Issue 4, 2016. August-September



The UK's decision to leave the EU, the so called "Brexit," has created turmoil in the UK and in the EU. It initially hit global stock markets hard and has subsequently created a confusing picture for observers abroad. While the situation is still rather fluid, this article presents some of the possible political and economic consequences of Brexit for Georgia.

George Welton

Short-term economic consequences of Brexit are the easiest to predict. Economic uncertainty has already hit share prices and the value of the Euro and the British pound (though U.S. stocks are at an all-time high). This has driven the dollar higher globally, which will drive down the dollar value of the GEL and other regional currencies. It will also make the markets more risk averse and therefore make the FDI environment more difficult.

It is worth fleshing this out a little, specifically as it relates to Georgia. The significant decline that occurred in the GEL at the end of 2014 and continued throughout 2015 was driven by a range of factors. A big part of the picture was that the U.S. dollar was stronger globally than it had been at any time in the last 13 years. This was the result of a drop in the growth rates of developing countries, particularly China, which made developing countries less attractive for international investment and reduced the value of commodities like oil.

Developing countries that were also dependent on commodities were hit twice. Georgia was hit three times, because the sanctions that followed Russia's invasion of Ukraine further depressed the regional market.

However, historic highs, almost by definition, are unlikely to last and as oil prices started to recover a bit this year we have seen the dollar decline from its 13 year high relative to the Euro and developing-country currencies. This is the main reason that the GEL has become stronger since the spring.

Brexit has reversed this trend by making investors nervous again. General nervousness usually helps the dollar but in this case the dollar is further helped by concerns about how the Eurozone will manage Brexit. A dropping value of the Euro means a rise in the value of the dollar. This has helped

to weaken the GEL relative to the dollar. If Britain and Europe mishandle Brexit and the Euro drops further against the dollar, then we could expect to see the GEL get weaker still.

This weakness in global markets also reduces interest in investment risk. Assuming all things are equal, this would negatively affect Georgian FDI. However, Georgian FDI is hard to predict and rarely simply reflects global trends.

Georgia's small size and underdeveloped capital markets mean that its foreign investment profile can be very idiosyncratic. As a result, if any of the major capital or infrastructure projects currently under consideration (ports, road, rail, hydro, etc.) move forward in the next year or two, it would almost certainly be big enough to overwhelm any negative global trends created by Brexit.

Politically, the most predictable result of the Brexit vote is that the EU will be distracted and its Eastern Neighbourhood seems unlikely to be a priority.

The most obvious likely impact is that it may make it less likely that we will see a resolution of the visa-liberalization issue anytime soon. European member states will be even more concerned than they were previously about the risks of fueling the nationalist movements in their own countries - which have been given a boost by the UK's Brexit vote.

As most people understand, the recent delay of Georgia's visa liberalization aspiration had more or less nothing to do with Georgia. Georgia had done all that was asked of it. Instead, the delay was principally a reflection of German internal politics. Angela Merkel, who had allowed over 1 million refugees to enter Germany in less than a year, saw a backlash in Germany's March local elections. As a result, Germany has joined the increasingly large pool of EU countries that are concerned about the rise of the nationalist politics.

Unfortunately, in this context, softening visa rules for a developing economy like Georgia is more than France or Germany seems likely to do.

This does not mean that visa liberalization will not happen in the fall. It just makes it more difficult. Though the Brexit decision makes nationalism more of a pressing concern for Europeans, it is also possible that, by the time we get to the next EU meeting on the subject in September, we will be far enough passed Germany's political woes that cooler heads will prevail.

Certainly, in practical terms, any likely increase in illegal immigrants from softening rules on tourist travel from Georgia is likely to be small. And there do seem to be signals coming from a number of countries that the EU understands the importance of living up to their commitments in this area. However, Brexit does create further negative pressures and is a convenient excuse to delay, if member states choose to do so.

More broadly, the Brexit vote will probably mean that foreign policy issues will get less attention. In particular, the EU is currently going through a strategic review of its Eastern Partnership and its broader Global Foreign Relations Strategy. In fact, its new Draft Global Foreign and Security Strategy was published on June 27th. This seems unlikely to be a focal point for discussion in Brussels anytime soon.

Longer-term scenarios

The longer-term picture is a lot more speculative and, of course, depends on the reaction to the Brexit vote on all sides. Probably the most important question is whether this is the beginning of the end for the EU altogether.

That seems unlikely, even in the longer term. Problems with security and the Euro may persist, but France and Germany are committed to the idea of the EU in a way that Britain never was. In addition, in the aftermath of the Brexit vote, it seems unlikely that any of Europe's overwhelmingly pro-European governments would risk a similar referendum.

On the other extreme, is it possible that the UK figures out a way to ignore this decision, or to put it back to a second vote? If that happens then one would expect that in the medium/long term, the world would return to normal and, like previous EU crises, this drama would soon be little more than a cautionary tale.

PM Theresa May

This also seems unlikely. No senior British politician has suggested that this is a likely scenario, and no one except Nicola Sturgeon from the Scottish Nationalist Party is taking the idea of a Scottish veto seriously. Theresa May, the new Prime Minister, has been clear that "Brexit means Brexit" (though she has not been clear what that means).

Alternatively, if the UK does leave, is it possible that it gets a deal so close to membership that it makes little difference to the UK or the world? The most common version of this scenario is the so-called "Norway model". This allows the UK to remain as part of the common market, which would leave economic and trade relations generally unchanged, though the UK would have little role in European political decision making.

It is hard to see how the British electorate would accept this, as the Norway Model would mean continuing to allow the free movement of labor and this issue, more than anything else, is the reason why the UK voted to leave.

Some politicians have wondered if it is possible to get a deal that includes greater access to the Common Market with more control over labor migration. As of today, the EU has made it clear that this so-called "Norway-plus" model is a non-starter, for the obvious reason that they can't give the UK such a great deal because other countries would want the same thing. That would almost certainly mean disaster for the EU.

Therefore, currently the most likely scenario is for the UK to substantially leave the EU. This will most likely happen following a two-year negotiation that will, according to new Prime Minister Theresa May, start toward the end of the year.

If that does happen, most economic assessments conclude that it will be bad for the UK and for the EU. Economically, the UK is currently expected to have a short recession over the next 12 months and will then to grow more slowly than it would have. At the same time, this will add to the EU's many economic woes. In leaving the UK, the EU will have lost more than 10% of its population and its GDP.

However, this economic weakening probably won't matter much to Georgia. The drop in size and growth of the EU still leaves the EU as a massively attractive market for Georgian businesses and, while Georgia exports around 30 percent of its goods and services to the EU, it only exports around 1 percent to the UK. The biggest factors affecting Georgia's export growth to the EU are how Georgia implements the EU Association Agreement and how well the Georgian economy reshapes itself to suit that market,not EU growth levels internally.

In addition, unless the EU significantly collapses, it will continue to be an economic powerhouse, with a population of over 400 million people and a collective GDP that is approximately the same as the United States'. As a result, the implementation of the Association Agreement, as a means of gaining access to that market, will continue to be incredibly important for Georgia's economic development.

The political changes to the EU are likely to be far more important to Georgia than any general impact to the EU economy, though these are even harder to predict. One big political impact for the EU is that Britain is currently the EU's biggest military power and second largest economy. Losing the UK will diminish the EU's standing in the world. Perhaps more importantly, the loss of the UK will change the general structure of the EU and could change its political orientation. The UK is strongly open-market oriented, fairly low-tax and low-spending (compared to the rest of the EU) and, in the Anglo-Saxon tradition of business, the UK sees regulation of business as something to be avoided where possible.

In the absence of the UK, one might expect the EU to become more "French"- which would mean more social protection and regulation. This may make the EU an increasingly problematic model for a developing country to mirror.

With the UK gone, the EU will also be more dominated by Germany and France, which will together account for around 40 percent of the region's GDP (based on 2015 IMF numbers). This centralization of power could be worrying for the other 25 member states.

The EU as an institution will also be poorer. Although the UK's initial contribution to the EU was about $18 billion in 2015, about 1/3 of that is spent in the UK, suggesting a net contribution of about $12 billion or 7 percent of EU spending that will be lost when the UK leaves.

The most directly relevant part of the EU contribution to Georgia is the $1.4 billion that the UK contributes to the EU's foreign aid budget. This reduction in the EU budget would seem to be bad for Georgia. In the aftermath of the Association Agreement signing, EU spending in Georgia has grown. According to the OECD, in 2014, the EU spent $167 million. If EU aid budgets are cut, then this large item may need to be reduced.

However, it is not that simple. The $1.4 billion that the UK currently contributes to the EU aid budget counts towards the UK's aid targets. The UK, in line with UN global goals, has committed to spend 0.7 percent of GDP on aid. Returning this money to the UK may hurt EU budgets, but it will increase the money that the UK has to spend directly on aid.

This would not generally work to the advantage of a country like Georgia. The UK principal aid agency DfID, tends to focus on poorer countries in Africa and Asia, and Georgia has just recently become an "upper middle income country" by IMF standards. Normally, an upper middle-income country would not be a likely recipient of "poverty reduction" financing.

However, in the aftermath of Ukraine, the UK has started spending more in Georgia, supporting governance reform (and financing initiatives like the Investor Council, of which AmCham is part). With its hawkish attitude to the Russians, this trend might be a beneficiary of possible UK aid-budget increases.

Impact on Western agenda?

Perhaps most importantly, is the Brexit result likely to have any broader impact on Georgia's Westernization agenda? If the Brexit result helps to encourage nationalism and protectionism in the EU, then that would certainly be bad for a country like Georgia, which is looking for an expanded role in the EU club. If it makes the EU look weak and distracted, that may embolden Russia, or may simply make the EU a less attractive looking club to join.

One bad possible future scenario sees the possibility that the Germans and the French, who have always been less hawkish on Russia, decide that it is in their interest to normalize relations. This might encourage Russian aggression, as the West would seem even more internally conflicted and weak.

On the other hand, there are brighter possibilities. The optimistic scenario for the EU, the UK and Georgia is that, like many amicable divorces, both parties can end up better than they were in an unhappy marriage. Under this thinking, both the UK and the EU could end up better off, if they are able to make a more coherent global path for themselves after the split. The UK, separated from the need to be part of an EU consensus, may choose to be a more strident foreign policy actor. Its hawkish position on Russia, for example, may no longer be held back by an aspiration for EU unity.

For the EU, the optimistic scenario is that Brexit will encourage reform and allow for necessary further integration. Most obviously, it has been accepted for a long time that the Euro cannot work unless the EU integrates its finances, allowing for far bigger internal fiscal transfers and greater rigor in governance.

Similarly, the recent terrorist attacks in Paris and Brussels have suggested that if Schengen is to work, the EU needs to better integrate its policing and internal security systems.

The UK was never very comfortable with ever-deeper integration in the EU, but with the UK leaving and with the shock of Brexit, it is possible that the EU will figure out how to make these changes and communicate its importance better to its member state populations. This would ultimately mean a stronger and more integrated Europe, which would seem to be a very good thing for Georgia, sitting on Europe's periphery.

Perhaps, in the final analysis, it is a fool's errand to try and predict the long-term impact of Brexit. In a world where Donald Trump is currently the Republican candidate for U.S. President, anything is possible. One silver lining is that, given the collective insanity of current global politics, Georgia looks increasingly sane. I am certainly happy today to have both Georgian and UK citizenship. If Georgia's EU aspirations reach their eventual goal, maybe I will get to be a European again, after all.