Hard Brexit concerns are back

It seems that Britain’s Prime Minister Theresa May still does not hold much truck with a soft Brexit – at least not if the UK has to give up control of immigration. The British media reported that the prime minister will set out the key points of her Brexit strategy in a speech to be given on Tuesday. She is expected to maintain the tough stance vis-a-vis the EU that she had asserted already at the Conservative party conference at the start of October. Speculation about soft Brexit models along the lines of Norway or Switzerland that had been given impetus only a few weeks ago – not least because of the more conciliatory tones adopted by some of May’s cabinet colleagues – was undermined as these countries must also accept the free movement of persons that applies in the EU in return for access to the EU single market. This therefore raised the likelihood again of a hard Brexit; the pendulum is swinging in the other direction again.

It still goes without saying that a hard Brexit – total loss of access to the EU single market – would represent a watershed for the UK economy and burden economic growth. However, opinions are highly divided as to the impact of these burdens. We are very pessimistic in this respect. As we see it, adopting a tough stance in respect of the EU would cost the UK economy dear. One major loss in particular would be the forfeit of the so-called EU banking passport, which currently allows banks domiciled in the UK to easily offer services throughout the entire EU. This however would no longer be feasible after a hard Brexit, as the banking passport is a key element of the freedom to provide services in the EU single market. The banks would have to establish legally independent subsidiaries in an EU state to continue to do business with EU customers. This would also involve moving staff from the UK to other EU financial centres, such as Frankfurt, Paris or Dublin. The initial considerations of large banks in this respect are already being discussed. This would be a serious blow for the financial centre of London. The financial sector is one of the largest export sectors of the UK economy. In addition, around half of the financial institutions are foreign banks that operate their EU business out of there, and act as a kind of bridgehead for the UK into the EU. This is also evident from the high level of foreign investment that the UK has attracted like no other EU state – from countries outside of Europe in particular. Half of this direct investment to date has been in the financial sector and would be at stake to a certain degree at least in case of a hard Brexit.

Access to the single market has been a key location factor for the UK economy up to now – mainly but not only for the financial sector. The British industry, particularly the automotive industry, is closely involved in the complex manufacturing chains within the EU. The uncomplicated trade with auto parts between the UK and other EU countries would be severely impaired, if it were to become more expensive and bureaucratic as a result of customs and other non-tariff trade barriers. Non-European companies, above all the Japanese auto groups Nissan, Honda or Toyota, also operate large production sites in the UK from which they service the European market. The question is whether it will still be profitable to export to the EU under new customs barriers, despite the state aid announced by London.

Hope still prevails among the companies that Brussels and London will ultimately come to some sort of a comprise, so that business activities out of the UK will not be too severely impacted. They have not made any hasty decisions yet at least. If a hard Brexit now seems increasingly likely, companies will no doubt reach key decisions about relocating from the country. Investment activity in the UK will then probably slump well before the country actually exits the EU (presumably in early 2019) and increasingly burden the economy, the closer the exit date approaches.

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