26 October 2018

Fed Trust: Hard Brexit: Passport to Nowhere for British Services

No Brexit Bonanza has been identified, and the government appears to have no fiscal room to provide additional counter cyclical support for the UK service and other sectors. To achieve this, the government would either have to raise taxes, or increase borrowing. Both of which cross its own electoral “red lines”.

The results of this analysis strongly suggest that a Hard Brexit is effectively a passport (road) to nowhere. Either continued membership of the EU, or becoming a member of the EEA, or in negotiating similar arrangements as with Switzerland, would all appear to be more economically beneficial than the current Hard Brexit course. [...]

The analysis of a number of service sectors in the UK economy has shown that passporting of services with the EU is vital to the continued prosperity of many service industries. And it has also been established that parts of the service sectors are already adapting to the likely reality of Brexit, and even to the prospects of a Hard Brexit. This means that while the prospects for activity levels in financial services and insurance look relatively poor for Britain, companies involved in the industry may be able to find ways to continue to sell into the EU market by establishing subsidiaries on the European mainland that will continue to enjoy the full benefits of passporting. These benefits will not necessarily accrue to the British economy though.

Assuming that current demand conditions across the EU remain as they are, then a Hard Brexit could well lead to a change in the distribution of activities. Britain would lose some of its comparative advantage in financial services, and in some other services as well…

The ramifications of a disorderly Hard Brexit are likely to prove disruptive in many areas. They are likely to permanently affect the profitability of many areas, including the road haulage, air transport and financial services areas, including corporate and investment banking, and asset management.

It is possibly true that financial services may make “good” by expanding its reach outside of Europe. However, as with other trade areas, the UK would need to have exceptionally good relations with large markets such as China, the US and India, if the losses of business in the EU are to be fully compensated for. Not only are there no international trade agreements that cover services, the UK is currently exiting from one of the best international service trading arrangements in existence, namely the internal EU market.

The fiscal implications for government following the ending of EU passporting arrangements do not look good. As sectors experience reduced business volumes, so tax revenues will fall. Demands on government expenditure are likely to rise, and there is no Brexit Bonanza in sight.

Given stated government priorities, and a low growth/recession scenario, the government can only provide a counter-cyclical fiscal stimulus by either raising taxes, or by increasing borrowing, which break other election promises and “red lines”.

There are broader negative impacts on services following from a Hard Brexit. It will reduce EU support for R&D and technology, and reduce the attractiveness of our educational system to EU based foreigners. Being cut off from the Horizon programme will also weaken the UK’s role in international research projects. The ending of freedom of movement of people between the UK and the EU, one of the government’s red lines, will make it difficult to staff the NHS, and to find skilled employees for the financial services industry.

Indeed, it is striking to note how a series of poor decisions by the UK government has produced a set of “red lines” that rule out what otherwise might have been an inferior, but at least orderly arrangement, namely for the UK to become a member of the European Economic Area.

Authors started the paper by referring to the notion of a passport to nowhere. This appears to be the case at the moment (Quarter 4 2018). The government is handing in a passport that went somewhere in and with the EU, for one that goes precisely nowhere. [...]

Full analysis

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