Are the aims of the UK prime minister on the outcome of the forthcoming negotiations on Brexit obscure? The gyrations of the foreign currency markets suggest that investors believe they are. Yet that is not so. Theresa May is merely unwilling to spell out the implications.
We know what Mrs May’s red lines are. We know, too, what they imply: two years after the exit negotiation begins, the UK will lose much, if not all, of its favourable access to EU markets, whether Mrs May admits this to the world or even herself. We can call that outcome “hard Brexit”, whatever she herself wishes to call it.
Mrs May is not exactly fibbing when she says that the UK is “going to get an ambitious, good and best possible deal for the United Kingdom, in terms of trading with and operating within the European single market”. She is merely sugar-coating the pill. The best possible deal is almost certain to fall somewhere between a hard and a chaotic Brexit.
Mrs May wants control over immigration and freedom from the rulings of the European Court of Justice. Angela Merkel, chancellor of Germany, has made it equally clear that not conceding on these points is her red line.
The UK is therefore highly likely to leave the single market at the end of these negotiations, unless Mrs May does a volte face. She would not want to do so and her party would not allow her to do so. The single market option is dead, even as a transitional arrangement.
So are there other options for preserving some of the existing trade relationship? Yes, there are two.
The first is to stay inside the customs union for goods, either as a transitional or permanent arrangement. That would give manufacturers much of current trade access, particularly if a deal could be done on establishing conformity with regulations. But being in the customs union would rule out preferential tariff deals with other countries. Such deals would be limited to regulatory matters.
The second would be a bespoke deal that falls short of a customs union, possibly, as some Brexiters argue, including sectoral customs unions - but mainly consisting of a preferential tariff arrangement similar to that of the European Free Trade Association.
This, again, is theoretically feasible. But it is unlikely that such a deal could be negotiated within the time available. It is inconceivable that it could be agreed in time to give business the clarity it needs for planning well in advance. Business should therefore plan on the assumption that it will not be agreed.
One should add that sectoral customs unions would be hard to negotiate. They would also violate World Trade Organisation rules that state preferential arrangements should cover “substantially all” trade. It would be unseemly for the UK to return to the WTO as a full partner only to ignore this basic rule. Particularly in the world of US president Donald Trump, the UK should want a strong WTO, not a weakened one.
Where the UK is heading is clear. The question is only whether an exit deal can be reached within the two years or whether it crashes out of the EU without one. Many are now becoming increasingly relaxed about a hard Brexit. The robust post-referendum performance of the economy is believed to prove that the costs will turn out to be negligible. That conclusion is far too hasty.
First, nothing has happened. Some argue that if these costs exist they would have been expected and so would have been acted upon by now. Yet, unless one thinks the public had another model in their minds than the models used by economists, these costs were expected and were not acted upon. Consumers, in particular, decided to ignore them - until something happened.
Second, the fall in sterling represents a substantial loss in purchasing power that will, over time, be reflected in domestic prices and real incomes. It is of course possible to argue that the currency was overvalued and that its decline will help bring about a helpful rebalancing of the economy. It is also possible to argue that a post-Brexit shrinkage of the financial sector would do the same. But there will be substantial transition costs associated with such rebalancing. Experience also suggests that a falling exchange rate does little to bring needed rebalancing about.
Finally, the long-run costs will come from having an economy that is less open to trade and skilled immigration. That is a choice still to be made. But it is, alas, likely to be the choice that is made.
Investors and other decision makers should therefore not be in much doubt. The direction of travel is sadly clear. To many, that direction remains highly unwelcome. It is not welcome to me. But it is clearly the reality.
