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Analysis
No Brexit deal is worse than bad deal

No Brexit deal is worse than bad deal

Breakdown could precipitate sharp fall in sterling

by John Springford and Simon Tilford in London

Wed 7 Jun 2017

UK Prime Minister Theresa May claims that failing to achieve a deal on Britain's exit from the European Union would be better than settling for a poor deal. She is wrong. The costs to the UK economy of failing to strike a deal would dwarf those of signing up to a bad deal.

The likelihood that Brexit negotiations break down irrevocably and Britain leaves with no deal is slim, but certainly not zero. The UK government may balk at paying the bill for EU budget commitments – the remaining member states' recent demands have been costed at up to €100bn. The two sides could fail to reach agreement over their respective citizens' rights. Or the UK might refuse to accept a transition deal which includes continued free movement and the jurisdiction of the European Court of Justice.

If the UK were to leave without a deal, EU tariffs would immediately be payable on imports from Britain. British food exporters would face average tariffs of 14%. British car exports, which grew more rapidly than any other category of manufactured goods exports over the last 10 years, would face a 10% tariff. Furthermore, the UK would need to impose tariffs on its imports from the EU. It would be allowed to reduce tariffs to zero – as some eurosceptics propose – only if it did so for all countries, not just the EU.

Britain would exit the EU's customs union, meaning rules of origin would immediately come into force. These are used to determine the national origin of a product, and hence whether tariffs need to be applied to it and at what level. The UK would face the EU's common external tariff, so all British exports would face EU tariffs. In addition, rules of origin are used to determine EU anti-dumping measures, labelling and product standard requirements, and for the collection of trade statistics. Many firms would be unable to comply and would cease exporting to the EU.

Perhaps the most damaging aspect of not reaching a deal would be that, outside the EU's legal framework, many UK products would no longer be accredited for sale across Europe. Sales of British pharmaceuticals in the EU would not be immediately authorised. Similarly, British-based airlines would no longer be allowed to fly to EU member states, because the UK's authorisations of British airlines would no longer be recognised by the EU. British airlines would quickly seek authorisation to fly to and from the EU, but, since they would not be part of the 'single European sky', would not be able to fly between airports within the union. British-based financial firms would lose their passporting rights overnight, and mutual recognition of many regulatory standards would end. That would lead to a sharp fall in financial services exports, and acute legal uncertainty over contracts. Crucially, it would affect the clearing and settlement of financial trades, especially of derivatives, which are overwhelmingly centred in London.

Failure to come to an agreement with the EU would cause British exports of goods and services to shrink sharply. This would probably provoke a fall in the value of sterling. Inflation would rise as the weakening of sterling and the imposition of tariffs boosted the prices of goods, eroding disposable incomes and consumption. The result could be a deep recession which would lower tax revenues and weaken the government's ability to impart fiscal stimulus.

The loss of investor confidence in the UK economy might present the Bank of England with the difficult choice of either having to stabilise sterling by raising interest rates or keeping them low to stimulate the economy. The EU negotiators understand this, which explains why they are dismissive of British threats to walk away with no deal.

John Springford is Director of Research and Simon Tilford is Deputy Director of the Centre for European Reform. This is an edited version of an article first published by the CER on 24 May.

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