Might it just be better for the UK to stop negotiations and announce a hard Brexit? Is having a year and a half to prepare for a complete separation better than negotiating and waiting it out for a marginally better deal?
These are questions that UK Prime Minister Theresa May must ask herself as Brexit negotiations continue this week.
May travelled to Brussels on Monday for more Brexit talks. Through the first few rounds of meetings, progress has been slow. May and EU negotiator Michel Barnier have yet to iron out the first items on the table, including the divorce settlement paid to the European Union. A discussion on trade can’t even begin until the issues of the first round come to a close.
As the discussions drag on, May must consider the possibility of a “no deal” hard Brexit. This would be akin to ripping the bandaid off well ahead of the March 2019 deadline to leave the European Union.
The Game Theory of the Brexit Negotiations
Theresa May and Brexit Secretary David Davis have thrown around the possibility a “no deal.” The idea might be that this would give the British a better bargaining position. A hard Brexit would certainly hurt both parties, but perhaps the EU would give better terms if the British threatened to leave without any agreement in place.
That might be true, but it ignores two possibilities. First, the British have a lot more to lose than the continental Europeans. It is estimated that between 8 and 18 percent of continental EU exports go to the UK, while the UK sends 44 percent of its exports to the EU. The UK would also lose out on trade deals they are already covered by through its EU membership, so the number is really 100 percent of UK exports that are on the line. The asymmetry of the trade relationship means the British are standing closer to the cliff’s edge in negotiations.
Second, the negotiations favor the EU simply because there is a hard deadline for talks. The EU negotiators aren’t in a hurry to make a bad deal. For them, a bad deal is far worse than no deal. They will just pass the ball back and forth until the buzzer sounds if there isn’t significant action on the part of the UK.
All this uncertainty is hitting the British economy. Yields on 10-year UK bonds have jumped about 30 basis points over the past few weeks. The combination of expected rate hikes from the Bank of England and the increasing likelihood of a hard Brexit are weighing on investors.
What Happens if Theresa May and the UK Don’t Get a Brexit Deal?
Nobody really knows, but it likely wouldn’t be positive. According to an analysis by the late Financial Times journalist Paul McClean, the UK would have to renegotiate 759 treaties in a post-Brexit world. That would be quite disruptive.
In the short-term, there would be chaos for parts of the British economy, including airlines and travel, shipping and healthcare. International flights, customs, international cargo shipping and critical medical supplies that are imported from abroad would be immediately disrupted.
Over the longer-term, the British economy would have a serious adjustment to its post-globalized life. Without trade deals, it is harder for British manufacturers to sell goods abroad. The pound sterling would likely fall to offset the higher costs of foreign goods and services. According to Business Insider,
“Most… predict that sterling will drop to a range between $1.10 and $1.20. The lowest end of that spectrum would represent a 17% drop from current levels — which already mark a more than 10% from sterling’s pre-referendum high.”
Data that was released in the UK this week showed another month higher prices. Inflation increased by 3.0 percent in September, in line with forecasts. Higher inflation and lower wage growth is squeezing British residents (see: The UK Death Cross: Wage earners are feeling poorer thanks to inflation and Brexit uncertainty). A weaker pound coming out of a “no deal” Brexit will only add to that inflationary burden. Central banks have been jockeying for inflation for years. The only condition is that wages must rise faster than inflation.
Theresa May’s Leadership Challenges
Negotiations continue, but Theresa May is feeling the pressure. The Brexit negotiations unearthed a deep divide in the Tory party. Hard Brexiters won’t be satisfied with any concessions, while other mostly pro-business Tories would like to see the relationship with the continent repaired. Meanwhile, Jeremy Corbyn, himself nominally pro-Brexit, and his Labour party is gaining momentum in the fractious Parliament.
Theresa May is finding out that Brexit negotiations are producing no winners. She herself, with a tenuous grip on the Prime Ministership, is feeling the burn the most.
Cover photo: EU2017EE (Flickr Commons)
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