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By William H. Witherell, Ph.D.
After lengthy and difficult negotiations, the UK and the European Union on Monday 27 February finalized an agreement on trade rules between Great Britain and Northern Ireland, the ‘Windsor Framework’. This agreement should be effective remove the extreme risk of a trade war with the EU for the UK economy. However, they are unlikely to significantly reduce the negative effects of Great Britain’s exit from the EU (“Brexit”).
The UK-EU deal addresses the serious dispute over the Northern Ireland Protocol, which lays out the rules that would govern trade between Britain and Northern Ireland (NI) following the UK’s exit from the EU. Remember that NI is part of the UK and borders the Republic of Ireland (RoI) which is a member of the EU and remains single in the EU market for goods. Also remember that the Good Friday Agreement that brought peace to NI called for maintaining an open border between NI and RoI. The protocol aimed to prevent a hard border but required physical checks on goods moving from the UK to NI, effectively creating a border between the two parts of the UK and keeping NI in the EU single market and some EU – Subject to regulations. This agreement led to a dispute over the extent of these controls, which have restricted the flow of goods, and also over the application of EU regulations in NI, which is not part of the EU. The Democratic Unionist Party (DUP) in NI has refused to continue power-sharing in the NI government until their concerns about the protocol are resolved. The British government threatened unilateral action to change the protocol and the risk of a trade war with the EU became a possibility.
The Windsor framework addresses the two main concerns of the protocol:
Trade between GB and NI. Goods that are only intended for NI go into the “green lane” and are not checked. Goods destined for RoI and elsewhere in the EU are driven into the “red lane” and checked. This means, for example, a free flow of food products from the UK to NI without the delays and burdensome controls under the current system.
Application of EU regulations in NI. NI will remain in the EU single market and will be subject to some EU regulations, but the number of EU regulations will be greatly reduced; For example, the UK will license new medicines for NI instead of the European Medicines Agency. In addition, there will now be a “brake” allowing the UK government to veto new or amended EU regulations against application to NI if they so choose.
The deal is expected to be confirmed by a vote in Parliament, which may require some votes from Labor as opposition is expected within the Conservative Party.
This agreement is a very positive political development for both the UK and the EU and resolves years of bitter dispute. If the parliamentary vote shows strong support for the deal and political “goodwill”, it will boost confidence in the 2021 renewal of the Trade and Cooperation Agreement (TCA), the post-Brexit trade deal that will be renewed, revised and revised shall be. or termination every five years. This strong support would ease some investors’ uncertainty. If, on the contrary, the vote reveals a serious split within the Conservative Party, that split will spell a bumpy road for investors in UK-EU relations and heighten their concerns about a future deterioration in access to the single market for resident firms.
Whatever the outcome of the vote, the overall impact of the trade deal on the UK economy will be far less than the negative impact of Brexit. The deal focuses on trade in goods between Great Britain and Northern Ireland. This trade accounts for a very small part of the UK’s total economic activity with the rest of the world. While it is difficult to separate the impact of Britain’s exit from the EU from the simultaneous impact of the Covid shock on the UK economy, the negative impact of Brexit is becoming increasingly clear. The TCA created significant friction in trade between the UK and the EU. While duty-free and quota-free trade continues, non-tariff barriers to trade have been introduced, as have barriers to the free movement of people. The latter have led to serious labor shortages, which are adding to inflationary pressures. Net immigration from the EU was still negative in mid-2022, according to the Center for European Reform, which estimates there are 460,000 fewer EU workers in the UK as a result of Brexit. Data issues make it difficult to compare pre- and post-Brexit trade and identify the extent of trade disruption taking place. The Bank of England estimates trade with the EU was lower than official data indicated and that the productivity slump may have come earlier than expected. It is noteworthy that UK trade has not recovered from the Covid shock as quickly as in other major economies. Business investment is no higher than just after the Brexit referendum in 2016. The stalemate in investment appears to reflect uncertainty about the future and the red tape associated with Brexit for doing business in the UK. For example, export customs declarations have more than tripled. After all, the promised “dividends” from Brexit did not materialize. Instead, Brexit is proving to be a political decision that continues to affect the UK economy.
Considering the above and other negative costs of Brexit, the UK Office for Budget Responsibility estimates that the UK economy will ultimately be 4% smaller than if the UK had not decided to leave the EU. The Center for European Reform estimates that the UK economy is now 5.5% poorer than if the UK had stayed in the EU. The new trade deal is unlikely to have a significant impact on the UK’s overall trade situation or boost the UK economy directly. The potential for more constructive bilateral relations may prove to be their most positive effect.
The outlook for the UK economy this year is the weakest among those for the largest advanced economies, as it is the only one with a negative forecast annual growth rate – falling from 0.4% (OECD) to 0.6% (IMF) . However, recent data suggests that a less negative outlook may be developing. The surprise upbeat February flash PMI reading for the UK, as well as the strong final February manufacturing PMI point to a strong rebound in business activity despite headwinds from rising interest rates, a cost of living crisis, strikes and labor shortages . Elevated inflationary pressures are likely to prompt the Bank of England to raise interest rates further, aggressively when conditions warrant. We note the comments of C. Mann, member of the Monetary Policy Committee: “Uncertainty about turning points in inflation should not motivate a wait-and-see approach as the consequences of tightening too little far outweigh… the alternative.” The resilience of the UK economy is likely to be tested in the coming months.
UK equities have performed better year to date than would have been expected given the economic forecasts above. The FTSE 100 Index is up 5.4% year-to-date on February 28. That’s about half the 10.9% gain that eurozone equities, as measured by the STOXX Europe 600 Index, made. Cumberland Advisors International and Global Equity portfolios do not currently include UK ETFs. We will continue to follow developments closely.
Sources: Oxford Economics, OECD.org, IMF.org, S&P Global, Reuters.com, barcap.com, Financial Times, actioneconomics.com, CNBC.com.
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Editor’s note: The summary bullet points for this article were selected by Seeking Alpha editors.
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