In Brexit Talks, the Risk of No Deal Looms Large

By Stephen Fidler Features Dow Jones Newswires

The prospect of a "no-deal" Brexit is once again exciting British politicians. Prime Minister Theresa May threw a bone to her party's Brexit supporters this week by promising that, while the U.K. was hoping for successful negotiations with the European Union over leaving the bloc, it was preparing the ground in case talks failed.

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Two reasons are usually given for preparing for a no-deal scenario. The first is prudence: Given the possibility that the two sides won't reach an agreement, it is the cautious thing to do.

The second is negotiating credibility: Only if the EU is convinced of the U.K.'s willingness to walk away from the talks will it be motivated to offer the U.K. a good deal.

But there are reasons to doubt whether such a posture, often advanced by Brexit supporters, would carry much weight as a negotiating tactic.

In the first place, time is running short.

In the absence of a transition period in which trade rules stay unchanged after Brexit day in March 2019, the scale of necessary preparation -- including building extensive infrastructure at ports to cope with increased customs bureaucracy -- is too ambitious in the next 17 months, given the limited preparation so far.

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Second, EU decision makers believe that the damage would be overwhelmingly worse for the U.K. economy than for the EU. True, the bloc would suffer, in some places and sectors quite significantly, but most economic models predict the U.K. would face by far the biggest economic hit.

There are in fact two potential types of no-deal Brexit, as Chancellor of the Exchequer Philip Hammond pointed out on Wednesday to a House of Commons panel. Under what he called a "bad-tempered" Brexit, there would be no agreement between the two sides and therefore no legal basis for many EU companies to do business with the U.K., a chaotic outcome under which he said it is "theoretically conceivable" though highly unlikely that flights between the EU and U.K. would be grounded.

Then there is an orderly no-deal, a recognition from both sides that they can't reach an agreement on a preferential trade accord. EU-U.K. trade would shift to most-favored nation terms under World Trade Organization rules, bringing tariffs and a host of customs-clearance procedures that would gum up free flows of trade between the EU and U.K.

Michel Barnier, the EU's chief Brexit negotiator, said Thursday, "No deal would be a very bad deal." He isn't the only one who thinks so.

Few economists appear to have modeled a bad tempered Brexit. But even in the case of a more orderly no-deal exit, a growing number of economists believes that some better-known forecasts -- including that of the U.K. Treasury -- have underestimated the likely longer-term impact.

They note that many before-the-fact models in the past have undervalued the eventual beneficial effects of preferential trade agreements such as Nafta on economic integration, productivity and growth. That suggests the converse may be true: these conventional models may underrate the growth impact of backing out of a trade arrangement like the EU.

A paper from economists at the World Bank this year suggests many studies haven't taken into account how much deeper intra-EU trade relations are than traditional trade deals focused mainly on tariffs. The EU, it points out, encompasses 44 legally enforceable provisions impacting trade in goods and services. Their forecasts suggest a no-deal scenario could halve U.K. trade in goods with the EU and cut trade in services by 62%.

Indeed, over the past four decades, the EU has embedded the U.K. in just-in-time supply chains and other arrangements only possible under almost frictionless trade.

Take the Port of Dover, the main gateway between the U.K. and the rest of the EU, which handles 10,000 truck movements a day. The absence of customs and other procedures needed for traffic destined for the EU reduces the time to process a truck to two minutes. Double that to four minutes, the harbor authority says, and you quickly get traffic backups of 17 miles. The chaos, it says, could be replicated at ports on the other side of the Channel.

A new study published Thursday from Rabobank, the Dutch lender, tries to capture economic effects of Brexit that other models have underestimated, including by focusing on the impact of resultant higher prices as well as the hit to productivity that would flow from less efficient trading relations with the EU.

A non-chaotic no-deal Brexit in March 2019, it estimates, would push the U.K. immediately into two years of recession. By 2030, it estimates U.K. gross domestic product would be 18% lower than if the country had stayed in the EU, the equivalent of GBP11,500 (nearly $15,200) per British worker.

Such studies reinforce the view that it is irrational for the EU and U.K. not to seek some kind of post-Brexit preferential trade accord. They also suggest that a U.K. effort to exact a better deal from the EU by pretending it is ready to walk away is a tactic of limited credibility.

Write to Stephen Fidler at stephen.fidler@wsj.com

(END) Dow Jones Newswires

October 12, 2017 16:16 ET (20:16 GMT)