The economic impacts of a Brexit would make us more, not less, reliant on other countries

21^st June 2016

Yesterday’s letter from Ford to its employees was the latest chapter in the economic debate on Britain’s EU membership, which has largely focused on the impact of Brexit on the UK’s big manufacturers. But it’s services exports that we should be worried about if we vote to Leave on Thursday. Brexit could increase, not reduce, our reliance on inflows of foreign capital, and trigger another recession.

The economic debate on our EU membership tends to centre around trade. The big picture on trade for Britain at the moment isn’t great – our current account deficit is at a record high. The gap between the value of our imports and that of our exports is higher than it has been since World War Two.

The current account deficit is important because it increases our reliance on external financing to close the gap. That’s ok as long as you are not excessively reliant on short-term funding – particularly short-term bank borrowing, which can leave a country vulnerable to a sudden loss of lender confidence and lead to a currency crisis. A quick look at recent British economic history tells you this isn’t as unlikely as it sounds – the IMF crisis of 1976 and the ERM crisis of the early 1990s being prime examples.

So the issue underlying much of the economic discussion is whether Brexit would help close our trade gap overall – or make things worse. So far, Britain has been able to finance its current account deficit because of the stability of our macroeconomic position, and our continuing openness to trade and investment – secured within Europe by our EU membership. The uncertainty around what Brexit would mean for that openness means that it’s not hard to imagine a scenario in which leaving the EU makes it harder to finance our current account deficit.

The other impact is likely to be on the size of the deficit. Our EU membership is disproportionately important to our services exports – because market access for services within the EU is more secure than under the World Trade Organisation regime. As ONS graphic below shows, half of our services exports (total value £59 billion) are to Europe.

And although last year Britain’s current account deficit was £92.9 billion, our services sector generated a £28.6 billion surplus. Anything that harmed the terms of trade for our services exports risks outweighing the small benefit (as we identified in our Make or Break report last year) of a likely currency depreciation for manufacturing exports.

Taking ourselves out of the EU could therefore put the success story of Britain’s export economy – high value services such as banking, law, IT and transport – of the last couple of decades in danger. And that would mean an increased reliance on foreign capital inflows to bridge the gap. As I’ve already explained, attracting the ‘good’ forms of external financing would become more difficult. Instead, as the Treasury had to do in the aftermath of the 2008 financial crisis, we will probably have to turn to short-term bank funding, which would increase Britain’s vulnerability to short-term losses of confidence in our economy. So there are clear reasons to fear a Brexit-induced financial crisis that would trigger another recession. It’s not surprising, then, that the City of London almost unanimously supports the Remain camp.