This week’s article is a continuation of last week’s in which we provided a background to the United Kingdom’s (UK) proposed withdrawal from the European Union (EU), known as Brexit, following the referendum of June 2016. Prime Minister Boris Johnson obtained the Queen’s approval for the suspension of Parliament from 10 September to 14 October, a move that critics considered an attempt to deny the legislature a say on Brexit. The UK is scheduled to leave the EU on 31 October.
On three separate occasions, the UK Parliament had rejected the withdrawal proposals brokered by the former Prime Minister Theresa May with the EU over what it considered the inadequacy of the “backstop” arrangements involving the 499-kilometre border between Northern Ireland and the Irish Republic. Both the London High Court and the Scottish court ruled that the Prime Minister’s action to suspend Parliament was not illegal. However, upon appeal, the Scottish Inner House overturned the latter’s ruling. The Government has since appealed the ruling.
Today, we continue from where we left off last week.
Implications of Brexit on UK Trading
The UK is the fifth largest economy in the world and the second largest in Europe with a nominal GDP of US$2.62 trillion. Approximately 44 percent of all UK exports go to the EU each year while more than 50 percent of UK imports are from the EU. In particular, the UK automobile industry depends heavily on the EU for the supply of vehicle components.
Almost 80 percent of UK’s economy relates to services. In 2016, the UK exported £106 billion in services to the EU and the four European Free Trade Association (EFTA) countries, compared to £158 billion in goods exports. It is also the top financial centre in Europe and the second ranked in the world. In addition, the UK is the most recognized international centre for legal services and dispute resolutions.
The first sign of possible adverse impact of Brexit on UK trading and its economy as a whole, came two days after the June 2016 referendum. The value of the British pound plunged by more than eight percent from £1 = US$1.47 to £1 = US$1.37, the lowest since 1985. It has not recovered since then, and as of 12 September 2019 the exchange rate was £1 = US$1.23. There was also a corresponding adverse effect on London Stock Exchange, with the FTSE index dropping by 3.3 percent while in the European stock markets, shares fell by 8.6 percent.
The real effects of Brexit will depend on whether it will be soft one or a hard one. The proposed withdrawal plan is referred to as soft Brexit because there will be no need to have a physical border between Republic of Ireland and Northern Ireland, and the common rule book will be used. The latter is likely to result in a minimum disruption to trade with EU countries. If a revised withdrawal plan is not agreed on, there will be a hard Brexit, requiring, among others, instituting border controls and immigration checks at all UK ports of entry and exit.
Soft Brexit scenario
Soft Brexit represents a compromise between remaining in the EU and leaving completely with no conditions. The key feature is the common rule book which critics argue will make the UK a ‘ruler-taker with insufficient influence over the contents of the rules … the UK must accept existing EU rules on goods forever, together with a further permanent obligation to accept any changes unilaterally decided on by the EU in the future’.
(https://www.prospectmagazine.co.uk/politics/brexit-chequers-common-rules-single-market) Although there is provision for making changes to the rule book to suit the circumstances of the UK, any such changes are likely to pose significant challenges for trade with the EU countries.
Soft Brexit is somewhat similar to the relationship between Norway and the EU where the former, although not a member of the EU, applies trading rules that are consistent with those of the EU based on its membership of the European Free Trade Area (EFTA). However, there has been no suggestion of the UK following the path of Norway. With soft Brexit, the UK will leave the Single Market but apply the common rule book on trading in goods. However, this should be viewed as a short-term arrangement to minimize any disruption to trade with the EU countries. The UK will therefore have to expedite negotiations for a separate and comprehensive free trade agreement with the EU, in addition to separate agreements on fishing and agricultural policies.
UK trading with individual EU Member States is unlikely to be adversely affected unless there are significant changes to the rule book. Brexit also offers new opportunities for the UK to strike deals with non-EU members, which would be particularly beneficial for UK exporters. However, such deals could be disadvantageous for the UK since by virtue of the EU’s size, the latter has a greater bargaining power to negotiate more favourable trade deals. Another significant downside is that the UK will not benefit from the 36 free trade agreements that the EU has entered into over the last 20 years with some 58 non-member countries.
The absence of a physical border between the Irish Republic and Northern Ireland will present some challenges for trade in goods where there are tariff differentials by virtue of the UK being able to trade directly with non-EU Member States. This is likely to encourage cross-border smuggling. The same would apply in situations where there are changes to the common rule book. It may therefore be necessary for a customs presence to be in place along the Northern Ireland border which could pose additional difficulty for the movement of goods to and from the UK and consequential adverse effect on trade.
Restrictions on the movement of people may affect business activity in the services sector. This could result in many businesses shifting their operations to EU countries, or elsewhere. There is therefore the distinct possibility of the UK losing its status as the top financial centre in Europe, the world’s foremost destination for legal services, and leading international centre for dispute resolutions. If this happens, the UK economy will almost certainly be affected because of the overwhelming size of its service sector vis-à-vis other sectors. A survey of the key services sector agencies indicated that growth in the last quarter of 2018 was its lowest point since the 2016 referendum. The Mayor of London had issued the following warning:
Slamming the door shut on thousands of European workers who want to come here to fill crucial roles, while making it tougher for businesses and the NHS to access the talent they need, will damage our competitiveness and ultimately mean less opportunity for all Londoners. (https://www.reuters.com/article/uk-britain-eu-immigration-reaction-factb/factbox-reaction-to-the-uk-governments-post-brexit-immigration-plans-idUSKBN1OI1XK)
The UK will charge EU tariffs for goods that would end up in the EU. However, since it will no longer contribute to the EU budget and therefore there can be no offset, a mechanism has to be agreed on for remitting revenue to the EU in respect of such tariffs. This will require enhanced customs examination of the goods which may very well cause undue delays, thereby discouraging suppliers from using the UK as entry point for goods entering the EU. However, the EU has expressed its unwillingness for the UK to act as a collecting agent for its revenue. The same would apply for goods entering the EU that are destined for the UK. The situation could be complicated where there are mixed consignments.
Hard Brexit scenario
As regards leaving the EU without a withdrawal Plan, the UK will have to follow the WTO rules on trading which essentially involve: no discrimination in trading and the application of the most-favoured nation (MFN) rule, except for FTAs entered into; equal treatment of foreign and locally produced goods once they enter the market; adherence to the provisions of the Uruguay Round Agreements; lowering of tariffs to promote trade; and promoting fair competition. The UK is currently a member of the WTO and operates within the framework of the arrangements between the EU and the WTO. With hard Brexit, it will have to go it alone with the WTO which could be challenging.
Despite its reservations about certain provisions of the Vienna Convention, the UK may also have to re-consider its position and become a signatory. The Convention is applicable to contracts for the sale of goods where the parties involved are from different jurisdictions or ‘when the rules of private international law lead to the application of the law of a Contracting State’. As of 2018, 89 countries are signatories to the Convention. Currently, the UK relies on the Sale of Goods Act 1979 and the EU rules for its trading activities.
Border controls and customs examination will have to be introduced at every entry and exit point and along the Irish Republic/Northern Ireland border. This could be a costly affair for the UK already saddled with a liability estimated at £35 billion – £39 billion to bring a closure of existing arrangements with the EU, including contributions to the EU budget during the transition period.
Since it is unlikely that there will be a transition period compared with soft Brexit, businesses are likely to find it difficult to cope with the new arrangements. The Bank of England has warned that ‘the UK economy could shrink by about 8% within a year…That fall would be the worst the country has seen in roughly 100 years. The pound would crash, inflation would spike, and house prices could fall by about one-third…’. (https://ca.yahoo.com/finance/news/no-deal-brexit-163627436.html). The Bank estimated that inflation and unemployment could rise to as much as 6.5 percent and 7.5 percent respectively; and thousands of people would leave the UK.
Whatever course of action the UK takes in its relationship with the EU, decision-makers need to reflect on the words of the Chancellor:
Any solution which left the country divided, left a large segment of the population feeling betrayed, in my view, would have a negative political impact and societal impact that would far outweigh the very small economic impact that the White Paper scenario is showing here. (https://uk.news.yahoo.com/brexit-betrayal-hurt-uk-more-leaving-hammond-134104826.html)
Conclusion
From all indications, Brexit will have an adverse effect on the UK’s economy, especially if it is a hard Brexit. The economic and other consequences were perhaps not fully and carefully thought out and presented to the public when the decision was taken to go to referendum. The statement attributable to the Bank of England should serve as an important warning of the dangers ahead. Soft Brexit, although representing a compromise, is fraught with difficulties, leaving more questions than answers.
The UK’s exit from the EU will be a significant blow for the Union which up to 2014 was the largest economy. The EU is now in danger of being overtaken by the United States since the size of its economy without the UK will be reduced to $17.3 trillion. If the Union is to remain intact and build on its achievements over the last 61 years, it needs carry out serious introspection on several fronts. Critics have argued that the EU has become very inflexible and bureaucratic in its administration. This needs to be urgently addressed. The EU should also allow Member States to have a greater say in the formulation of rules, regulations and administrative procedures, through periodic dialogue and meaningful consultations.
At less than four percent of the world’s economy, the UK’s departure from the EU is unlikely to affect world trade though it may change the pattern of world trading.
