“No deal is better than a bad deal” is the mantra that the UK government keeps repeating, probably for negotiating purposes. However, in economic terms, “no deal” would be highly detrimental.
First of all, the absence of a deal does not automatically mean the UK can trade with the EU on World Trade Organization (WTO) terms. To be able to do this, a great many deals on new administrative procedures governing certification of regulatory standards, customs processes and so forth will be required.
The agreements must be reached well before Friday 29 March 2019. In fact, it is hard to see how trade can continue if these deals are not made by the summer of 2018. The problem is that so far, the UK has done nothing, nothing at all, to prepare itself for a ‘hard’ Brexit. No arrangements have been made with regard to customs, new agencies or residency rights.
Moreover, even if it were possible to trade on WTO terms almost immediately after leaving, a recent World Bank study suggests that trade in goods with the EU would halve, and trade in services would fall 60%. It would be highly irresponsible not to make a deal and therefore unlikely. So “no deal” is nothing more than an empty threat. The recent US Bombardier tariffs are a reminder that life is cold outside the largest internal market in the world.
In the meantime, the clock is ticking. The EU is demanding sufficient progress on three issues: the size of the divorce bill, the citizens' rights for EU-27 citizens in the UK and UK citizens in the EU-27, and the future of the current, ultra-soft border between Northern Ireland and the Irish Republic, before negotiations on future trading relations can start. As the UK government intends to leave both the customs union and the internal market, solving the Irish border problem looks a lot like an attempt to square the circle.
Furthermore, the UK government is in no hurry to settle the divorce bill, as it is one of the few trump cards in its hands. What we can expect is that businesses will start to panic more and more, the longer it takes to conclude a preliminary deal. At some point, the UK government will probably surrender to the fact that “no deal” is not a viable option. Nobody is under the illusion that the upcoming negotiations on the future trade relationship between the UK and the EU will be finished quickly.
In the meantime, the transitional relationship will be more or less the same as it is now: the UK will still be subject to new EU rules and to the jurisdiction of the European Court of Justice, and will still contribute to the EU budget, etc. In Florence, Prime Minister Theresa May indicated the transitional period would last for two years. However, it is doubtful that will be long enough. The negotiations regarding the recent EU/Canada deal, for instance, took seven years to complete.
Initially, the Brexit saga will continue to be a substantial drag on the economy. Only if the UK ends up remaining a de facto member of the EU for the years to come, will the drag subside. An additional benefit would be that the Irish border could remain soft for the foreseeable future.
This article forms part of the Robeco 2018 outlook entitled Playing in Extra Time.
Are there risks? Of course, there always are. One might be that a new and improved Fed will prove more hawkish than it is now. No fewer than three FOMC monetary policy committee positions are currently vacant, with Chair Janet Yellen’s term ending in February 2018. The latest rumors have it that QE critic John Taylor is now the preferred candidate to replace her, but if we have learned anything from this administration, it’s that the rumors cannot be trusted. In general, monetary policy is decided by majority vote, which makes any radical change unlikely.
What’s more, the fact that inflationary developments continue to be favorable mean there is little reason as yet to implement monetary tightening in 2018, at a point no more than two steps after the modest rate hike of December 2017.
Another risk specific to the US, is that the threat of impeachment could dampen ‘animal spirits’. This risk will likely only become critical after the 2018 Congressional elections, if the Republicans lose their majority in the House of Representatives. In that sense, the main risk to the growth outlook is the rise of protectionism as illustrated by the difficult negotiations surrounding NAFTA.
All in all, in 2018, US economic growth could easily surprise on the upside.
This article forms part of the Robeco 2018 outlook entitled Playing in Extra Time.
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