Five years on

Five years ago today the world awoke to find that the British electorate had narrowly voted in favour of leaving the EU. The pre-2016 era feels like another world: in many ways it was, not least because Covid has had an even more transformative effect on the political and economic landscape. Looking back, the impact of the Brexit shock remains vivid and neither Leavers nor Remainers have since covered themselves in glory. Regular readers will know I regret the decision to leave the EU, largely on economic grounds but also because the UK is no longer part of a block which amplifies its voice on the world stage. However, it makes little sense to replay the debates of the past five years.

A quick retrospective

Nonetheless, this week marks a good time to assess the impact of Brexit, giving rise to a number of retrospectives in the British press. One of the best commentaries I have seen is this one by always excellent Fintan O’Toole, who points out that the Remainers never had a big idea which could overpower the simple narrative of taking back control espoused by the Leavers. As he put it, “Leave offered some kind of an answer [to the question of what defined British identity] – albeit a very bad one. Remain barely recognised the question.” He also argues that the project was not subsequently weakened by the “political discourse [which] ought to have doomed it … [because] uncertainty about what Brexit would mean in reality allowed it to sustain its character as a gesture.”

As a summary of what has happened over the last five years that just about nails it. As an economist, my mistake was to try and offer economic arguments against Brexit – not that they are wrong, but the simple but powerful notion of “controlling our own laws and our own borders” was a much more compelling vision. The fact that this was and is complete tosh is irrelevant – it is difficult to argue against a messianic vision with mere facts. The bigger concern is not so much the losing of the referendum but the way the process of departure was subsequently conducted, as the government tied itself in knots to reconcile many of the irreconcilable arguments made during the campaign.

A consultative (non-binding) referendum was treated as a winner-takes-all event with little attempt to engage with the near-half of voters which opposed the outcome. Three years of intense political debate eroded trust in the political process and far from lancing the boil of Euroscepticism which David Cameron feared would swamp his Conservative Party, the divisions opened up by the referendum have if anything grown deeper. This in turn has weakened the ties that bind the United Kingdom and given support to Eurosceptic movements in continental Europe. As the historian Timothy Garton Ash has pointed out, we find ourselves in a lose-lose position and it appears that the culture war which has largely been confined to the US for the last 25 years has now washed up on European shores.

A look at the economics

From an economic perspective there are no good arguments in favour of Brexit. Imposing barriers to trade with our biggest trading partner has no merit. The government has been telling us since 2016 that the UK will be able to strike better trade deals with third countries than those drawn up by the EU. There is little evidence so far that this is bearing fruit. Most of the agreements that have been struck so far represent a rolling over of existing EU trade arrangements. The first trade agreement to be drawn up from scratch was the recently-announced deal with Australia. However the government’s own figures suggest that this will increase UK GDP by just 0.02% over the next 15 years which is, to all intents and purposes, zero. On the basis that “the additional trade barriers associated with leaving the EU” will subtract around 4% from UK GDP over that period, Britain needs 200 Australia-type trade agreements merely to offset what has already been lost. To the extent that distance is one of the biggest obstacles to goods trade, the Australia trade deal is a largely meaningless exercise.

That said, most people have not really noticed the economic impact of Brexit (though in fairness, most people have not travelled abroad since the Covid crisis hit). But many exporters have highlighted the difficulties resulting from the erection of trade barriers and although year-on-year comparisons are distorted by Covid effects, a pattern is emerging whereby trade with the EU has fallen by far more than with the rest of the world. A recent report by the Food and Drink Federation noted that UK food and drink exports to the EU in Q1 2021 were 28% lower than a year ago whilst remaining unchanged to non-EU markets. On a more positive note, ONS aggregate data suggest that trade flows are slowly normalising but there is no doubt that UK-EU trade has taken a hit.

A synthetic control assessment

To obtain a handle on the joint impact of Brexit and Covid I have attempted a synthetic control exercise which constructs a synthetic (or “Doppelgänger”) GDP index for the UK based on trends in a panel of 23 other countries. The rationale behind the analysis is to use GDP outcomes in the control group to approximate what might otherwise have happened in the UK. When I conducted the analysis two years ago, I concluded that UK GDP was around 2.5% below what might otherwise have been expected which I attributed to Brexit-related uncertainty. Latest estimates suggest that GDP in 2021 Q1 was almost 10% below the synthetic indicator.

As can be seen from the chart, the UK began to underperform during 2017 as Brexit-related uncertainty kicked in and by Q1 2020 GDP was 4% below the synthetic control index which is in line with estimates made in 2016. However this pales into insignificance compared to the impact at the start of 2021. It is likely (but not certain) that the Covid-related output collapse contributed most to this underperformance and we will only be able to assess the impact of Brexit once the Covid shock dissipates.

Markets giving the benefit of the doubt

Despite this poor performance, markets have given the UK the benefit of the doubt with sterling trading at around 1.39 against the USD versus 1.36 at the start of the year (a gain of around 2%). In a similar vein, GBP is up around 5% versus the EUR whist the BoE’s broad effective exchange rate has appreciated by 4.1% since the start of the year. Sterling is still a long way short of where it was on 23 June 2016 (6.3% down on an effective basis) but it does seem to be moving in the right direction. UK stocks also continue to look cheap on an international comparative basis and there has been much discussion in recent months that the relative post-Brexit stability represents a good time to buy into the UK market.

To the extent that Brexit has not represented a seismic shock, there are good reasons why international investors might want to dip their toe in a market they have shunned in recent years. To the extent that much of the recent underperformance was the result of self-inflicted policy errors, so long as the government can avoid the mistakes of the last three years there may be some scope for catch-up. But the truth is we do not know how Brexit will pan out nor what the final balance of costs and benefits will be. Whilst Brexit has not proven to be a seismic economic event it may well prove to be a boiled frog problem with the cumulative effects building up over time. As it fades from the forefront of our consciousness and ceases to be the headline-grabbing event that has shaped the news agenda over recent years the devil will continue to make its presence felt in the economic detail.

Bordering on the bizarre

Editorial policy at the Financial Times has taken a strange tack of late. A sensible, sober newspaper has published two opinion pieces in recent weeks illustrating the lack of knowledge displayed by policymakers on matters of real economic importance. Last week’s piece by former German finance minister Wolfgang Schäuble on euro zone fiscal issues was followed by UK Brexit minister David Frost’s call for a rethink of the Northern Ireland protocol (NIP). The latter is part of a government media blitz to convey the message that the NIP has not panned out as expected. It is difficult to buy that view given the warnings which were issued ahead of Brexit.

All this was very predictable

To remind people of what was said at the time the agreement was signed, the deputy leader of the Democratic Unionist Party warned in October 2019 that, “You are really in danger here of causing real problems with the Belfast agreement … and political stability in Northern Ireland.” The charity Fullfact.org reported in December 2019 that Boris Johnson’s claim that there will be “no checks on goods going from GB to NI” was false. They also reported that “it’s not correct, as Mr Johnson said, that if there are any terms of the Withdrawal Agreement that people in Northern Ireland don’t like that they would lapse automatically after four years.” Everything that has happened in recent weeks was thus entirely foreseeable. 

I noted in April that “the contradictions inherent in the Brexit deal regarding Northern Ireland are becoming more evident by the week.” Of all the problems inherent in Brexit, the Northern Irish border issue can be laid directly at the door of Boris Johnson’s government. British MPs simply would not sign up to the “backstop” arrangement negotiated by Theresa May’s government. Johnson’s alternative, which was acceptable to parliament because it prevented the UK from being trapped in the EU’s embrace, imposed a border where previously there was none. Indeed the one thing which the British government has always refused to acknowledge is that there must by definition be a border between UK and EU customs territories. In this case it runs down the middle of the Irish Sea. Anyone who thought otherwise is being disingenuous.

The government adopted a "sign now, deal with it later" approach

According to Frost, “when we agreed this new protocol in 2019, we did so in order to remove the old disastrous “backstop” and to enable Brexit to happen, but to do so in a way that maintained our overriding priority of protecting the Belfast (Good Friday) Agreement and avoiding a hard border.” As to whether it was “disastrous” the Irish government did not think so, nor did Northern Irish nationalist politicians who won more seats than unionist politicians at the 2019 general election. Unfortunately, nobody thought to directly ask the Northern Irish people (who, by the way, voted 56-44 in favour of remaining in the EU in 2016). The protocol was passed through parliament primarily by English Conservative MPs because this was the least objectionable option “to enable Brexit to happen.” 

Frost goes on to say “we underestimated the effect of the protocol on goods movements to Northern Ireland.” Again, I am not sure who is the “we” referred to but the government was warned for years, both before and after the referendum, that imposing frictions to cross-border EU trade would come at a cost. Frost concluded his missive by suggesting that “we agreed … to control certain goods movements within our own country and customs territory. If that situation is not to be totally unsustainable we need to be able to do so in ways which do not disrupt everyday life and which respect everyone’s identity and interests. We continue to work for negotiated solutions which achieve this.” Most rational people believe that the protocol represents just such a negotiated solution and it increasingly looks like the UK government signed on the dotted line simply to get Brexit “done” with the intention of trying to renegotiate the details later.

And now it is paying the price

The international community has little sympathy for the UK’s position. Unsurprisingly, Emmanuel Macron is not to be moved. As he told journalists earlier this week, “We have a protocol. If after six months you say we cannot respect what was negotiated, then that says nothing can be respected. I believe in the weight of a treaty, I believe in taking a serious approach. Nothing is negotiable. Everything is applicable.” More seriously news reports have emerged to suggest that the US government privately rebuked the British for endangering the peace process over the NIP, although both sides have been careful to keep this out of the public domain.

Many of the more deluded on the Brexit spectrum cannot bring themselves to admit that there are big costs associated with their signature policy and continue with the narrative that the NIP was somehow “imposed on the UK by Brussels at the moment of our greatest weakness” (I will leave it to you to decide whether it is fortunate or unfortunate that it is behind a paywall. Ironically the same author extolled the virtues of the NIP less than two years ago). It beggars belief that the British government finds itself in such a position. Johnson promised “an oven ready deal” just 18 months ago which was meant to lead us to the sunny uplands. Instead we find that the deal does not do what it said on Johnson’s tin. To add insult to injury, Frost is not an elected politician – he is an unelected (recently ennobled) member of the House of Lords. The British government has thus appointed an unelected trade novice to oversee trade policy. Brexit is not yet at the stage of devouring its own children but the pot may be about to be readied.

A wider problem is that if the government has treated major issues such as trade policy in such a cavalier fashion, can it be trusted on other issues? As the OECD put it, “trust is the foundation upon which the legitimacy of public institutions is built and is crucial for maintaining social cohesion.” So far there has not been any significant loss of domestic trust with Johnson’s act continuing to play well at home but the UK’s reputation in international dealings is not exactly being burnished by recent events.

The EU is not blameless either but the UK government must shoulder the blame

This is not to say that the EU is entirely blameless. Its actions regarding the NIP reflect a tendency to hide political problems behind technical issues, arguing that the purity of the single market must be protected at all costs. This intransigence is what caused the Swiss to recently walk away from seven years of negotiations to achieve a framework deal with the EU to replace the patchwork of deals currently in place. Of course, one of the great ironies of the current situation is that Brexiteers always argued that the EU was an excessively bureaucratic institution that the UK was well advised to leave whereas the truth was that as a member, the UK was shielded from the worst of it.

We can debate the extent to which the EU needs to change its policy towards its neighbours – and this argument is not without merit. However, the recent spat demonstrates that the UK government’s casual approach to legal details over the past five years does have consequences. I have made it clear for many years that there is no such thing as British exceptionalism, which appears to be the leitmotif of many hardline Brexiteers. As it is, the Northern Irish problem, serious as it is, affects a relatively small proportion of the UK population. Over time, a larger proportion of the population may begin to become aware of the damage that Brexit has inflicted upon them. Only then might we start to have the debate we should have been having five years ago about the price of the policy.

The jury is still out

The topic of Brexit has figured prominently on this blog over the last five years but in recent months I have resisted the temptation to look at it, primarily because there was not enough information to make an informed assessment of how much impact it was having on the economy. But more than 100 days after the UK left the safety net provided by the EU transitional arrangements, and with key data for the first two months of the year now in, it may be time to look once again at where we stand.

Trade: The story is still unfolding

It was always to be expected that trade would take a significant hit in early-2021 following the late signing of the EU deal on 24 December 2020 which meant that companies had little time to adapt to the new trade rules. Accordingly, the collapse in trade with the EU in January came as no surprise, with exports falling by 42% and imports by 30%. The question was always how quickly it would rebound in February. This week’s trade data release provided us with an answer. UK exports to the EU in February jumped by 47% versus January whilst imports increased 8%. In other words, a large proportion – but not all – of the January export collapse has been reversed but imports remain well short. Nonetheless, exports are still around 7% below levels prevailing in the second half of 2020 whereas imports are running almost 15% lower.

But this does not provide a definitive answer to the trade impact. There was clear evidence of stockpiling in late 2020 which means that companies may be running down inventories before picking up imports again. This may be one reason why imports from the EU have not rebounded very quickly. It is notable, however, that there was a sharp jump in imports from non-EU countries in February (+26%) which may be a first indication of import substitution away from EU sources although we should be wary of over-interpreting one month’s worth of data. We should also bear in mind that although full border controls have applied on British goods going to the EU since 1 January, goods coming in the other direction have benefited from a grace period.  The UK originally planned to impose regulatory checks from 1 April but recently announced it would now only do so from October 2021 in recognition of the fact that customs systems and port infrastructure are still not ready. Accordingly, we may not be able to determine the full trade impact of Brexit on UK trade flows until the end of the year. 

Northern Ireland: Contradictions unresolved

However, the contradictions inherent in the Brexit deal regarding Northern Ireland are becoming more evident by the week. During the Brexit negotiations both the UK and EU made it clear that they wanted to adhere to the Good Friday Agreement and avoid the imposition of a hard border in Ireland. But the UK’s decision to leave the EU single market meant it was inevitable there would have to be a border somewhere. Theresa May rejected the option of a border between GB and the EU running through the Irish Sea as unacceptable since it would effectively slice Northern Ireland away from mainland Britain. Unfortunately, the deal that her government agreed with the EU was not acceptable to the British parliament since the UK would have remained in a common customs territory with the EU until such times as alternative arrangements could be made. Many Conservative MPs (including Boris Johnson) refused to back this plan arguing that it would indefinitely bind the UK and the EU together since the UK would be unable to unilaterally break away.

Boris Johnson’s government subsequently renegotiated the Northern Ireland Protocol (NIP) leading to an agreement whereby the whole of the UK left the EU Customs Union, but Northern Ireland adopted EU Single Market regulations on goods and thus remained an entry point into the EU market. Whilst this avoided the imposition of a border on the island of Ireland it did introduce one in the Irish Sea, despite the fact that Johnson said last summer that such an outcome would only occur "over my dead body."

There has been a considerable amount of political fallout in recent weeks, highlighted by a significant degree of violence on the streets of Belfast. This has been attributed in large part to dissatisfaction within the loyalist community towards the provisions of the NIP as it fears a permanent separation from the mainland. It was always the case that the May government’s deal was the least-worst option since it preserved the integrity of the UK and minimised the frictions in cross border trade. It was opposed for ideological reasons by large parts of the Conservative Party which wanted a clean break from the EU. Ironically, MPs from the DUP, who between 2017 and 2019 provided parliamentary support to the minority Tory government, also voted against it. Their fear was that if Northern Ireland remained bound by single market regulations (as May’s plan envisaged) this would eventually lead to the imposition of an Irish Sea border. They also voted against the Johnson government’s plan for precisely the same reasons but following the 2019 election they were no longer in a position to demand concessions from the Conservatives and they ended up with the outcome they had feared. The people of Northern Ireland have been let down by their politicians.

There have recently been efforts to rewrite the history of the Northern Irish border problem. An article in the Daily Telegraph earlier this week was headed “Northern Ireland is paying the price for Theresa May's negotiating blunders” whilst an article published in the Daily Mail blamed the “spiteful” EU. None of this stands up to scrutiny. The problems stem from the construction of the deal signed by the UK government which has spent five years attempting to resolve the unresolvable of where to locate the border without actually putting one in place. Not that this matters to the electorate on the mainland where the majority of those believing the Brexit vote was a mistake has narrowed in recent weeks (chart 2). However this is heavily influenced by the EU’s poor performance on the vaccine rollout and will undoubtedly change again in the months ahead. Nor is it a cause for concern to Westminster politicians who, as I noted in 2019, knowingly sold the DUP down the river.

An ongoing process

I have long pointed out that Johnson’s 2019 election slogan to “get Brexit done” was disingenuous and that the process of normalising relationships between the UK and EU would take considerable time. Accordingly, the UK and EU are currently engaged in discussions on how to resolve the problems in Northern Ireland. Negotiations are also still ongoing with regard to the future of financial services although on 26 March the Treasury did confirm that technical discussions on the text of the promised Memorandum of Understanding have successfully concluded.

But it is simply too early to tell what effect Brexit is having on the UK economy which continues to suffer under the fallout from the Covid-induced collapse. According to research by John Springford at the CER, trade in February was 5% below what might have been expected had the UK not left the single market. Knowing what I do about the method he used to make this calculation we should treat this with a pinch of salt, but it does sound plausible. Nonetheless, businesses are reporting that the main challenge for companies exporting and importing is the increased administrative burden. This confirms my view that the business impact will be a boiled frog problem – it will take time for firms to realise just how much damage has been done. They will naturally adjust and probably even get used to the inconvenience but compared with the counterfactual of pre-Brexit admin, the costs to the overall economy will mount up over time.

Much of the heat and passion has gone out of the Brexit debate. Now it is up to its proponents to demonstrate that it will improve the lives of those in whose name the whole exercise was conducted. We might have to wait a long time!