Theresa May Seems To Opt for Hard Brexit

UK Prime Minister Theresa May has now announced that the UK will formally file for divorce from the EU by the end of March 2017.

She plans to repeal the 1972 European Communities Act next year. This act gives effect of EU law in the UK.

To minimize disruptions, the UK wants to essentially copy and paste all current EU legislation into the UK rulebook initially. In order to keep in line with EU laws while still a member, the UK would not be able to make any major changes to these laws until after Brexit.

Most importantly, Mrs. May seems to lean towards a so-called “hard Brexit,” pointing out that the UK would not take back its sovereignty just to “give it all up again.” May focused on key voter issues such as reducing the inflow of EU migrants into the UK.

Don’t be fooled

A so-called “hard Brexit,” in which the UK places heavy restrictions on inflows of EU economic migrants, risks doing the most damage to the UK economy in the long-run.

The EU will not compromise its four freedoms to accommodate the UK. The UK will only get full access to the single market if it maintains an open door policy to EU citizens.

As a starting point in terms of market access, a hard Brexit would likely mean that the UK loses its so-called passporting rights for financial services. “Passporting” means that UK firms can freely sell financial services across the EU from their UK-regulated base.

Steep price to be paid

Estimates of the proportion of UK-based financial services that require an EU “passport” in order to be provided inside the EU range from 10-20%.

In 2015, the UK exported £26 billion of finance and insurance and pensions to the EU, equivalent to 1.4% GDP. A decline in exports from these industries to the EU of say 20% would subtract 0.3 percentage points from annual GDP.

Over time, this and the resulting loss in inward investment would add up to make a significant difference.

Although London would remain the major European hub for financial services, reduced access could lead to some firms relocating parts of their business to the EU in order to secure full market access. A hard Brexit could also put free access to the EU market for goods at risk.

Pride before the fall

While the near-term demand side shock of Brexit has been less bad than anticipated, supporting a good growth outlook for the medium term, news that the UK could be heading for a hard Brexit reduces the supply potential of the UK economy via less trade, investment and migration with the EU27.

Almost half of all UK exports go to the EU – UK exports to the EU make up 12% of UK GDP. Such self-inflicted dislocations with its major market are unwise, to put it mildly. After all, the UK already carries

• a high level of public debt,
• a large current account deficit and
• severe imbalances across major sectors.

Since many of those UK voters who opted for Brexit did so for economic reasons (to counteract low pay, poor job prospects etc.), a hard Brexit would achieve the opposite of what these voters hoped for. Their present-day circumstances will only worsen.

This could eventually entail negative domestic political consequences, not to mention that such an outcome runs counter to Theresa May’s important and laudable goal of “a country that works for everyone.”