Theresa May’s Plans for a Hard Brexit Could Be Catastrophic for the UK

On January 17th 2017, British Prime Minister Theresa May spoke to her nation and the world in order to finally put a rest to speculation. The goal was to formulate a clear approach on how her government wants to deal with the upcoming Brexit negotiations once article 50 is triggered at the end of March. Her speech, while not coming as a huge surprise, confirmed what many Europeans and Brits had feared: The UK will be seeking a hard Brexit, abolishing any current connections to the EU single market. Our predictions for such a path are clear: The costs for the British economy will be immense!

In her speech May made clear that there would be no half-measures taken by her government and that leaving the EU but staying in the single market would not be an option. The priorities for the UK would be to take back control over their own border policy, regaining control of the laws and putting an end to the jurisdiction of the European court in Britain. Instead of a membership in the single market, Britain would want to seek “the greatest possible access to it through a new, comprehensive, bold and ambitious free trade agreement”.

A hard Brexit could have enormous negative consequences for the British economy

In our study “Nobody Wins With Brexit” we have shown that the Welfare Effects of a Brexit, even in its soft variation would be negative for Britain and the remaining EU Countries. In the case of the now proposed hard exit, they are downright catastrophic. While a soft exit with the UK remaining a member of the European Economic Area (such as Norway) or a de facto member (such as Switzerland) would only result in a decrease of annual GDP of around 0.6%, ten years after a Brexit, the more unfavourable scenario (“Isolation of UK”) would already lead to a decrease in GDP of around 3% annually through static trade effects alone. Indirect dynamic effects, such as a future loss of investment or innovation growth due to isolation could substantially add to those losses.

Is the UK heading towards a trade war?

While the UK’s plans to swiftly replace their current membership with a comprehensive free trade agreement with the EU might aim to counter any such negative effects, the realistic feasibility of such an agreement under current political tensions and in such a short timeframe seems highly questionable. The UK, furthermore, would also lose the preferential access to those countries, with which the EU has signed and ratified bilateral free trade agreements (such as, for example, with Mexico), which would mean even more complex and uncertain future negotiations for the United Kingdom. For Germany a hard Brexit could mean up to 0.3% less GDP growth.

It has to be noted though that these estimates reveal a large amount of uncertainty. First, there is substantial modelling uncertainty afflicting the predicted changes in openness levels; second, the elasticities borrowed from the trade-and-income literature are estimated with standard errors, and thirdly recent events such as the election of Donald Trump and a potential reduction in the UK’s Corporate Tax rate have not been accounted for in these estimates. Especially the last point could shake things up and potentially even worsen the overall situation in the long run, should the UK decide to use their tax rates as a hardball bargaining tool for forcing the EU to comply with their demands regarding a future trade deal. On this, economic history paints a clear picture: a trade war, in which two fractions deliberately try to undercut the competitor’s tax rates or restrict each other’s economic and trade flexibility almost definitely will end up with both party’s economies suffering heavy costs as a result.

British businesses are clear in their opposition to a hard Brexit

UK and EU major business, too, fear the results of an impending hard Brexit. Last year we issued a survey, asking 782 high level business representatives from both the UK and Germany for their opinions on Brexit. Again, even with the assumption of a now obsolete soft exit approach, a striking four fifths (79%) of all respondents spoke strongly against a separation from the EU. Such a strong result comes especially surprising since for our survey we went with the assumption of a “best case scenario” for the UK. One can only imagine then that with the current scenario, where Britain will lose access to the EU single market, respondents’ opinions would be even more adamantly against a Brexit.

Perhaps most alarming were the respondents’ predictions when asked about their companies’ reactions to a potential Brexit. Almost a third (29%) of all companies surveyed in both countries said they would react to a Brexit by either reducing capacity in the UK or relocating elsewhere, a figure that applied equally to German companies (29%) and British (28%) alike.

The thesis, that now that the UK has decided on a hard Brexit, businesses will be even more in opposition to a separation is strongly underlined by the survey’s other results too. A whole 52% of companies cited the EU’s large single market as the number one main benefit of their country’s membership within the EU. With the governments new plans those companies now have more reason to be pessimistic than ever.

Update: The British supreme court has since ruled that any form of triggering article 50 will first have to be authorized through the UK’s parliament. Such a step could have potentially softening effects on a British Brexit approach, though the degree of such an influence remains to be seen.

If you want to read up on the results of our study in more detail you can do so here and here and if you want to read more about our business survey you can click here for a full version or here for a more visualized presentation of the results.