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March 12, 2018

German industry is starting to panic about Brexit

We have noted before that the German media have been overemphasising the strength of the Brexit revocation lobby in their reporting. One of the consequences of this skewed reporting is that people underestimated the likelihood of the Brexit event, and that they have not started to prepare in time. German industry is now slowly waking up to the idea that they may be facing a dual onslaught - US tariffs, and an end to the customs union with the UK. These are two of Germany's three largest export markets. FAZ notes this morning that the president of the German federation of industry (BDI), Joachim Lang, is demanding a customs union with the UK. The EU is playing the same card indirectly - by insisting that Northern Ireland stays inside the customs union. But these are dangerous demands because they might backfire.

It is possible that the UK agrees to a customs union, but outside pressure is not helping. There is going to be an amendment to the trade bill, at some point in the spring, to demand a customs union agreement. If that amendment is accepted, we would assume that Theresa May would resign, and make way for a Tory successor who might either assemble a different majority, agree to a customs union, or start the process towards early elections. Several outcomes are possible - including in theory a majority to revoke Brexit. Our baseline scenario is that the amendment will be narrowly rejected, though.

The biggest risk to the Brexit process has always been political miscalculations on both sides. The UK clearly overestimated its ability to split the EU, and underestimated the cohesion of the European Council. But the EU also misjudges important aspects of UK politics. The EU's heavy-handed interference in the highly unstable political situation of Northern Ireland is ill-advised. The EU is right to insist that the border issue needs to be addressed - but the time to do so is not in the Article 50 withdrawal agreement, but in the subsequent trade agreement. Withholding the EU's assent to the withdrawal agreement, as Donald Tusk is threatening, will only increase the risk of a cliff-edge Brexit in 2019 - a point at which EU solidarity will be massively strained. The statement by the BDI is already an indication that industry is no longer willing to subordinate its own interests to EU-level power politics. And we don't think that Tusk will be able to uphold this position all the way through. 

FAZ cites a study by Oliver Wyman and Clifford Chance, according to which EU companies face tariffs and regulatory costs of €37bn under a WTO deal, while UK companies will be hit to the tune of €32bn. The article notes that the EU's costs are spread between 27 countries. But we argued before that this is a rather short-sighted argument. If the UK receives more money in tariffs than it pays, the government can fully compensate UK companies for the losses. The UK will, after all, no longer be subject to EU state-aid restrictions in this scenario.

One point the Germans keep on making is that there is really not a lot of time left. They are critical of the lack of progress in the Brexit negotiations - a criticism that is directed at both sides. We agree with Chris Lockwood (@chrislockwd) from the Economist, an ardent Remainer, who tweeted over the weekend: 

"This is the Brexiteers’ plan. They want to run out the clock, so that there is no time to scrutinise the deal before exit day. After that, it can’t be reversed."

This is also consistent with a Bloomberg story quoting UK officials as saying they do not expect a Brexit deal until two months before exit day. We do not know whether this reflects the government's view, but it would explain why the UK is in no rush right now, and why May is keeping up a negotiation position - her three baskets - which the EU will obviously not accept. 

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