Sunday, January 22, 2017
An EU cliff edge looms - May has to avoid taking us over it
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Certainty and uncertainty. The certainty from Theresa May that Britain will be leaving the European Union’s single market is enabling some businesses to prepare now for that eventuality.

For some that is a good thing and for some it will make no difference. But those who need more of their operations to be inside the single market can now plan for that. The car industry is worried. So are others. HSBC and UBS have already told us what they are intending in terms of moving some jobs from London. Others will do so.

Those who think the loss of some investment banking jobs is nothing to worry about, something I hear quite a lot, should remember that the City generates a disproportionate amount of the tax revenue needed to pay for public services.

It still will; on any plausible scenario London will remain comfortably the biggest financial centre in Europe. But such is its lead that it will remain the biggest even if it were to lose a chunk of it activity, and its generation of tax revenues, which seems likely, and which will be bad for Britain.

On top of the certainty of leaving the single market, of which more in a moment, there is the massive uncertainty of what happens after two years. The two-year article 50 period, intended to set the terms of Britain’s departure from the EU, is now intended by the prime minister to also include a “bold and ambitious” trade deal with Europe. That looks not merely ambitious, but unachievable.

In setting a high bar, and an over-ambitious timetable, May has significantly increased the chances of failure. Britain’s combined Brexit and free trade agreement talks with the EU could founder for any number of reasons, including the cost of the divorce settlement, with Brussels talking about a figure of at least €60bn (£52bn).

If not a good deal then, as the prime minister has promised, she will walk away. The “cliff edge” that many thought should be avoided at all costs, and which the government would seek to avoid at all costs, is now part of the official negotiating position. The logic is that the EU would be hit by such an abrupt breaking-off of economic relations, which it would. But Britain would be hit very much harder. That is not bold; it is irresponsible. The prime minister is not only given us a harder Brexit than business feared, but has also inserted a “hardball” element.

Positions will adjust, on both sides, over the next two years. Avoiding the cliff edge, and ensuring what Philip Hammond, the chancellor, describes as a “phased process” of leaving the EU, will be vital.

The prime minister was right last week to say that Britain wants a successful EU, though I am not sure that she was speaking for all, or even most, Brexit voters in saying so. She was also right to say that a strong and close relationship, and not just on economics, is in the interests of both the EU and Britain.

As for her rhetoric about a global Britain being a new force for openness, “the strongest and most forceful advocate for business, free markets and free trade anywhere in the world”, all that is exactly what a prime minister trying to make the best of Brexit should be saying.

But we also have to be realistic. Depending on how it is done, and we have yet to see a successful system, including for non-EU migrants during her six years as home secretary, slashing immigration numbers will be hard to square with the prime minister’s declared aim that “openness to international talent must remain one of this country’s most distinctive assets”. In many parts of the world, and not just in the rest of the EU, Britain is already seen as less welcoming.

Not all of that is the prime minister’s fault. She would like to guarantee the rights of EU citizens already in Britain, but requires reciprocal guarantees for British citizens in Europe, which the EU will not offer until the article 50 process is underway.

The bigger problem is trade. Many things influence trade, and not just trade agreements. Though the share of Britain’s trade conducted with the rest of the EU rose last year, the trend in recent years has been downwards. That reflects a drop in North Sea oil exports and the faster growth of emerging economies such as China and India. Britain’s exports to China have fallen over the past couple of years but the trend has been upwards.

Seven of Britain’s 10 biggest export destinations are, however, elsewhere in the EU (the others are America, China and Switzerland) and membership of the single market is greatly superior to any free trade agreement, particularly as far as services are concerned. In these, as the National Institute of Economic and Social Research (Niesr) put it in its most recent review, “non-tariff barriers such as regulatory constraints play a more important role, especially for high value-added business services such as financial services, legal services or accountancy”.

Calculations by Monique Ebell, an economist at Niesr, suggest that replacing single market membership even with a comprehensive free trade agreement would over time reduce Britain’s exports to the EU by 22% compared with the status quo.

What about the government’s mission to strike trade deals with the rest of the world? Would that not make up the difference? No, not even close. Even on the optimistic assumption of free trade agreements with the rest of the world, Ebell calculates that these would only lift goods exports by 11%-12% to non-EU countries, implying a 7%-8% rise in total trade (goods and services), relative to the previous trend. Most free trade agreements do not cover services in any meaningful or comprehensive way. Unless this changes, in rough terms we will lose nearly three times as much from leaving the single market as we gain from our new buccaneering trade deals with the rest of the world, if an when they can be negotiated.

These numbers can never be precise but they underline the scale of the challenges that lie ahead, at a time when, according to a new EY Item Club forecast to be published tomorrow, Britain faces three years of weak economic growth.

Preventing that sluggish growth from turning into something worse will require an avoidance of the cliff edge exit from the EU, the “walking away” spectre raised by the prime minister a few days ago. Turning Britain into a new post-Brexit global trade champion, on the back of a sustained improvement in export performance and market share, looks even harder.