Tuesday 25 October 2016

A possible Brexit would hit Irish-owned firms hardest

Dr Edgar Morgenroth

Published 17/04/2016 | 02:30

Boris Johnson and David Cameron, the two Tories represent different sides on the Brexit debate. GETTY
Boris Johnson and David Cameron, the two Tories represent different sides on the Brexit debate. GETTY

After almost 60 years of expansion and integration, the UK referendum on EU membership that will be held on June 23 could result in the first significant contraction of the EU. Given that the UK is the second-largest economy and third-largest population in the EU, a Brexit would reduce total EU GDP by almost 18pc and slash the population by almost 13pc.

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If the UK votes to leave the EU, there will be a two-year period of uncertainty when the details of the eventual relationship between the EU and the UK will be worked out. In the short term, the referendum has already increased uncertainty and has resulted in a slide of the value of Sterling.

A changed relationship between the UK and the EU could potentially have far-reaching consequences for Ireland. While it is impossible to write definitively about the eventual outcome of the negotiations between the EU and the UK that would follow a UK vote to leave, it is possible to identify the areas which are likely to be affected. These include trade, migration, foreign direct investment, energy and the EU budget. In addition, an EU without the UK there would imply a shift in the balance of power within the EU and a loss of influence outside the EU.

Recent ESRI research on the potential implications of Brexit on the Irish economy has provided some insights into the potential risks to trade flows, migration and energy as well as potential benefits in terms of foreign direct investment. This research considered a worst-case scenario where the UK would sign a bilateral trade agreement with the EU. The results suggested that the trade impacts are likely to be most significant.

The share of Ireland's trade accounted for by the UK has declined significantly since Ireland joined the EU in 1973, when more than 50pc of trade was with the UK. The UK is still the single most important trade partner when one considers merchandise and services exports and imports together. However, the rest of the EU is a considerably more important export market for Irish exports than the UK. For example, merchandise exports to the EU excluding the UK are two and a half times larger than exports to the UK.

Research has shown that trade among EU members is significantly higher than trade between EU members and countries with which the EU has a bilateral trade agreement. That difference has been estimated to be about 20pc. This shows the significant benefit of EU membership and also indicates the likely impact of a situation in which the UK only achieves a bilateral trade agreement with the EU following a Brexit. Such an outcome could reduce total Irish merchandise exports by 3pc.

The research also shows that not every sector and every type of firm is likely to be affected equally. Irish exports to the UK are concentrated in sectors such as food and beverages, chemicals and pharmaceuticals, electrical and optical equipment, financial services and business services. These sectors are most vulnerable to a Brexit.

Irish-owned firms are also on average more reliant on the UK market than foreign-owned firms. While foreign multinational firms located in Ireland export a considerably larger share of their output, Irish-owned firms export a much larger share of their output specifically to the UK.

In terms of merchandise, Irish-owned firms export only just over 50pc of output - while non-EU FDI firms export almost all of output. Of the 50pc of output that Irish firms export, over 40pc is destined for the UK while the corresponding percentage for non-EU FDI firms is only about 10pc. This reflects the fact that it is considerably easier to trade with the UK than it is for countries with different legal systems and languages, and which are further away from Ireland.

Of course, exports are only one dimension of the trade relationship between the UK and Ireland. The share of merchandise imports into Ireland that is sourced from the UK is twice as large as the corresponding export share. This reflects the significant supply chain linkages between the UK and Ireland, including the significant presence of UK retailers in the Irish market. Any trade impediments such as border controls or tariffs are likely to raise import prices, which would feed into a higher retail price for affected products.

There is a common travel area between the UK and Ireland. While the UK may still allow access to its labour market to Irish citizens, Ireland would be bound by whatever settlement on the free movement of workers would be reached between the EU and the UK.

Impediments to free movement of workers into the UK, even if they did not apply to us, could have the effect of diverting migrants (who would otherwise go to the UK) to Ireland, thereby expanding the Irish labour force. This would affect wages and unemployment in Ireland.

There might also be an upside to a Brexit. The UK's inward FDI stock is the largest in the EU. Leaving the EU would make the UK considerably less attractive to inward FDI, which might be diverted to other EU member countries, including Ireland. While Ireland is likely to attract some of this diverted FDI, estimates suggest that the benefit would be modest and would not compensate for the loss due to any trade impediments.

Apart from demonstrating that a Brexit would be bad for Ireland, the analysis also shows the significant benefit of EU membership.

If the UK votes to leave the EU, the immediate impact would be continued uncertainty and the negative trade impacts would not start until the exit negotiations between the EU and the UK are completed. This gives some time to develop strategies to minimise the losses, for example through trade promotion in other markets.

If the UK votes decisively to remain in the EU (to Bremain), the uncertainty that is already affecting markets would vanish. A strong pro-EU result would also allow the UK government to play a stronger role in the EU, which arguably was hampered by the significant degree of euro-scepticism. This would strengthen the EU and might stimulate some much-needed dynamism.

Dr Edgar Morgenroth is an Associate Research Professor at the ESRI and was the lead author of the ESRI report entitled 'Scoping the Possible Economic Implications of Brexit on Ireland'

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