in place a selective immigration policy akin to the point-based systems in Canada and Australia.

It Would Cost Britain, Politically and Economically 

All of these decisions may have to be made by a new government, though. A vote to leave the European Union would almost certainly prompt the resignation of British Prime Minister David Cameron, who has campaigned to remain in the bloc. The factions of his Conservative Party that support a Brexit would then have to prove they control enough seats in Parliament to appoint Cameron's successor without triggering new elections. But given the deep divides within the party, its ability to make such a claim is anything but certain.

Meanwhile, London would also have to cope with renewed demands for independence from Scotland. After all, Scottish voters are largely supportive of the European Union, and members of the ruling Scottish National Party have called for an independence referendum to be held if Britain leaves the bloc. Though roughly 55 percent of Scottish voters decided against separating from the United Kingdom in 2014, a Brexit would revive the debate about Scotland's future.

Britain's problems would not be confined to the political realm, either. It has been widely predicted that a Brexit would cause an immediate economic shock as uncertainty about the future of Britain and Europe leaches throughout global markets, leaving volatility in its wake. Indeed, British economic growth slowed in the first quarter of 2016 in response to unease over the impending referendum. Things would only get worse in the weeks after a Brexit vote as money is pulled out of the country and the pound weakens even further. That said, no consensus has emerged on how deep Britain's downturn would be. According to Her Majesty's Treasury, the British economy would contract by 3 to 6 percent in the two years after a Brexit, an estimate the country's "leave" camp believes is exaggerated. But on May 13, International Monetary Fund chief Christine Lagarde echoed British officials' concerns, warning that a Brexit would lead to recession, as well as the possibility of crashing stock markets and housing prices, in the United Kingdom.

In the longer term, a Brexit's effect on the British economy after the first year or two will depend on a number of factors. For one, its appeal as a foreign investment gateway to Europe could diminish if it is no longer a member of the European Union, putting its position as the bloc's largest recipient of foreign direct investment in jeopardy. Along a similar vein, half of the European headquarters of non-EU companies are located in Britain, many of which might choose to relocate to countries that are still members of the bloc. The same may be true of the banks and financial institutions operating in London, which could find Paris or Frankfurt more attractive centers in which to take up residence. Though many of Britain's natural advantages — its light regulations, business-friendly environment, strong capital markets and use of the English language, to name a few — would not be affected by a Brexit, many of the vote's effects would depend on the type of relationship Britain builds with Europe after leaving it. Such ties could follow one of three models:

  • The Norwegian model. Britain could join the European Economic Area under terms similar to Norway's. Though Norway is not an EU member, it participates in many of the bloc's structures. This option would preserve Britain's access to the European Union's common market, but it would also require London to adopt EU regulations and contribute to the bloc's budget without having a say in its policymaking. Simply put, Britain would be forced to follow rules it could not help set, a scenario that is rather unlikely.
  • The Swiss model. Alternatively, Britain could follow Switzerland's example by negotiating a set of bilateral agreements with the European Union that would govern its access to the Continent's common market in certain sectors. Under this arrangement, Britain would have to adhere to EU regulations only in the sectors covered by the agreements. But Switzerland's patchwork deals, which number over a hundred, took years of tough bargaining with the bloc to create, so although it is a more likely outcome than the Norwegian model, it still poses serious problems for Britain.
  • The South Korean model. Britain's final option would be to sign a free trade agreement with the European Union, much like South Korea did in 2009. London and Brussels would have to negotiate the scope and depth of such an accord, and it is possible the bloc would try to limit Britain's access to specific sectors, such as financial services. Talks could prove to be lengthy; in South Korea's case, they took roughly a decade. Members of Britain's "leave" camp have said in recent weeks that the South Korean model would be their preferred route in the event of a Brexit.

It Would Damage Europe's Economies, Too 

Britain's withdrawal from the European Union would hurt economies on the Continent as much as it would its own. Exports would fall among some of Britain's main trade partners, including Ireland, which sends about 14 percent of its exports to Britain, and the Netherlands and Belgium, which send about 9 percent each. Unsurprisingly, these countries would probably be the biggest supporters of a rapid resolution to trade talks with Britain.

Without a trade agreement in place, Britain's exports to the European Union would be subject to tariffs, as would EU exports to Britain. London would be forced to pay the "most favored nation" rates set by the World Trade Organization, which range from 4.1 percent on liquefied natural gas to 32 percent on wine. Services trade could be further complicated by the fact that EU members have erected different non-tariff barriers, such as domestic regulations, in the services sector.

Meanwhile, political uncertainty stemming from a Brexit vote would hurt economies across Europe, as would a decline in trade should London and Brussels fail to reach an agreement. Central banks worldwide, including those of the United States, India and Japan, have issued warnings about what a prolonged period of uncertainty in Europe could do to global financial markets. Even if Britain-EU talks take just two years to settle, these markets would not be able to avoid the fallout.

Southern Europe might even receive a double dose of pain. Spain is scheduled to hold general elections on June 26 that will likely lead to a fragmented parliament, while Italian Prime Minister Matteo Renzi has linked the future of his administration to a constitutional referendum in October. When coupled with the uncertainty that would follow a Brexit, such political instability in the eurozone's third- and fourth-largest economies could raise questions about the economic health of Southern Europe as a whole, leading to turbulence in international debt markets.

It Would Change the Balance of Power on the Continent 

As for Europe's faltering unity, a Brexit would have very different implications for the Continent in the short and long term. In the immediate aftermath of the vote, the shock of an EU member's departure would spark demonstrations in favor of Continental unity across Europe. Germany and France, the bloc's biggest heavyweights, would seize the opportunity to advance cooperation by drafting proposals to deepen European integration. The new measures would likely avoid controversial issues, such as fiscal integration, and focus instead on areas where consensus already exists, such as security and defense.

But the sudden enthusiasm for European unity would be short-lived. For one, the electoral calculations of French and German leaders would make it exceedingly difficult for Paris and Berlin to reach any substantive agreements before late 2017. Furthermore, though France and Germany share an interest in creating a more federal Europe, they have different views on what that should look like. And though countries in Central and Eastern Europe generally support the bloc, they are becoming increasingly wary of decisions that would strengthen Brussels' supervision of EU members.

The Brexit's critics have warned that over time the gap between British and European regulations would widen, hurting British exports to the Continent and making Britain a less attractive destination for investment.

Meanwhile, Euroskeptic parties across the bloc would interpret a Brexit vote as support for their own proposals to leave the European Union. And after the dust settles, the Continent's nationalist streak would likely re-emerge. If Britain offers proof that it can endure after quitting the European Union, the bloc's opponents would begin to hold it up as an example to follow. Euroskeptic parties stand to make the most gains in countries with large economies such as France and Italy, where citizens are particularly skeptical of the Continental bloc and optimistic of their countries' future success independent of the European Union or eurozone.

Perhaps the most important effect a Brexit would have in the long run is on the balance of power in continental Europe. Without Britain, the European Union would lose a liberal, market-friendly member, giving interventionist countries such as France, Italy and Spain the upper hand in the bloc. Germany has historically seen Britain as a counterweight to France within the European Union, and without its vote on the European Council, Germany, the Netherlands and Nordic states would lose a key backer in negotiations with Europe's Mediterranean states. Germany's weakened position could even encourage France to try to seize the reins of the bloc, exacerbating tension between the two EU leaders. If Northern European countries start to fear a takeover by the Continent's Mediterranean bloc, Euroskepticism in the north would likely grow.

The divide between Western and Eastern Europe could widen as well in the wake of Britain's departure. Central and Eastern Europe consider Britain the primary defender of the interests of EU members that do not belong to the eurozone. London has also been one of the staunchest supporters of sanctions against Russia, which aligns with the policies of Poland and the Baltic states. If Britain leaves the bloc, states in the EU periphery could become more isolated from the rest of the bloc, and in time, more Euroskeptic. 

Because Britain accounts for approximately 12 percent of the EU budget, the North-South and East-West fissures could deepen even more as the bloc adjusts to a tighter budget. Brussels, forced to either cut spending or ask remaining EU members to contribute more money, may find itself torn by the Continent's regions. (Countries in Southern and Eastern Europe tend to defend generous agricultural and cohesion funds for member states, while Northern Europe typically pushes for spending cuts or freezes in the same areas.)

On top of its growing internal weakness, the European Union would see its clout abroad decline as well. Because of its military might and former colonial networks, Britain boasts a role in international affairs that is not easily replaced, with the possible exception of France. In Britain's absence, Germany would come under increasing pressure to play a bigger role in asserting the bloc's foreign policy — a role that Berlin has sought to avoid and several EU states have tried to prevent. Since Britain would no longer be able to lean on its EU membership for additional backing, it, too, would be unable to maintain its influence within the international community.

Scenario 2: Britain Stays in the European Union 

If British voters choose to remain in the European Union, relief will be palpable throughout the bloc and global financial markets. But even though the effects of a "remain" vote would be less dramatic than those of a Brexit, they would still be felt at home and abroad.

In Britain, Cameron and his supporters would be strengthened, albeit temporarily. His Conservative Party would continue to be plagued by political discord, however, since nearly half of British lawmakers want to leave the European Union. Despite the victory a "remain" vote would represent for the prime minister, he might find the differences within his party insurmountable, and a Cabinet reshuffle or early elections could not be ruled out.

Europe, for its part, would avoid the proximate crisis of a Brexit, but its underlying problems would be far from over. Britain would prove that governments could successfully exact concessions from Brussels, as Cameron did, and then reaffirm their support at home. Though few EU members are as influential as Britain, Euroskeptic parties and moderate governments elsewhere in the bloc might start planning to make their own demands of the bloc, and there is little Brussels could do to stop them from holding similar referendums. These votes could include a number of topics, such as demands for more flexible fiscal targets in Southern Europe or additional reassurances for Northern Europe against financial contagions. Meanwhile, countries in Central and Eastern Europe might call for the transfer of more powers from Brussels to member states.

Neither Result Would Unify Europe 

Of the impending referendum's two possible outcomes, the consequences of an exit vote would be far more dramatic than a decision to remain, though it could be several years before they make themselves known. For the first time in six decades, the European Union would lose a member — an event that could be the first in a chain of developments that transforms how the Continental bloc operates. It might even mark the beginning of the bloc's end, paving the way to its eventual dissolution.

But the European Union's position would not improve much with a remain vote, either. The forces driving a wedge between the bloc's members run deep, and they will continue to pull Europe apart at the seams, regardless of the actions of a single member. 

Lead Analyst: Adriano Bosoni

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