Tactical genius or reckless gambler?

Many moons ago I did wonder whether Theresa May’s plans were an elaborate attempt to strangle Brexit or whether she had become a convert to the Brexit cause. I subsequently concluded that she was determined to deliver Brexit, irrespective of the cost to the economy. Over the last week, I have found myself revisiting the question once again. The PM has basically presented a plan which will put the UK at a significant disadvantage vis-à-vis the EU compared to its current position, with the only alternative being no deal. The “my way or the highway option” is really no option at all, which makes me wonder whether May is a strategic genius trying to manoeuvre the idea of a second referendum back onto the agenda or whether she really means it.

If MPs thought that these really are the only two choices on the table, they clearly have to accept the draft Withdrawal Agreement because the option of a no-deal Brexit is unthinkable. We have been told by Brexit supporters that because the economy remained afloat following the June 2016 referendum, despite suggestions to the contrary, that all will be well on 30 March 2019 even in the event of no deal. I do not share this optimism. The fact that the UK will no longer be a member of EU institutions such as the European Aviation Safety Agency, for example, means that aircraft parts or indeed whole aircraft made in the UK would not have legal clearance to fly in international airspace. Imagine for a minute what that means: Something like 750,000 people who travelled in and out of British airports on March 29 would be unable to do so on March 30. Around 6,660 tonnes of freight will also be grounded. Public frustrations that well up around holiday periods when flights are delayed will have nothing on this.

And that is just air travel. What about the ports? Some simple calculations suggest that 297 lorries arrive at the Port of Dover each hour. Let us assume that half of them travel from the UK to continental Europe and that WTO customs checks require them to be processed at a rate of one per minute. In other words, 60 per hour cross the Channel towards France rather than the current flow of 148. Assuming that each lorry is 15 metres long, within six hours the traffic jam will extend back 8km and it will take 9 hours for lorries joining the queue to get onboard a ferry. After 24 hours the tailback will extend for 32 km and it will take 36 hours to escape. After 3½ days the tailback will extend all the way to London (115km) and it will take more than five days to get across the Channel. Naturally, this is a stylised example but it serves to highlight that, given the extent to which the UK depends on free movement with the EU, even small obstacles can quickly gum up the works.

It is for this reason that economists fear a no-deal Brexit will have big effects on the economy. In practice we can only ever guess at the magnitudes, but some of the analysis I have conducted using a gravity model of trade suggests that losing easy access to the EU single market will incur a one-off reduction of 8% in exports and 5% for imports, implying a reduction of 1.5% in GDP relative to the case where access is maintained. Running the numbers through a structural macro model to assess the feedback effects on the domestic economy produces a loss of output equivalent to anywhere between 3% and 8% of baseline after a five-year period (chart). It might be possible to limit the decline in output to 3% of GDP if the BoE steps in with a huge liquidity injection. But if there is little to no additional monetary support in the event of a no-deal Brexit, as the BoE has recently hinted, I fear that the worst case outcome could materialise. Indeed, the threat to raise interest rates to counter an exchange rate-induced inflationary spike in the no-deal case strikes me as a hollow threat when the rest of the economy is likely to be in such dire straits.

To return to the political calculus, any MP who votes for a no-deal Brexit would have to be crazy given the economic risks. Equally, however, it is clear that the Withdrawal Agreement is such a sub-optimal piece of legislation that I can understand why MPs would want to vote it down. But a second referendum would also be such a hugely divisive tactic (as I pointed out here) that it is difficult to see how this resolves anything in the near-term. Consequently, I still favour an extension of the Article 50 period.  It has the advantage of postponing many of the hard choices (although not indefinitely) and would permit the government to continue testing public opinion.

Of course Theresa May does not publicly favour this option – as she said yesterday, “the British people want this settled.” But she has said many things over the course of the last two years from which she has been forced to backtrack. The Brexit debate is far from over. Like kabuki theatre, it just goes on and on.