What does a possible no-deal Brexit mean?

With Brexit getting closer, it is still extremely difficult to predict which one of the possible outcomes will materialise. Guntram Wolff examines what exactly it would mean for the UK to 'crash out' of the EU, for both parties.

By: Date: January 24, 2019 Topic: European Macroeconomics & Governance

This article was published by Caixin, Expansión and Nikkei Veritas.

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On March 29th 2019, two years will have passed since the United Kingdom notified the EU of its intention to withdraw from the European Union. As it stands, the UK will then become a third country and cease to be a member of the EU.

With the deadline getting closer, it is still extremely difficult to predict which one of the four possibilities will materialise: (1) the UK exits based on a withdrawal agreement, (2) the UK exits without any agreement signed, and the exit is therefore disorderly, (3) the UK asks for an extension period, or (4) the UK unilaterally revokes its Article 50 notification and chooses to remain in the EU. After this week’s decision of the British House of Commons, a no-deal Brexit sounds like a more likely scenario.

Given such uncertainty, the EU is actively preparing for the scenario of a no-deal Brexit – and rightly so. It would have serious short-run consequences both in the EU, and even more so in the UK. A no-deal Brexit would have a significant impact in key areas: the EU budget, EU-UK trade relations, the Irish border, specific sectors such as aviation and, last but not least, EU citizens living in the UK and conversely UK citizens living in the EU.

The first issue at stake in the event of a no-deal Brexit is money: the UK could decide not to honour its financial commitments to the EU. The overall long-term Brexit bill is estimated to be about €45-50 billion. In the ongoing budget period 2019-20, the EU would lose some €16.5 billion, which other members would have to pay for. Germany alone would have to increase its contribution by about €4 billion according to estimates by my Bruegel colleague Zsolt Darvas.

Filling this gap is neither a legal nor an economic problem for the EU. But the EU would justifiably consider the non-honouring of the UK’s financial commitments as a hostile act. De facto, the EU would consider it as a default of the UK, with implications for political relations. The EU might want to condition short-term collaboration with the UK on payment of the outstanding amount.

Second, and economically much more relevant, a no-deal Brexit has major implications for the trading relationship. There would be immediate and significant administrative and logistical challenges. For example, the port of Dover, one of the main entry points for lorries into the UK, could do customs controls only for a fraction of the 2.6 million lorries that arrived in 2017. But it is not just customs controls at the border. There are immediate administrative challenges – for example, the checking of regulatory conformity of products, as well as veterinary, sanitary and phytosanitary checks. Preparations to reduce those disruptions are under way, but are unlikely to be sufficiently advanced by March 30th of this year to prevent major short-term disruptions in trade.

A no-deal Brexit would be bad news for the EU as well as for the UK in the short term

Somewhat less relevant, tariffs would rise from the current level of zero to the then-applicable WTO most-favoured nation (MFN) tariffs of the EU. The EU and the UK have notified the WTO that the UK will apply the EU MFN tariffs post-Brexit. Those tariffs are not very high, but in some sectors, such as the automotive sector, the tariff does amount to 10%, hitting that particular industry on both sides. In the medium term, regulatory barriers could turn out to be more costly, but all of this will depend on the future relationship between the UK and the EU, which a no-deal Brexit is rendering more uncertain.

The biggest and most significant concern is the situation in Ireland. A possible border in Ireland was already the most contentious part of the Brexit negotiation. But if the EU wanted to protect the integrity of its single market, a no-deal Brexit would mean the imposition of customs controls on the Irish border. This would be a paradox: the very rule in the Brexit withdrawal agreement that aimed to prevent a hard border may have been the main reason for the UK to reject the deal and, in turn, would lead to a hard border. Faced with a choice of an immediate hard border, the EU and the UK might be ready to go back to the negotiating table to prevent violence on the island of Ireland. So, I would argue that the Irish situation is the main reason why there may still be a deal in the coming weeks.

When it comes to specific sectors, the European Commission has issued a number of draft regulations to mitigate the effects of a no-deal Brexit. For example, on financial services, the most important contingency plans have been made and both the Commission and the British authorities have shown flexibility on clearing to limit financial stability concerns. In the aviation sector, in turn, a no-deal Brexit would still lead to many flight cancellations, but not all flights from the UK to the EU would be grounded.

Last but not least, a no-deal Brexit would create significant uncertainty for citizens on both sides of the channel. The total number of EU citizens living and working in the UK and UK citizens living and working in the EU amounts to around five million. Will their rights be preserved, at least partially? For example, accumulated pension rights in one country can be taken home when returning after working abroad, according to an EU right. Will this right be lost, and these citizens consigned to losing parts of their pension?

Overall, a no-deal Brexit would be bad news for the EU as well as for the UK in the short term, creating lots of uncertainty and causing various disruptions. The effects of a no-deal Brexit in the medium to long term are more difficult to assess, as an alternative long-term relationship is yet to be defined.

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