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For Britain, path forward shrouded in uncertainty

Wed, Apr 19, 2017 (2 a.m.)

British Prime Minister Theresa May’s decision to seek early elections reveals a simple truth: The hard edge of Brexit has begun.

The challenge of launching a fundamental renegotiation of Britain’s economic and political relationship with Europe, and a transition that could take a decade, is straining political consensus both in the United Kingdom and the continent. Brexit will produce a Britain that is poorer and less of an economic and financial power than if it had remained. At the same time, the Brexit vote adds to the populist and inward-looking centrifugal forces pulling at Europe. Economically, Brexit is bad for the United Kingdom and bad for Europe.

Britain’s economy weathered the initial shock of the June 2016 Brexit vote impressively well. The economy proved resilient, supported by solid consumer spending and a better export environment after the fall of the British pound. Economic policy played a role, as the central back stepped in with timely support and the government sensibly reversed pre-vote threats of fiscal cuts.

But the primary cost of Brexit was never to be measured by short-term dislocation, but rather through the long-term loss of investment and reduced efficiency that comes from lost access to Europe’s common market and a less prosperous economic future.

Economist estimates of the long-term pain from Brexit on the United Kingdom range from 1.5 percent to 9.5 percent of U.K. GDP, between one-third and one-half of the growth the U.K. would have expected over the next decade. That’s a wide range of outcomes, underscoring the uncertainty involved in the calculation, and even these numbers perhaps underestimate the longer-term benefits to an economy in terms of vibrancy and innovation that come from the two-way flow of migrants, students and entrepreneurs.

The outcome, of course, depends critically on the new arrangements that are negotiated, and the invocation last month by Prime Minister May of Article 50 of the Lisbon Treaty brought the challenge ahead into sharp relief. Formally, the process begins a two-year negotiation of the terms of Britain’s exit, and involves difficult questions as to Britain’s remaining financial commitments to Europe and the rights of expatriations once Britain is no longer part of the European Union.

As challenging politically as agreeing the terms of the divorce arrangements may be, the more difficult and ultimately more important decisions regard the future arrangements linking Britain and Europe. Because it could take a decade or more to fully negotiate those terms and achieve the unanimous agreement of all European countries, a set of transitional arrangements governing relations in the interim will be needed. Thus, a successful Brexit requires negotiations on three separate but tightly interconnected tracks — divorce, transition and new relationship — without a clear playbook or expertise to chart the way forward.

Further, the coming elections in Europe — French elections beginning this weekend and German elections in the fall — make it impossible for tough decisions on the future of Europe to be made by leaders. After those elections, and allowing some time for preparation, negotiators will have roughly six to nine months in 2018 to make the critical decisions on the path forward, in order for the exit agreement to be confirmed and implemented by the March 2019 deadline imposed by the Lisbon Treaty.

The most likely outcome at this point is Brexit is followed by an extended transitional period in which Britain receives many of the benefits of free trade with Europe and in return accepts many EU rules. Some have suggested Britain joins the European Economic Union (the “Norway model”), which would in principle give it access to Europe’s single market and certain EU programs in exchange for a financial contribution, while the longer-term arrangement is worked out.

But even that approach could prove politically too difficult for a U.K. government that has campaigned on restoring sovereignty. Meanwhile, Europe continues to struggle with economic and financial union amid mounting discontent.

Thus, we are left with a difficult transition to a highly uncertain long-term. The political instinct may be to delay, but markets operate on a different timeline. Investors will need to make decisions on where to invest and operate, and where to employ their workers. Even if agreement ultimately is reached on a new, strong free-trade arrangement linking Britain to Europe, this disconnect between political and economic timelines ensures that markets will increasingly struggle with the uncertainties created by Brexit.

Robert Kahn is the Steven A. Tananbaum senior fellow for international economics at the Council on Foreign Relations. He wrote this for InsideSources.com.

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