Friday, May 20, 2016

Brexit: What Start-ups Need to Know

In 30 days, on June 23rd, UK voters will be asked a simple question: 

“Should the United Kingdom remain a member of the European Union or leave the European Union?”

I hope the answer will be "Stay" - currently the betting odds are 1:5 for "Stay" and 10:3 for "Out", so the odds are clearly in the "Stay" camp. But who knows? The interesting part about this vote is that voters will not have a clear picture of what a Brexit actually means, since the post-Brexit UK/EU relationship will have to be negotiated after the referendum.  If the "Out" vote succeeds, it will trigger a 2-year notice period during which the negotiations will take place.  

I worked with my colleague James Cameron to look at the potential outcomes and in particular how it would impact start-ups in the UK and Europe and we put together this short post.

Three key areas will be on the negotiation table:  

  1. Trade terms and the extent to which the UK can still access the EU single market
  2. UK control over EU immigration
  3. How EU regulations will continue to impact the UK
All are interrelated and there will be trade-offs between all three. 

The likely options
Neither the major parties nor the "Out" campaign have released proposals for the UK’s future after a Brexit –so we can only speculate based on other models that currently exist: 

Option 1:
The Norwegian model
Option 2:
The Swiss model
Option 3:
The Turkish model
Option 4:
WTO rules
Out of EU, but still in EEA (e.g. like Norway, Iceland). Preserves access to the EU single market for most trading sectors, but most EU-derived laws remain in place.  Free movement still applies.
Out of EEA, but the UK would negotiate access to the single market, sector by sector.  Example - Switzerland has 129 different bilateral trade accords with the EU, but must accept free movement of people and still pays fees to the EU.
Outside EEA, but with a negotiated customs union.  In Turkey’s case, it doesn’t pay fees to the EU and there is no freedom of movement.

Simply rely on WTO rules for access to the EU market.
The situation would be very similar to what we have now, but the UK would have reduced power to influence the rules that would apply domestically.  This solution may appease ‘Out’ voters’ desire for more sovereignty - but is arguably an unattractive result for both sides.
This model could give UK more latitude to negotiate preferred deals in certain areas. However, the EU think the current situation with Switzerland is unsustainable, and many commentators think it’s unlikely they will accept a similar deal for the UK.
The Turkish customs union covers only goods, not services or finance, so a similar deal for the UK would deny the UK access to a big part of the single market.
This is a fallback option would give the UK more sovereignty at the price of less trade and a potentially big fall in income.

A Fifth option?
  • A fifth option that is advocated by ‘Out’ proponents is to negotiate a special deal for Britain alone that retains full access to the single market without observing all the EU’s rules (including freedom of movement) or contributing heavily to its budget (i.e. a form of ‘EEA lite’). 
  • Whether the UK will be able to negotiate such a deal comes down to the relative bargaining power of the two parties.  The Leave camp believes that UK will be in strong position since it is the 5th biggest economy in the world.  However, the Remain camp notes that it is the relative size of the market that matters most - the EU is half of Britain’s export market, whereas Britain would be only 10% of the EU’s. 
  • Ultimately, in a post-Brexit with a potentially hostile EU, we can expect that it will be extremely hard to secure as favourable a trading relationship as the UK enjoys at present, especially if it insists on curbing free movement of people. 
Possible impacts on the UK tech ecosystem
  • Skilled labour migration:  This is probably the biggest single concern for the UK tech scene. Restricting free movement will need to be negotiated if the UK wants to keep favourable trading terms post Brexit, but given immigration control is central to the Out campaign, we should expect the UK to push for at least some restrictions on free movement.  Many in the Out campaign want to design a system that will favour immigration from skilled migrants regardless of origin (the ‘Australian model’).  This may be workable in the longer term, but at least in the short-to-medium term we should expect a Brexit to trigger a sharp drop in the number of available skilled immigrants from the EU, which would be highly detrimental to the UK tech ecosystem. 
  • Existing immigrants: Any EU nationals that are already in the UK pursuant to the existing arrangements should be unaffected.  Under the Vienna Convention on the Law of Treaties they cannot be removed from the UK unless the countries agree otherwise – which is unlikely.
  • Financial services: Unless UK remains in the EEA (i.e. the Norwegian option), the European passporting rules for financial services will no longer apply to UK firms after Brexit.  This will impact any UK companies operating regulated financial services in Europe or vice-versa.  
  • EU R&D funding: UK is the second largest recipient of EU research and innovation funding (expecting £2bn in the next 2 years – roughly 20% of the total science budget allocated by the UK gov).  Most has gone to university R&D programmes, but at least 15% typically goes to startups/SMEs. This funding will likely no longer be available after a Brexit.   
  • Data privacy: On a Brexit, the EC must decide whether to designate the UK as a 'safe third country' for data. If it didn’t, personal data transfers to the UK could be restricted – similar to the US. 
  • No Digital Single Market:  A Brexit will most likely mean that the UK firms are excluded from the proposed digital single market – a basket of regulations that expect to be implemented between now and 2018 to streamline EU copyright applications, streamline VAT payments for digital goods, harmonise ecommerce rules and abolish EU roaming charges, amongst other things.
  • Currency impact:  The pound will almost certainly continue to suffer a sharp sell off in the wake of a Brexit vote – which will benefit any UK based startups that sell globally, at least in the short term.
Possible impact on the broader economy

Base case
Upside case
Downside case
Similar to Norway or Switzerland - the UK maintains deep and wide trade relations with the EU after leaving the bloc, but continues with many of the laws and regulations that are currently part of EU law (inc. free movement).
UK negotiates more favourable trade terms with the EU and is able to quickly put in place favourable terms with other key countries.  At the same time, the UK gets more control over immigration and finds an immigration solution that does not restrict flow of skilled labour. 
Drawn out negotiations, with UK eventually trading controls over immigration for much weaker access to the single market.  At the same time, UK finds it difficult to sign beneficial trade deals with other countries.
The impact on the broader economy over the long term may be neutral, but we will likely still see a period of volatility and low investment with the risk of a run on the pound.  Sovereignty will be re-established, but in practice UK will be subject to regulation without representation.
Most commentators discount the likelihood of this scenario heavily – it will be very difficult to secure as beneficial trading relationship outside the EU as it enjoys at present, especially if it insists on curbing free movement of people.
Britain receives less inward foreign direct investment, fewer skilled immigrants, and does not improve the regulation of the economy.  The tech ecosystem is disproportionately impacted by the reduction in skilled immigration.

Broadly neutral (between -0.8% and +0.6% of GDP by 2030 according to OpenEurope)
Moderately positive (+1.6% of GDP by 2030 according to OpenEurope)
Strongly negative (-2.2% of GDP by 2030
according to OpenEurope)

Expert views on the outcome
  • In one of the most comprehensive polls of experts done so far (an FT poll of >100 economists in Jan 2016), >75% thought Brexit would adversely affect the UK’s medium-term economic prospects, only 8% thought Britain’s economy would benefit.
  • “There are few issues that unite UK economists but Brexit is one of them: they overwhelmingly believe leaving the is bad for the country’s economic prospects.”  Financial Times

30 more days before we know...let's hope the "Stay" will prevail!