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Beauty contest due to Brexit

30 Jun 2016 - 13:52
Source: www.telegraph.co.uk

The British people have spoken. A small majority has chosen to leave the EU and go it alone. Many reports have highlighted the potential economic downfall of this scenario. The IMF has calculated in its report ‘Macroeconomic implications of the United Kingdom leaving the European Union’ that the EU countries with the tightest economic links with the UK will sustain the most damage: Ireland, Cyprus, Malta, The Netherlands and Belgium. The CPB Netherlands Bureau for Economic Policy Analysis estimated the loss for the Dutch economy at 10 billion euros in 2030.

The Brexit, however, does not only represent substantial costs for the EU economies and geostrategic risk for companies. Important opportunities might also emerge as many international companies and financial institutions reconsider in which country to establish their European activities. This could initiate a new beauty contest between countries to seduce companies to make inward investments in their country.

In the Netherlands the chairman of the employer’s organisation VNO/NCW Hans de Boer expressed this view on 24 June, the day after the vote. According to De Boer ‘the Netherlands should seize its opportunities on Brexit’. He wants the Dutch government to do its best to persuade companies that want to invest in Europe to come to the Netherlands.

Competition between countries for inward foreign direct investments is not something new. It was happening before Brexit. However, with the UK turning its back on the EU a new beauty contest could emerge, which could lead to countries rekindling competition in terms of the business climate. In this new European economic configuration, countries will try again to persuade companies to pick their country for investments and activities.

It is clear that the UK has put itself in a very unfavourable spot when it comes to persuading companies for inward investments. Firstly, and most importantly, Brexit provided UK-based companies with substantial uncertainty about easy access to the largest single market in the world. The outcome of the negotiations between the UK and the EU is very unclear.

Secondly, political stability within the UK has deteriorated. With a large, passionate minority of 48% of its population in favour of EU membership political unity is under pressure. The division in the country also cuts through the main political movements: both Labour and the Conservative Party wanted to stay in the EU. Political unrest might also come from the demographic component: the youngsters wanted to stay in, while the elderly wanted to get out. And finally there is the geographical component: the Scottish renewed call for independence and the position of Northern Ireland. It is obvious: the UK is a country that will be battling substantial internal political instability in the coming years.

The British comfort themselves with the argument that they have regained freedom in their policy making. They are no longer capped by regulations from Brussels and they might be able to secure current foreign direct investments by further deregulation. The level of regulation is one of the main instruments with which countries can compete to create a more favourable business climate. However, an important question is what room to deregulate countries still have. It could well be that this room is rather limited because both the UK and the EU are already among the least regulated areas in the world. According to the OECD Product Market Regulation index, the UK ranks second and the Netherlands ranks first as least regulated market. Another element is that important regulations cannot just be abolished as they reflect globally-agreed standards such as environmental and financial regulations. In addition, some European-imposed regulations will have to be replaced by domestic equivalents, such as consumer protection and health & safety regulations.  

The UK might try to persuade companies with favourable tax measures but also in this field there might be limited room to manoeuvre. In addition, jockeying with tax measures goes against the global trend of ‘less tax competition’. If the UK is nevertheless going to take this route, it would be faced with strong competitors such as Ireland, Luxembourg and the Netherlands. An undesired ‘race to the bottom’ could be the result of this route.

Another arena for competition will be the currencies. The pound sterling is expected to structurally depreciate in the near future. This will benefit the competitive position of the British exporters but it will also lead to higher inflation in the UK. If British labour unions want workers to be compensated for the higher prices, this might lead to higher wages, eroding British competitiveness. On the other hand, if the unions do not demand wage rises, the British people will have less disposable income.

Brexit will put the UK in an unfavourable spot when it comes to competition on inward foreign investments. The country might at first be helped by a weaker currency but its political instability and lesser access to the European single market are substantial disadvantages. The benefits of the merry-go-round of increased competition in terms of the business climate, such as deregulation and a favourable tax regime will be limited and might lead to a ‘race for the bottom’. That was probably the last thing the leave camp wanted.