Credit Writedowns 2019 Outlook, Part 2 – Brexit

I’ve been thinking about how to write this piece on the outlook for the political economy in the UK for a number of days. I had it teed up to finish yesterday. But I have left it until today. Apologies

I still have the bias that economics drives politics and not the other way around. But, increasingly, both in the UK and the US, we are seeing extreme political situations that will have an impact both over the longer-term and the shorter-term. And the situation with Brexit is a textbook case of politics affecting the economics.

Rising polarization, rising thuggery and an increase in open protest

Take a look at this video and tell me what you see.

What I see is a woman surrounded by a bunch of men who are calling her names and taunting her in public, in a way designed to instill fear in her of bodily harm. The woman, Anna Soubry, is a well-known Conservative Member of the British Parliament who backs the UK remaining in the EU. And the men are ordinary British people, acting as thugs and inciting each other to what could eventually be assault – or worse.

You can hear one man telling Soubry he’s going to put her “on the Internet” for others to see, indicating he thinks the encounter will show him in a positive light and her in a negative one. So that tells you what his mindset is – that intimidation and thuggery are acceptable, even warranted, when the stakes are high, as they are with Brexit. And he believes others will agree. Likely, they will.

ITV presenter Robert Peston condemned the video on Twitter, only to be met with a torrent of squabbling between Remainer vs Leaver factions, such is the polarization in the UK right now.

My view: It will only get worse in 2019 because the monumental decision on whether to leave the EU will be decided (or postponed) by the end of March.

On Euroscepticism

Everything in the UK now is about Brexit, so colossal is the political decision surrounding it. So, it swamps all other issues.

Let me be upfront about my views here. This may come as a shock to some of you. But I am sympathetic to the  notion of Brexit – not as a rational decision per se, but as a means of self-preservation for the UK. I understand and identify with the euroscepticism in Britain. But there are costs to abandoning the EU, greater for a Euro area country like Ireland than the UK certainly, but not insignificant for the UK either. I tried to make that case regarding Ireland back in 2011 during the European sovereign debt crisis. See my entry from April 2011 here.

I think the core issue is that the EU has moved toward integration with too many very different member states, too quickly. But, there’s more nuance to this. Back in October, I looked at the EU’s legitimacy amongst the voting public for the last 45 years. And “the UK has always been a eurosceptic nation, even in the period just after its admission to the EU”. That’s the only conclusion you can draw from the Eurobarometer data. But, it was the euro – and the political edifice of an ever closer union that went with it – which created the mortal blow. As I put it in October, “The euro was Europe’s first crushing blow on sentiment”.

…the EU was on a very good path before 1991. But when the Berlin Wall fell and the Soviet Union collapsed, the world changed in a fundamental way. The EU’s response was to allow Germany to unify, but to create a single currency as a way of further integrating the new potentially hegemonic unified Germany into the European economy.

From a public opinion perspective, this was a mistake. The euro never had popular backing in Germany. And it had no backing in any of the higher income entrant states, Denmark, the UK, Sweden, Finland and Austria.

And when the EU expanded membership into Eastern Europe, making integration that much harder, it was only a matter of time before the wheels came off. It is ironic that one of the eurosceptic nations outside of the Euro is the first to try to leave.

The economics of Brexit

So that’s the political background to all of this.

My view on the economics hasn’t changed a lot. Brexit will make Britain poorer.

When the British voted to leave the European Union last June, it was effectively a vote for sovereignty over wealth…

Outside of the EU, the UK will suffer losses due to tariff and non-tariff trade frictions – meaning an annual decline in growth relative to where it would have been. It is difficult to put a number on the loss but reasonable estimates are of a cumulative loss of more than five percent of GDP.

Moreover, there’s the currency. Think of Brexit as a competitive currency devaluation that the likes of Italy and Spain never had as a part of the euro. The monetary and fiscal easing associated with this is a shot in the arm, yes. The economy will grow faster than it would without this natural adjustment. But it also means Britons are poorer. Currency depreciation means that UK assets are worth less and that UK incomes are lower relative to everyone else.

Is sovereignty worth it? That’s a political question as much as an economic one.

But what about the transition period? That’s where the chaos will come. And it will come in 2019. Take a look at this tweet from the Guardian’s Brexit reporter Lisa O’Carroll

This is the real problem. Theresa May’s deal is very problematic, with the Irish backstop just one of many issues. But, the alternative, a no-deal Brexit, is not just tantamount to a unilateral repudiation of the Good Friday Agreement – and a political bomb as a result, it will result in the kind of logistical chaos that Lisa O’Carroll has been documenting. The UK will certainly be a ‘loser’ in that outcome. But other losers will be Ireland and Germany in particular because of trade ties.

Where do we go next then?

British Prime Minister Theresa May claims she isn’t just running down the clock to force MPs to back her deal. She is attempting to win concessions from the EU that will make her deal more viable. Irrespective, we have just over two and a half months before Britain crashes out of the EU. And that is a very risky prospect, as just the one example from O’Carroll above attests. There would be logistical chaos on many levels afterward.

The sensible thing to do would be to delay Brexit by asking for a pushback in the timetable. But that would require each of the other 27 EU member states to agree, setting the EU up for another unbearable period of time dominated by Britain’s exit negotiations. You might not get all 27 to vote yes. And you need a unanimous decision.

In lieu of a pushback, the UK could rescind its Article 50 declaration altogether so that it could start afresh. Interestingly, doing so would work in Theresa May’s favor politically. Not only is she immune to another intra-party challenge to her leadership for another 11 months due to the failed challenge in December, her party also holds an increasing lead over Labour. And this would mean that even in the event of new elections, see might retain power (given the strong caveat that she doesn’t go into Maybot campaign mode again).

But just because this is the safe bet doesn’t mean it’s what’s going to happen. Right now, no one knows what is going to happen.

My view

Incumbent politicians don’t like complexity because it creates uncertainty. So, that alone makes me see a revocation of Article 50 as a viable option. I said so a month ago when discussing possible outcomes. But the politics of the situation are fluid.

What’s changed since then is that the pro-Brexit group tried and failed to topple May as Prime Minister. Additionally, Jeremy Corbyn, the Labour Party leader has come out as likely to vote FOR Brexit because he can only achieve his progressive agenda outside the EU. And so, that combination puts Theresa May in the driver’s seat. She has no opposition with enough of a power base to dislodge her. In some senses then, she can do whatever she wants – subject of course to a final vote by the House of Commons by 21 January.

This means she can run the clock down if she wants. It also means she can decide not to revoke Article 50 if she wants. All she need do is present Parliament with a vote by 21 January, at which point, we’ll have just over two months until Brexit.

I see her deal getting voted down. And then, the question for the next two months is one of either no deal or revocation of Article 50.

Frankly, there are no obvious political outcomes here. And the economic outcome for the UK depends very critically on what happens with Brexit. For the UK then, the 2019 Credit Writedowns economic outlook is still undetermined! I wish I had a better answer. But, I hope this run through was helpful.


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