Jeremy Warner
A no-deal should not in itself be economically catastrophic, but the PM will need a new mandate
How’s all this going to end? Disbelieve anyone who gives a definitive answer. But ever since Boris Johnson came to power, my working assumption has been that a no deal is now overwhelmingly the most likely outcome. Like Mr Johnson’s rhetoric, where the “million to one chance” of no deal was quickly ditched for recognition that securing a deal is going to be “touch and go”, my view has been hardened by events.
I still wouldn’t altogether discount sufficient compromise by the EU. Rhetorically at least, some EU leaders do notably seem to have shifted. In this sense, and contrary to the prevailing narrative, prorogation may have made a deal more likely, not less so. All the same, from merely odds on, I would say that a hard Brexit has become more than probable, and not just because Boris has Nigel Farage breathing down his neck, threatening to scupper his electoral chances if he strays from the path of righteousness.
Mr Johnson’s commitment to securing an arrangement that ensures a smooth transition to a Canadian-style free trade agreement should not be doubted; as Farage correctly concludes, he’s no clean-break idealogue. But a deal that can pass Parliament? I doubt he thinks this is any more than a long shot.
This makes current developments – with the proroguing of Parliament paradoxically meant to improve the chances of a deal by convincing the Europeans that the Government is deadly serious about leaving without one – something of a charade.
On both sides of the fence, the game has changed. No longer is it really about avoiding a no-deal outcome, but rather who to blame for it. European leaders pretend to hold the door ajar so as to claim they tried their best. For them, no deal needs to be presented as a choice that the UK is making for itself after every effort to avoid it. By the same token, Boris needs to blame the Europeans for holding fast to unreasonable terms that no British Government could ever accept.
Assuming my analysis proves correct, how should macroeconomic policy respond? In the jargon, no deal threatens both a supply and demand side shock to the economy. By overnight making trade with the EU more expensive and difficult, it rips a big hole in supply, and therefore potential output.
Even so, this in itself shouldn’t be catastrophic. Lots of countries trade quite happily with larger neighbours without being part of a customs union or single market with them. What’s more, if Brexit leads to a permanently lower pound, it could over time result in a fair amount of import substitution, which in itself is a bit of a holy grail of UK economic policy.
Yet here’s the problem. As I crept back into London along the M20 from Dover the other day, it was already all too visible in the two lanes of the northbound carriageway that mile upon mile of road has been closed off to traffic so as to be turned into a giant lorry park. Having not had a border for more than 40 years, the UK and indeed the Continent are completely unused to the checks and customs clearance that imposing one entails. With queues of lorries backing up on both sides of the Channel, trade with the Continent faces the very real possibility of a sudden stop. The necessary diversion of traffic to other, less well used ports will take time to establish.
Scenes of chaos could quickly transform this supply side shock into a collapse in demand, particularly if the inability to shift goods and services causes large-scale layoffs. To raise this possibility is not to succumb to project fear, but only to recognise a looming threat. Economic confidence is a very fragile construct; it can be easily upset, even among those who regard Brexit as a form of economic liberation.
Policy must therefore react to address these two parallel traumas. By cutting interest rates, and launching a fresh round of quantitative easing, the Bank of England can attempt partially to offset the hit to demand, even if, with interest rates already so low, the continued potency of such action must be open to question. Easier money would also be in conflict with countering the inflationary pressures of the supply side adjustment.
Similarly, the Government can cut VAT, fuel duty, national insurance and income tax, thereby giving households more spending power. Again, to do so may be problematic, in that it would undoubtedly mean junking the present framework of fiscal rules. But needs must.
On the supply side, monetary policy can do little or nothing. However, the Government can have some effect by cutting business taxes, deregulating, subsidising key industries, and signing alternative free trade deals with major economies. Unfortunately, such measures will take time, possibly years, to work, and in any case there is as yet no sign of a coherent strategy for supply side reform.
All this underlines the need for Mr Johnson to secure his position through a general election, either immediately before he leaps over the cliff edge, or immediately afterwards, while still in mid-air as it were, but before falling onto the rocks below. He’s a man on a wire.