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Hard Brexit is better than no deal

The British government triggered Article 50 in March, thereby starting the two-year clock on the U.K.’s Brexit negotiations with the European Union (EU).

As an economist, I was vocal in the run-up to the Brexit referendum that if the United Kingdom ended up choosing to leave the EU, the best option from an economic standpoint would be for it to remain in Europe’s Single Market—a soft Brexit—and the worst option would be a hard Brexit—leaving the Single Market.

My, how perspectives have shifted since then. In the intervening months, and particularly since Prime Minister May’s speech in January, hard Brexit has become the relatively rosy scenario for the U.K. economy. This is because there is now a material risk that the United Kingdom, failing to recognize that the liberal order is falling by the wayside, will misplay its hand and fall out of the EU with no agreement on terms of the relationship between the United Kingdom and the EU. The choice used to be between a soft Brexit and a hard Brexit. Now the primary choice seems to be between a hard Brexit and an even harder one.

New information as the Brexit story unfolds

A number of economists and analysts have been surprised by how well the U.K. economy has performed ever since the vote to leave the EU. Some have even argued that those claiming that Brexit would be negative for the U.K. economy were just sensationalists. I would highlight that Brexit has not really affected the U.K. economy, in large part because Brexit has yet to happen.

The ultimate impact of Brexit on the U.K. economy depends on its choreography, and on that front, we have slightly more information now than we did before Prime Minister May’s landmark speech in London on January 17. The part of the speech that grabbed headlines was her unambiguous assertion that the United Kingdom will leave the Single Market.1

This seemed inevitable ever since Prime Minister May indicated last October that her top priorities were controlling immigration and freeing the United Kingdom from judgments of the European Court of Justice. It was always seemingly impossible to pursue those goals and remain in the Single Market; still, investors were surprised to learn that a hard Brexit was looming. As with many developments in the eighth year of a sluggish economic recovery, the belief that the United Kingdom might not leave the Single Market seemed based more on hope than anything else.

Prime Minister May has reiterated her belief that formal terms of the United Kingdom’s relationship with the EU will be mutually agreed on within the two years after Article 50 is triggered. Most important, she has made it clear that no deal on the United Kingdom’s new relationship with the EU would be better than a bad one.1

Falling out of the EU and into a new world order

Prime Minister May’s statement that no deal is better than a bad deal for the United Kingdom may just be a wise negotiating tactic, but in my view, her statement is untrue: No deal would be much worse. If the United Kingdom and the EU cannot agree on their new relationship within two years, the United Kingdom would not be leaving the EU so much as stumbling out of it. Britain would rely on World Trade Organization terms, with tariffs and nontariff barriers. This could provide a significant headwind for the economy, as documented in a leaked U.K. Treasury report.2

Prime Minister May might not be worried about this, but, in my opinion, she should be. Her vision for her country is global, a Britain that is liberal and open and capable of negotiating bilateral trade deals with whichever countries it wants. The problem is that the rest of the developed world seems to be increasingly turning its back on this kind of openness.

This is perhaps best exhibited in the special relationship between the United Kingdom and the United States. U.S. President Trump has been clear about his support for Brexit and his openness to negotiating a trade deal, but the United Kingdom is running a trade surplus with the United States, something President Trump finds unfavorable. Does Prime Minister May think that this deal will be a particularly good one for the United Kingdom? Even if the United Kingdom is not going to prioritize protectionist policies, the United States may well do so. The same goes for the rest of the developed world.

The decision by the United Kingdom to leave the EU, the U.S. election of President Trump, and the surge of populist parties across Europe represent a sea change in the liberal economic order. For decades, Western leaders have been proponents of globalization as a tide that lifts all boats. This year at the World Economic Forum in Davos, it was Chinese President Xi Jinping who was the most vocal about supporting globalization. The rest of Europe and the United States are not so sure that globalization has served their populations well after a long, sluggish recovery and rising economic inequality. It is in this environment that Prime Minister May will have to reach out to possible trade partners.

A hard Brexit will pose challenges to the United Kingdom, but an even harder Brexit—with no deal at all—would be much worse.

 

 

 

 

1 “The government’s negotiating objectives for exiting the EU: PM speech,” gov.UK, 1/17/17.

2 “Leaked Treasury report warns of painful ‘economic shock’ if Britain crashes out of the EU without a deal,” independent.co.uk, 3/12/17.

 

Foreign investing, especially in emerging markets, has additional risks, such as currency and market volatility and political and social instability.

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