Power 3rd May 2017 XL Catlin, 20 Gracechurch Street, London, EC3V 0BG Brexit and the UK Martin Wolf, Associate Editor & Chief Economics Commentator, Financial Times Power 3rd May 2017 XL Catlin, 20 Gracechurch Street, London, EC3V 0BG

What lies ahead for the UK Post-referendum economy Negotiations Costs Conclusions

1. Post-referendum economy: output EXAGGERATED PESSIMISM

1. Post-referendum economy: inflation INFLATION SURGE

2. Brexit negotiations: UK approach The UK prime minister has rejected freedom of movement and surveillance by the European Court of Justice: This means leaving the single market and rules out membership of the European Economic Area It does not rule out membership of the customs union. But that would also preclude new trade deals at least in goods The result is a UK demand for a “tailor-made” deal on goods and services. This will take a lot of time So a transition will be essential. But a transition to what?

2. Brexit negotiations: UK as weaker party The UK enters the negotiations as the weaker party: In 2015, 44 per cent of UK exports of goods and services went to the EU. But only 7 per cent of EU exports of goods went to the UK The UK runs a large trade deficit in goods and a smaller surplus in services. The former gives leverage. But the UK deficit in goods is also concentrated in just a few countries, notably Germany and the Netherlands.

2. Brexit negotiations: trade dependence IMPORTANT TO BOTH SIDES, BUT UNBALANCED

2. Brexit negotiations: vulnerable services SCALE AND DIRECTION OF UK EXPORTS

2. Brexit negotiations: complexity & timing Article 50 was designed to be unusable – and it is: The Brexit negotiations will be highly complex and political. They will involve 29 parties on the EU side: member countries, plus Commission, plus European Parliament And they are to be completed in very little time – even less time than appears to be the case Given the need of time for ratification and for businesses to plan ahead, negotiations will need to be completed at least six months before the deadline

2. Brexit negotiations: divergence UK wants to move fast: Nothing is agreed until everything is agreed; Transition plan needed early UK leverage disappeared once Article 50 was triggered UK will be desperate for a deal as the deadline approaches EU wants to play for time: Divorce first, post-divorce relationship later; Uncertainty means relocation, so play for time EU leverage now grows over time, so again play for time EU probably wants a deal, but not desperately so

2. Brexit negotiations: hopes and fears The best outcome would be an agreed exit, an agreed transition and a clear view on a final deal It now seems likely that, even under this best outcome, passporting for services will have gone and so will membership of the customs union The more likely outcome is failure: the UK would then be at ground zero for trade policy and confront an administrative and policy mess

3. Costs of Brexit Whatever happens in the negotiations, the UK will lose its current favourable access to its most important markets It will have to shape a new trade policy It will also be impossible to replace what it has lost, especially in services It will have to reshape its domestic economy

3. Costs of Brexit: lost trade THE EU MADE THE UK FAR MORE OPEN

3. Costs of Brexit: lost trade IMPACT ON TRADE OF LEAVING THE EU

3. Costs of Brexit: short and long run POSSIBLE ECONOMIC COSTS TO THE UK

4. Conclusion An agreed Brexit will be “hard” and incomplete But no agreement at all is quite likely Both the uncertainty and the costs created by the latter are likely to be high Trade deals with the rest of the world will not offset the loss of market access to the EU The UK will be poorer and less influential outside the EU