A vote to leave would represent an immediate and profound shock to our economy. That shock would push our economy into a recession and lead to an increase in unemployment of around 500,000, GDP would be 3.6% smaller, average real wages would be lower, inflation higher, sterling weaker, house prices would be hit and public borrowing would rise compared with a vote to remain.

George Osborne, Chancellor of the Exchequer, May 2016.

The longer-term consequences are predicted to be even more parlous:

If we take as a central assumption that the UK would seek a negotiated bilateral agreement, like Canada has, the costs to Britain are clear. Based on the Treasury's estimates, our GDP would be 6.2% lower, families would be £4,300 worse off and our tax receipts would face an annual £36 billion black hole. This is more than a third of the NHS budget and equivalent to 8p on the basic rate of income tax.

George Osborne, April 2016.

And yet Britain has voted to leave.

As usual in economics, 'it all depends', but there is near unanimity that this will turn out badly for Britain's economy, even in the longer run when the shockwaves have dissipated. See the chart on page 24 of the IMF's assessment. The only positive prediction is from a cock-eyed optimist who sees Britain retaining the substance of its EU relationship, supplementing this with free-trade agreements with fast-growing economies, and a productivity burst resulting from deregulation.

The main economic issues are:

  • trade
  • investment
  • regulation
  • fiscal costs of membership
  • immigration.

On trade, the starting point is that favoured access to a large nearby market should provide a clear advantage, and about half of Britain's exports currently go to Europe. Many economists are lukewarm about so-called 'free-trade agreements' and common markets as they distort trade and Britain is currently buying some EU goods which could be obtained more cheaply from a non-EU supplier. Let's not, however, make too much of this argument. The EU is a large market and the distortions are probably small (with the notable exception of agriculture — more later). Losing preferential tariff rates doesn't matter much because tariffs are generally low, but it will be painful to lose the seamless connectivity that a common market provides with its uniform regulations and procedures.

It might seem that Britain could negotiate a deal with the EU that retains its current access (as Norway has done). The EU may well be peeved about Britain's departure, but it is still in the EU's interest to maintain a larger trading block. The UK is much less important for Europe than Europe is for the UK (its exports to the UK amount to 3% of the EU GDP, compared to Britain's 13% of GDP from exports to Europe). That said, Europe would be better off with close integration with the UK. 

While economics doesn't stand in the way of this outcome, politics probably does. Norway has to abide by all the EU rules except fishing (an outcome was critically important to its economy), including immigration. Switzerland has negotiated largely-free access to the EU, but contributes to the EU budget, abides by EU rules and is a signatory to the Schengen immigration protocols; all without a vote in Brussels. With these precedents, it seems unlikely that the EU would provide the current degree of access without insisting on many of the existing obligations (including immigration) and fiscal contributions.

The main trade advantage which the UK has at the moment is the ease-of-doing-business which harmonisation of standards and protocols brings. Whatever the deal finally reached, it won't be as good as Britain has at present.

The EU currently has 60 FTAs (and even more under negotiation), with the likelihood that Britain will be excluded from these once it leaves. Where will Britain stand in the Transatlantic Trade and Investment Partnership (TTIP) currently under negotiation? Maybe there is a glimmer of hope here. The US aim is to make this type of high-level agreement the new model for global trade. If Britain could somehow tag along with these arrangements, the result might provide good access to Europe. But the TTIP is a long way off and in any case these broad rules and high level principles are far removed from the detailed harmonisation of the EU common market. 

Potentially just as serious is the impact on foreign investment into Britain. There is not much doubt that Britain has benefited very substantially from being the first choice as an investment destination for non-EU companies looking for easy access to the EU market. Similarly, EU firms find the global orientation of Britain's legal system and language attractive in their dealings with the outside world. This applies particularly to London's financial sector which accounts for 8% of UK GDP. Under the 'passport' system, financial transactions are seamless not just for travel, but for mutual acceptance of prudential regulation. Some of this financial business will shift to Frankfurt, Paris and other European cities. No wonder London voted overwhelmingly to stay!

The popular complaints are about over-regulation, with lots of risible anecdotes about requirements on the dimensions and shape of bananas and cucumbers. But Britain has managed to remain lightly regulated overall, including (most importantly) in the labour market. Derisory anecdotes are legion, but the reality of a globalised economy is that any exporter will have to meet foreign-designated specification (at a minimum, for biosecurity, product safety and rules-of-origin) if it wants to do business overseas. This won't change much. In any case, many of the most efficiency-sapping regulations are home-made (such as urban planning and building regulation). Britain could go its own way on issues such as the environment, but again there are powerful pressures to conform (not least from the domestic public). Thus, EU regulations will probably be replaced by similar domestic rules.

Won't Britain be freed from the undoubted inefficiency of the Common Agricultural Policy (where domestic farm production is sheltered by the highest tariff levels, around 20%)? Much of British agriculture is subsidised (Britain gets back around half of what it puts into funding the CAP) and wouldn't survive without subsidies. It is inevitable that the CAP subsidy will be replaced by a domestic one in the short term, and even in the longer term it will be hard to wean British farmers off their subsidies.

What about the burden of supporting the EU's budget, with all its bureaucracy and costly subsidies for Europe's poorer members? The net cost of EU membership to Britain is around 0.3% of its GDP: not small change, but not all that large either.

Even free-market economists understand there are political sensitivities when it comes to labour markets. Nevertheless, they generally see economic advantage in immigration. The IMF assessment (section 25) quotes a number of studies showing the positive impact of EU immigration on the UK. A growing labour force is usually thought of as a positive for an economy (for the counter example, think of the gloom associated with Japan's declining demographics). That said, the public generally doesn't like outsiders. Looking more closely at the composition, however, only about half of Britain's recent immigrants come from the EU, and these tend to be, in economic terms, the best immigrants; educated, young, mobile, hard-working, motivated, and often bringing special skills. If there is a political imperative to cut immigration, reducing the non-EU migrants could be done without leaving the EU.

From an economic perspective, Britain obtained an attractive deal within the EU. It isn't a member of the euro-zone (it kept its own currency), so it continues to have independence in monetary policy. It is not a member of Schengen, so it keeps control over its borders. It had to accept EU immigration, but this is a plus in economic terms, especially as Britain negotiated the right to restrict social security benefits for the newcomers. Its net membership cost is below average as a share of GDP. It negotiated specific exclusion from the inevitable costs of bailing out troubled EU members like Greece. The sometimes-weirdness of regulatory burden is a source of endless amusement, but is a serious issue only for doctrinaire libertarians; an increasingly globalised economy requires more regulation at a supra-national level. Britain's natural advantages of language and law meant that it could dominate Europe's finance industry and that led to lots of high-paying jobs.

Thus from an economic viewpoint, Brexit is inexplicable. Does it make more sense in a longer timeframe? If the 'Europe' project is moving inexorably towards a huge country called 'Europe', with fully integrated budgetary policy involving large transfers to the poorer members, then the push-back is more understandable. Perhaps Britain's half-hearted integration (notably, its decision to stay outside the euro zone) was a forewarning that it wasn't a suitable candidate for the Europe project, and what happened last Thursday was inevitable at some stage.

Even if this were true as a longer-term trajectory for Britain, why not ride along for the benefits which remain to be gained for continuing membership? The economic case for remaining in the EU is so overwhelming that Brexit has to be counted as yet another case where the economic arguments never gained traction. Of course the economics may not turn out as badly as Chancellor Osborne predicted (he was, after all, a biased source). Financial markets hate uncertainty and always overreact. But what is indisputable is that the down-side risks facing the economies of both Britain and Europe have substantially increased.