28 August 2017

OMFIF: Brexit threat to Thatcher-era reforms

Hard-core Brexiteers, almost all of whom are Thatcherites, might see their wish to leave granted, but at the price of dismantling the policies of their heroine: a hard exit will erode competitiveness, exports and jobs.

Britain runs a current account deficit with the European Union, which Brexiteers argue strengthens the UK's position in exit negotiations with the bloc. This, however, is a false interpretation. Exports from Britain to the other 27 EU member states account for 12% of UK GDP. For the EU, exports to Britain account for only 3%-4% of GDP. A fall in trade flows, therefore, would proportionately impact Britain more than the EU.

Such circumstances will be exacerbated in the immediate post-Brexit period. The EU will continue to trade with the rest of the world under its existing free trade agreements. For Britain, however, any FTAs that it negotiates are unlikely to be come into effect for at least three or four years after Brexit.

The UK's financial services sector, which accounts for around 10% of GDP, will suffer if Britain rejects the single market. The question is how badly, and that will only be known when a deal is settled. The British government's attitude towards the free movement of persons, one of the EU's four freedoms, damages the financial sector by obstructing the recruitment of talented professionals from outside the UK. The notion, too, of turning the City of London into an offshore financial centre – a tax haven in disguise – is raised occasionally but quickly dismissed. If tried, it will poison any deals with the EU and upset FTA negotiations with non-EU countries.

Britain's manufacturing sector employs 2.7m people – at least 500,000 more than in financial services – and accounts for 14% of GDP. This sector, heavily affected by customs duties, rules for state aid, and regulations for working conditions and the environment, will torment the Brexit negotiations. To support manufacturing, the British government will almost certainly rely on a weaker exchange rate. Though positive for exports, lower real incomes could harm consumption and economic growth.

Britain is already the least regulated country in Europe, and there is little left to deregulate. The remaining option, spurred by perturbed industries that could lose free access to the EU, would be to set a course in the opposite direction, towards heightened government intervention in the economy. [...]

On the legal side, the implementation of such assurances rests on the tenuous assumption that the EU will freely allow this to happen. EU representatives in the Brexit negotiations will argue that British access to the European market depends on commitment to EU rules for state subsidies. The pledges made to car manufacturers will be investigated to determine whether market forces could be distorted. If the assurances are deemed to be distortive, the EU will demand their dismantling. If Britain does not accede, countervailing duties may be imposed.

If Britain and the EU do not reach an agreement or reach only a basic agreement at the end of negotiations in March 2019, their business relations would rely on World Trade Organisation rules. In that case, countervailing duties may be imposed if the EU can prove a causal link between subsidised imports and industry disruption.

A good Brexit keeps the EU market open for Britain, diminishing the need for disruptive policy measures to enhance competitiveness. [...] A hard Brexit raising barriers to EU market access will erode competitiveness, hurt exports, jobs, and growth.

The latter will lead to deafening appeals for the government to do 'something'. The only remaining course of action, however, will be to dislodge the free market model. Similar policies failed before 1979 – the year Thatcher took power – and will fail again, but not before considerable harm is done to remaining competitive sectors, forced to contribute through raised taxes to buttress non-competitive parts of the economy. [...]

Full article on OMFIF

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