Media  Global Economy  2019.08.22

Is a no-deal Brexit frightening? : The primary victim of Brexit will be the UK. The British Empire may be dismantled.

The article was originally posted on RONZA on August 4, 2019
The UK has no choice but a "no-deal Brexit."

Since Boris Johnson, a Brexit hardliner, took office as the UK Prime Minister, a "no-deal Brexit" has become ever more likely.

First, he appointed Brexit hardliners to key cabinet positions, replacing Conservative moderates (some of whom resigned voluntarily), who support a Brexit based on the draft Withdrawal Agreement to which Former Prime Minister May and the EU agreed.

On top of that, Boris Johnson affirms that the UK will leave the EU on October 31 no matter what happens. He also vows not to accept the backstop arrangement of the draft Withdrawal Agreement which Mrs. May agreed with the EU. Under this arrangement, the UK would remain in the EU's Customs Union and single market after the withdrawal from the EU in order to prevent the introduction of border controls between the Republic of Ireland and Northern Ireland.

The EU, the other concerned party, flatly rejects the renegotiation of the draft Withdrawal Agreement which it agreed with Mrs. May, and underlines its position to support the backstop arrangement to prevent Northern Ireland conflict from re-erupting. Ursula von der Leyen, the new president-elect of the European Commission, affirms that the EU will not revise the draft Agreement including the backstop arrangement, while hinting at a possible re-extension of the Brexit deadline.

In brief, the EU is unlikely to agree to what Boris Johnson demands.

The nomination process for the EU's top leadership positions including European Commission President clearly showed the waning influence of German Chancellor Angela Merkel, contrasting with the increasing influence of French President Emmanuel Macron, who is calling for greater European integration, disregarding the UK, which expresses dissatisfaction with the EU. Merkel gave in to Macron, agreeing to von der Leyen's candidacy for European Commission President, about whom nobody had talked previously, after Macron denied the candidate whom both Merkel and Germany backed.

Macron admires Former French President Charles de Gaulle, who rejected the UK's application for the EU twice, and has the view that if the UK wants to leave the EU, it should leave now without grumbling.

It would be desirable for the UK to leave the EU under the Withdrawal Agreement with the backstop arrangement included so as to prevent the Northern Ireland conflict from re-erupting. However, even if the conflict erupts as the result of a no-deal Brexit involving no backstop arrangement, it will occur in the UK territory including Northern Ireland, not in EU territory. It was Macron who made Donald Tusk, Permanent President of the European Council, agree to the short extension until October 31. He will not mind if the UK leaves the EU without any deal.

Even from a logical point of view, the only viable option is a no-deal Brexit.

The UK Parliament rejected Mrs. May's draft Withdrawal Agreement three times, and none of the Brexit options earned a majority to test Parliamentary support. Meanwhile, the EU has no intention to make any concessions on material issues, such as the revision or withdrawal of the backstop arrangement, as demanded by Brexit hardliners in the UK, although it may agree to cosmetic revisions of the draft Withdrawal Agreement, which it agreed with Mrs. May.

In short, there will be no draft agreement which convinces both the UK and the EU. Or, conversely, if there is no "Brexit with a deal," the remaining option is a "no-deal Brexit."

You may think that the UK can re-extend the Brexit deadline. However, if the UK plans to exit the EU, the re-extension will be for the purpose of agreeing to the draft Withdrawal Agreement as demanded by the EU. Because no "Brexit with a deal" is possible, a re-extension will not be an option, either. Above all, Boris Johnson and Emmanuel Macron, the heads of the concerned states, paradoxically agree that the UK should leave the EU on October 31.

Until last year, it would have been possible to hold a second national referendum and to cancel Brexit. It is, however, absolutely unlikely that Prime Minister Boris Johnson, a Brexit hardliner, will take this option. That's not all.

Boris Johnson was elected as leader of the Conservative Party. This was the result of the Conservatives' crushing defeat in the European parliamentary elections in May, in which the Brexit Party led by Nigel Farage achieved sweeping victories while the Conservatives suffered heavy losses. The Conservative Party is in fear that it will face catastrophic defeats in future elections overwhelmed by the Brexit Party unless it has a Brexit hardliner as its leader. Even if Boris Johnson is tempted to change sides, the Conservatives will not allow him to do so.

In addition, there is the time limit. Boris Johnson claims that he will renegotiate with the EU. However, the European Commission, the executive arm of the EU, is not really functional in August when most are on summer vacation. The UK won't be able to start the renegotiation with the EU until September. So, there will be only two months left till October 31.

In any case, as discussed above, the UK and the EU will be unable to reach a consensus. Given the time left until October 31, it would be impossible to pass a vote of no confidence proposed by the opposition party by drawing the support of pro-Remain Conservative MPs, and then hold a general election, let alone hold a second national referendum based on the outcome of the general election, following the collapse of the renegotiation.

Is a "no-deal Brexit" bad?

So, how bad is a "no-deal Brexit"?

The people who criticize a "no-deal Brexit" must claim so, considering that a no-deal Brexit is bad compared to a "Brexit with a deal."

If so, what do they think is a "Brexit with a deal"? They may vaguely assume that it is an "orderly Brexit."

In the first place, a "no-deal Brexit" will not happen all of a sudden, unlike natural disasters such as earthquakes or typhoons.

The Brexit deadline was originally set in March, which was later extended to October. Companies must be fully prepared, increasing their stocks of merchandise and parts which they import from EU countries and making necessary arrangements for new customs processes which are expected to be introduced.

After the UK's withdrawal from the EU, the UK and the EU will impose tariffs on commodities traded between them, applying the same tariff rates as those applied to commodities traded between EU countries and non-EU member countries. Companies must be also well aware of this. They must be preparing for it in the same manner as companies in Japan are making necessary preparations for the consumption tax increase scheduled in October.

A "no-deal Brexit" is indeed an "orderly Brexit."

Companies in the UK will engage in trade with EU countries (following customs procedures, etc.) in a way which they have been doing with non-EU member states including Japan and the US. That is all.

In other words, while "nothing is beyond expectations," the media has been exaggeratedly reporting on a "no-deal Brexit" as if the UK will be abruptly thrown into a storm. The public believes this.

So, apart from short-term preparations, what will be the effects of a no-deal Brexit in the medium- and long-term?

Provided that the backstop arrangement of the draft Withdrawal Agreement, which Former Prime Minister May agreed with the EU, is adopted, the UK will remain in the EU's Customs Union and single market. This is what is happening now. However, the governing Conservative Party and the UK Parliament opposed it, claiming that it was not a full Brexit. There is no possibility that the UK and the EU will agree to this draft Agreement.

In the first place, the UK has no option to proceed with a "Brexit with a deal." For this reason, we should not regard a "no-deal Brexit" as a bad option as we have no other option comparable to it.

Once the UK exits the EU, it will be able to engage in foreign trade independent of any country in the world including the EU, as Japan is independent of any country. That is all. In addition, the UK is resolved to deal with various issues resulting from its departure from the EU.

Some raise issues concerning the revival of tariffs on commodities traded between the UK and the EU, claiming that they will lead to an increase in the price of vegetables/fruits and bottles of wine in the UK, and a 10% tariff will be levied on automobiles exported from the UK to the EU.

However, these issues will be resolved if the UK concludes a free trade agreement (FTA) with the EU. What people vaguely regard as an "orderly Brexit," the opposite of a "no-deal Brexit," may be an FTA of this sort.

You may think that it will take time to conclude an FTA.

However, there are a variety of FTAs such as the EU-Japan Economic Partnership Agreement, which can serve as samples. Because both the UK and other EU countries are involved in these FTAs, they will be able to conclude an FTA between the UK and the EU, referring to them.

The most contentious issue in FTA negotiations is generally that associated with the reduction/abolition of tariffs on commodities. Because the UK is currently a member of the EU's Customs Union, no tariff is imposed on commodities traded between the UK and other EU countries. For this reason, there will be no negotiation required to reduce/abolish tariffs. What they need to do is to practice what they have been practicing.

Meanwhile, there is another problem which will be caused by the revival of border controls. Companies in the UK will incur a time loss in importing parts from EU countries (although the same applies to companies in the EU territory in importing parts from the UK, this is not considered a crucial issue.) However, it is a natural consequence of the UK's withdrawal from the EU's Customs Union and single market, which is one of the UK's wishes.

As discussed in the previous articles, this issue will not be resolved even if the UK concludes an FTA with the EU. Even if no tariff is imposed as a result of the conclusion of an FTA, border controls will be required for proof of origin. After the UK exits the EU, the UK and the EU need to check at borders if commodities coming from the other are compatible with its standards and regulations. (See "Who is Boris Johnson?" for further details.)

How will a "no-deal Brexit" affect Japanese companies?

Larger issues to which we need to pay attention are who is going to be more negatively affected, provided that there are any problems relating to a "no-deal Brexit."

Will Japanese companies be negatively affected?

It is reported that financial institutions having offices in the UK (the City of London) have already transferred part of their functions to Frankfurt, Paris, Madrid and Brussels. One of the EU countries has been actively conducting a campaign to invite Japanese companies, dispatching cabinet members in charge of economic affairs and members of the business community to Japan last year in anticipation of Brexit.

Honda publicly announced its withdrawal from the UK this year. If manufacturing including the automotive industry encounters disruption of the cross-UK and EU supply chain due to border controls, they will try to deal with the situation by using stocks which they build up before Brexit in the short-term, and by transferring their production bases from the UK to other areas in the medium- and long-term.

Above all, uncertainty over production and sales in the future in the UK will have very negative effects on the minds of investors.

Brexit confusion has demonstrated that companies are required to take grave risks in investing in the UK. Foreign companies will likely reconsider their decision to invest in the UK. Further, companies which have been already operating in the UK will try to leave there. The UK unemployment rate is significantly lower than that of other EU countries currently. Hence, it may be difficult for the British people to imagine the damage which will be caused by Brexit. However, the exodus of companies from the UK will have a devastating impact on the UK economy in the future.

It is not only companies. UK citizens working elsewhere in the EU who are fearful of a "no-deal Brexit" have made an attempt to acquire citizenship in EU countries, such as Germany and France. Some Brits are reportedly looking for Irish relatives to acquire Irish nationality.

Possibility of Scottish independence and Irish unification

What is more, Brexit may lead the British Empire to its dismantlement.

The official name of the UK is the "United Kingdom of Great Britain and Northern Ireland," which is composed of England, Wales, Scotland and Northern Ireland.

Brexit supporters are mainly found in rural areas of England and Wales, not in urban areas such as London. In the national referendum, 62% of Scottish and 56% of Northern Irish voted to remain in the EU.

A "no-deal Brexit" may lead to Scottish independence and Irish unification. If it happens, both Scotland and Ireland will become EU members. The current UK will be reduced to the union of England and Wales.

There is a bizarre coincidence of the UK and the US. In US elections, the country is also clearly divided: Democrats dominate urban areas and Republicans dominate rural areas. Some say that the US, which has become sharply divided, is not "United States" anymore but "Divided States of America." The UK may also become a "Divided Kingdom," not a "United Kingdom."

The primary victim of Brexit will be the UK.

Brexit will also negatively affect other countries to some extent. But impacts will be limited. In economics, investments made by Japanese companies in the UK in the past are called a "sunk cost" (a cost made in the past which can be no longer recovered and should not be considered when making new decisions.) Any entrepreneurs who are obsessed with a sunk cost are not fit for their positions.

Although Brexit won't pay economically at all, the UK has politically no choice but to exit the EU. However, I feel that the UK, which leaves the EU now, will rejoin the EU someday. Brexit this time will be a "sunk cost" for the UK in the future.

(This article was translated from the Japanese transcript of Dr. Yamashita's column in "RONZA" on August 4, 2019.)