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posted on 12 October 2017

Why A No-deal Brexit Doesn't Even Bear Thinking About - Let Alone Planning For

from The Conversation

-- this post authored by Panicos O. Demetriades, University of Leicester

I couldn't help feeling a sense of déjà vu when I heard the news that Theresa May's government has started preparations for a no-deal Brexit.

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For the notion of a no-deal Brexit resembles the thinking of those politicians who, in March 2013, argued that Cyprus should reject the Eurogroup's bailout offer - because they thought the conditions involved were unfair - and prepare to abandon the euro, and consequently the EU. I was governor of the central bank of Cyprus at the time. These politicians argued:

"If we show our readiness to turn down their offer, the Eurogroup will come to its senses and will then offer us a better deal, as they wouldn't want to face a disorderly unravelling of the euro."

I suspect that's the thinking behind Theresa May's latest bravado. By publicly showing her readiness to crash out of Europe, which is certainly bad for Britain but also bad for Europe, she thinks she is demonstrating her determination to get a better deal in Brexit negotiations, which do not seem to be making much progress.

Worse for whom?

But who is going to suffer most from a no-deal Brexit? The rest of Europe or Britain itself? A report by the credit rating firm Standard & Poors' market intelligence unit is illuminating on this front. It finds that, out of the other EU states, the country that would be most affected by Britain crashing out of the EU is actually Ireland.

In the worst-case scenario, Ireland stands to lose exports amounting to 10% of its GDP and has a relatively high exposure to the UK in other areas (including foreign investment and migration). Next in line are Malta, Luxembourg and Cyprus - all three of which have significant trading links with the UK. But they are the smallest countries in Europe with hardly a voice in Brexit negotiations.

Germany and France - the countries that arguably have the biggest say in negotiations - stand to lose less than 3% of their respective GDP in terms of export revenues and could gain substantially from the relocation of financial services and European agencies, such as the European Banking Authority, which would, in all likelihood, be relocated to Frankfurt.

For the EU-27, therefore, a no-deal Brexit could prove little more than a relatively minor irritation, if not a blessing in disguise.

No-deal would massively hold up trade.

By contrast, the UK could be heading towards a major calamity. The EU is the UK's largest trading partner - it accounts for 44% of all UK exports of goods and services and 53% of UK imports.

Grinding to a halt

All of that could grind to a halt if Britain crashes out of the EU without a deal. Trade flows are made possible because of a trading framework that has evolved over decades that by now makes trade within the EU appear seamless. Removing that framework overnight, without anything to replace it, will be extremely disruptive. Border controls on both sides would suddenly need to become extensive, which will disrupt the supply chain of many products not least because port storage and processing capacity is not ready for a post-Brexit world.

Interruptions to trade between the UK and Europe will not just mean that UK consumers may have to forego some of their favourite European brands. They could also be deprived of domestically produced goods that depend on imported raw materials from Europe. In an economy that is as open and as well integrated in European supply chains as the UK's, it is hard to think of any manufactured products that do not contain imported raw materials.

But what if the UK started preparing for that calamity? Would that not minimise the disruption, as well as increase its bargaining power?

The UK can certainly prepare its borders for the brave new world in which more customs officers will be needed to carry out new checks. But in the short run, increasing processing and storage capacity at ports on both sides will be very challenging. So the disruption of trade flows between the UK and the EU is inevitable under a no-deal scenario. And that's before we even consider the likely effects of any air traffic disruption and increased uncertainty over trade and investment.

Companies will also be hard-pressed to prepare for a no-deal scenario. They should certainly be drafting contingency plans, which will probably involve hoarding raw materials. The same goes for households. We could all do well to stock up on our favourite European brands well before March 2019.

But a far better contingency plan would be to avoid the crash altogether and watch it happen from a safe distance. There will be many in the private sector who will, in all likelihood, relocate or at least reduce their presence in the UK. That's why so many banks are opening new offices in Dublin and Amsterdam. And the same is true for individuals who are already voting with their feet.

All this will, of course, make Brexit even more costly for Britain and less costly for the rest of Europe. It is, therefore, very doubtful that any amount of contingency planning will make the no-deal scenario any easier for the UK. It is even more doubtful that it will have any impact whatsoever on the UK's bargaining position vis-a-vis the EU-27, which, united and unyielding as they stand, have the upper hand in Brexit negotiations.

In March 2013, Cyprus' political leaders realised - just before time was about to run out - that it was much safer taking what was on the table than engaging in a game of chicken where they had much more at stake than the other side. Four years later, the government is taking the credit for a recovery aided by an EU-IMF bailout, all the while criticising Europe for its treatment of Cyprus during those negotiations.

The ConversationBy declaring that she is getting ready for a no-deal Brexit, Theresa May probably thinks she is making a well-calculated gamble that will help her own political survival. But I wonder if she or her advisers have contemplated how they will escape from the avalanche of economic and political repercussions as we get closer to March 2019 without a deal. Studying cases where other countries came close to leaving the EU could be a good starting point.

Panicos O. Demetriades, Professor of Financial Economics, University of Leicester

This article was originally published on The Conversation. Read the original article.

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