No Deal? Here’s A Thought

Please note this blog post was published over 12 months ago and so may not include the most up-to-date information, for example where regulation around investing has changed.

No Deal? Here’s A Thought

Participants in the Brexit discussions have gone to great lengths to paint a sombre picture of the economic implications of the UK leaving the EU without a trade deal.

According to Bloomberg the probability of ‘no deal’ currently sits at 20%, down from 36% earlier in the year. However, what if this low probability is wrong and a no deal becomes reality. What options would we have as a country?

The default position, under a hard no deal Brexit, is for the UK to become a third country to the EU; moving from the current single market and rules of the customs union to those of the World Trade Organisation (WTO). Under WTO rules, the UK can set their own tariffs, but they must be applied to all WTO members under the most favoured nation rule. There are exceptions for developing nations and when a free trade agreement has been agreed previously.

The mainstream assumption is that on leaving, the UK will mirror the same tariffs and border checks which the EU currently applies to external members. As a net importer of EU goods this sounds impractical and expensive. Forecasts suggest it could cost the UK 3% of GDP.

German economists at the Institute for Economic Research (Ifo)- a Munich based economic think tank- entertain, and have modelled, a different approach which they refer to as ‘a hard but smart Brexit’ which suggests the costs leaving would be negligible.

They model the UK slashing all import tariffs and opening their door to free trade. They believe the impact of this will be positive:

• improving the UK’s international competitiveness

• achieving a reduction in UK business and household costs

Once the doors are open, they say, the UK should be in a good position to promote itself as a highly desirable place to do business. There are many factors to consider, such as the fact the UK has the third lowest rate of corporation tax in the G20 at 19% but overall desirability can be summarised in the Global Competitiveness Index which scores nations on the quality and advancement of human capital, infrastructure, innovation and economic stability in which the UK ranks 8th globally.

The model they envisage considers differing trade relations between the UK and the EU with tariff charges and border checks only on the European side. In their models, costs of UK goods imported into the EU and purchased by businesses and consumers will rise (currency aside), in turn putting the EU under pressure to replicate and to agree a free trade deal with the UK.

Models are theoretical and practical implications are often downplayed, but they have merit in that they challenge normative thinking. In this case the outlook modelled by the IFO institute conveys more scope for upside than currently being contemplated.

Naturally, any transition from one system to another takes time. It often  causes angst in the process and leaves plenty of room for fictions from those preferring the status quo.

A particular stumbling block for any form of hard Brexit is that the planned departure is only weeks away. Another is that Ifo make a good argument for their model but then say an agreed deal delivers a better outcome overall. That said, we wonder if these smart German economists are worried that under a ‘hard but smart Brexit’ their suggestions work rather too well for them to promote unconditionally!

With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Past performance is not a guide to future performance. Tax rules can change at any time. This blog is not personal financial advice.

Global Markets