25th July 2017
(Originally published by Prospect Magazine, 24th July 2017)
It was inevitable. The release of Christopher’s Nolan’s new film Dunkirk has spurred the supporters of Brexit in parliament and the media to hijack the bravery and spirit of that time in support of their cause. They forget that Winston Churchill told the House of Commons in June 1940 that “Wars are not won by evacuations,” and that the whole episode represented a “colossal military disaster” (except, he was at pains to point out, for the RAF). They mischievously conflate the avoidance of national humiliation—and a lot worse—that might have been imposed by Nazi Germany with the national humiliation imposed by their own strategy to withdraw from the EU. Nevertheless, if one of the messages from Dunkirk is that people have the capacity to overcome a seemingly lost cause, perhaps something positive will yet emerge because the Brexit ground seems to be shifting a bit.
There is no question that the election result has been the catalyst for the change in sentiment, but the agents of change have been the same all along. The economy is, slowly but relentlessly, slowing down as consumers and businesses cancel or defer spending and borrowing decisions. And businesses, which have long warned about the deleterious consequences of Brexit in general, and a poorly managed Brexit in particular, now seem to have the ear of the government.
Three new reports beg the question: is Britain losing its resilience?
In the last week, for example, three reports have been published suggesting that the UK economy is in a precarious position with ebbing confidence as Brexit negotiations continue. The latest, published today, was the International Monetary Fund’s “World Economic Outlook,” in which the prediction for UK growth this year has been lowered from 2 to 1.7 per cent. The IMF predicts that the immediate impact of Brexit will be “mild negative,” but this is almost certainly drawn from a UK Treasury assessment, moderated slightly by the IMF economists in Washington DC. It’s how large sections of the WEO are written. Privately, the IMF is not as sanguine.
The main takeaway from the IHS Markit consultancy report, published last week, was the sharp fall in the net balance of UK firms expecting a rise in business activity over the next 12 months (or the difference between the proportion expecting better and worse outcomes). The balance was +35 per cent in June, down from +52 per cent in February, and the lowest since October 2011. The slump was all the more worrying for two reasons. First, because comparable survey evidence in the US, the EU and Japan all moved in the other direction. Second, because service-producing firms, which is what the UK economy is mainly about, were far more pessimistic about prospects than manufacturing firms, though both recorded weak overall results.
The EY Item Club’s regular forecast update, also published last week, lowered the UK growth estimate for this year from 1.8 per cent to 1.5 per cent, largely because of the squeeze on spending generated by stagnant income growth and the rise in inflation, brought about by the Brexit-related fall in Sterling. Last week alone, Sterling fell by another 2 per cent against the Euro, prompting media stories about rising costs for holidaymakers and consumers, more generally.
These things matter because resilient economies can withstand shocks, such as Brexit uncertainty, let alone Brexit itself, much better than non-resilient ones. If the resilience itself is being undermined by the shock, as seems to be the case, then that bodes poorly for the coming 15 months, the effective period in which Article 50 negotiations will have to be concluded. The actual shock of Brexit, once it happens, will be less headline-grabbing, but more corrosive as it saps the UK’s capacity to recover its productivity sea-legs and damages its trade and investment environment.
What are the prospects for a “transitional arrangement”?
Presumably, that is why Theresa May assured business leaders last week that she would not let companies fall over a Brexit cliff-edge. Not all her ministers think alike, but she and others seem to be lining up behind Chancellor Philip Hammond’s idea that the UK should negotiate with the EU27 for a transitional arrangement after March 2019, or what is euphemistically called an “implementation phase.”
The difference is not just semantics. Devout Brexiteers like Liam Fox and Michael Gove seem to think the latter means months, rather than a few years, while Hammond and others seem to think the former means a couple of years, or perhaps a bit more. Businesses certainly think in terms of years of transition, if needs be. The chasm between these two positions boils down not just to the economic consequences of collapsing out of the EU, but to the politics.
The UK government might want to pitch for a special transitional arrangement with all sorts of trade and business privileges to protect commercial interests and employment, but the EU27 may prove to be resistant for two reasons. First, it is very likely to insist that any arrangement that involved continued membership of the Single Market would necessarily involve accepting the terms, that is, EU regulations on freedom of movement, the jurisdiction of the European Court of Justice in dispute settlement procedures, and financial transfers. Second, it wouldn’t entertain the idea of compromising on the substance of the kind of Brexit it thinks Britain wants, partly on principle, and partly because if it did it would almost certainly be challenged successfully in court.
If the government decides that a transitional arrangement is in the country’s best interests and negotiates to that effect, then it and the Labour Opposition will have to swallow hard and accept conditions that they have studiously avoided explaining to UK voters. They may in any case be at the mercy of “events,” many of which will represent businesses acting to protect their markets and commercial interests.
Jaguar Land Rover, for example, has just announced that it will make and assemble petrol engines in China to serve the world’s fastest growing car market, but as a result, its China-based imports of UK parts and components will fall away. This reminds us about the great significance of supply chains to UK companies, and not just in automobiles. The entire UK car industry is dependent on supply chains within the EU, which might become less accessible or more costly—or both.
Below the tip of this trade iceberg lie transportation, port and shipping efficiencies that we stand to lose outside the EU; up to 759 trade, regulatory and sector treaties with third countries from which the UK would be excluded outside the Single Market, according to the Financial Times; licensing and supply arrangements that we would have to leave; and regulatory agreements spanning the nuclear, chemical and air traffic sectors from which we might be excluded. In financial services, Bank of America Merrill Lynch has just announced that it would make Dublin its European hub post-Brexit, following decisions made by JP Morgan, Deutsche Bank, Citi, and HSBC, among others, to move operations and headcount to Frankfurt, Paris, and Dublin. The announcements comprise relatively small-scale shifts to begin with, but with the precedent established, economies of scale and network arrangements would mean larger shifts before too long.
If Brexit has to happen, it would be better it happened in an incremental fashion, allowing businesses to adapt to radically new and uncertain circumstances, and mitigating the negative consequences for jobs and living standards. It is at least a positive that the government is finally listening to business concerns, rather than pandering to wholly inappropriate and exploitative references to Dunkirk.