Brexit – What happens next?

This is the question I am most often asked and also the hardest one to answer.
I will try to provide a framework for the many overlapping threads:

The possible outcomes

  1. No Deal (Chaos Brexit)
    It is often said that there is no majority in Parliament for this, however there is also no majority for anything else. The key point is that, if nothing happens, on March 29th, the UK leaves the EU with No Deal, and there must be an Act of Parliament to stop it. It is the default option and, as such, this chaotic outcome should not be underestimated.

To avoid it, one of the other outcomes needs to find a way to a majority.

  1. May’s Deal
    This option will have be voted on in Parliament and is universally expected to fail.
    The fundamental problem is that this deal spells out that Brexit is clearly worse than Remain and clearly worse than Fantasy Brexit.But to be fair any Brexit deal would have the same problem.
  1. Remain
    With the news today that Labour may be attempting to form a coherent policy on Brexit, this option has gained a glimmer of a realistic chance.

Non-possible outcomes

  1. “Fantasy” or “Have cake and eat it” Brexit

Given that it would require more compromise from the EU, the EU is never going to offer anything like this and will not allow any renegotiation for this purpose.

  1. Delay Brexit while we work out what to do

A delay would need the unanimous agreement of all 27 EU countries, so it seems rather unlikely for them to do so.

 

If the options are so simple, why is it all so complicated?

The simplest answer is that this situation is unprecedented so there is no clear procedure to follow.
Here are some of the wild cards:

  • Vote of No Confidence in May.
    This requires letters from 48 Tory MPs. However, they have not managed it yet, and may never get there. Even if they manage to get enough to trigger a vote, it is likely that May would win and then she could not be challenged for another year, her position strengthened. But if May lost, then we head to a new leadership election which is a lengthy process, pretty much running down the clock to Mar 29th. This is why only the most hardline Chaos Brexiteers champion such a route.
  • Vote of No Confidence in the government.
    It is highly likely that Labour will call for one after May loses the vote on her deal (and probably if she lost a vote of No Confidence within the Tory party), but it unclear if they expect to win it. If they did and forced a general election, it would be fascinating to see what the manifestos would say. With May as leader, it seems likely she would stand on a platform of her deal. Do Brexiteer rebels have to honour the manifesto pledge? Note there is no time to replace her with another leader before an election!

There is another important reason this is so complex. A lot of UK politicians do not understand the EU because they have never tried to. They really believe the EU can be forced to renegotiate. Talking to politically engaged people here, I get the sense that they are so engrossed in Westminster and party politics, they miss the point by assuming that important decisions are made here in the UK, without considering the viewpoint of our negotiating partner. I have previously used the example of Greece; if you misunderstand the EU then you play chicken and lose. Unfortunately, political journalists seem to have the same issue. They are obsessed with covering domestic political gossip here in the UK and so the coverage focuses on Westminster intrigue and the related confusion, whilst simultaneously missing the issues that are relevant.

  • Another Referendum?
    I think that a large majority of MPs and the electorate do not want this, but it still may happen if Parliament cannot agree any deal. The important issue here would be what question is asked. One aspect of this that I have not seen discussed is that the EU would have to agree to a 6-month delay to Brexit to allow this to happen. Therefore, the EU would have to agree with the question posed; if the vote was between Remain and May’s Deal, they might agree; if No Deal were one of the options, I do not see why they would do this. 

 

My personal forecast

I still think that the most likely outcome is that something close to May’s deal is agreed.
Perhaps losing the first vote will actually help her bring the rebels into line?

  1. Voting pattern could resemble the TARP votes in the US in 2008
    i.e. the politicians want to make a statement that they hate the deal before reality strikes and they have to vote for it the second time
  2. Labour officially endorse a new referendum which brings the Brexiteers into line
  3. May renegotiates a softer Brexit (recent EFTA talk) and gets enough Labour MPs to support
  4. We crash out of the EU, have chaos for a short period and then ask the EU if we can have the deal please and they allow it.

How bad is No Deal Brexit?

We have all seen the headlines yesterday with Bank of England estimates of a 25% hit to the currency and the Brexiteers talking about how the economy will be better off.

I will try to lay out what drives their wide disparity.

1 . ‘No Deal Brexit’ will cause limited problems

This is the case made by people like Krugman. Essentially the value of UK exports to the EU is 15% of GDP. Even with a really disruptive Brexit, this would fall by at most 1/3 i.e. 33% loss of exports. Given domestic substitution, the case could be made that this is still far too high a number and so GDP would be less than 1% lower, depending on exact elasticities.

2 . ‘No Deal Brexit’ will cause no problem – it maybe even better than the current situation

Take the analysis above and add in fantastic trade deals with the rest of the world which will more than make up for the lost EU trade. Trade deals may well take a little while to negotiate so there will be a minor cost short term, but longer term the UK will be better off.

I could take issue with any number of assumptions in the argument above. In particular, the gravity model of trade makes a mockery of the idea that you can replace an enormous market on your doorstep with markets halfway across the globe. Furthermore, it is hard to see why the UK would get better trade deals than the EU currently gets; negotiating deals with reduced clout, it seems obvious such a deal will be worse.

But leaving this aside for now, we can see the order of magnitude of potential benefits of new trade agreements with the rest of the world as perhaps 1% of GDP at best.

3 . ‘No Deal Brexit’ is Chaos Brexit

The reason for this is we do trade with the EU is a simple manner – we have highly embedded supply chains across vast swathes of the economy.

The classic example is of course the car industry (https://www.theguardian.com/business/2017/mar/03/brexit-uk-car-industry-mini-britain-eu)

It is important to recognise that these movements of goods do not form part of the official figures for exports to the EU. National Accounts are based upon transactions – i.e. the final sale of goods. When a company moves parts around between different factories in the EU it is not doing a transaction. It does not sell them to itself. Imports within the EU are called “acquisitions” not imports. Note that they are recorded for VAT purposes however, based upon the change in value (value added at each stage in the process), but this does not give a sense of the importance of intra-company physical movement of goods across the border.

The mistake in the analysis of people like Krugman, is to have a very simplistic model in which the UK and the EU are the sole creators of goods and they trade with each other, much like a model of trade between two parties in an economic textbook. The reality is that the UK and EU are intertwined in the production process and the impact of this is grossly underestimated by only looking at the destination of the final product.

It is worth then considering the likely reaction of industry.

If making cars in the UK is subject to expensive issues and frictions in the supply chain with a possible tariff when you try to sell into the EU – then why make them in the UK at all? Make them entirely in the EU. Will there remain a UK car industry selling to UK buyers? Well possibly – but given the enormous economies of scale in manufacturing, it seems far more likely that production moves to the EU. Then we not only stop exporting cars, we have to import even more of them. With over 1 million people in the UK currently employed in the wider automotive industry that is a huge problem.

The way we get to a real economic catastrophe is very similar to what we saw in the financial crisis. You take a well-functioning system and smash it. Then stand back and be very surprised by the unintended consequences.

Brexit – The Endgame

Quick Recap thus far

The path of Brexit up to this point has been depressingly predictable. I have previously laid out the logic of the issues and nothing meaningful has changed in the past 2 years which is why I have found nothing new worth writing about. The EU has been very clear at all times on its approach whereas the UK seems yet to work out what it wants Brexit to mean.


Options for the UK

  1. Remain
  2. Leave EU but maintain very close economic ties
    This makes the UK a rule taker and is very similar to being in the EU except with no say. A clear loss of sovereignty with no obvious benefit i.e. Brexit means “Giving Up Control”
  3. Leave EU and break economic ties
    clear rise in independence but at a very severe economic cost. This could be

a.  Orderly i.e. a negotiated transition or

b.  Disorderly i.e. “No Deal” Brexit.

The current strategy of the UK is to move to a transition that leaves options 2 and 3 both open.
In this way many decisions are deferred, however the Irish border is an obstacle that makes it difficult to fudge.


The Irish Border Problem

The issue can be stated very simply, either

A. UK has no customs border with the EU
This is much the same as the current situation and so is unacceptable to the Brexiteers. May has committed that we will not do this.

B. UK has a customs border with the EU
If so where?

  • Around the UK i.e. a land border between Northern Ireland and the Republic
    This breaches the Good Friday Agreement and, as one of the red lines, is unacceptable to the EU. May has committed we will not do this.
  • Around Britain i.e. a border in the Irish Sea.
    This is unacceptable to the DUP. May has committed we will not do this.

You will notice that the UK government has strongly and categorically ruled out all possible options to appease different factions. How can this be resolved? The main approach so far appears to participate in magical thinking, but we fast approaching the point where choices have to be made. Furthermore, denial of the issues and refusing to make a choice at this stage becomes a choice with ramifications.

 

Brexiteer solution

It is important to recognise the Brexiteers do not form in any way a unified group with a plan. They are united in their opposition to the EU, not in their plans for what comes next.

  • Boris Johnson – resigned so he could continue to talk nonsense and magical thinking solutions from the side-lines. He will claim whatever happens was not his fault, would have worked out much better if he were in charge, and therefore should now be PM.
  • Michael Gove – wants the exit from the EU to be as smooth as possible e.g. temporary Norway, thereby not risking a 2nd referendum or a “no Brexit” but leaving the difficult issues for later. Presents himself as the pragmatic face of Brexit and therefore he becomes the next PM
  • Liam Fox – had tried to follow the pragmatic line of Gove but recently has been dragged into arguments on sovereignty, with the ECJ involvement in the Backstop quitting arrangement.
  • Jacob Rees Mogg – profoundly does not care about Ireland and thinks it is ridiculous that the independent future of England could be impacted as such. Taking his values from the 18th century, his attitude to the Irish is no different. The border is not important to him and he dismisses anyone who suggests it should be or that he should come up with a proposal.
  • The DUP – I do not have the foggiest clue as to what they want. A return to the Troubles perhaps?

Some of these factions are aligned with May in aiming for an agreement with the EU that fudges the Irish border issue (the EU are masters of drafting wording which can be interpreted any way you want). However, others are demanding clarity and will vote down any deal with does not have it, believing that a game of brinksmanship with the EU will lead to a better outcome.

This leaves us at a point of impending chaos which makes it the hardest stage to predict. I found this BBC graphic a helpful guide as to some of the possibilities (https://ichef.bbci.co.uk/news/624/cpsprodpb/125F1/production/_104294257_brexit_flow_chart_12_11_640-nc.png)

 

Brexit – where are we going? An alternative view

May says that the deal may be struck in the next 24 hours, and so at the risk of being immediately proved wrong, I will lay out another potential path, with the help of a little recent history

A Greek tragedy?

In all the analysis of the various complexities of the negotiations, I have not read anything which draws upon the similarities to the Greek financial crisis. This is surprising given the clear precedent on how the EU behaved during a negotiation and furthermore, how it reacted to a crisis.

 

Recap

Greece spiralled into a huge government debt crisis starting in 2009 and couldn’t contain it domestically. To fund the large ongoing budget deficits in addition to historic debt burden, it was forced to turn to the IMF and the EU for loans, resulting in the first Greek bailout package in 2010.

A key part of the bailout terms involved Greece submitting to austerity demands from the EU. This then developed into a narrative within Greece over the next few years (note the echoes for today)

  • Germans are the enemy – they are imposing this pain on us. Lots of references to World War 2 and reparations (read The Telegraph in the past 2 years?)
  • The EU needs us more than we need them. If we drive negotiations to the brink they will cave in and offer us better terms (listened to any Brexiteer in the last 3 years?)
  • Varoufakis claims his clever negotiating strategy (i.e. not engaging in any meaningful dialogue) will force the EU to give in and back down (David Davis past 2 years and still!?)

 

Pushback from Greece?

In 2011 amid public anger over austerity, the Greek Prime Minister called for a referendum on a second bailout, attempting to pushback on the EU’s demands. However, when it came to it, the Prime Minister called off the referendum and then resigned; Greece backed down and applied for a second even larger bailout with expanded austerity.

 

Crunch-time

  • Early 2015
    Having been elected in January on an anti-austerity ticket, the Greek government did not want to agree to the third bail out terms. The EU said there would be no improved offer and that any further deal would likely have harsher austerity conditions
  • 5 Jul 2015
    The Greek government calls a referendum, telling the electorate to reject the terms of the EU offer as it would give the government more leverage in negotiations and they would secure a far better deal.

The referendum votes down the bailout offer by 61% to 39%

EU does not improve its offer

Greece faces immediate economic collapse
(already in default after missing a payment on 30th June 2015)

EU banking system does not collapse.

EU allows Greece to choose to leave the Euro if it wants to.

  • 13th July 2015
    Greece accepts a revised bailout from the EU with harsher austerity conditions
  • Aftermath
    The Greeks seem to view all this as a great success in standing up to the Germans

 

What does this teach us?

It shows us that the EU is highly predictable. It does exactly what it says it will do. The EU does not back down in a game of chicken against a smaller nation. When the EU tells us that it would prefer “No Deal” to breaching its red lines, it means it.

The UK, on the other hand, will not be able to secure a better deal from the EU via a repeated game of brinkmanship. If the Greek saga is anything to go by, the deal will likely get worse.

It also shows that nations are capable of material self-harm in the name of independence. We should not assume that the UK will not end up with a “No Deal Brexit” just because it is horrific.

 

What happens if we are Greek?

  • May agrees a deal with the EU
  • Either the Cabinet or Parliament vote it down and we move towards No Deal.
  • Corbyn’s Opposition continues to fail to come up with any alternative plans and just wants to use the chaos to claim power.
  • We wait for the EU to offer us a better deal, which of course they don’t.
  • The market and economic implications start to bite, but perhaps not enough for us to agree to make the deal.
  • We drop out of the EU into chaos
  • After a week of chaos we go back to the EU and take whatever terms they offer us.
  • We call Brexit a triumph.

 

Sovereignty and Power

I have been pondering in what sense does Brexit affect UK sovereignty. In simple terms, the UK’s sovereignty is unchanged. The UK has the right to leave the EU, therefore it has independent authority whether it chooses to use it or not.

What is Sovereignty?

Wikipedia defines Sovereignty as the “power of a governing body over itself, without any interference from outside sources or bodies.” This suggests that we need to consider degrees of power, and this takes us rapidly beyond the simple terms above.

In one regard, the definition above suggests leaving the EU would clearly increase the UK’s sovereignty. Currently there is a lot of interference from EU bodies that a Hard Brexit would remove.

Sovereignty – to give it away or to exercise it?

Another way to think about degrees of power is to consider effectiveness i.e. the power to do or get things you want. While a country might claim theoretical power to do anything it wants to, in practice all countries enter in binding agreements with other countries which put constraints on some behaviour in return for other benefits. For example, a trade treaty creates easier trade once you agree to certain standards, or joining NATO because you care about your economy and your security. In this way, you exercise your sovereignty, giving up some of your autonomy in exchange for a benefit you value more highly. To use an analogy to the individual: you lose autonomy by having a job (you have a boss and you have to go to work) but you gain power to do what you want by having money.

Relative power

Relative power therefore, is an important determinant of the effective sovereignty of a country.
If you are very powerful compared to another country, then a treaty you enter into will likely be better suited to your preferences than to theirs. Whilst superpowers and small states are both sovereign, in practice the superpower gets to set the terms a lot more often.

Smaller states can change this is by clubbing together: finding like-minded states, forming coalitions, standing up to larger powers by, in effect, acting like a large power themselves. If your internal values and goals are similar, then the loss of independence is more than made up for by the increase in power you gain. Thus, the EU is a greater global power than any of its constituent countries. The US, when thought of as constituent states, is similar. Under this approach, you could even suggest “sovereignty” has been increased by pooling it, rather than diminished.

And finally back to Brexit….

The question for the UK is whether it had more effective sovereignty by pooling its sovereignty within the EU or by going it alone. This is a way to think about why people voted the way they did.

  1. Is the UK pooling its sovereignty with countries with which it shares values?
  2. If the UK left would it be a significant global power?

For people older than me, my guess is that they do not feel an affinity with continental Europe let alone its values, and at same time retain clear memories of when Britain was a significant global power.

For people younger than me, there is a much greater affinity for European culture and values, and a very limited sense that the UK is an important independent state if it were alone on the global stage.

Thus, one group sees a freedom from EU control, and with that an ability for the UK to use its power without restraint. The other sees a separation from modern liberal values, towards political extremism and a rapid decline in economic and political power.