James Stewart: Brexit marks a fundamental change in how we think about the EU and our relations with our closest neighbour. Advice on what should be done has been both freely given and plentiful.
Some examples: “It is time to be calm, rational, and act in Ireland’s self-interest” (David McWilliams Sunday Business Post, June 26 2016), or “now is a time for calm heads” and “time to put on the green jersey” (Sunday Independent Editorial, 26th June, 2016). The problem with these prescriptions is that it is difficult to identify what is in Ireland’s interest. There is considerable uncertainty.
Uncertainty on many fronts
Unpredicted and unpredictable events have already occurred. Turmoil in the main political parties in the UK etc. Some consider that the political and economic effects will “take many years to understand”.
The process of leaving the EU (enacting Article 50) may not now start until 2017, after a new leader of the conservative party and perhaps a general election.
But the main uncertainty is whether the EU will survive. Austria, Finland, France, Hungary and Netherlands may all potentially leave according to a leaked German Ministry of Finance paper. There is no doubt that there is and will be intense focus on the UK in terms of the political economic and social developments.
In the U.S. Walmart’s policy of sourcing goods from China is estimated to have eliminated 415,00 jobs, mostly manufacturing jobs. Devaluation now and in the future will help British manufacturing but the devaluation required to compensate for lower wages in India and China would be impossible to achieve.
Political turmoil and constitutional turmoil
Political turmoil will translate into constitutional turmoil as Scotland seeks independence. The ‘settlement’ in the North of Ireland may no longer provide a basis for continued stability given the majority vote for continued EU membership. The scapegoat of migration will be seen as hollow.
It is likely that Britain will become more, not less, dependent on foreign workers because of an ageing population and an inability to produce a labour force with the required skills. Thus several factors indicate that the Brexit decision may not provide a role model for future leavers, but the UK decision is final.
What to do?
Several consider that, as in the past ‘England’s difficulty is Ireland's opportunity’. It is not only individuals who will seek a new passport. According to the Sunday Business Post (June 26th 2016) “The State has drawn up a hit-list of banks and financial institutions that it will target for relocation to Dublin”, the main attraction being a ‘passport’ enabling a firm located in any EU country (for example, Ireland) to sell products, especially financial and service products, to any other EU country.
On first consideration this appears a rational, calm response in the Irish national interest. There are however several factors indicating that future economic success in Ireland does not lie with footloose international financial services.
Light-touch regulation
One key issue is regulation. Post the financial crash, EU policy has sought to increase and centralise regulation of banks, insurance and securities trading. This placed the UK (and Ireland to some extent) in conflict with major Eurozone countries. The UK Chancellor in a warning of Brexit in 2014 stated:
“If we cannot protect the collective interests of non-eurozone member states then they will have to choose between joining the euro, which the UK will not do, or leaving the EU”
To help reduce this conflict, a UK nominee (Lord Hill) was appointed as Commissioner for Financial Services, Financial Market Regulation and Banking Regulation. Financial Services regulation under Lord Hill was seen as very beneficial for Ireland.
“I think he has a much more realistic view about the necessity of keeping the financial services industry in Europe competitive... he’ll take a stand against the one-world regulation view that often comes from the European Commission.”
Hill resigned as Commissioner on the vote to leave.
Taxation
Another issue is taxation. The UK along with Ireland, is fundamentally opposed to EU policies such as a Financial Transaction Tax, and threatened to bring the U.K. to the European Court of Justice (ECJ) if such a tax was introduced (Financial Times, June 5th, 2016).
The UK (along with Ireland) is also fundamentally opposed to EU policies to harmonise corporate taxation by introducing common rules on a definition of the tax base (known as a Common Consolidated Tax Base – CCTB). UK tax policy is based on tax competition rather than tax harmonization.
The Commission is also actively opposed to tax rulings which benefit particular companies. The bizarre decision of the Irish Government to oppose the EU case against Apple and to devote public funds (€667,000 by June 2016) in opposing the EU case, will increasingly be seen as unwise.
Other aspects of Ireland’s tax regime may become subject to greater scrutiny, for example the special tax regime for what are referred to as ‘section 110’ companies. PWC, a professional services company to many MNCs, stated that for these companies, with appropriate structuring “the effective tax rate can be close to zero”.
Relatively “light touch regulation” and “a highly competitive tax offering” are some of the main reasons for financial service companies to locate in Ireland. Increasing regulation and tax reduces the attraction of Ireland. At the same likely UK economic strategies outside the EU are likely to focus on a regime of relatively low tax and regulation. The UK will still be subject to international norms as regards taxation, but as determined by the OECD “guidelines” rather than the far more “intrusive” Commission.
Thus the UK is likely to adopt even more of the characteristics of a tax haven, which Ireland cannot and should not try to emulate.
Attracting footloose mobile international investment with limited employment opportunities will not ensure long run economic success.
Devaluation as a UK policy option
Of immediate concern is the exchange rate with Sterling, as devaluation may become a more central UK policy option. This in particular affects retailers (in border areas and depending on exchange rates, the Dublin area) and tourism which has been one of the drivers of Irish recovery. SME’s both exporting and competing with imported goods from the Sterling area are particularly vulnerable.
Hedging for SME’s is not an option due to the high costs involved and the long run nature of likely exchange rate movements. The MNE sector is much less affected by Sterling/Euro exchange rates because domestically priced inputs, such as labour costs are a small fraction of output values.
Exchange rates are not under the control of the Irish Government, but other factors are. For example VAT rates and changes in VAT rates for affected sectors should be urgently examined. Emergency credit should be made available to affected sectors. Lending by the Strategic Banking Corporation of €172 million amongst 4619 SME firms for 2015 is likely to be a fraction of what is required.
There is an asymmetry in the effect of exchange rates. Firms that close because of Euro appreciation will not reopen if the Euro then depreciates, as assets and employees are dissipated, organisational capability is lost as are markets.
The New York Times comments that: “By deciding to leave the European Union, Britain has become a major source of uncertainty, not only in Europe but in America as well."
Uncertain times indeed. Appeals for calm as a policy prescription are not only vacuous, but dangerous. Finding yourself in the middle of a firestorm is not the time to take a sedative.
Prof James Stewart is in the Business School, Trinity College Dublin.
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