A “hard brexit” looks inevitable

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J. Soedradjad Djiwandono

IO – The recently-concluded EU Summit had just three key items on its agenda: migration, a “trade war” and transition issues around “Brexit”. As for this final matter, it was originally hoped that an agreement could be reached regarding the terms of a Brexit transition, i.e. the 21-month period following the official “divorce”, commencing in March 2019.

It is broadly agreed that three major issues need to be resolved, i.e., how much the UK owes the EU, what is to happen to the border of Northern Ireland with the Republic of Ireland, and what UK citizens living elsewhere in the EU and what EU citizens living in the UK will have to deal with. The negotiations so far have been focusing on the details of those issues and on future relations – after an agreement was reached on a 21-month “transition” period to smooth the way for post-Brexit relations.  Since the most recent Summit could not conclude any mutually-acceptable agreement, the next date set is for October 18. The final opportunity will be on December 23, 2018 or otherwise Brexit will take place without any deal – what is known as a “hard” or “cliff-edge” Brexit.

Negotiations have not proceeded smoothly, even though neither side is pessimistic enough to consider “no deal” as a desirable outcome. However, the EU has recently begun to realize that they have to be prepared for any possibility, including a worst-case scenario. In fact, the media have started to mention the need for the business community to be prepared for no deal by the date the UK leaves the EU (March 2019).  Indeed, this was what Claude Junker, European Commission President, plainly stated, as quoted by the Financial Times.

The trigger seems to be political, but with economic ramifications as well.  The tricky issue concerns the Republic of Ireland. As we know, Ireland (and Scotland) both voted to remain in the EU; thus, they will be separated from the UK by a border after the divorce. Prime Minister Theresa May is however fighting hard to for them to stay in the United Kingdom. This is one of the hard issues that remain difficult to solve, and thus the possibility of a “hard Brexit” arises.

While we still have to wait for the outcome to see how these issues are resolved, we should study the likely implications of a “no deal” or hard Brexit for global trade that would of course have some ramifications for Asian emerging economies, including that of Indonesia.

Patchy information on business concerns
If no deal emerges from the negotiations prior to the date of the divorce there will be no 21-month transition period after March 2019. Thus, by that point, UK trade relations with the 27-member countries of the EU will be completely changed. Starting from March 2019, trade relations between the UK and the 27 EU member countries would be in accordance with the general rules of the WTO, whereby the most basic would mean 2 per cent tariffs imposed on most goods, 10 per cent on cars and 20 per cent on agricultural products. Customs barriers will be everywhere, which would further increase costs and slow down deliveries.

According to a recent article from the Financial Times, five sectors in the UK may be particularly vulnerable: financial services, automotive, agriculture, food & beverages and chemicals & plastics. Problems would be similar for EU member countries, depending on how dependent they are on trade relations with the UK.  However, information on these issues, how severely they will affect each sector or company – let alone a country – is patchy at best, partly (as mentioned above) because no parties have included a hard Brexit in the equation.

Leonid Bershidsky, a Bloomberg columnist writing in the Straits Times (June 22, 2018) may shed a little light on the issue. He stated that a 2 per cent tariff, slightly longer delivery times and the added cost of customs clearance, for example, would cost Germany, the EU’s biggest economy, €500 million a year, which is not much.  But he wrote that “the economic actors who really do need to prepare for a cliff-edge Brexit are primarily in the auto industry, agriculture and finance, where British and European firms would be cut off from operating in each other’s markets directly by the end of a borderless EU for the UK.”  The financial industry, with a loss of London’s current position as a financial center, and a possible move from wholesale to retail finance, would prove really costly. Actually, Mr. Bershidsky mentioned that Dr Wen Chen of the University of Groningen in the Netherlands and his international team of collaborators have analyzed which regions in EU countries are most exposed to Brexit. But despite the fact that no other studies are publicly available at present, the study is based on an assumption that Brexit would result in trade between UK and EU dropping to zero, which is hard to imagine.

Still, he mentioned that according to Deloitte, a hard Brexit would cut German car exports to Britain by 255,000 a year, worth about €6.7 billion or 5 per cent of sales. About 18,000 jobs would be endangered. European automakers would lose about €8.7 billion in total sales. Car-part sales would not be hurt as badly, because the tariff on them would be 4.5 per cent, not 10 per cent as for cars, but thousands of jobs could still evaporate, as imports from the rest of the world become more economically viable for Britain.  Those are only patchy samples offered for illustration. The actual impact would certainly be more substantial, and my guesstimate is that they would be worse for both parties.

Worrying notes
It is frustrating to follow the development of negotiations between London and Brussels on Brexit. It is even more so to observe that there has been extremely slow progress and that a successful conclusion does not seem to be in sight. For sure, the latest summit was dominated by discussions on migration, while for Brexit the message is more toward asking stakeholders to be prepared for a “no deal” Brexit.

At a time when the world witnesses high tensions from a tariff war that no longer simply involves the US and China, but also concerns the US and its close allies, including Canada, Mexico and of course the EU, Brexit is bad enough – and the specter of a hard one is certainly very distressing. The prospect of a positive resolution looks remote indeed, since China and other countries impacted have been responding to President Trump’s tariff attack by countering with an attack of their own. Now, some are already concerned about the possibility of a currency war (“devaluation war”), another word for a “beggar thy neighbor” policy.  Meanwhile, President Trump in his latest statement claimed that other countries are now “begging” for negotiation; he seems to feel he has done everything right.

These developments pose additional challenges for other countries – even those not directly involved in the disputes and not prime targets of the attacks, such as emerging Asian economies, including that of Indonesia. At a time when in finance the implications of monetary normalization by responsible authorities in advanced countries, leveraging and narrowing fiscal space have resulted in capital reversals, a trade war that may spread to a currency war are discouraging indeed.

For major players, the best reminder would be to bear in mind what Winston Churchill remarked: “Democracy is the worst form of government, except for all the others.” I would like to apply this to free trade and globalization: that they are “the worst type of trade system, except for all the others”.