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12 March 2019

Even if MPs pass Theresa May’s deal, the UK’s Brexit nightmare won’t end

Britain will have avoided one cliff-edge only for another to appear as it seeks a new trade deal. 

By Simon Wren-Lewis

If you enjoyed the last two years and want more of the same, vote for Theresa May’s Brexit deal.

Trade negotiations begin after the Withdrawal Agreement (WA) is passed, so why don’t those wanting a softer Brexit just vote for the WA and argue about trade later? The Political Declaration, which does talk about trade, is vague and non-binding. The reason is straightforward. Parliament will get very little say on the framework for those trade talks. The only real chance most MPs will get to influence the type of trade relationship the UK has with the EU is by directing the government now, as the price of passing the WA.

However, so far parliament has largely failed to do that, primarily because Conservative MPs have put party unity above the future health of the country. So what will happen to politics and the economy if parliament votes for May’s deal, either today or in a few months’ time?

The first and well-known point to make is that nothing would immediately change as far as UK firms and citizens are concerned, because we would start a transition period during which we remain inside the customs union (CU) and the single market (but no longer have any say on the rules of either). There will be little economic bounce from ending the possibility of no deal, for reasons outlined below. So the immediate action will be about the politics of negotiating what happens after the transition period ends.

If you want to know what that would be like, just look at the last year or two. Most of the recent arguments within the Conservative Party have been about trade, and not the content of the WA. So signing the WA settles very little. It does mean that we have signed up to “the backstop”, but May still pretends that this backstop means we can stay outside the CU.

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I cannot see Brexiteers meekly accepting that the UK should join the CU either. We will continue to have endless discussion of unicorn-like “alternative arrangements” for the Irish border designed only to avoid membership of a CU. The inevitable truth of course is that the backstop implies some part of the UK has to be in a CU, but as the last two years have shown large parts of the Conservative Party refuse to accept reality when they don’t like it.   

At some point during the transition period, May could be replaced as prime minister. It seems very likely, given the views of Conservative members on Brexit, that a Brexiteer will be elected in her place. The likely outcome of that, as far as Brexit is concerned, is either that nothing changes, or that the government attempts to persuade the EU to do the impossible.

For example, May is determined that we should leave the single market (SM) because her primary aim is to end freedom of movement (FM). Any successor is likely to want to leave the SM because they do not want to be bound by EU regulations on minimum workers’ rights or the environment.

Because of the economic damage that will cause (see below) the government will attempt to get a trade agreement with the EU that mitigates that harm. They will find out, yet again, that it is impossible to get anything close to the benefits of the SM without being in the SM. And because the UK will not want to accept that, the negotiations will go on and on.

But will no deal at least be off the table? Unfortunately, just as you think you have avoided one cliff-edge, another appears. If no trade deal is done during the transition period, we will crash out much as we would with no deal now. And the Brexiteers in government will be saying not to worry: the EU always cave at the last minute. They will fight any extension of the transition period from 21 months, even though it is impossible to negotiate a trade agreement in that time, because the ERG wants to fall off a cliff.

In short, if May’s deal is approved we can look forward to a politics dominated by internal squabbles among the Conservatives, and the absence of constructive negotiations with Brussels, for perhaps the next four or more years, much as we have seen for the past two years. This is because the WA does nothing to resolve internal Tory conflicts, and, more fundamentally, because of conflicts inherent to Brexit itself.

If, in spite of all this, the government manages to negotiate a trade agreement with the EU, what will be the economic and political consequences for the UK? Will it all be worthwhile in the end? A good guide to the economics is a collaborative study between the Centre of Economic Performance and The UK in a Changing Europe, which is both authoritative and representative of similar work. They believe that from 2030 onwards, UK GDP per capita will be lower by between 1.9 per cent and 5.5 per cent as a consequence of leaving the SM. The midpoint of that range represents lost resources for each household of about £3,000 each year. There will of course be a large hit to the public finances, implying higher taxes or less public spending, even after allowing for an end to budget contributions to the EU.

Why such a large range? The 1.9 per cent mostly comes from the direct effects of lower and more costly trade, using standard trade modelling techniques together with reasonable estimates of the barriers created by leaving the SM. The government, using a comparable model, produced similar numbers.

The higher figure in the study’s range is based on empirical evidence for the impact of trade on productivity, which captures other effects such as lower foreign direct investment or reduced competition. Because the empirical evidence captures many more effects than the model, we would expect it to be larger. Those who dispute numbers of this scale in this range have to explain not only why the models, including those used by the government, are wrong but also why the simple correlations between trade and prosperity more than back the models up.

Our best guess is that we have already lost over 2 per cent of GDP as a result of stagnant investment and sterling’s depreciation. As a result, most people will probably not notice the economic impact of ending the transition period, because most of the firms that were going to leave will have already left as a result of cliff-edge uncertainty. Instead, Brexit will represent the gradual decline of the UK relative to the rest of the EU.

What about “Global Britain”? Most trade agreements involve tariff reduction, so being in a CU largely limits the scope for Mr. Fox to do new trade deals. In addition, who would want to harmonise their regulations with the UK, when the gains from doing the same for the EU are much greater? A more likely outcome is that we harmonise our regulations with the US.

The government will be desperate to sign a trade deal with the US to show that Global Britain is more than a slogan, and that means the US will largely get their way in terms of regulations (including food standards) and participation in the NHS. Thus, the longer-term political consequence of parliament agreeing to May’s deal is the gradual transition of the UK into a US-style economy.  

In an age where trade regulations are increasingly decided by large regional blocs, the only rationalisation of Brexit that makes any kind of sense is the transfer of the UK from the EU bloc to the US bloc. That is what a lot of the Brexiteers want, which is why they resist the backstop so much, because it ties our tariffs to the EU.

But the political consequences of tariffs are less important in shaping an economy than labour and environmental regulation. That is why, even with the backstop, Brexit will mean we will become more like the US economy. Whatever the merits or otherwise of that, a big difference is that while we had a say over how the EU is run, we will have none over what the US does: a 51st state without representation, if you like. Taking back control it is not.