UK’s weaker Brexit hand with the EU

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DAN STEINBOCK

Prime Minister May pushed for a snap election in June 2017 to strengthen her hand in the impending Brexit talks. In practice, she has weakened UK’s bargaining power at the EU’s expense, while the latest London Bridge incident introduces new uncertainty and volatility into the EU/UK divorce proceedings.

LIKE too many times before, British police declared a “major incident” on London Bridge after a van reportedly hit multiple pedestrians.

The terrorist incident took place only days before a critical “snap election” that Prime Minister Theresa May was supposed to win with a landslide victory; but in which her Conservative Party’s lead has dropped to a new low of just one or more percentage points.

While British pollsters predict May will win most seats in Thursday’s election, some expect a landslide victory, but others believe that the Conservative majority is under threat. Not only have UK polls been highly volatile amid election campaigns and fairly inaccurate, but the most recent ones do not yet reflect the potential effects from the London Bridge incident.


Collapse of neoliberalism, path to uncertainty
About a year ago, the UK had its referendum on the European Union (EU). At the end, the “Leave” camp triumphed, by focusing on costly EU bureaucracies, over-inflated security concerns and immigration’s negative tradeoffs. While the campaign had less to do with facts than flawed perceptions, it proved effective.

Unfortunately, the adverse impact of the Brexit decision is still ahead.

If the UK’s neoliberal economic policies peaked in the Thatcher years, they were sustained by labor governments led by Tony Blair (1997-2007) and Gordon Brown (2007-2010). As they got the blame for the global crisis, Conservatives’ David Cameron won a mandate to govern in a coalition with Liberal Democrats.

Cameron championed fashionable social causes, including same-sex marriage and the UN target for aid spending, but cut down government’s large deficits through harsh austerity measures, including large-scale changes to welfare, immigration policy, education and health services. Nevertheless, prior to the referendum, government debt peaked at 90 percent of the GDP, which led to an IMF warning.

In 2011, Cameron became the first UK Prime Minister to “veto” the EU treaty, perhaps to bargain better membership terms with Brussels, while boosting Conservative support at home. In 2013, he pledged that, should his Conservatives win the parliamentary majority in the 2015 election, the government would negotiate more favorable terms for British membership of the EU, before a referendum. The gamble came with a price – his failure to win the Brexit referendum.

So Cameron was succeeded by Theresa May, a veteran “law and order” Tory and a long-serving Home Secretary. Meanwhile, Ed Miliband resigned as Labor’s leader and was followed by Jeremy Corbyn of the party’s “hard left.” As neoliberal economic policies collapsed, both parties sought to defuse euroscepticism that the right-wing UK Independence Party (UKIP) and Nigel Farage had popularized.

In a sense, both parties have won. Today the two account some 80 percent of the polls, compared with barely 65 percent in the 2015 election. But in the process, co-optation of the Euro-skeptics has recalibrated each, internally. Conservatives have left behind Cameron’s laissez-faire globalization; Labor has shifted further to the left; the current leadership of neither party has much faith in the EU.

Since July 2016, May has been focused on withdrawing the UK from the EU. Last March, the UK finally invoked Article 50 of the EU treaty to leave the EU, while May even blurted that “no deal is better than a bad deal.” In April, she announced a snap general election for June 8, “to guarantee certainty and security for years ahead.” Like Cameron in 2016, she thought she could capitalize on her popularity to ensure political consolidation before tough talks with Brussels.

Despite 20 points ahead in the polls, the row over the so-called “dementia tax” on elderly people cut her poll lead to 9 points. After May’s U-turn on elderly care tax, the polls still pointed to a Conservative victory. At the eve of the London Bridge incident, Corbyn’s Labor had almost caught up with May’s lead.

What is certain, however, is that if May wins, her majority could be far less than expected or that she has to govern without a majority, or worse. And that means a weaker hand in the impending Brexit talks.

Again, the British political landscape has shifted dramatically, in just two months.

Rising economic pressures
The UK economy is beginning to feel Brexit pressures, particularly in business and financial services and foreign direct investment. As long as big companies lack adequate certainty about their EU operations, they tend to hedge location decisions and exhibit great caution in investment.

After the global crisis, the UK benefited from US recovery, while being propped up by the European Central Bank’s (ECB) ultra-low rates and quantitative easing. Prior to the global crisis, the UK’s growth had rested on housing and mortgage-lending, huge expansion of the financial sector, government services, oil and gas production in North Sea. While the economy had performed relatively well in the post-crisis era, growth began to slow in early 2016, along with lingering productivity growth, rising current account deficit and vulnerabilities associated with property markets.

In the first half of the 2010s, the overall fiscal deficit had been cut from the peak of over 10 percent of GDP to 4 percent. Monetary policy had remained boldly accommodative. Structural reforms sought to boost potential output. Yet, in 2017, growth was expected to remain around 1.9 percent in 2017.

As the more negative consequences of Brexit will impact the UK, GDP growth may decrease to just 1.2 percent in 2018; that’s below the eurozone’s 1.5 percent.

While rates have been cut to 0.25 percent and have been on hold, rate increases are looming in the horizon. Consumer inflation may climb to 2.6 percent in the ongoing year. Moreover, the UK continues to face fiscal and trade deficits.

In 2015, the pound peaked at almost $1.50. Prior to the referendum, I forecast the Brexit could penalize the UK pound by more than 20 percent and it did plunge to $1.20 by the fall. Thanks to resilience, it is now around $1.29 (about 0.87 euro). As markets open and trading begins, the pound will face new election and terror pressures.

Structurally, weaker pound supports increased overseas demand for British exports and decreased domestic demand for foreign imports. But as the UK relies more on services exports (financial and insurance services), vulnerabilities will increase if London loses its “passporting” rights upon exiting the EU.

“Soft” or “hard” Brexit
In April 2016, UK Treasury published its report about the probable annual impact of leaving the EU on the UK after 15 years. It estimated that the Brexit could cause an almost 10 percent loss of GDP. In practice, much depends on the post-Brexit UK’s choice of trading arrangements and relationship with the EU.

The question is whether the UK would retain its membership of the European Economic Area (EEA), like Norway; or the UK opts for a negotiated bilateral agreement, such as that between the EU and Switzerland, Turkey or Canada; or a simple World Trade Organization (WTO) membership without any specific agreement with the EU, like Russia or Brazil.

A “soft” Brexit could entail some form of membership of the EU single market, in exchange for a degree of free movement. Whereas in a “hard” Brexit, the UK would not compromise on such issues as the free movement of people, leaving the EU single market and trading with the EU as if it were any other country outside Europe, based on WTO rules.

Currently, the UK appears less prepared for the impending Brexit negotiations than the 27 remaining European member states that seem united in their stance. A risk prevails that talks could fail at the first stage over the UK’s cost of leaving the EU, the so-called “Brexit bill.” Moreover, the election is not likely to strengthen May’s hand in Brexit negotiations. The reverse may be more likely.

After a nearly “lost decade,” the eurozone is eventually feeling more optimistic about the future. The ECB is likely to continue asset purchases until the year-end and hopes to begin rate hikes starting next year. However, if the Brexit runs out of control, what happens in the UK will not stay in the UK but spread across Europe.

Dr Steinbock is the founder of Difference Group and has served as research director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore).

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