BREXIT in a Nutshell

In June 2016 the United Kingdom, the world's seventh largest economy with a current GDP approximately over $3 trillion, voted to leave the European Union, with an official exit date (Brexit Day) now set for October 31, 2019.

The European Union (EU) is an economic and political union currently made up of 28 European member nations, with the objective of ensuring peace and safety in Europe and fostering economic prosperity wellbeing among member nations. Headquartered in Brussels, Belgium, the history and evolution of the EU can be found here.

The 51.9% vote in favor of leaving the EU was largely driven by the wave of nationalist sentiments being felt in many Western nations over the last few years but particularly in the UK where British nationals began to voice feelings of alienation from the policies that were being made in Brussels and seemingly being imposed on them, and which had adverse effects on their lives.

As the referendum vote was in favor of leaving the EU, in March 2017 Article 50 of the EU Treaty was triggered to formally begin the divorce process with the goal of ensuring a smooth and minimally disruptive outcome given the current entanglements of lives, property, trade and finance relations currently in place involving British and EU nationals across the UK and the remaining EU member nations.

The Issues

Three key issues highlight the potential messiness of the process and outcome. The first has to do with citizen's rights - how would the roughly 3 million EU nationals living in the UK, post-Brexit, be treated, and similarly how would the roughly 1.3 million UK nationals living in the EU also be treated?

The second is the Irish Border problem - the United Kingdom includes England, Scotland, Wales and Northern Ireland. Northern Ireland is therefore a region separate from the Republic of Ireland. The Good Friday Agreement of 1998, which led to peaceful relations between both countries, following decades of violent conflict between the two regions, introduced a soft border between both regions. With Brexit, a hard border might need to be reintroduced between Northern Ireland (since it still is part of the UK) and the Republic of Ireland (as it is still a member of the EU).

The final issue involves the nature of trade relations are expected to be in place between the UK and the EU after Brexit. Currently the UK is part of the EU Single Market and is in a Customs Union with the EU. This means there are existing business and work related arrangements made by millions based on the existence of less restrictions in the movement of people and goods between the UK and the other EU member nations and on the basis of the same trade policy toward other non-EU countries. Brexit poses a huge challenge for these individuals and businesses, so some form of mutually beneficial trade agreement needs to be reached so as to mitigate any disruptions from Brexit.

It has indeed been a really messy process...

Coalition Government Politics

Theresa May became British Prime Minister in July 2016 following the resignation of David Cameron shortly after the Referendum vote on the UK remaining within the UK. Cameron had campaigned to have the UK remain in the EU. Theresa May then went ahead to call for early general elections perhaps to buoy her policies and to secure a more certain majority within the Conservative party to enable her follow through on the Brexit mandate.

The election which still gave her Conservative party a plurality of seats however failed to retain its majority in Parliament which forced Theresa May to enter into an alliance with the Democratic Unionist Party (DUP) in order to maintain a majority government. The DUP is a socially conservative party from Northern Ireland that favor maintaining strong ties to the rest of the UK as being British, and less ties to the EU in general.

Well, while the citizen's rights issue moved along with reciprocity agreements being reached between the UK and the EU on a smooth transition program for their nationals residing in their respective countries/ regions post-Brexit, the trade negotiations have been more contentious in particular because of its necessary association with the Irish Border issue.

The Problem:

A major desire for Brexit, in addition to being untethered to the EU, is to allow the UK make separate trade deals with other countries, which it deems more favorable than those struck by the EU which it had to comply with if in a custom's union with the EU. May pledged to have a deal with the EU that included the UK leaving both the Single Market and the customs union. However how to implement such a policy while leaving a soft border between Northern Ireland and Ireland remains a thorny issue.

To compound things, the DUP is loathe to having any agreement in place that weakens the connection of Northern Ireland to the rest of the UK while strengthening their ties to the EU via Ireland. So having a border in the Irish Sea is a non-starter. This means that if a trade agreement is not reached between the UK and the EU, perhaps some sort of free trade area (FTA) and not a customs union, then a hard border has to be reintroduced between Northern Ireland and Ireland.

The EU of course is not likely to agree to the establishment of such an FTA since it could lead to trade diversion, if for example, the UK introduces lower tariffs than the EU on similar products for their same trade partners. Further, it would send a wrong message to other member states that perhaps leaving the EU might be advantageous to them if they could also negotiate similar trade deal as the UK and this would ultimately break up the EU.

Enter the Backstop Deal

So what happens if no trade agreement can be struck? As the negotiations between May's government and the EU continued over these thorny issues, the EU staked a hardline position and requested for a backstop arrangement to address the Irish Border problem should a no-deal Brexit happen - that is, should Brexit Day arrive and no agreement be reached on trade, what is to happen with respect to the border between Ireland and Northern Ireland.

The Backstop Deal calls for Northern Ireland to remain in a trade alignment with the EU trade rules so as not to change the status quo on the soft border between the two regions indefinitely until both the UK and the EU jointly agree to end this arrangement.

Well through several attempts by May to get the UK parliament to vote in support of this arrangement, including minor revisions, and failing on all attempts, and with prior attempts to negotiate with the EU on the use of technology to monitor the border or to collect tariffs on behalf of the EU for goods heading to the EU via Northern Ireland etc. having failed, Theresa May decided to resign from the position of Prime Minister.

No-Deal Brexit Approaching?

Theresa May's resignation became official Wednesday, a day after the Conservative Party elected Boris Johnson as the new British Prime Minister. Johnson a hardline pro-Brexit conservative has promised to deliver Brexit claiming he can reach a deal with the EU on Brexit. Well, this is where we are at present.

As the Conservative Party is still supported in government by the DUP it remains to see what actions Johnson will take that are any different from the actions May had taken. It is clear that Johnson does not support the Irish Backstop deal and will steer any negotiations away from that so something that will garner full support from the DUP and hopefully more Conservatives in order to pass a Parliamentary vote.

Speaking yesterday on the first full day of his having become Prime Minister, Johnson vowed to complete Brexit within the next 100 days. Whatever his plans are, it will likely still be a messy divorce as the EU is unlikely to renegotiate a deal that gives a free pass to the UK regardless of who occupies 10 Downing Street.

Implication and Spillovers

The British pound has been in a free-fall since the announcement of Boris Johnson's win and while exchange rates are very volatile, it is expected that the pound would continue to trend downward in general as we approach Brexit Day and beyond. The Pound's weakening is due to the fact that investors holding assets in these economies may be rushing to move them into less volatile markets like the US or Japan given that a no-deal Brexit is forecast to adversely affect both the EU and UK economies.

This perhaps recessionary outcome will be due to widespread disruptions in business and trade that will further be compounded by uncertainty surrounding any new rules being put in place, and real and imagined concerns about how a hard border will affect peaceful relations between Northern Ireland and Ireland.

As both the UK and the EU (excluding the UK) are major trading partners with the US, the fallout from a hard Brexit with no deal will spill over to the US. Presently because the pound has weakened against the dollar, there might be a surge in British exports to the US along with capital flows. The combination of these may have a neutral effect on the US economy since the adverse growth implication from a decrease in net exports may be offset by the capital inflows which would bolster asset prices and increase consumer wealth and spending.