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Brexit Hurts Europe, But Hurts the UK More

Brexit Hurts Europe, But Hurts the UK More

Monday, 19 March, 2018 - 06:45
There have been numerous estimates of Brexit's cost to the UK but fewer similar ones for the European Union. But calculations are gradually surfacing, and while Europe's costs are serious, it's easy to see why the EU has a stronger negotiating position.

On Monday, the New York-based management consulting firm Oliver Wyman and the London-based law firm Clifford Chance published a telling report on "the red tape costs" of a so-called "no-deal" Brexit. They looked at the damage to importers and exporters from the added red tape, but not any indirect economic impact on firms down the established supply chains.

Their conclusion? The direct annual cost of moving to World Trade Organization rules -- the standard in lieu of a superseding bilateral deal -- is estimated at 27 billion pounds for the UK and 31 billion pounds for the EU-27.

That's just 0.4 percent of gross value added (a measure that adds subsidies to economic output, then subtracts taxes) for the EU but 1.5 percent for the UK. The damage is mutual, but it's four times as bad for the UK given the sheer size of the union.

A January forecast by the UK-based Oxford Economics raised alarms by predicting the UK would suffer more than the EU, albeit with numbers increased by adding in indirect costs. By 2020, it estimated a loss of 112 billion euros ($137 billion) for the EU and 125 billion pounds ($174 billion) for the UK. But only a fraction of that -- some 50 billion euros by 2020 to the EU -- represents direct costs to exporters and importers.

In both studies, the EU advantage looks strong. But it is slightly undermined by the uneven geographic and sectoral spread of the costs. Germany, according to the report by Oliver Wyman and Clifford Chance, will take the biggest hit. Its four economically strongest states -- Bavaria, Baden-Wuerttemberg, North Rhine-Westphalia and Lower Saxony -- absorb 70 percent of the damage in the study. That's because of their export strength in the auto industry and other types of manufacturing.

Throughout the EU, five sectors -- automotive, food and agriculture, industrials, chemicals and consumer goods -- account for 70 percent of the cost. No wonder British negotiators have started talking to decision-makers in specific countries rather than those representing the EU. Some parts of Europe have a higher incentive to make a deal than others.

The trouble with this strategy is that the affected sectors are largely populated by large companies. Over time, they will be able to mitigate the damage. Automotive and aerospace firms, expected to be the worst-hit, also have the best opportunities to reduce direct "red-tape" costs, the report said. For example, they could shift operations to "domestic suppliers or in some cases changing the location of final assembly."

The longer it takes to finalize Brexit and a new trade deal, the better these firms will be prepared and the less actual damage they will sustain. That explains why the EU is in no rush, and why it's probably useless for the UK to test EU unity. The important employers are operating on their own track. It'll take them a few years to adjust to the post-Brexit world, but the costs will be finite.

It's the smaller firms that will find it hardest to adapt, and some will fail to do so. But Europe has an advantage here, too, thanks to its size. If Monday's report is correct that impacts will be localized to just a few industries and regions, Europe has far more of each in which to spread the pain. The aggregate effect on national economies will be more limited in Europe than the UK.

According to Oliver Wyman and Clifford Chance, a trade arrangement close to the current one would drastically reduce costs to both sides. But it's obvious that the UK isn't keen on that option. It's increasingly likely that both sides will face painful economic impacts, with their large firms absorbing the brunt of it. As far as best-case scenarios go, it's not great. But it's the best they can hope for as long as the UK insists on hurting itself worse than its former partner.

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