Can Brexit Be Achieved With Minimal Damage?

American University’s Michelle Egan discusses Brexit.

The steep dive October 7 of the British pound in early Asian trading — losing more than 6% against the U.S. dollar — has been attributed to computerized trades amid low liquidity. It has, nevertheless, become the most visible barometer of how painful Britain’s imminent exit from the European Union could be.

Brexit Europe
Image source: Public Domain Pictures

[drizzle]British Prime Minister Theresa May last Sunday stressed immigration over economic issues as the driving factor behind Brexit at a Conservative Party meeting, where she said negotiations on leaving the EU must get underway by March 2017. Experts predict that Britain will have a tough time at the bargaining table, and advise the EU to play hardball, if only to deter others among its member-states from considering similar exits.

How Brexit can be achieved with minimum damage to either side depends on how exactly it is negotiated and how the transition is managed, says Mauro Guillen, Wharton professor of management and director of The Lauder Institute. “The U.K. is a large economy and to take it out of the EU of course disrupts years of assumptions that investors, companies and consumers have been making.”

For sure, the U.K. will attempt the least painful way out while trying to protect trade, capital and labor flows with the EU. Indeed, French Prime Minister Francois Hollande’s latest statement calling for tough exit negotiations increases the pressure on the pound. “The pound continues to lose value because markets are anticipating that this is going to be messy,” says Guillen. “Today’s fall is a reflection of the fears over how this is going to be negotiated.”

Uncertainty is the dominant sentiment. “The steep fall of the pound is very much softening the blow, but it is also showing that there is clear lack of confidence in the long-term impact of Brexit,” says Olivier Chatain, professor of strategy and business policy at the HEC Paris business school and a senior fellow at Wharton’s Mack Institute of Innovation Management.

Wharton finance professor Joao Gomes thinks May is making “a grave mistake by rushing to the negotiation table.” For one, he expects the EU to take a tough stance on Brexit ahead of the French and German elections next year. The French presidential elections will be held in April and May 2017, while the German federal elections are set for between August and October 2017. “Afterwards, it is very likely that realism and a fair dose of euro-skepticism will creep into the views of those two key governments,” he says. He advises against the haste he sees in May also because “time would allow every party to take a more objective stand on what is simply the negotiation of an international treaty by sovereign parties.”

“I’d recommend the EU, the EC and member states to play hardball,” says Michelle Egan, a professor at American University’s School of International Service and a fellow at the Wilson Center’s Global Europe Program. She notes that Article 50 of the Treaty on European Union, the legal mechanism for an EU member state to break away, has never been used before. “If they make it easy and give too many concessions to Britain, then the risk is other states will want an a la carte Europe as well,” adds Egan.

Egan spoke on the issues that will come up as Brexit nears on the [email protected] show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

Guillen feels the EU should not take a tough stance on Brexit but find some middle path. “It is not in the best interests of the EU to be tough on the U.K.,” he says. “The problem of course is that they also need to signal that there is a cost to leaving the EU because otherwise other countries may also say they want to get out. They have to find a balance.” He expects “some form of a soft Brexit,” adding that a hard Brexit would be difficult to implement.

“It is going to be very difficult for them to negotiate a soft Brexit in financial services.”–Mauro Guillen

Impact on Businesses

In gauging the business impact of Brexit, Guillen makes a distinction between the financial services and the non-financial industries such as manufacturing and tourism in the U.K. He says the non-financial industries would prefer some type of deal that allows them to remain in some way in the European single market.

The situation is much different with the financial services sector because of the fallout from the 2008 crisis, notes Guillen. “The uncertainty of the financial sector in Europe is because there is a lot of concern about the state of its banks,” he says. Banks in Italy, France, Spain and even Germany — with Deutsche Bank’s latest troubles — are in difficult straits, he explains.

For British banks, it would be important to negotiate a deal where they and their dealers could continue to do Europe-wide business, says Guillen. “But it is contentious because the Europeans don’t want to give the British the best possible deal without paying a cost for all this,” he adds.

Guillen notes that the City of London is critical for the U.K. because it is a major source of jobs and income. “Remember, the people in London voted to remain in the EU,” he says. All things considered, his projection is: “I think it is going to be very difficult for them to negotiate a soft Brexit in financial services.”

Economic Impact Thus Far

According to Gomes, the projections on the economic impact of Brexit have been “too pessimistic.” He says that is partly because he believes that “the Brexit vote will not amount to a significant change to business as usual.”

Gomes’s views are supported by the data for the months after the Brexit vote in June. “The economic indicators are strong after the Brexit vote, surprisingly,” says Egan. She notes that in July, unemployment stayed at about 4.9%, and company output, sales and orders have also been buoyant.

However, longer term pressures loom over the economy. In August, the Bank of England cut the interest rate to 0.25% and introduced monetary stimulus measures, stating that “the outlook for growth in the short to medium term has weakened markedly.” Egan points also to announcements by Philip Hammond, the U.K.’s Chancellor of the Exchequer, on higher infrastructure spending, housing growth, a focus on regional economic development and dropping an earlier plan to eliminate the budget deficit by 2020. Hammond on October 3 warned of a period of “turbulence” following Brexit, as The Telegraph newspaper reports. “He is focusing jobs, economy and living standards,” says Egan.

“The steep fall of the pound is … showing that there is clear lack of confidence in the long-term impact of Brexit.”–Olivier Chatain

Businesses will face changes in customs procedures, tariffs, their relationship with the EU single market, dealings with global supply chains and integrated production, says Egan. Brexit also brings new complexities for free trade agreements, especially CETA (Comprehensive Economic and Trade Agreement) that has been agreed between Canada and the EU;

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