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June 16, 2017

The emerging Brexit consensus

There are a large number of comments out there that are essentially now using the cyclical downturn in the UK economy (and the cyclical upturn in the eurozone) to peddle the message that Brexit is already an economic disaster and that undoing the whole thing should still be considered an option. We expect the number of Brexit laments to increase in the coming year.

Mercifully, there also appears to be a slowly-emerging consensus towards a solution we have been advocating ever since the Brexit referendum: use the Norway option, or a reduced version of it, for a long transitional period which would serve three fundamental purposes: 

  1. buying time to prepare for Brexit;
  2. defusing the Brexit bill issue politically - since the UK would be indirectly contributing to the EU budget;
  3. after Brexit, it allowing a smooth return to the EU via Article 49, if the UK electorates wants this, or, more likely, a transitional agreement.

Philip Hammond has been reported to be considering this option in his scheduled Mansion House speech last night, but he cancelled the event because of the London fire. 

Among comments, the most succinct is Andrew Duff’s analysis. He writes that, since both Conservatives and Labour campaigned in favour of Brexit, the option of revocation is now foreclosed. He predicts that there will be no further elections during the Article 50 negotiations, and the chances of an Article 50 agreement are actually increased. The nature of Brexit is likely to be softer because of the election result, as a bust-up would lead to the collapse of Theresa May's government and another general election. The Tories thus have every incentive to conclude a deal.

He also makes a series of other important points. One is that, while the UK and the EU will not conclude a parallel trade agreement, the nature of the relationship will have to be defined with some clarity because the Article 50 agreement will depend on it. Like us, Duff also believes that by far the best option for the UK would be to remain a member of the customs union during a transitional period.

One other factor likely to add pressure for a softer Brexit transition is the slowing economy and the rise in inflation. The Bank of England came close to voting in favour of an interest-rate rise, as inflation has hit 2.9% recently. The monetary policy committee voted by 5-3 in favour of leaving rates unchanged. One of the hawks, an external member, will quit the board at the end her term, leaving two open positions to fill.

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June 16, 2017

On the economics of supply chains

Paul Krugman offers a very useful reminder of how small changes in global transportation costs can have a massive impact on global trade. The observation he offers has important implications for current policy debates such as Brexit, but also about the dependence of many European economies on international supply chains. He gives the example of a manufacturing process with intermediate goods imports and a final assembly. In his example, if transport constitutes 10% of the costs, the emerging country would need to offer a cost advantage of 38% to become competitive because it would have to pay for the cost of transporting in the intermediate goods, and transporting out the final goods. He says reductions in transportation costs, mostly through containerisation, were the biggest factor driving the expansion of global trade in the 1990s and the last decade. But this is a one-time effect. 

The lesson is that small changes have large effects. The same goes for tariffs. If the US started to impose tariffs on German companies, for example, or if trade relations between the EU and the UK were to become subject to WTO tariffs, expect to see quite a dramatic reversal of this process as cross-border supply chains would become economically less viable.

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