The UK will finally define its relationship with the EU on June 23 as 45 million voters head to the polls for a historic referendum over whether the country’s future lies in or outside the European economic bloc. The economics of EU membership have taken centre stage since the outset of the animated political campaign, with the Remain and Leave platforms issuing their own conflicting predictions for the future of the economy outside the EU. However, both have failed to gain an edge amid mutual accusations of scaremongering and political manoeuvring.

As the referendum’s final outcome hangs in the balance, the UK economy remains in a state of limbo, with uncertainty over the vote adding to an already challenging domestic and global cycle. And if Brexit materialises, this uncertainty is expected to continue into the near future. It will take up to two years for Downing Street to wrap up a deal with Brussels on the country’s foreign trade policy, without considering the political crisis that could unfold within the ruling Conservative party – with the premiership of David Cameron, who has led the Remain campaign, at stake.

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Unavoidable uncertainty?

A period of persistent uncertainty is “unavoidable”, according to a Treasury report in May. ‘Brexiters’ rebutted this, saying such risks are eventually worth the upheaval. However, a transition outside the EU is already weighing on the decision making of businesses across the country, and putting a question mark over the country’s traditional appeal as an investment destination. 

Strong rule of law, flexible labour markets and a highly educated workforce have long made the UK the most attractive FDI destination in Europe, regardless of its EU membership status. Over the past five years alone, the country made up well over one-third of total FDI flows into greenfield projects in western Europe, and almost half of them in 2015, according to figures from fDi Markets.

“But since the EU membership reduces trade and investment costs, it is likely to have an impact even after controlling for these other factors,” said a paper published by the London School of Economics (LSE) in April. FDI inflows between two countries “always” jumps by an average 28% when either the sender or the recipient joins the EU, the LSE paper said after analysing FDI flows between OECD countries between 1985 and 2013. 

The finance factor

The UK financial sector in particular has benefited from EU membership. London’s role as a major European financial hub received an additional boost from the development of a common European market, with global banking, asset management and insurance groups turning the City of London into a springboard for selling EU-compliant products across the continent. Some 250 foreign banks operate in London – more than in Paris, Frankfurt or New York, according to figures from financial services lobbying group TheCityUK.

Overall, financial services have the largest stock of inward FDI in the UK, making up 45% of the total and originating a trade surplus of £72bn ($104.2bn) in financial and related professional services in 2014, TheCityUK figures show, with clients in the EU accounting for one-quarter of this surplus. If UK-based firms lost the benefit of the passporting regime – the ability to sell their financial products in any EU member state – they would be unable to automatically supply services in the EU from the UK on a crossborder basis. 

“Until we know exactly what happens, our future is on hold,” says Tim Skeet, a former RBS managing director with 30 years’ experience in the UK financial sector.

The same applies to key manufacturing sectors such as automotives, whose operations and performance is tightly intertwined with trade flows with EU members. The uncertainty over the referendum’s outcome has already adversely affected more than one in three companies in both the services and manufacturing sectors, according to the latest Purchasing Managers’ Index survey by Markit/CIPS.

Meanwhile, a May report by the UK Treasury said: “Foreign investors in the UK would be uncertain over their access to the European market, a significant driver of foreign investment in the UK, leading them to delay, relocate or cancel investment that otherwise would have come to the UK.” 

Business as usual

Brexiters have denied these risks throughout the campaign, playing down their significance in the country’s overall ability to establish trade relations with commercial partners. “I don’t buy these uncertainty elements,” says John Mills, chairman of UK-based retailer JML. “I think that trade will tend to continue very much as it has done. The investment grade in this country is very low anyway. It really needs to go up and I think it may well do as people see more opportunities in different parts of the world.”

The Leave campaign has given mixed signals over the framework that will regulate trade relations with the EU and the rest of the world in a Brexit scenario. The UK could follow the example of countries such as Norway and join the European Economic Area (EEA) outside the EU to retain some of the privileges it currently has, as an EU member, such as financial passporting – at the cost, however, of partly contributing to the EU budget without having any say in EU regulation issues. Or it could join the European Free Trade Association (EFTA) that comprises Iceland, Liechtenstein, Norway and Switzerland, and enjoy free trade of goods with EU members, but not of services.

“Striking a comprehensive free trade deal after Brexit is not a good substitute for full EU membership,” the LSE paper concluded, after sifting through the FDI impact of membership of alternative trade blocs such as the EFTA. Overall, the LSE estimates that Brexit would lead to a 22% loss of FDI over the next decade.

Trade renegotiations

Beyond the EU, the UK government would have to renegotiate most of the trade agreements that Brussels struck on behalf of its members should Brexit occur. The Confederation of British Industry, the UK’s largest business association, estimates that the EU and its trade deals currently account for 60% of UK trade, rising to 88% if all deals currently under negotiation (including those with the US and Canada) were completed. And the country’s World Trade Organisation membership may also face “tortuous” renegotiations, WTO head Roberto Azevêdo told the Financial Times in May.

Traders and investors will inevitably have to deal with a UK foreign trade repositioning, although Brexiters believe this will bring along not only challenges, but also opportunities. “After Brexit, returns would rise in industries that were previously unprotected by the EU, such as services; they would fall in industries losing their protection,” Ryan Bourne, one of the founder of the Economists for Brexit group, wrote in April. “Overall, as our post-Brexit forecast makes clear, growth and investment would rise in the long term, and so we can reasonably project that FDI would rise with it.”

As the June 23 referendum approaches, opinion polls show the Leave campaign gaining ground, sending volatility in the financial markets to its highest level since 2009. However, millions of voters are still reportedly undecided and they hold the key to the UK’s future relationship with Europe and the business proposition it eventually offers to its foreign investors.