The economic case against extending the Brexit transition

If you are someone who believes that Brexit is absolutely marvellous, or a complete disaster, then the question of whether the coronavirus pandemic justifies an extension of the transition period is presumably a no-brainer. But what about those who think the issues are more delicately balanced? This piece is pitched at them. In particular, I will argue that the Covid crisis will actually reduce the short-term economic costs of leaving the EU’s single market and customs union.

To keep it simple, let’s assume that the completion of Brexit will involve some economic costs, notably an increase in barriers to trade with the EU, and some benefits, including lower barriers to trade with the rest of the world, increased regulatory independence, and potentially some budget savings too.

Let’s also assume that the costs would be larger if the transition period ends without a free trade agreement (FTA) in place. The alternative of leaving with ‘no deal’ would mean new tariffs on EU trade, as well as higher non-tariff barriers.

Of course, some would prefer a relatively clean break on WTO terms. Nonetheless, I’m going to assume here that leaving with an FTA would be better for the UK economy than leaving without one.

The question of how the coronavirus crisis is relevant to the decision on the transition period can then be broken into three parts.

First, does the crisis make it more or less likely that the UK and EU will be able to complete the talks on time? Some have argued that an extension is now inevitable simply because social distancing and travel restrictions make it harder for negotiators to meet face-to-face. This is unconvincing. Other organisations have somehow been able to find ways to continue working remotely, often using ‘new’ technologies which are already familiar to the average teenager.

It has also been argued that political leaders are too busy dealing with coronavirus. But the idea that neither side has enough bandwidth to do more than one thing at a time does not hold water either. The UK and EU parliaments are now up and running again, and the EU has been able to make other big decisions during the crisis. There is no good reason why agreement cannot be reached in the coming months, if the political will is there.

Second, does the pandemic make it more or less likely that the talks will conclude with a deal? Assuming the practical problems can be overcome, sticking to the existing timetable should help to focus minds and make sure there is some sense of urgency. Indeed, the pandemic could actually mean that the chances of getting a deal done are now higher, because both sides will be even keener to avoid any additional economic shocks.

A further delay would therefore be a missed opportunity to get the talks over the line at last – four years, and counting, after the UK voted to leave the EU.

Third, how does the pandemic affect the costs and benefits of Brexit? Many supporters of an extension argue that the ‘double impact’ of coronavirus and the completion of Brexit would be too much for many businesses and that it would cripple the economic recovery. But this is a weak argument, even if we accept that leaving the economic institutions of the EU would bring more costs than benefits in the short term.

For a start, just think about the relative magnitudes. Any impact from the completion of Brexit will be dwarfed by the impact of coronavirus. Indeed, the swings in GDP due to the Covid crisis could easily be ten times as a large as any costs of leaving the EU’s single market and customs union.

What’s more, it would be wrong simply to lump the potential economic impacts of coronavirus and Brexit together without thinking properly about the interactions between the two. Unfortunately, a recent paper from the Social Market Foundation (SMF) was particularly guilty of this.

The SMF report did note two ways in which the Covid crisis could affect the costs of leaving the EU but, in my view, it drew exactly the wrong conclusion in both cases.

On the public finances, the report argued that the surge in spending in response to coronavirus would make it more difficult to provide additional financial support to any industries or communities particularly hard hit by Brexit. In fact, the government’s cost of borrowing has fallen as a result of the economic downturn and the prospect of an extended period of very low interest rates. Indeed, gilts are now being sold with negative yields. If the government does need to borrow more because of Brexit, the Covid crisis may actually have made it easier and cheaper to do so.

The SMF report’s other point here is that the Covid crisis could increase the economic costs of any reduction in immigration under the new points-based system, because there may be a shortage of workers willing to migrate internationally. But again, this point could – and probably should – be argued the other way. The jump in UK unemployment means that labour shortages are now far less likely to be a problem.

Supporters of an extension to the transition period argue that the Covid crisis will both increase the costs and reduce the benefits of leaving the EU’s single market and customs union in other ways too. This is debatable

On the cost side, if economic activity is indeed still depressed as a result of Covid, this might in fact be a better time to implement any new trading arrangements, because reduced trade flows mean there will be less pressure on borders. It certainly seems odd to worry that a ‘no-deal’ Brexit will disrupt the flow of medical supplies needed to tackle Covid when overall trade volumes are likely to be much lower than normal.

What’s more, there will be some value in ending the uncertainty about what the new arrangements might be. Many businesses will be rebuilding supply chains that have been disrupted by Covid and already incurring costs in doing so. Knowing what is coming should avoid the need to rebuild these supply chains twice.

Greater clarity here may also help businesses to make other investment decisions that have been put on hold because of Brexit uncertainty. As the CBI’s Carolyn Fairbairn noted on BBC’s Newsnight on 4th June, businesses will not want an extension of the Brexit transition period ‘because that is uncertainty magnified’.

There will be swings and roundabouts in other respects too. For example, it has been suggested that the Covid crisis will make it harder to recruit and train additional customs specialists. But the surge in unemployment could actually make that task at least somewhat easier.

There are also arguments either way on the benefit side. Reduced trade flows and a more protectionist global mindset may undermine or delay the gains from new trade deals with the rest of the world. But leaving the EU’s customs union will finally allow the UK government to implement the planned unilateral reductions in tariffs, which will be a clear win.

In addition, the benefits of increased regulatory independence may be much more important when the economy needs all the support it can get. Finally, extending the transition period is only likely to increase the UK’s exposure to the mounting fiscal and financial problems in the EU, even if additional budget contributions can be capped.

In summary, any short-term economic costs from a change in our relationship with the EU are likely to be trivial compared to the swings in GDP due to coronavirus. Indeed, these costs may actually be smaller as a result of the Covid crisis, and some of the benefits will be larger. The chances of getting a good deal may also have improved. Given that we will be leaving the EU’s single market and customs union eventually, it therefore makes sense to stick to the existing timetable rather than extend the uncertainty even further.

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