14 September 2016. The United Kingdom vote in June 2016 to leave the European Union will have major implications for developing economies, according to a report by the Overseas Development Institute (ODI). Least developed countries (LDCs) will be particularly affected, mostly via reduced exports and lower aid values. Aid and trade preferences are two of the main international support measures (ISMs) available to LDCs.
Although LDCs will be impacted differently depending on how (and if) the UK leaves the EU, the effect will mostly be negative, via trade, financial markets and investment, aid, migration and remittances, and global collaboration. The ODI conservatively estimates that the 10% devaluation of the pound in the first week after Brexit, together with a downturn in the British economy, could cost LDCs $500 million in lost exports. In addition the devaluation will in effect reduce total British aid to all developing countries by $1.9 billion, with LDCs probably among the worst affected. “If the pound continues to fall, the effects could increase,” says the report. Around half of Britain’s £12.2 billion aid budget is allocable to LDCs. By mid-July the sterling/dollar exchange rate had fallen by 12%.
The UK accounts for around 5% of LDC exports, although export dependency varies significantly by country. LDCs that export a lot to the UK will be most affected, including Bangladesh, which sends 10% of exports to the UK, and Cambodia, which sends around 7% of its exports to the UK. The devaluation effect could even be compounded by increased protectionism or a deterioration in Europe and Britain’s trade relations with the rest of the world.
LDCs also rely heavily on the larger EU market, the single biggest in the world. If the EU is negatively impacted by Brexit, these countries will suffer and import less from the rest of the World. Bangladesh sends half of its exports – mostly garments – to Europe including the UK. Ethiopia, Malawi and Uganda send nearly a third of their exports to Europe. Tanzania, Sierra Leone and Rwanda export less to the EU but will still be affected.
An additional channel for the Brexit effect is via investment – both portfolio and direct. Whilst the impact of a downturn in financial markets immediately after the vote appeared negative for developing countries and LDCs, the subsequent stock-market rebound suggests that the near-term fallout could be limited. Estimating the impact of further financial volatility is extremely difficult, and in any case LDCs tend not to be major recipients of portfolio flows. A greater long-term impact may be felt in the form of lower foreign direct investment (FDI). Zambia, according to the ODI report, is a particularly large LDC recipient of British FDI.
Another of the outcomes of the Brexit vote may be lower remittances, which will affect the countries most dependent on the UK such as Afghanistan, Angola, Cambodia, Haiti, Mali, Uganda and Somalia. Not only may Brexit lead to restrictions on immigration, but sterling remittances will be worth less following devaluation.
A final area of uncertainty for LDCs surrounds UK trade policy following the vote to leave Europe. The ODI, like a number of other commentators, envisages two main scenarios: either that Britain pursues a UK-EU customs union, or that the UK pursues an autonomous trade policy. The first scenario would be less disruptive, and in principle there need be no impact on trade preferences. The UK could continue to offer duty free access along the lines of Everything But Arms (EBA) and under the same conditions as under current Economic Partnership Agreements (EPAs) between the EU and African, Caribbean and Pacific countries (ACP).
An autonomous UK trade policy might present further problems. Some proponents of leaving the EU have suggested that Britain would reduce tariffs to either very low levels or to zero as part of a series of new trade deals with other countries. In this case the LDCs benefitting from EBA and the ACP-EPAs would lose their preferential margins. Preference-dependent LDCs may struggle to compete with more efficient or cheaper middle-income countries. This further underlines the need for LDCs to focus on building productive capacity and on generating greater efficiencies among exporters. LDCs also need to diversify and engage in economic transformation that makes them less dependent on European and UK aid, trade, remittances and investment.
Overall, the case of Brexit may only be the latest in a number of international economic shocks that LDCs are forced to confront as large economies experience slow growth and voters begin to question the benefits of economic internationalisation. Whilst ISMs are an important source of help for the LDCs, they depend on continued stability and prosperity in the biggest economies. Global political and economic events often have a much greater impact than aid and trade concessions granted by the international community.