Want a decent analysis of #Brexit from an EU view?

Another key theme of the weekend conference was Brexit, best summed up by one panellist as a decision made by a confused population about an issue their politicians can’t agree with, don’t want to implement and has no support. As a result, Theresa May is trying to keep the Conservative Party together; please the European Union; and deliver departure from the EU; all of which are incompatible objectives. She has to let one go … but which one?

One of the things that surprised me is that the audience – predominantly from European nations, particularly Italy – seemed to feel that Brexit was just as important to be resolved satisfactorily to get Europe back to some sense of normality, as it is for the UK. After political instability in Europe causing economic issues, Brexit was seen as the number one threat on the horizon. Bigger than the issues of terrorism, migrants or even Donald Trump, according to a poll of the audience.

To soothe those audience nerves, The European House – Ambrosetti produced a nice white paper outlining the effect of a hard no-deal Brexit. It was specifically prepared for the weekend’s meeting and here’s are the main findings:

1. With the agreed date for Brexit having passed (March 29, 2019), complete uncertainty persists about the future of EU-UK relations and, in fact, all scenarios remain valid and all results are still possible, including a “Hard Brexit”.

2. The most important unresolved issue is the Backstop solution, specifically in terms of customs checks between Northern Ireland and the Irish Republic. The Withdrawal Agreement text approved by the British government and the EU-27 has been rejected more than once by the British Parliament and, despite the short-term postponement conceded by the EU, a minimum majority within Parliament does not seem to be forthcoming. This despite the fact the Withdrawal Agreement contains only some agreement points in order to pave the way for more specific negotiations during the transition period.

3. Any forecast regarding potential impacts is currently premature, but all observers agree that the repercussions of Brexit will be negative for both parties, and greater for the United Kingdom. The worst scenario would be a Hard Brexit, with a lack of economic growth in the EU of 1.5% of the community’s GDP to 2030 and a lack of growth of the UK economy to 2030 of between 4% and 9.3% of British GDP.

4. A number of negative effects of Brexit on the British economy can already be seen:

• It is estimated that the results of the referendum have already caused a lack of growth in the British GDP of around 2% compared with a scenario of a “Remainers” victory. Thus, the annual growth rate of UK GDP in 2018 was 1.3%, the lowest in the last seven years, matching economic performance in 2011 and among the worst of the advanced economies (over 1 p.p.7 below the OECD average). In addition, in 2019 and 2020, only Japan and Italy will perform worse than the British economy.
• The pound sterling exchange rate dropped sharply following the results of the referendum and has remained structurally lower by over 12.5 p.p. in the 40 months following the referendum, compared with the 40 months preceding it.
• Exports have risen (thanks to the United Kingdom’s temporary presence in the single market and the lower sterling exchange rate). However, the overall effect has been negative: the United Kingdom remains a net importer with a negative trade balance of over £53 billion in 2017-2018 period.
• The situation of British families has worsened. Savings have collapsed, with the savings index of British families dropping from 7% before the Referendum to current 4%. At the same time, the level of indebtedness of British families has grown together with the total of unsecured loans per person and the ratio between unsecured loans and available income of families. In the first quarter of 2018, UK households recorded net debt of £5.8 billion (1.1% of GDP), in line with the average recorded since the third quarter of 2016. Before the referendum, UK households were net lenders amounting to 0.9% of UK GDP.
• At the moment, the most significant effects for business seem caused by the climate of uncertainty, with loans granted to British SMEs for which the annual variation has fallen from the 2.5% pre-referendum level to the current 0.5%. Investment by British companies has dropped for the fifth consecutive quarter8 (-2.5% over this period), as has manufacturing output (-1.4% during the same period). UK companies also registered the slowest growth in gross fixed capital formation (GFCF) of G7 companies in 2018.
• Considering migration, in 2017 almost 130,000 EU citizens residing in the UK left the country, 145,000 in the first six months of 2018 and 95,000 in the last half of 2016. Net migration of EU citizens to the UK is at its lowest level in 10 years (although it remains positive). The number of UK citizens who have applied for and obtained citizenship in another EU country has risen from just over 2,000 in the pre-Referendum years to almost 15,000 in 2017.

5. Considering the repercussions for business, what will feel the effects of Brexit most is trade. In the event of a hard Brexit, the WTO regulations will enter into effect, yet despite this, between 15% and 27% of bilateral trade is at risk from high tariffs, plus additional non-tariff costs and the need to update norms, procedures and ICT solutions, as well as longer time frames and greater red tape.

6. Pan-European value chains also face disruption. From this standpoint, manufacturing will be the area most-hit in the event of a hard Brexit. Automotive and aeronautics will be the sectors most at-risk. Overall, disruption in value chains could result in economic losses of 1.5% of European GDP and 4.5% of British GDP.

7. The service sector will also feel the impact. In fact, in the absence of an agreement which includes this sector, WTO regulations would offer few safeguards. The EU would see its banking sector hit, primarily, because London is its seat of operations. A hard Brexit would result in a capital market that is more fragmented and less efficient, with lower liquidity and more exposed to risk.

8. Considering foreign direct investment (FDI), one of the elements that currently makes the UK attractive to foreign capital is certainly EU membership. Since the referendum, the value of FDIs entering the UK has fallen by 19%, the number of FDIs projects decreased by 8.5%. On the other side, Brexit could also trigger virtuous competition between the remaining Member States, reconfiguring investment and capital flows at European and global level. The headlines and business plans announcing changes of headquarters by major European, multinational and British companies goes in this direction.

9. Human capital and research and development are two areas in which the effects of Brexit could be more limited. The draft Withdrawal Agreement reached to-date safeguards the 4.6 million people affected by Brexit, but a “no deal” could leave them without any sort of protection. In terms of R&D, the United Kingdom will remain part of Horizon 2020, although with some significant limitations. The draft agreement of the upcoming framework program, Horizon Europe, also provides for easier access for third countries.

10. Along with a further delay, the hypothesis of a Hard Brexit is becoming more and more common. There are several developments in the negotiations that could lead to the United Kingdom leaving the EU without agreement to regulate this transition and mitigate its impacts. This would be the worst option for businesses and individuals, but even a general, unfocused, long-term postponement would increase (or otherwise not reduce) uncertainty, which is particularly damaging to the private sector and market players today. A Soft Brexit remains, among the most probable outcomes, the less negative one for both the UK and the EU economic system.

You can download the full report over here.