As Britain tears itself apart over Brexit, the world is looking on trying to discern some lessons from this year’s most high-profile divorce. The UK’s ‘profound political crisis’ is a reminder of the modern world’s complex interconnectedness; ill-prepared attempts to unravel it may have unintended consequences and catastrophic implications. The question today is less about whether leaving the European Union (EU) was the correct decision in the long term, but whether economic instability and business uncertainty in the short term can be justified by the benefits which may never materialise.
The UK’s relationship with the Union has been complicated, at times rocky, right from the start. Whilst the idea of creating a union in post-war Europe is attributed to the UK’s Prime Minister Winston Churchill, French President Charles de Gaulle famously said ‘Non’ twice to the British application to join, first in 1963 and then again in 1967. When the UK was finally admitted in 1973, the EU quickly became a rather divisive question in domestic politics too and the membership was put to a public referendum two years later (at the time, the UK overwhelmingly voted in favour of staying). Forty years later, Brexit has polarized public opinion again.
Both sides of the political divide advocate their own version of a bright future for the UK. Leavers promote a vision of a truly independent country no longer subordinate to EU bureaucrats and able to pursue its own foreign trade policy (it currently relies on the European Commission to negotiate trade deals). They campaigned to ‘take back control’, warning of the dangers inherent to the EU ambitions for an ever closer political union. Leavers particularly take issue with the power vested in the European Court of Justice to rule on the UK’s compliance with the EU law which, in their view, has fundamentally compromised the country’s sovereignty.
Remainers, for the most part, acknowledge the shortcomings of the framework, but consider benefits to significantly outweigh any drawbacks. They point to multiple advantages of membership, including unhindered access to the world’s largest single market of over 500 million consumers as well as ability to trade on preferential terms with EU partners. Remainers dismissed demands for recovering sovereignty as populist and advocated a ‘stronger within’ approach.
On 23 June 2016, the UK voted to leave the EU, by a small margin and without providing a clear guidance on the form of Brexit, such as whether the UK should retain membership of the EU Single Market or customs union or – in the most radical scenario – leave without any deal and fall back on the World Trade Organisation (WTO) framework.
Britain is a trading nation; its rise to global prominence was largely propelled by its pursuit of commercial opportunities worldwide. Its advocacy for access to foreign markets often met with resistance. When Britain tried to force China into relaxing trade restrictions, Emperor Qianlong famously wrote to King George III rejecting all his demands: ‘As your Ambassador can see for himself, we possess all things. I set no value on objects strange or ingenious, and have no use for your country's manufactures’. Two hundred years on, and it is the UK that projects the self-sufficiency image, albeit not in goods, but in its political strength.
Supporters of Brexit are positive. In their view, restored sovereignty over trade policy would create a ‘global Britain’. The UK, for instance, could employ its links to the Commonwealth, an association of 53 countries – largely containing former territories of the British Empire – with 2.4 billion people between them. Arranging new trade deals would be easy, they say; reverting to WTO terms would be a satisfactory outcome, where existing deals are not renewed.
Pundits, however, point to fundamental flaws in such an approach. WTO terms represent a major step backwards for the UK which currently enjoys access to the world’s most integrated market (it accounted for 44% of all UK exports in 2017), as well as around 40 trade deals with countries, such as Canada, Japan and South Korea (an additional 11-15%). The UK Government moved to ensure that, at the date of EU withdrawal, existing arrangements are rolled over; by February 2019, however, it renewed deals with only seven out of 69 nations representing £16bn out of the £117bn total.
This is not surprising; trade agreements are notoriously complex and time-intensive to negotiate. If renegotiating existing terms stretches into its third year, striking new deals will most certainly consume more time – it took the EU seven years to finalise one with Canada. They may also fail to replace the lost benefits of the EU membership: Bloomberg estimates that a free trade agreement with the US would replace less than 15% of the economic damage in the no deal scenario whilst a deal with the Commonwealth would make an even smaller 13%.
A lot of experts fear that the UK would matter less in terms of political and economic weight once outside the EU. The UK’s attempt to negotiate its exit arrangements and the future relationship with the EU have already highlighted the country’s limited ability to drive a hard bargain. The EU, supported by its diplomatic and political unity on the issue, dominated the negotiations whereas British representatives have reportedly, on occasion, demonstrated little knowledge of the institution that some of them so adamantly advocated to leave. Pascal Lamy, former head of the WTO, commented: ‘Britain’s reputation is, there’s no denying, much diminished.
Most importantly, advocates of Brexit tend to disregard the fact that trade deals inevitably entail some sacrifice of sovereignty to make the agreement work and commitments enforceable. Even WTO membership includes the dispute settlement mechanism. Admittedly, the current EU arrangements are more far-reaching and pervasive, but future trade agreement with the bloc will be no doubt governed by a system that both sides will need to follow.
British Prime Minister Harold Wilson once said: ‘A week is a long time in politics’. Brexit negotiations take this to a new level as the unfolding political drama offers twists and turns on a daily basis. The UK has always been praised for its rational, well-informed diplomatic approach as well as sound investment climate based on business certainty. Brexit seems to have undermined both of these strengths and dealt a heavy blow to the UK’s international reputation.
Whilst the current economic indicators may not, on the surface, suggest significant stress, a closer look reveals a rough journey ahead. The British pound has not been as volatile, but it remains about 12% below the pre-referendum level. Unemployment is at the lowest level in 44 years but economists interpret this as firms investing in staff rather than technology which could improve productivity in the longer term. Brexit is the main business of the UK government, consuming most its time, energy and resources. In September 2018, Bloomberg Businessweek described the country ‘stuck in political and bureaucratic torpor’ as projects are put on hold and there is no space for non-Brexit agenda.
According to Gertjan Vlieghe, a member of the Bank of England’s Monetary Policy Committee, which sets the UK’s official interests rates, Brexit has so far cost the British economy about £40 billion per year, or 2% of the country’s GDP. The UK government’s own analysis, released in November 2018, estimates that the UK economy could be 3.9% smaller after 15 years if the country leaves under a deal and 9.3% smaller in the no-deal scenario. Figures are alarming and it is this uncertainty around Brexit’s final outcome that is so damaging for businesses which have to plan for every eventuality. To cope, companies have been stockpiling manufacturing parts, staple products and medication to deal with any scenario.
The EU is also weary of Brexit dominating the bloc’s agenda which has other pressing issues it needs to work through. The UK’s departure will impact EU businesses: According to the Halle Institute for Economic Research, up to 179,000 EU jobs could be affected in the event of a no deal. As the UK in Changing Europe, an academic think tank, points out, there will be plenty of blame to go around on both sides of the English Channel for economic consequences and relationships will most probably sour.
Leaving the EU removes one of the key advantages that the UK has exploited in attracting foreign investment: unhindered access to the EU market. When Nissan, the Japanese car manufacturer, looked to establish a European base in 1980s, it chose the UK largely for its EU membership. It now operates the UK’s largest car plant, employing around 7,000 people and supporting another 30,000 supply chain positions within the country. Around 55% of production is exported to the EU.
According to Nikkei Asian Review, Japanese companies support 160,000 jobs in the UK and the country is the second largest non-EU investor in the country after the US. Brexit is a factor that drives their decision making. Panasonic, the Japanese electronics maker, is moving its European headquarters to Amsterdam, citing tax concerns associated with the UK’s intention to reduce corporation tax (this may lead to tax haven designation). Sony decided to move to Amsterdam too as it looks to maintain existing customs and shipping arrangements.
Whilst Nissan first reaffirmed commitment to the UK, it subsequently withdrew its previously announced plans to manufacture a new X-Trail model in the country. Honda announced that its UK plant would close in 2021, eliminating about 3,500 jobs. Both companies pointed to global industry pressures, but Brexit no doubt weighed on the executives’ minds too.
The UK’s financial services industry has been described as the jewel in the crown of the British economy. According to the CityUK, an advocacy group, the financial and related professional services sector contributes over 10% of the UK’s total economic output and employs 2.3 million people. In 2017, it accounted for 52% of the UK’s service exports to the EU running a trade surplus with the bloc. Experts argue that maintaining this success requires continuous access to the EU Single Market; instead, businesses find themselves preparing for the unknown and some inevitably choose to relocate part of their operations.
In March 2019, the consultancy firm EY suggested that up to 7,000 jobs could leave the UK for the EU in the near future. As these represent highly paid positions, relocation will have significant impact on the UK tax receipts. Amsterdam, Dublin, Frankfurt and Paris are most popular destinations. According to Bloomberg, the top five banks – including Deutsche Bank and JPMorgan – are transferring assets to Europe to be able to provide services to local customers, with the latest figures hovering around €750 billion.
The UK’s political clout as a global financial centre has also somewhat suffered due to the inevitable relocation of the European Banking Authority, which oversees prudential supervision of the banking industry across the EU, to Paris. Observers are otherwise skeptical about the UK losing its status overnight due to its highly sophisticated infrastructure and interlinkages. Immediate and full relocation is perhaps less of a risk; rather, it is decisions on future investments that firms make now that will matter. Companies are likely to overlook the UK as the country continues on the course of uncertainty.
As Sir Ivan Rogers, former UK Permanent Representative to the EU, pointed out, Brexit exposed a fundamental contradiction between Leavers criticizing the EU for its invasive presence in all aspects of UK society and simultaneously promising a speedy and smooth withdrawal from the bloc. Instead, life is a lot more nuanced and constitutional decisions are no easy matters. If promises sound too good to be true, it is probably because they are.