‘Brexit’ Carries Risks for Both UK, Europe – Wall Street Journal

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The 30 St Mary Axe, also known as the Gherkin, is a landmark in the U.K.’s primary financial district, the City of London.

Just as it led the world in the industrialization of its economy, the U.K. has led the way in deindustrialization. Its economy is now overwhelmingly dominated by services. According to the Office of National Statistics, just 8.1% of jobs in the U.K. are in manufacturing, mining and quarrying. Services account for 83.1% of British jobs.

A significant surplus in exports of services partly offsets the big deficit on merchandise trade. In 2014, U.K. exports of services reached £220 billion (about $311 billion today), or 43% of all British exports, the largest share for any major economy.

Other European Union countries are big buyers of U.K. services, which cover lawyers, bankers, insurance and accounting as well as such areas as higher education and tourism.

The U.K. sold some £20 billion of financial services alone to the 27 other EU countries in 2014, its second-largest export to the bloc after oil and oil-products. Overall, the U.K. posted a £17 billion surplus on its EU services trade.

A new study by Deloitte LLP concludes London has 1.71 million high-skill, knowledge-based jobs, compared with 1.16 million in New York and 630,000 in its nearest European competitor, Paris. Finance and insurance alone account for almost a fifth of all employment in London, according to another report published this week by the mayor’s office.

If Britain leaves the EU, the impact on trade in services is thus a question of huge importance to the country and its capital. A new arrangement for market access could be negotiated, but any assessments of its likely scope are guesses.

While other cities aspire to take on London’s role in finance should the U.K. leave the EU, it would take years, possibly decades, for them to replicate the combination of skills, institutions and markets that London now has.

The creation of the euro in 1999 led to fears about business being lost to Frankfurt, Paris and Amsterdam, which unlike London are all in the eurozone. But London has left them in the dust, said Gerard Lyons, economic adviser to London Mayor Boris Johnson.

Even though his boss now favors a vote to leave, or Brexit, Mr. Lyons says that “London faces challenges whether the U.K. remains or whether it leaves the EU.”

In case of a British exit, or Brexit, from the EU, big questions relate to the EU “passport” for financial services and the ability of firms based in London to clear transactions denominated in euros.

The passport enables a firm established in one EU country to operate in the others without having to undergo separate regulatory oversight.

Many U.S. and other non-European institutions run their EU operations out of London. If the U.K. left, some would move at least some operations to another country to secure an EU passport.

In addition, clearinghouses based in London can clear euros now because EU courts said single-market rules meant the European Central Bank couldn’t discriminate against the U.K. With the U.K. outside the single market, the ECB would be free to discriminate against London.

The threats to London could arise inside the EU too, Mr. Lyons said.

British Prime Minister David Cameron failed to negotiate a veto for the U.K. over eurozone action that hurts British interests, Mr. Lyons said, though he did get agreement to have proposed actions debated among national leaders.

And while the U.K. won its case over clearing, it has lost other important court cases—including over short-selling, bonus caps for bankers and a proposed financial-transactions tax.

But leaving would set off potentially tough negotiations for a deal over services.

Norway, for example, has access to the EU market as a member of the European Economic Area—but it has had to accept conditions the U.K. wouldn’t like, such as allowing in workers from the EU and contributions to the EU budget—and has no say in how the rules are shaped. Switzerland has only limited access to the services market, as does Canada, which just negotiated a free-trade deal with the EU.

According to economists from Citigroup


led by Willem Buiter, in negotiations following Brexit, the EU would probably seek to limit any trade agreement to goods and a few services like tourism, where it is running a surplus. Some EU governments would also likely be tempted to lock out the hypercompetitive British financial sector, in the hope that their economies would benefit.

This they would find “disruptive at least in the short run given the U.K.’s near-monopoly in some sectors,” the economists wrote. Longer-term, if other EU countries fail to replicate British productivity, they would be permanently worse off.

Here, as elsewhere, Brexit carries economic risks for both sides.

Write to Stephen Fidler at stephen.fidler@wsj.com

‘Brexit’ Carries Risks for Both UK, Europe – Wall Street Journal