It is more than two years since the U.K. narrowly voted to leave the European Union and yet the terms of the departure, scheduled for March 29, 2019, seem as unclear as ever. Indeed, there is still an outside chance that Brexit will be delayed, using the flexibility allowed in Article 50 of the EU Treaty. Brexit could even be cancelled altogether. It is unlikely that those calling for a “People’s Vote” (in reality, another referendum) will get their wish, but it would be unwise to rule anything out.

Crisis? What crisis?

Given all this uncertainty, though, the U.K. economy has performed remarkably well. GDP growth has settled at a lower but still decent pace, while unemployment has fallen to the lowest rate since the 1970s, at just 4 percent. This contrasts to the recession that many predicted in the wake of a vote to leave.

The much-feared “Brexodus” of City jobs has also been more like a trickle. London is still way ahead of its European competitors in surveys of the world’s top financial centers and as a destination for inward investment. The advantages of the U.K. in this sector – including the favorable business environment and supporting infrastructure – are largely “Brexit-proof.”

Many see the election of a Labour government under Jeremy Corbyn as a far greater threat.
That said, the initial economic impact of the vote to leave the EU has clearly been negative. The additional inflation resulting from the fall in the pound has squeezed real incomes, while the heightened uncertainty has held back business investment. It is also notable that many other major economies have picked up, whereas the U.K. has slowed.

However, this tells us very little about the longer-term impact. The fact that the U.K. has not yet left the EU means that it is too soon to expect the bulk of any benefits from Brexit to come through, as well as any additional costs. Even the initial hit may be partially reversed, especially if investment snaps back once uncertainty clears.

The big issues

This relatively upbeat view assumes, of course, that Brexit itself will be positive, or at least not as bad as feared. There are many unknowns here, including the nature of the future relationship between the U.K. and the EU, and what the U.K. government will do with the control it will regain over trade policy, domestic regulations and migration. But this essentially comes down to two related questions.

The first is what to do about the border on the island of Ireland, between the Republic of Ireland (part, of course, of the EU) and Northern Ireland (part of the U.K.). All parties recognize the importance of avoiding a “hard border,” meaning any form of physical infrastructure, such as customs posts, that could compromise the peace process.

The second question is how far the U.K. will move away from the two central pillars of the EU: the Customs Union (which eliminates tariffs between member states, but requires them to operate common external tariffs), and the Single Market (underpinned by the four freedoms of movement, covering goods, services, capital, people, and a set of regulations and standards that apply to the whole economy, not just goods and services traded internationally).

At the moment, the EU seems convinced (and has apparently managed to convince the U.K. government too) that the only way to fix the Irish border is for Northern Ireland to remain in some form of customs union with the EU. It has therefore offered the U.K. two options.
One is a free trade agreement for Great Britain only, with a new customs border drawn between Northern Ireland and the rest of the U.K. This is, of course, completely unacceptable to the U.K., including the unionist MPs from Northern Ireland, who hold the balance of power in Westminster.

The other option is only slightly more palatable. This is associate membership of both the single market and customs union for the whole U.K. Many would regard this as “Brexit in name only” (though there are also some in government and business who might welcome this too).

For now, the U.K. has responded with the “Chequers Plan,” named after the prime minister’s country retreat. This also has two main elements. The first is a “Facilitated Customs Arrangement,” where the U.K. runs two customs systems at its borders, applying U.K. tariffs to goods destined for the U.K. and EU tariffs to those destined for the EU. This may well prove to be too cumbersome, and it has already been rejected by the EU.

The second element – just as controversial – is a “common rulebook” for goods, where the default position is that the U.K. accepts all EU regulations and standards with little, if any say, on how these are determined. This would severely limit the scope for independent trade deals.

In summary, the Chequers Plan is a compromise that appears to please nobody. So, what’s the alternative? Yet again, there appear to be two. The first is to take a step back towards the plan the government was originally working on, before Chequers was proposed.

This starts from the assumption that the Irish border is fixable by a mix of technological solutions, trusted trader schemes and exemptions for small businesses, which together allow customs systems to be operated away from the border itself. Northern Ireland then need only keep EU rules in a few, relatively uncontroversial areas, like animal welfare (the island of Ireland has long been regarded as a single unit for these purposes anyway).

The rest of the plan then comprises a comprehensive free trade agreement between the U.K. and the EU, similar to, but better, than the EU-Canada deal, which would eliminate tariffs, streamline customs, and allow for mutual recognition of rules in areas such as financial services. The U.K. would then be free to look outwards too, with a new U.S.-U.K. free trade agreement an early priority.

Graphic showing two 'hands' of cards of two cards each. We can see the EU cards that have 'deal..' and 'no deal..' on them.

How bad would ‘no deal’ be?

The other option would be “no deal,” meaning the U.K. leaves in March 2019 without a withdrawal agreement and is simply treated by the EU in the same way as any other third country. The U.K. public is currently being bombarded with warnings of potentially devastating impacts of “no deal” on the economy, their security and their welfare.

This has generated some truly daft headlines. My favorite is that U.K. would run out of food by August 2019 (the 7th, to be precise). This relies on the bizarre assumption that the U.K. would no longer be able to import food, not just from the EU but from anywhere in the world, and that the U.K. would continue to export food even as its own people starve.

Some other warnings do need to be taken much more seriously. But almost all describe hypothetical scenarios that are (very) unlikely to happen in practice. After all, “no deal” does not have to mean no new agreements at all, on anything. In reality, the EU has lots of arrangements with other countries that are not dependent on EU membership, let alone signing up to all the rules of the Single Market and Customs Union. A good example is the air service agreements that allow planes to fly.

These warnings also often assume that the EU would ignore its other legal obligations and the threats to its own economy. There is a rather fruitless debate about whether the U.K. or the EU would suffer more from a “chaotic” Brexit. But the key point is that both sides would be worse off, and therefore it is in their best interests to cooperate. Just talk to German car manufacturers, or French cheese-makers.

Finally, the warnings assume that the U.K. cannot fix problems on its own, or even that the U.K. government would do things that actually make problems worse. For example, the U.K. government has already said it would allow the U.K. regulator to decide the medicines authorized in the EU are safe in the U.K. too. Similarly, scare stories about labor shortages and higher food prices assume that the U.K. would choose to restrict migration in crazy ways, or impose new tariffs rather than reduce existing ones.

So what happens next?

The clock is running down quickly, and there is an awful lot that would still need to be done to allow a clean break in March 2019. A “no deal” scenario would be a risky second best. But I believe that both sides will show more flexibility (especially on the Irish border), allowing a smooth departure, with a time-limited transition period to work out the finer details of the future relationship.

Once this period is out of the way, there will be all to play for. For sure, the consensus is that the long-term impact on the U.K. economy will be negative, including the government’s own published analysis. However, this observation is not as persuasive as it may first appear.
First, modeling the economic impact of Brexit is inherently difficult, because the benefits from independent trade and regulatory policies are harder to quantify than the initial costs of looser ties with the rest of Europe. In my view, this reinforces the danger that policy-makers focus too much on keeping as close as possible to the status quo, rather than seeking an outcome that makes the most of the opportunities created by the U.K.’s departure from the EU.

Second, the conventional wisdom has often been wrong (for example, on the case for joining the euro, and even the immediate economic impact of the vote to leave the EU). This does mean, of course, that the consensus is wrong this time too, but it should be taken with a large pinch of salt.

Third, estimates for the impact need to be put in their proper context – recognizing the uncertainties and kept in perspective, especially when they represent relatively small changes in the level of GDP compared to the growth that might otherwise be expected over long periods.

For example, conventional modelling of all the easier-to-quantify costs and benefits of Brexit might suggest that the level of U.K. GDP will be 5 percent lower than otherwise in 15 years’ time. However, this would be relative to a baseline where GDP might be 25 percent higher. In other words, GDP would still increase by 20 percent over this period, even without allowing for the harder-to-quantify gains, both economic and non-economic, that the departure from the EU might bring.

Hopefully, we will look back at this period of extraordinary uncertainty and upheaval and wonder what all the fuss was about. In the meantime, though, it is worth taking comfort from the fact that, outside the Westminster and Whitehall, ordinary U.K. consumers and businesses seem to be keeping calm and carrying on.