It is now 23 days to Xmas and 117 days to Brexit on 29th March 2019. While one of these events is certain, the other is less so and this post looks at the Brexit picture in the run-up to the vote in Parliament on 11th December.
What happens in the vote is crucial. One possibility is that Mrs May wins but this is looking increasingly unlikely since there are two key groups likely to vote against her. Firstly, there are those seeking a “Hard Brexit”, such as the members of the European Research Group, on the right wing of the Conservative Party who are not happy with the way the deal ties us to Europe. On the other side are those who would wish to remain in the EU or seek the softest possible Brexit deal and might oppose it, hoping it will open up the possibility of a second referendum. If the government does lose the vote much will depend on the scale of the loss. It is possible that after falls in the value of sterling and of UK shares as markets take fright and, maybe, some small adjustments in the terms of the UK’s departure arrangements, (said by the EU not to be on offer), that there is a second vote and the government’s deal is accepted.
Alternatively, it could be that there is no majority for the current deal and this leads to Parliament opting for either a “People’s vote”, the UK leaving with no deal, a general election or the current or a new prime minister seeking a new agreement during an extended transition period. A “People’s vote” has difficulties – it is likely to take at least five months to organise and there will be significant disagreement over the question or questions to be asked. Is the choice between the current offer and no deal or should we include the possibility of remaining? Finally, what might the effect of a second referendum voting to remain be on those who voted to leave previously who were told that the 2016 vote was a “once in a generation” decision.
A no deal Brexit, whether adopted deliberately or drifted into is another possibility. The view of the KPMG Head of Brexit is that the government is not prepared for this and, while some sectors, such financial services, pharmaceuticals and the motor industry are ready for this, many others, particularly those dominated by SMEs (small and medium-sized enterprises) are not. A key area which the government will have to address is the transport of goods into and out of the UK. At present 17% of UK trade and 1/3 of our trade with the EU in goods uses the port of Dover. It is the shortest crossing, making it the cheapest and fastest way to import and export to nearby countries, particularly important for perishable products and those companies adopting ‘just in time’ production methods. It has been estimated that a 2 minute delay at the Dover ferry and Eurostar terminals would cause a 20 mile tailback on the motorways into Dover. This would arise because lorries which are currently able to enter and exit at Dover do not face checks because of our membership of the single market which, among other freedoms, allows the free movement of goods. The government has suggested that other ports might take part of the traffic but, not only would this result in longer and therefore more expensive crossings, pushing up prices, other ports lack the necessary infrastructure for customs checks and do not have the capacity, and possibly not even the space, to expand in the short term.
While we can be certain, or fairly certain, that the impact of a ‘no deal’ would be mitigated by the government for essential industries such as water and pharmaceuticals, those which are less essential will suffer. Newspapers are already reporting stories of firms building up stocks of components and finished products; for example, a major pharmaceuticals company is planning to build up 6 months stocks of products and raw materials on both sides of the Channel and even Fortnum & Mason, the luxury Piccadilly grocer, has built up an extra two months’ supply of champagne! However, such actions are costly for firms and impossible for some which might lack the space or cash to build up stocks. Another area of concern is our import of fresh food. At present the ratio of fresh: frozen food imports is 9:1 and a result of ‘no deal’ might be to increase the proportion of frozen food imports. Although this seems relatively straight-forward, it would require an increase in refrigeration capacity, not currently available.
No deal will mean that tariffs are placed on UK goods entering the EU so, for example, the 54% of UK car exports which go to the EU would face a 10% tariff, making them less attractive to EU consumers, and thereby reducing sales and employment in the car industry and possibly even encouraging firms, particularly foreign ones, to relocate from the UK to the EU to avoid the tariffs. At a recent FT conference on Brexit, the Senior Vice President of Honda Europe suggested that, as well as tariff barriers, non-tariff barriers, such as the need for physical inspections of vehicles being exported and components being imported at customs, would be equally important for the company, which operates a ½ day Just In Time production model with components being delivered straight to the production line. The Economist recently reported on the BMW Mini plant in Oxford where 200 lorries deliver 4 million parts to the factory EACH DAY. Therefore, border delays of even a few hours might impact significantly on their ability to produce smoothly. Because of the threat of a hard border, some UK chemical and pharmaceutical firms are considering opening a second testing facility in the EU so that its products can be sold there without difficulty. Such adjustments are costly and will be passed on to consumers in due course.
Supporters of a no deal see our departure from the EU as a matter of moving from EU to WTO rules on trade, reinforced by our ability to sign free trade deals with many countries. (It is worth noting that we have not yet been able to negotiate independently all the deals that we, as members of the EU, had with 3rd countries). However the CBI point out that this would mean both taxes on our exports and us levying taxes on imports from the EU. Also important will be such things as checks on food products which will be introduced on our exports. Another concern is that the WTO focuses more on trade in goods than in services, which has explained why a number of financial institutions are establishing bases in the EU. Interestingly, the FT conference referred to above was partially sponsored by Paris and Luxembourg, both using the opportunity to promote themselves as attractive places to set up. We do not know the effect which ‘no deal’ would have on sterling, with some talking of it even dropping to parity with the dollar, as holders of short-term sterling assets sell them. Bearing in mind that a 10% fall in sterling causes an increase in inflation of 2%, the effect of such a steep fall would lead to significant falls in real incomes. We also do not know whether the Bank of England would increase interest rates in order to protect sterling or cut them to boost GDP if a recession loomed (and the scope for the latter is seriously limited by their current low levels).
Even the impact of Mrs May’s deal, which involves maintaining the single market in goods but not services, is not totally clear since although the documentation on the UK’s departure is extensive, it is not clear exactly what will happen for the UK when the transition period ends in December 2020, since there is still much to be decided, hence, for example, the need for a backstop to prevent a physical border between Northern Ireland and Eire if a trade deal is not signed.
In the last two weeks, a number of estimates have been published. The National Institute for Economic and Social Research, a well-established think tank, suggests that Mrs May’s deal will leave the UK’s GDP per head 3% smaller by 2030 than if we had remained in the UK. Another think tank, ‘The UK in a changing Europe’, published research from the Institute of Fiscal Studies, LSE and King’s College, suggesting GDP per head would be between 1.9% and 5.5% smaller by 2030, depending upon what happens to productivity. The Bank of England and the Treasury have also published forecasts. The latter looks at the impact on the UK economy in 2035, 15 years from the end of the transition period (a longer period than the previous two forecasts) and suggests that, under a no deal scenario, GDP might drop by 10.7% while under Mrs May’s deal, the fall would only be between 0.2% and 1.4%.
A different option which is being proposed by Nick Boles MP is called ‘Norway for Now’ or ‘Norway Plus’. This involves the UK negotiating to join the European Free Trade Association (where we have free trade with the member countries but, unlike a customs union, there is no common external tariff). We would also negotiate a customs deal with the EU. This would allow unrestricted access to the EU market but would allow the UK to escape the jurisdiction of the European Court of Justice, be outside the Common Agricultural and Fisheries Policies and pay less to the EU than at present. However EU immigration would not be restrictable unless there were significant problems and we would not be able to sign trade deals with other countries outside EFTA and the EU.
All that is clear at the moment is that nothing is clear! Hopefully, after 11th December, we might know a little more but even that is doubtful.