Brexit or bust: a Belgian economist's view

The UK has decided to end its 44-year marriage with the EU. Admittedly, it was never a fairytale, and mainly based on reason rather than sentiment. By contrast, the decision of the second-largest economy in the EU to leave seems to be largely based on feelings, in particular that of sovereignty. The perception in certain camps is that more rational considerations, such as economics, were ignored or ill-represented during the referendum campaign. Gauging the consequences of Brexit is a tricky task, but there will be economic consequences, and we can already see the British economy slowing down. But the long-term effect will depend on the new relationship that is currently being negotiated.

By 30 March 2019, a new relationship should officially be in place. In practice, this means an agreement needs to be found by September 2018 to give the national and European parliaments time to ratify the deal. Businesses that need to plan ahead will want clarity even earlier. Airlines, for example, need to know if they will be allowed to fly between the EU and the UK. If not, can they sell advance tickets?

What will become of the rights of the 1.2 million Britons living in other EU countries and the 3.5 million people from other EU countries living in the UK? Brexit also affects the UK’s relationship with the rest of the world. Over the years, the EU has negotiated treaties with 168 non-EU countries, covering almost every external function of an economy, from nuclear energy to importing bananas. The Financial Times identified 759 separate bilateral agreements that are potentially relevant to the UK. If the UK is not part of the EU, these agreements will have to be renewed, meaning Britain’s exit will also trigger hundreds of mini-negotiations. What’s more, before these negotiations can start, most third parties would like to know what the future EU-UK relationship will be.

Uncertainty is bad for business

Meanwhile, the uncertainty makes business leaders more cautious, putting a brake on investment and hiring. For the UK there is an additional effect, namely that the pound depreciated by about 15% against the euro compared to the pre-Brexit level, leading to higher inflation in the UK. With wages not growing as quickly, purchasing power declines. As a result, the British economy has slowed since the beginning of 2017, growing by 0.3% in the first and second quarter of 2017 compared to 0.6% in the fourth quarter of 2016. Once the negotiators communicate what is agreed, however, the uncertainty could disappear and the outlook for the UK may improve.

Even though we have already seen a negative impact on the UK economy, the long-term effect for both the UK and the EU will depend on the final agreement, and in particular on the future trade relationship. Today, the UK is part of the single market and customs union. The former makes it easy to trade within the EU, as the four freedoms (free movement of goods, services, capital and people) aim to remove trade barriers and harmonise national regulation. The customs union organises trade between EU and non-EU countries and implies a common import tariff on goods that enter the EU. This trade relationship led to an increase in trade links among EU countries. Today, about 44% of UK exports flow to the other EU countries and about 8% of EU exports flow to the UK.

Brexit means the current trade arrangement will change, and trading will be less smooth than today. The UK government has already announced that it will seek to leave the single market and the customs union. In their place, the UK favours a comprehensive free-trade agreement, such as the recently completed Ceta deal between the EU and Canada, or the nearly concluded EU-Japan deal. This could preserve tariff-free access for most goods and some services and allow the UK to control immigration with no automatic adoption of EU regulation. This, however, would introduce barriers to trade between the UK and the EU, and therefore economic costs. There would be custom controls and rules-of-origin checks, many areas would not be covered by the agreement, and there would be non-tariff barriers due to differential regulation. And the time it takes to agree a deal like this is notoriously long. Ceta took seven years.

All in all, it seems unlikely that everything will be decided by 30 March 2019. British negotiators recently accepted the need for a transition period and said that during that period Britain should be in a customs union with the EU. Expect many more twists and turns during the negotiations.

This article first appeared in ING Expat Time