‘Getting Brexit Done’ was a Bullish Deal — for Europe

By John Banks

Brexit, as you likely know, is shorthand for “British exit,” in reference to the United Kingdom parting ways with the European Union (E.U.) after a 47-year relationship. Brexit was made real through a U.K. referendum vote whose results shocked the world — few expected it would happen — in the summer of 2016.

For four long years, in an excruciating process that often felt like drilling a tooth without novocaine, the U.K. and Europe struggled to “get Brexit done” (a campaign slogan wielded by U.K. Prime Minister Boris Johnson, known as BoJo in the British press).

On Dec. 24, 2020 — Christmas Eve — Brexit finally got done. The actual details of Brexit amounted to 1,246 pages of customs requirements and red tape. But it was finally over, and BoJo announced to the world with glee that the U.K. would finally, at long last, be completing its split with the European Union.

The Johnson government wanted to give the impression that Brexit was wrapped up and over, having finally come to a deal. The reality is closer to the opposite, due to all the negotiating still left to be done.

With the initial part done, the truth of Brexit is captured in an old Winston Churchill quote:

“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

The shape of the deal offers unique benefits for each side.

The E.U., for instance, will have the chance to “take back control” (to use another BoJo campaign phrase) of Europe-related banking activity and financial services, with activity now concentrated in London dispersing to the continental finance hubs of Paris, Frankfurt, and Amsterdam.

The E.U. will also have an easier time making policy and coming to important decisions, as the U.K. had long been the member most likely to kick up a fuss and go its own way.

Then, too, the E.U. could wind up with two new members before the end of the decade — Scotland and Northern Ireland — with an independent Scotland joining the E.U. directly, and Northern Ireland joining by default after returning to Ireland (which is already an E.U. member). 

On the U.K. side, there will be more “regulatory freedom” (yet another BoJo slogan), though it will also come with an explosion of new customs requirements and onerous red tape.

The E.U. will remain the U.K.’s nearest and largest trading partner, and it will carry most of the weight in the relationship by dint of being six to seven times larger, economically speaking. The U.K. will no longer have open access to European markets, hence the explosion of new customs requirements and red tape issues that are already causing headaches at British ports.

“Many truckers are still warning of chaos as they struggle to adjust to the new paperwork required by Britain’s departure from the European Union,” Bloomberg reports. “Drivers are being held up for hours because they lack the right documents, they say.”

In exchange for jammed-up trade lanes and piles of new paperwork, the U.K. is being paid in sovereignty, meaning that U.K. citizens will now have the ability to feel more sovereign than before. This feeling of sovereignty is not tangible without a translation to some kind of policy advantage, but for many who voted for Brexit, the feeling alone seems worth a large economic cost.

Prior to Brexit, the U.K. had a unique deal with the E.U. that was astonishingly favorable, so much so it could only have been an accident of history.

As an E.U. member, the U.K. had two stellar advantages that were even more incredible when combined in one package. As an E.U. member, it was easy for London to remain the cultural and financial center of not just the U.K. but the entire European continent, automatically making it one of the top three finance hubs in the world.

The other potent advantage the U.K. enjoyed was full and unfettered access to E.U. markets, coupled with the U.K.’s ability to keep its own currency (the British pound) and run its own monetary policy.

Both of those advantages meant significant economic gains for the U.K. When put together in combination, the net upside was spectacular. It is hard to describe how lucrative it can be to run the financing for a body of countries nearly seven times your size, with full trading access to all of their economies, while retaining the ability to adjust your own monetary policy as you see fit.

But such forms of membership advantage, as powerful as they are, do not translate well to politically charged referendum campaigns, which helps explain why the more “accessible” feeling of sovereignty, though not actually attached to a net upside, won the day.

The down-to-the-wire Brexit negotiations also seemed fishy, in two different senses of the word, based on the areas it emphasized versus those it neglected completely.

Sharp disagreements around fishing rights in U.K. waters, for example, were one of the most contentious parts of the deal, even though fishing as a revenue source represents less than one-half of 1% of U.K. economic activity.

At the same time various forms of services, which make up roughly 80% of the U.K. economy, were not really addressed, and financial services in particular — a massive earnings source for the U.K. — were left to be addressed later, too.

As such the deal felt fishy in the descriptive sense of the term — meaning something that is dubious or suspect — in that it focused aggressively on an area of the economy that is practically a rounding error in GDP terms, while ignoring the elephant in the room in terms of financial access.

The U.K. and the E.U. have agreed to work out much of the services part later, and they want to have a “memorandum of understanding” for financial services access within the first few months of 2021.

This is like negotiating an employment agreement that emphasizes reimbursement for office supplies, while leaving the matter of salary and bonus compensation to be handled at a later time. It doesn’t really make sense — unless the driving goal was simply to “get Brexit done” before a deadline, leaving the real work still ahead.

All in all, the Brexit deal seems quite bullish for Europe, in our view, in part because of what the U.K. is giving up that the E.U. will be able to count as a gain.

To the extent that E.U.-related banking and finance activity migrates away from London, and toward the financial centers of Paris, Frankfurt, and Amsterdam, the E.U. economy will be strengthened; and if Scotland and Northern Ireland cross over to the E.U., its economic heft and clout will be strengthened further.

The U.K., meanwhile, will have the ability to go its own way on negotiating trade deals — but it has paid a significantly heavy price, not just in terms of new red tape and customs headaches with European trade, but also in regard to heavyweight players like China and the United States.

Then, too, as the U.K. slogs its way through ongoing rounds of Brexit negotiations on matters unresolved, the Johnson government will also have to deal with increasing feelings of frustration and resentment in Scotland, where an independence streak is already strong.

When Scotland held an independence referendum on Sept. 18, 2014, the measure was voted down by a margin of 55.3% “no” to 44.7% “yes.”

But the proposal then involved Scotland going its own way as an independent country, because the U.K. was part of the E.U. at the time. When another referendum comes up, which seems only a matter of time, Scots will have the added cushion of knowing they’ll be able to join the E.U. immediately.

And if the U.K.’s economic waters are rough these next few years, Northern Ireland sentiment will move in the same direction: Merging with Ireland, already an E.U. member, would make Northern Ireland a part of a much larger whole.

As these and other realities sink in, BoJo is going to have his work cut out for him. The overall outlook for Europe, at least, looks more bullish now than before.