If the UK leaves the EU, the impact will be felt far beyond its borders. Indeed, one country that will be particularly affected is Ireland. In the short term, there will be a painful economic dislocation, as the two close trading partners adjust to the UK’s new status. But it could be far more positive for Ireland in the longer term, as it attracts significant investment flows from the UK, notably in the financial, chemicals and pharmaceutical sectors.
Ireland should be able to attract a sizeable proportion of the foreign direct investment (FDI) inflows that would otherwise have gone to the UK, thanks to its low tax, business friendly and flexible labour market environment. If Ireland attracts 25 per cent of the UK’s inflows, it could receive as much as $20bn more FDI between 2017 and 2018, equal to 10 per cent of its GDP.
Part will come from financial services. The 250 foreign banks currently in London will be considering where they would relocate in the event of a Brexit, as it will be more costly and difficult for them to sell investment services and retail products to EU clients in this scenario. Within the EU, Ireland is the fourth biggest financial platform, with 15 per cent of total bank assets foreign-owned. Given the potential ease of transition, we think the majority of London-based banks could, potentially, move to Dublin.
In recent years, thanks to its highly educated workforce and attractive tax regime, Ireland has managed to diversify its trade performance, with a focus on high value-added sectors like electronics, telecoms, chemicals and pharmaceuticals. Ireland has also decoupled from the UK in favour of the US, which has been its main trading partner since 2004.
However, in the short term, the negative effects of a Brexit would be sizeable, given the Irish economy’s high degree of openness and the comparative importance of the UK. Exports account for more than 100 per cent of its GDP, so a shock could have significant consequences. Ireland has a trade deficit with the UK that has steadily worsened over the last decade (it was €7bn in 2014, three times higher than in 2005).
We expect the most unfavourable consequences for Ireland of a Brexit to arise mainly due to new tariffs on exported and imported products. This would hinder trade between the two countries, as Ireland would not be able to negotiate its own free trade agreement with the UK but would be part of any wider deal agreed by the EU. As a result, we expect that Irish exports of pharmaceuticals, agri-food, machinery and chemicals would suffer the most.
We also anticipate that energy and agri-food prices would rise significantly in Ireland, since 89 per cent of oil products and 93 per cent of gas is imported from the UK. This would cause disruptions in the supply chains across these sectors. Furthermore, 51 per cent of total Irish agri-food exports go to the UK (worth €3bn), making this sector much more dependent on the UK than the industrial sector.
All in all, we think there is only a 10 per cent chance that the UK will leave the EU, but expect Irish GDP to fall by 2 per cent in the first year if there is a Brexit. Ireland should, however, gradually recover afterwards, provided it replaces its lost export market share and attracts additional FDI.