Like Prime Minister David Cameron before her, Britain's Theresa May is guiding the Conservative Party into a reckless political and economic gamble over the issue of membership in the European Union. She has signaled a willingness to make a speedy withdrawal from the EU in order to pursue the "quiet revolution" of British society to make it work for everyone, as she announced in front(link is external) of party activists in Birmingham in early October.
Perhaps May's bet that a "hard" Brexit will not hurt the British economy much will pay off. But the long-term economic damage—as indicated by the accelerating decline in the value of the British pound(link is external)—is likely to prove so dire that voters will punish the Conservatives and open the way for another government in Westminster.
Feeling pressure from the party's anti-European grassroots, May revealed that her government preferred to start Article 50 negotiations to leave the EU no later than the end of March 2017, setting in motion a process for an exit at the end of March 2019, at which time the UK would revert to trading and interacting with the 27 EU members on regular World Trade Organization terms.
The difficulties most likely to arise from the "hard" Brexit will derive from May's determination to prioritize political sovereignty to control immigration. Her statement(link is external) is unambiguous: "We have voted to leave the European Union and become a fully-independent, sovereign country. We will do what independent, sovereign countries do. We will decide for ourselves how we control immigration."
Underscoring the point, she declared(link is external): "Our laws will be made not in Brussels but in Westminster. The judges interpreting those laws will sit not in Luxembourg but in courts in this country. The authority of EU law in Britain will end….. let me be clear. We are not leaving the European Union only to give up control of immigration again. And we are not leaving only to return to the jurisdiction of the European Court of Justice." Such clear rhetoric from the prime minister on key political issues directed at her own party is not a negotiating position likely to be mollified. Leaders' words matter and these are clearly some of May's red lines for the upcoming Article 50 negotiations.
So what are the economic implications of these political choices—which will help May maintain Conservative Party unity in the months ahead—for the UK economy? Insisting on the UK's sovereign right to regulate migration and ending the jurisdiction of EU law and the European Court of Justice in Britain are perfectly legitimate political choices, but they will make continued UK membership of the EU's Internal Market politically and legally impossible. The "passporting" rights of financial services firms based in the City of London to conduct business across the EU would also end. May's stance indicated that the UK intends to leave the European Customs Union as well, since the government would be required to do so to strike new trade agreements with other countries.
All told, May seems to have felt the political need to tell Conservative Party activists and the anti-EU press—who overwhelmingly supported Brexit(link is external)—what they wanted to hear, while attaching less importance to the economic implications. Remarkably, the UK Treasury seems to have very little influence over Brexit—the most important economic event in Britain in decades. As with the Brexit vote itself, it is increasingly clear that domestic UK politics will trump economics in the process of implementing the UK's departure from the EU.
May's rhetoric suggests that her government will pursue a clean break with the EU. Given that the EU will not compromise on free movement of labor, the EU and UK don't really seem to have much to negotiate about during the Article 50 negotiations, which once begun could conclude quickly. On the other hand, a clean break will set the stage for arduous and time-consuming negotiations over the long-term EU-UK relationship. A subsequent free trade agreement between the two could take an inordinately long time to conclude.
For a prime minister without a direct political mandate from British voters (or even her own party) and only a narrow parliamentary majority of 16, May has cleverly used the democratic legitimacy of the Brexit vote to keep her party together. If you oppose her definition of Brexit, you will be accused of insulting the "will of the British people," so all Tories are Brexiteers for now.
Ironically, the accelerating decline of the British pound—the symbol of sovereignty—may provide enough short-term economic benefits from rising exports and bargain-hunting tourists to direct the UK towards a "hard" Brexit in the coming months. But when domestic inflation picks up from rising prices of UK imports (which account for 30 percent of GDP), living standards will start declining, real growth will slow, government revenue will decline, and the Bank of England's monetary policy options will narrow. But by then it will likely be too late to change the direction of the negotiations with the EU.
The EU response to May's gambit is easy to predict. They will wait until Article 50 is triggered by March next year, then calmly tell the UK government that its political priorities will result in a "hard" Brexit. It is hard to imagine the EU accepting any transition period without the UK continuing to allow free movement of labor. If the transition period is more than a year, then May's government would fail to control EU immigration by the time of the next scheduled UK election. The Conservatives would surely not accept this, especially since the new Home Secretary, Amber Rudd, has proposed far-reaching policies to reduce immigration(link is external).
The EU will simply wait and see what happens in financial markets and the economy. Perhaps there will be no real effects, and the UK and EU will quietly go their separate ways, though without particularly good prospects for a close economic relationship.
But a departure from the EU's Internal Market and Customs Union would hurt the UK economy enough for voters to take notice—and blame May and the Conservatives for the fallout. Economic crisis is just about the only outcome that could benefit a battered Labour Party. A massive bungling of Brexit by the Conservatives would be its only chance at regaining political power in Westminster any time soon. An economic downturn would also boost the EU's negotiating position, because it would have achieved its strategic political goal of making a departure from the EU so economically painful that a government bent on pursuing it would not survive.
May's political gamble on a "hard" Brexit is a high-stakes game for the UK.
