UK vs EU, let’s look at the numbers

Brexit negotiations are about to begin. Certain voices inside the  EU Commission are advocating adoption of a hard line against the UK. Specifically re: future trading arrangement.

Couple of things need to be taken into account when negotiating positions are analyzed:

i) GBP vs Euro exchange rate
Screen Shot 2017-03-19 at 12.17.53 PM

GBP is down 17% vs Euro since January 2016.

ii) Big Mac Index – implied currency valuation

Big Mac

Euro is approximately 10% overvalued

iii) Inter EU largest trading partners

UK is either second or third largest export market for: Denmark, Germany, Ireland, Spain, Italy, Cyprus, Malta, the Netherlands, Poland, Sweden – that’s roughly a third of the EU.

iv) UK trade balance of goods with the EU

UK trade w EU

UK is a net importer of goods from the EU.

v) WTO tariffs for major UK exports to the EU

WTO tariffs.png

Assuming that should there be a “hard” Brexit, tariffs would revert to WTO levels.

What do these numbers tell us?

In January Theresa May said:”I am equally clear that no deal is better than a bad deal”. Is she right? If we look at the figures above then it would look like she is right. In case of “hard” Brexit, it is logical to assume that WTO rules would govern trading relationship between the UK and the EU. If we look at import duties across the major UK exports, we can see that general rates are much lower than the implied over-valuation of Euro vs GBP. All this means that UK’s competitive position at current exchange rates would not be eroded if there is no deal and WTO level tariffs are applied against UK exports to the EU.

EU’s leverage over the UK is limited, unless EU decides to go nuclear and unilaterally increases customs duties above WTO levels. How likely is that the EU will take a hard line? If the decision is left to EU Commission in Brussels, then it should be expected that hard line will be taken. EU Commission is currently demanding that UK should agree to pay some 60 billion euros as part of its exit bill, and that is before any negotiations even start! Seems like a huge arbitrary sum of money that has very little chance of getting paid, for starters it is very unclear which court would even have jurisdiction over such a demand. This demand in itself could stall the negotiations with WTO rules automatically becoming a de-facto new trading standard after 2 year negotiations period has expired. If WTO tariffs become the standard, UK would end up with a pretty good deal, while EU’s exporters to the UK would be hurt.

More likely scenario is for the EU Commission to feel pressured by the EU exporters to make an economic deal that will maintain EU’s access to the UK’s market at preferential rates, especially in a weak GBP environment. When we analyze where will the political pressure come from – Germany, Denmark, Italy, Spain, Sweden – it is reasonable to expect that EU Commission will give in to the pressure. Commission’s interest and national interests do not align if we assume that Commission will want to make a political statement while national governments will have to live with the economic consequences of such political statement, possibly a gamble too risky for national governments to take.

Overall, UK’s position going into the negotiations is pretty solid, that position only looks better if free trade deal with US is a possibility. This analysis begs the question:”Who is next?”

 

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