Negotiators for the United Kingdom and the European Union are racing the clock to reach agreements on a long list of remaining issues before the United Kingdom formally leaves the bloc on March 29, 2019. Ongoing discussions are focused on a Withdrawal Agreement that would establish the legal terms of the Brexit and a political declaration outlining the general framework for future ties between the European Union and the United Kingdom. London and Brussels would ideally like both documents to be finalized in time to be signed during a European Council summit in October. But negotiators are still far apart on both deals, opening the door for a no-deal scenario, in which Brexit would happen without any prearranged conditions. If that happened, the economies and the political and institutional systems of both would have to cope with a number of possibly disruptive effects.
Stratfor's Annual Forecast noted that the European Union and the United Kingdom would spend the year trying to figure out what their future relationship would look like in the wake of Brexit. Furthermore, it said that disagreements over the future of the Irish border would be one of the main obstacles to a deal, and that the British government would remain internally divided on the approach to negotiations. The complications leave open the possibility that the Brexit date will arrive with no agreement over how to handle a host of issues.
The Current Situation
London and Brussels are already aligned on several aspects of the Withdrawal Agreement. For example, the United Kingdom has agreed to pay its "Brexit bill" — some 39 billion pounds ($52 billion) to the European Union to honor its financial commitments to the bloc, and both have pledged to preserve the residency rights of EU citizens living in the United Kingdom and likewise of British citizens on the Continent. They have also negotiated a transition period that would allow the United Kingdom to remain within the EU single market until December 2020. This would give both parties time to adapt to the new reality and to negotiate a trade agreement.
But the Withdrawal Agreement is not complete, and several sticky issues remain unresolved, including future cooperation on police and judicial issues and the role of the European Court of Justice in the United Kingdom after Brexit. But by far the most controversial issue remains the eventual status of the border between Northern Ireland and the Republic of Ireland. Both parties want the border to remain open, but they cannot agree on a way to accomplish that. In March, negotiators settled on a "backstop option" that would leave Northern Ireland in the EU customs union if a better solution cannot be found before Brexit day arrives. In July, however, the British House of Commons voted to make that option illegal, possibly complicating the chances of reaching a border agreement (the bill has yet to be ratified by the House of Lords).
British Prime Minister Theresa May’s government is internally divided between those who want to keep close ties with the European Union and factions pushing for a hard exit. This has forced May to seek compromise with both groups, often resulting in complex policy proposals. Further complicating the situation are the divisions in the British Parliament between hardliners and softliners, meaning that even if May can hold her government together, she cannot guarantee that her proposals will pass parliamentary muster. The European Union, in the meantime, says that it will not approve an ad hoc agreement with the United Kingdom, insisting that it must follow an existing trade model, whether that be membership in the single market or the customs union or a free trade agreement.
What a No-Deal Scenario Would Mean For Trade
If the two sides fail to reach a Withdrawal Agreement by early 2019, or if they sign a deal that either the British Parliament or the European Council reject, it would most likely force the United Kingdom to exit the European Union under a no-deal scenario. While EU rules allow for the negotiation period to be extended after the March 2019 deadline, the bloc would likely demand concessions on a soft exit in exchange, a prospect that British politicians could find unacceptable.
Without the Withdrawal Agreement, beginning March 30, 2019, the United Kingdom would find itself suddenly out of the single market, and EU laws and regulations would no longer apply to it. The European Union would treat the United Kingdom as it would any other country with which it has no agreements, applying tariffs and customs controls, and enforcing EU sanitary and phytosanitary standards for British goods. The new border controls would cause delays at borders and ports, and supplies of food and other goods would stack up as they awaited inspection. (The British government recently suggested that in a no-deal scenario, it could waive checks to keep traffic moving, but it would require the European Union to do the same.)
Without a deal, World Trade Organization (WTO) rules would govern relations between the European Union and United Kingdom. British exporters would have to contend with EU tariffs that are low on average (roughly 5 percent). However, the rates run higher in specific sectors (10 percent for cars, for example, and an average of 11 percent on agricultural products). EU exporters, in turn, would have to deal with whatever tariffs London decides to impose. Even if the United Kingdom unilaterally reduced or eliminated its own tariffs to prevent an escalation of the price of imports, non-tariff barriers (such as standards and regulations) would still create obstacles for bilateral trade. The United Kingdom could try to remain aligned with EU standards and regulations to limit disruptions in trade, but it’s only natural that over time, the two would progressively drift apart.
The effects of a no-deal situation would be even more pronounced in the case of services, which constitute about 80 percent of the British economy. The British financial sector would lose the "passporting rights" that allow companies to sell their services within the single market without having to apply for authorization in each country. Without those rights, the financial services sector, which accounts for more than 6 percent of Britain’s gross domestic product, would be among the main losers. Although not every financial activity would be affected in the same way (banks that operate domestically would not be as affected as other activities that rely on foreign customers), a no-deal could deal a heavy blow to the sector.
And the impact on services would go well beyond finance. Providers of professional and business services, like legal, accounting, advertising, architectural and engineering services, now have relatively unrestricted access to EU countries through the single market. In a no-deal scenario, London would have to reach specific agreements with Brussels to preserve this access. Similarly, a no-deal would mean that for British airlines to maintain the access to European markets that they now enjoy though the European Common Aviation Area, London would have strike a new agreement with the European Union. At the same time, to preserve their access to the single market, companies in a wide range of other sectors would have to move some of their operations to continental Europe.
Under a no-deal scenario London would be free to sign free trade agreements with any countries it wishes to (such as the United States and Australia). But negotiating, ratifying and enforcing such deals takes years. In the meantime, the United Kingdom would lose access to the free trade agreements that the European Union already has with countries like Canada, Japan and South Korea.
What Else Would Be Affected?
If no Withdrawal Agreement is signed, the future of the roughly 3.6 million EU citizens living in the United Kingdom and the 1 million British nationals living in the European Union would be thrown into doubt. There would not be massive deportations, but they would remain in a legal limbo for weeks, if not months, until their status was defined.
The United Kingdom would be free to set an independent immigration policy, and considering that this was one of the key issues in the Brexit referendum campaign, London would probably impose restrictions, such as work visas or annual quotas, on future migrants from the European Union. Associations representing sectors from tech and manufacturing to construction and tourism have warned that doing so could create a shortage of skills in the British economy, as it would be harder (or at least involve more layers of bureaucracy) for British employers to hire workers from the European Union. Should the United Kingdom decide to impose restrictions for short-term visitors as well, the tourism sector would feel the pinch. And should the European Union retaliate by imposing visas for British tourists, that would hurt tourism destinations like Spain and Portugal.
At the same time, in a no-deal scenario, British individuals, companies and institutions would lose access to EU financing in areas such as education and scientific research. The European Union would also likely restrict, or even exclude, British participation in continental projects such as the Galileo GPS system or in regulatory entities such as the European Medicines Agency.
Without a Withdrawal Agreement, London would probably refuse to pay the Brexit bill, at least initially. That would leave less money for the EU budget and force spending cuts. The British government would be able to redirect that money to domestic needs, such as compensating British farmers for lost access to EU agricultural subsidies. But refusing to pay the Brexit bill would sour UK-EU relations and make it harder for London and Brussels to negotiate the bilateral agreements needed to cope with the effects of Brexit. As a result, London would probably agree to make the payment at some point.
The Economic Impact Would Be Spread Unevenly
Trade, supply chains, capital movement and migration flows between the European Union and United Kingdom are so tightly entwined that the economic impact of a no-deal scenario would be felt in both. But the effects would be spread unevenly. A recent International Monetary Fund (IMF) report found that if the European Union and the United Kingdom start trading under WTO rules, the economic growth of the 27 remaining EU countries would fall by as much as 1.5 percent by 2030. Countries with close ties to the United Kingdom like Ireland, the Netherlands, Denmark and Belgium would feel a particular sting, but the pain would be much milder in those with bigger economies or weaker UK ties like Italy or Spain. The biggest downturn would come in the United Kingdom itself, where the economy could contract by as much as 4 percent in the decade after Brexit. According to the IMF, softer versions of Brexit (like a comprehensive free trade agreement or remaining in the single market) would lead to softer economic impacts everywhere.
In January, British media published a leaked internal British government document that paints an even darker picture. That report estimated that British economic growth would be reduced by as much as 8 percent in the first 15 years after Brexit in a no-deal situation, compared to reductions by 5 percent under a free trade deal and by 2 percent with membership in the single market. Impact reports by private companies offer different figures, but most agree that trade under WTO rules would be the most disruptive scenario for both the United Kingdom and the European Union, and that the British would feel the strongest impact.
The unprecedented situation presented to Europe's political, economic and institutional actors by a no-deal scenario would generate confusion and uncertainty. But the chaos would not necessarily last for a long period or affect every aspect of EU-UK relations the same way. Even in a no-deal scenario, both parties would still be interested in reaching a permanent trade agreement, which means that negotiations between London and Brussels would likely continue. In the meantime, the United Kingdom and the European Union would probably reach temporary deals to try to minimize disruptions as much as possible, with many people carrying out business as usual while they waited for further instructions. A no-deal scenario would trigger a significant change after four and a half decades of British membership in the EU, but while its ties with the Continent would be disrupted, they would not be completely severed.