Brexit

On Friday, the UK voted to leave the European Union, the first time that a member country has voted to leave. Not only is this is the first time that a country wants to leave, but UK is also a big part of the Eurozone's economy at $2.7 trillion. Lets go over some scenarios that are likely to play out in the aftermath.

No Brexit

The referendum is not binding and can be ignored by the parliament. The current Prime Minister has indicated he will not invoke Article 50, which will formally announce the intention of a member state to leave. He plans to step down by October and leave the decision to his successor. At present, this is likely to be Boris Johnson and it is unsure if he will follow through and actually pull the trigger. The conventional view has been that nobody expected the Leave vote to actually win. This keeps open the possibility that as public opinion swings away from Brexit, it will keep getting delayed, and increasingly less likely, and finally forgotten.

Second referendum

This is a remote possibility, but still possible. There are roughly 1 million+ signatures for a second referendum where votes will be counted only if turnout crosses a high threshold. This seems far fetched and very unlikely, given that a second Leave win will seal all options and prolong uncertainty damaging the economy. However, if this actually moves forward, and is planned at a distant date, it is likely to be one of the worst outcomes, as lingering uncertainty causes a paralysis of decision making in the government as well as private sector.

Brexit , Scotland stays

While Scotland has overwhelmingly voted for Remain, and the First Minister has called for Scotland to secede from UK to stay in EU, this remains the most optimal outcome for both Scotland and England. An independent Scotland has a very small population, no special natural resources, and quite dependent on imports. This would keep the economy very weak and perhaps spark a migration from Scotland to England. The politicians are aware that while Scotland would prefer to be in EU, it may not be practical to go alone and into EU without being part of the UK. In such a case, perhaps increased autonomy or some arrangement where Scotland joins the EU but UK doesn't is also possible. This puts UK in control of its finances, immigration while preserving access to the EU open market.

EEA - Norway, Switzerland style arrangement

This is unlikely to work, since UK will still contribute to the EU budget and also not be in control of its immigration. Present free movement of labour will continue. UK will also lose a say in rule making that it has at present.

New deal

A new deal that is negotiated over the next couple of years which gives UK partial or complete access to the EU market similar to the present arrangement gets negotiated, or perhaps marginally worse. UK is also free to sign FTAs with other countries outside the EU, and moves ahead with deals that it has not been able to in the past. Trading with EU with current WTO rules is also possible, without specific arrangement with the EU as a whole. Lastly, UK may negotiate individual deals with partner countries where it gets most of its trade and slowly build agreements with other countries.
This is the best case scenario for the UK, but the EU is unlikely to give the UK a free pass, as this would be encouragement for other countries to leave the EU. Similar to the hardline positions taken during negotiations with Greece, it is likely that EU takes hard positions and is unwilling to make any concessions. This is a bad outcome for the EU as well as the UK, but is very likely.

Brexit, Scotland and Northern Ireland leave UK

This is quite possibly the worst case outcome. If Scotland votes to leave UK, as well as Northern Ireland, it will be very messy and complicated to work out a lot of details about how they will survive as independent countries, after almost 300 years of complete integration. While the loss to the UK economy would be about 10-12%, it would be very chaotic and create prolonged instability that would be worse than a Brexit alone. It remains to be seen if we do indeed get to this.

Benefits

The UK leaving the EU could have unexpected benefits to the country, as a result of the complex laws and bureaucracy of the EU. Any new deal negotiated is likely to be designed to minimize disruption and continue the status quo with regards to trade and legal systems. A country located within Europe geographically, tightly integrated into the economy and yet with a separate parallel regulations and currency is likely to create a regulatory arbitrage. This could lead to further shifting of some companies from Europe to UK. This is contrary to what the majority opinion tilts towards currently- that Brexit will cause innumerable job losses as companies shift jobs from UK to continental Europe. There will certainly be job losses as some companies shift base to Europe, but there will also be some benefits as companies shift to UK.
Further, UK may negotiate better trade agreements with countries outside the EU. UK has made significant efforts under Cameron to be the point of entry into Europe for Chinese companies and other Asian investors. This will likely take a hit now, but a well designed and planned Brexit may keep it afloat.

Conclusion

The most likely scenario so far is Scotland staying in the UK, and the UK leaving the EU. This is likely to have a negative short term impact on the UK in the short run, (next 2-3 years). But in the longer run, this is likely to have a positive impact on the economy.

The major loser from the Brexit is not the UK but Europe, and Germany in particular. This may be why the FTSE closed down 3-4%, but the German DAX closed down almost 8%. A major EU member deciding to leave has exposed fractures in the otherwise harmonious picture presented and weakens the idea of a united Europe. Germany enjoys large trade surpluses with most European countries and this is on account of their common currency and superior German productivity. After Brexit, if this is followed by similar referendums in other countries, most notably France, Spain, then Germany will be the sole large economy left in the block. Countries that leave will be free to devalue their currencies and thus remain competitive against Germany. This would hit German exports substantially and affect the German economy in a major way.

Lastly, this event could trigger a series of referendums across Europe. If the EU unravels, individual countries are unlikely to retain the relevance that a united Europe commanded. Local markets are not large and deep enough for large investors and this could lead to a decline in foreign investment and trade. the Euro has also been one of the major reserve currencies held by central banks, although it is far from being anywhere close to the share of the US Dollar. A complete disintegration will have catastrophic global impact as systems need to be rebuilt, basic assumptions rewritten and contracts renegotiated. A united Europe is also capable of standing up to Russia, a divided Europe is likely to lead to competition among the countries and everyone will be worse off. Perhaps, better sense will prevail, and before UK takes the irreversible step, EU negotiates and comes up with a new agreement that addresses UK's immigration concerns and the UK stays in the EU.