Brexit: Wishful thinking

While the result of the EU referendum has clearly hit the UK economy already, with growth in Q3 likely to have been only around half the 0.7%Q/Q rate seen in Q2, the greater damage to the UK economy from Brexit was always going to come in the longer term. Having spent 43 years in the EU, the UK’s economic structures have inevitably become intimately tied to those of the wider EU. This is no truer than in the car and financial services industries. In both sectors, membership of the Single Market has attracted world-leading firms (typically foreign-owned) to locate and thrive in the UK. Brexit threatens to undermine those successes. The financial services sector will likely lose automatic access to EU clients when Brexit occurs, forcing firms to relocate at least some activities to the EU. For the car industry, meanwhile, Brexit threatens the imposition of tariffs on car exports from the UK to the EU, while operating outside the EU customs union will add enormous expense to UK-based car companies, all of which rely on international and highly-complicated supply chains. With Nissan threatening to suspend further investment in the UK until the details of the post-Brexit trade arrangements are clear, and financial services firms already indicating that they are looking at relocating parts of their businesses, it appears to have started to dawn on at least some in Government that Brexit threatens to significantly damage both of these important sectors.

The Government has therefore let it be known that it is examining potential ways of keeping car firms within the customs union, while also hoping that paying continued contributions to the EU budget even after Brexit will secure continued access for UK-based financial services firms to EU customers. But while appealing at face value, thinking about both proposals for more than one minute highlights their implausibility. For a start, the UK Government has said that it is looking for a bespoke agreement with the EU, not an off-the-shelf one (i.e. EEA membership). That raises the question of what institutional arrangement any such special-status deals would operate within. While it is true that Switzerland has an ad hoc arrangement with the EU that provides broad Single Market membership (but, crucially, not for financial services), that arrangement has proved a tricky one to manage, not least given the lack of any institutional framework within which to ensure Swiss compliance with EU regulations (except the nuclear option of the threat to suspend the agreements in their entirety) and is not one that the EU would repeat.

For that reason alone, the proposals seem nothing more than wishful thinking. And even in the unlikely event that the issue of institutional arrangements could be resolved, the risk that they could be cancelled by the EU at short notice (the ‘equivalence’ rules for financial services, for instance, allow access for non-EU firms to be withdrawn with just 30 days’ notice), means that firms will not dare to rely upon them – there would simply be too much risk of massive business disruption in the event that Single Market access was revoked at short notice.

As such, while it is good to see that it is finally dawning on at least parts of the Government that Brexit means disaster for some of the UK’s most successful industries, what they are currently proposing provides nothing more than newspaper headlines, presumably aimed at calming jittery financial markets, rather than concrete, deliverable proposals to allow the UK economy to thrive outside of the EU. Indeed, if the Government really believes that they are deliverable, it shows an unbelievable naivety on its part about both the institutions that underpin the EU and the motivations of the other 27 Member States in how they will handle Brexit. As such, with UK Government policy still seemingly controlled by those pushing for a “hard” Brexit, under which the control of immigration takes precedence over minimising the economic consequences, further market volatility in UK assets, in particular Gilts and the exchange rate, can be expected as Theresa May’s self-imposed deadline for triggering Article 50 of end-March next year draws ever closer.

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