The Economy after a Brexit vote

UPDATED

I didn’t expect to come back to economics; but I’ve been prompted by repeated discussions (and some accusations) on Twitter. Last time, I didn’t dwell on the options available in a post Brexit world because I said that they were uncertain and so – whether the economics turned out to be good or bad – the uncertainty itself was an economic risk.

I’ve had two different types of responses to that. Firstly, there have been people who have said that despite that uncertainty I should discuss the economic options that the UK may have in the event of Brexit. Since there seems to be a general desire there to discuss them, I will. Secondly, there have been people who say that Brexit isn’t a risk and there is a safe economic route out of the European Union. These two points cross over so I’ll address them together.

The first thing to note is what we are and what we are not talking about. This is not a discussion about the relative strengths of the Eurozone, the wisdom of that structure and the restrictions it puts on a member state. Nor it is a discussion on political union, democracy or identity. This is a discussion solely on the potential economic impact on the UK of leaving the EU – nothing else.

Process of Leaving

There are a lot of claims floating around out there about what the UK could or couldn’t do if it left and how it would leave. As with anything, it’s best to go straight to the horse’s mouth, in this case Article 50 of the Lisbon Treaty. This covers the process of leaving and the negotiation of the withdrawal agreement. I have had this quoted at me saying the EU would have to negotiate a deal with a UK within two years. To answer that, it is worth quoting the third clause of Article 50:

  1. The Treaties shall cease to apply to the State in question from the date of entry into force of the withdrawal agreement or, failing that, two years after the notification referred to in paragraph 2, unless the European Council, in agreement with the Member State concerned, unanimously decides to extend this period.

That’s a countdown, not a deadline. If negotiations fail – or the EU just drags them out – all the UK’s current trade terms and agreements end after two years. No further discussion, no wriggle room, nothing. They just end. So if the EU doesn’t want to do a deal, it doesn’t happen, regardless of what the UK wants. This puts them in the driving seat, which is never a good position from which to start negotiations. The question therefore becomes not what deal we want; but what does the EU want?

The view from the EU

The most important point to make here is that I don’t know what the EU does or will think. I don’t think that they know what they will do yet; so we should be all rightly suspicious of anyone who tells you that they will be either desperate to do a deal or will want to punish us; both of which have become articles of faith to the opposing sides.

The guiding force behind the EU’s position will be the self-interest of its states, as one would expect (this will also be the UK’s objective as well). Leave supporters tend to say look at all those German cars on our streets. That means that the EU will be desperate to keep selling those so they will do a deal (this point even features in Brexit the movie). There are a few obvious responses to that:

  1. An economy is about more than just car manufacturers
  2. The EU is more than just Germany
  3. No trade deal means using WTO rules, which cover cars
  4. There are many other industries – perhaps most notably finance – who it could be argued would love the UK to be excluded from the single market as it means our finance industry would be blocked in the EU and they can take over

So even if German politicians were calling all the shots (and they aren’t) and they were the puppets of the leading figures in the German economy (which they aren’t); just from the above example, you can see that there would be at least two industries lobbying different ways. So the only thing that any of us can be certain of is that the final result is uncertain. But no one will be “begging” for a deal.

The EEA option

This has been championed by some as the “safe” way to Brexit; especially in the “Flexcit” proposal which has been championed by some. In essence this envisages leaving the EU via the European Economic Area (EEA), with that providing a safe stepping stone. It’s an interesting piece with many good ideas – phases two and six sound like the sort of thing we should be doing anyway – but I’m just going to concentrate on the first stage concerning leaving.

I think it is fair to say that joining the EEA on leaving the EU would be the option that causes the minimum amount of disruption to both the UK and the EU economy. It would still involve freedom of movement, paying a contribution and accepting most EU laws, though, and so will never be a good option for many. But because it would give access to the single market, it would undoubtedly cause the least disruption. Some have therefore concluded that if Brexit was done on these terms, it would be economically safe.

The difficulty is that it is not guaranteed. It ignores what the EU may want as well as ignoring the EU’s strong bargaining position and perhaps its political will. It is perfectly possible that the EU considers the idea of an EU-lite option in the EEA to be a threat to its existence and so it may – for its own self-interest – want to make sure that such an option is unattractive. Therefore it’s perfectly conceivable that they will refuse such a deal. And the most important thing there is that, if they do, there is absolutely nothing the UK can do about it. So hardly “safe”. It might work out and everyone will be happy; but it might not and this makes it highly uncertain and therefore a risk.

Other Options

There have been other versions of the future and options suggested and any negotiations could wander between working under the limited World Trade Organisation (WTO) rules and the EEA single market option. But again, the main point is we don’t know. Some have said the UK could claim certainty under the Vienna Convention on Successor States. That is legally very dubious to the point that if any country believes it is in their interest to ignore such a claim; it will be almost impossible to enforce. Especially when you have the head of the WTO coming out and saying No, you will have to start afresh with every other country and negotiate new deals with them all. But that’s ok, isn’t it, because we can be nimble and quick and negotiate some excellent trade deals quickly, can’t we?

Trade Deals

These take time. Years normally; but let’s assume we’re brilliant at it (even though we have no real experience) and we can get a trade deal done every three months (incidentally, no one ever has; but let’s Believe in Britain). There’s almost 200 countries in the world and we currently have trade deals (though the EU) with about 50 of them. Being nimble and quick, we’ll get through at least 4 a year. That’s brilliant; but means we’ll have economic uncertainty for 13 years – just to get back to the current position. And every second we wait – our competitors are getting ahead, stealing our customers, hurting our economy.

Does that matter if we get better deals? Possibly not; but is that possible? The problem is that in trade, size matters. Simply put, you say to a potential partner – I’m going to give you access to my X million consumers if you give me access to your Y million consumers. If the sizes are similar, you can get a good deal; but if you have 64 million and you’re negotiating with someone who has over a billion like China or India, it doesn’t take a genius to work out who’s in the driving seat.

And when other countries look for who to deal with first, are they going to choose us with 64 million or the EU with 444 million or the US with 319 million? Think of it from our point of view. Who would we put the effort into doing a deal with: Norway with 5 million customers or the USA with 319 million?

Do we actually need trade deals?

There are a number of economists, perhaps most notably Prof Patrick Minford, who say that we don’t need trade deals and we just need to trade in the global market. Such economists make two main points:

  1. We already trade globally with countries that we don’t have trade deals with. So trade is perfectly possible.

Yes, that is true; and yet completely misses the point. Trade deals aren’t about making trade possible (well, not normally) they’re about freeing up trade and allowing more. For example, imagine you as a country make three goods A, B and C. At the moment, because you are so good at making good A, you can sell it around the world to country X and still make a profit despite the fact that they subsidise their own versions of A, B and C and tax the ones that come from you. With a trade deal which reduces subsidies, taxes etc, it now becomes profitable to trade good B with country X as well. No trade deal – one good traded. Trade deal – two goods traded; but never good C as they can make their own ones well enough.

  1. It’s a global market place and free trade will allow the best result to come out for everyone and our success will be determined by our own talents.

Broadly speaking, that is right; but there are two important considerations to make before totally endorsing that statement. Firstly, that only works if everyone does it. If we adopt this but other countries do not, then it’s not a level playing field and our industries that could have prospered under total free trade could fail because of the restrictions that others have put in place. So it’s a great ideal; but unfortunately it’s not the current world. Something to work towards, perhaps, but while things are as they are, we need to deal with the world as we find it and not sacrifice our industries by going it alone.

Secondly, there is a cost to totally unfettered free trade. Such free trade forces completion and specialisation and that can mean that anything we do in the UK that could be done cheaper elsewhere is likely to be done elsewhere. That brings down costs for consumers; but it will lead to decline in some industries. Perhaps – if competition around the world is fair – that should be a long term goal; but it has to be balanced by other considerations such as being reliant on others or traditional communities and skills disappearing. There’s a case to be made here; but there is also an inevitable cost that is rarely mentioned. If Leave want to make this argument, good luck to them; but they need to be honest to the Steelworkers, Farmers and the like who could see their jobs, industries and communities disappear.

Regulation-Lite

The last version of our future economy outside of the EU I want to mention is the one where it is claimed that we will be liberated from all the EU red-tape and thus will lift the load from UK businesses, boosting the economy. There’s a number of points here:

  1. Even with all that burdensome regulation, we in the UK already have one of the lightest regulated economies in the world. (any economic comparative report will say this but here’s a link to an OECD one)
  2. It doesn’t matter where the regulation comes from, all that matters is does it make sense? How many of those EU regulations would we have needed to write ourselves if we had not been part of the Single Market? Certainly before the EEC, we had more regulations; not less.
  3. Which ones are going to get torn up? This point is usually skated over but it’s perhaps the most vital. Are we going to remove regulations on consumer goods that make them safe; on employment to remove workers’ rights; on environment standards that protect it? Each of those would help businesses; but at what cost? Until Leave can answer those clearly and honestly, I can’t see where their bonfire of the regulations is going to come from.

Conclusion

The process of leaving the EU is very clear and obliges the EU to do nothing towards the UK apart from say “Goodbye”. They will therefore do whatever is in their interest, irrespective of what the UK wants. In those circumstances, even if they were feeling charitable towards us, it is hard to see how they won’t screw a better deal out of the UK. So ‘Brexit’ is not risk free.

If the potential reward of breaking away from the EU is high enough then it may still be worth it. So would liberation from the EU’s rules and regulations usher in a golden era of prosperity? Highly unlikely. We’ll still need regulations (or we have to face the cost to the environment and people of junking them all) and it will take years to sort out new trade deals, years where our competitors are getting ahead.

Even if we did arrive at free-trading glory days where everyone trades without barriers, there would still be a huge adjustment – and a huge cost. Perhaps that is worth it; but if you propose that you have to be honest about the potential cost.

Ultimately, Brext unavoidably produces risk and uncertainty and there are NO safe guaranteed options. But a risk can be worth it if the reward is great enough. Unfortunately, in today’s world and with the people we have to compete with globally, that is highly unlikely. In my view, trade is beneficial and we should be pushing for freer trade globally; but we should be doing it carefully and while being conscious of the world we live in and being sensitive to the consequences of those moves. The Brexit economic proposals do not address any of that.

UPDATE – 10th June

Since writing the above, the German Finance Minister, Wolfgang Schauble has come out and said what I feared might happen, “Out is Out”.

Of course, this is all hypothetical but the fact that one of the major politicians in Germany – the state so many in the Leave campaign say will be begging to deal with us – has come out and said that has massively reduced the probability of such a deal. Personally, I thought that given the fact it had to have the approval of 27 states, some of whom aren’t that economically tied to the UK, a deal like that was always unlikely. Now, it’s almost certainly off.

Leave has to face the fact that Brexit means leaving the single market and that will hurt the economy. There are other reasons to vote Leave; but doing so must be done in the full knowledge of the economic damage it will do.