The potential economic consequences of Brexit

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Brexit – reverse globalisation in action

The UK’s vote, in the referendum held on 23/06/16, to leave the European Union (to Brexit) can be viewed as a political event driven by a desire to reverse some of the changes brought about by globalisation. This post explores some of the potential economic consequences of ‘Brexit’.

The hardest form of Brexit ?

The UK Government wants a hard Brexit

  • The UK wants to take back control of borders and laws
  • The UK wants the freedom to strike free trade deals
  • This implies the UK cannot remain inside the single market or the common tariff wall

However, the UK Government thinks it can agree a bespoke trade deal with the greatest possible access to the single market

  • The UK wants to reach agreement within the two-year Article 50 process that Prime Minister Theresa May triggered on 29/03/17
  • The UK wants a phased implementation of the new deal
  • The UK is willing to make financial contributions to the EU after Brexit

Is this realistic? There is a real risk that the UK is heading for the hardest sort of Brexit, possibly involving:

  • No agreement on a free trade deal
  • The erection of tariffs
  • That is, the worst possible outcome from an economic perspective

Why it may be hard to reach a deal:

Timing

  • In theory the Article 50 process allows two years after the notification of the intention to leave given by the UK on 29/03/17
  • However, if you exclude the period before the German elections and allow for time at the end for national parliaments to approve a deal, that length of time is roughly halved

Sequencing

  • The Europeans want to discuss the contentious subject of the UK’s exit bill before discussing trade
  • A EUR 50 billion bill is likely to poison the well on ongoing financial contributions and further limit time spent talking about trade

Incentives

  • Europeans cannot afford to give the UK too good a deal
  • The UK Government cannot afford to compromise on its major points: migration, sovereignty

Misjudging your opponent

  • The UK cannot assume that the economic interest of key trading partners will drive EU decision making
  • Europeans may not view the UK’s threat to cut taxes and deregulate as credible

Events

  • The UK cannot assume that Brexit will be the sole item on EU’s agenda for the next two years

What would be the economic consequences of the hardest form of Brexit ?

The economic impact of Brexit comes in two stages:

  • In the short run: impact of increased uncertainty on consumption and investment
  • Over the longer run: impact of reverse globalisation on productivity, competition, cost of living, public finances, etc.

So far there has been little negative impact,

  • But that only tells us about stage one. The hit from increased uncertainty may have been delayed rather than avoided altogether and stage two is far more significant because that cost will be permanent

There will be difficult adjustment for key economic sectors:

  • e.g. equivalence rules offer little reassurance for the financial sector

Concerns remain about the long-run economic impact for the UK:

  • Lower migration, trade and foreign direct investment will damage productivity (and prosperity)
  • Limited offsetting gains from further deregulation for an economy like the UK
  • It’s not necessarily easy to agree on good trade deals with other countries, nor is it straightforward to rebalance an economy to produce and export different goods and services

Potential political consequences of Brexit:

  • The break up of the UK cannot be excluded

    Published on 30 March 2017

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