British Robustness

As matters stand, the UK is scheduled to leave the EU on 29 March 2019. After UK Prime Minister Theresa May’s Withdrawal Agreement was rejected by a historically unprecedented 230 vote margin in the House of Commons on 15 January 2019, the UK could well leave at the end of March with no deal. Who will suffer more in this scenario — Britain or the Eurozone?

Most of the economic discussion has focused upon how bad such a no deal scenario might be for the UK. Some proposals are rather lurid. Last November the Bank of England published its estimates of the impact various Brexit scenarios. In the “Disorderly — No deal, no transition” scenario UK GDP was estimated to drop by 8 per cent within around 6 months. That (frankly rather absurd) scenario would put the impact of no deal on the UK economy as akin to the impact of a serious tsunami, a widespread famine, or occupation by a hostile power.

 

Disruption and strikes

No sooner had the Bank of England published this extravagance than it tried to rein back from it, saying we should think of it not as a forecast but as an extreme stress test. Hmm. Well, be that as it may, other forecasters are not sanguine about the short-term economic prospects if there is no deal, but none are as fanciful as that.

The widely-quoted National Institute of Economic and Social Research (NIESR) forecasts 0.4 per cent annual GDP growth for the UK in 2019 in a no deal Brexit scenario, very close to my own 0.5 per cent. I’m assuming that in the period April to June 2019, if there is no deal a combination of disruption and strikes will mean the UK economy contracts by around 1.5 per cent, with a bit of catch-up growth over the following six months. That would mean quite severe disruption over that three month period somewhere roughly akin to that of the notorious “Three day week” period in the 1970s when there were energy shortages during the miners’ strike or during Mrs Thatcher’s strike-ridden first year in office in 1979/80.

Perhaps that is too pessimistic, but there should be little doubt that no deal will be unattractive in the short-term for the UK. What about the Eurozone, though? For whilst UK voters chose to leave the EU and it is the UK Parliament — cheered on by much of the UK press — that has resoundingly rejected May’s deal, the Eurozone has not chosen this scenario at all.

No deal could come at a very fragile time for many parts of Europe. Germany’s economy appears to have only just avoided contraction in the final quarter of 2018, with industrial production seriously down over the year and full-year growth the weakest since 2013. French growth was only slightly better than these even before the Gilets Jaunes protests gained momentum. Italian banks continue to struggle and the government’s budget row with the European Commission has been deferred rather than resolved.

A no deal Brexit could tip the Eurozone over from this fragile position into outright recession. Indeed, I think the Eurozone could contract 0.4 per cent on an annual basis in 2019. Particularly vulnerable areas include the automotive sector, where UK consumers buying fewer Continentally-produced cars under no deal would add to the woes from diesel and from falling autos demand from China, and the financial sector, where no deal could produce a regulatory standoff that impaired access of needy Eurozone banks to City of London services and capital.

Even a modest initial Eurozone no deal downturn could rapidly escalate through political pressures. The 2019 European Elections in May would be held right in the worst of the no deal storm. Voters that have just lost their jobs in what must seem like a pointless politicised fight with the Brits could turn in droves to populist parties, seriously changing the balance in the European Parliament. That could be just the preamble to a wider populist backlash, triggering austerity resistance and budget fights in many countries. And all the while parties like AfD in Germany shift ever higher in the polls and the threat of a referendum to leave the euro becomes ever sharper.

 

Substitute imports for domestic production

Trade with the EU is a larger portion of UK than of EU trade. But the UK is heavily a net importer from the EU. No deal barriers could benefit the UK economy in the short-term as imports are substituted for domestic production. Eurozone exporters will be the losers. And the Eurozone economy is neither as economically robust as the UK economy nor as politically resilient to the economic costs of no deal.

It isn’t just a matter of who is hurt more. It’s also about how much pain you can bear and how much you suffer psychologically as a consequence. We could well find that, actually, it is the Eurozone that (at least in the short term in 2019) will suffer more.

 

British economist Andres Lilico was the lead economist of the official leave campaign in the 2016 referendum. He is working at Europe Economics, a technical consultancy that also works for the European Commission.

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