Letter from Britain: A Looming Trade War With Brussels

Britain’s economy is grinding to a halt, inflation is set to reach double digits, interest rates are rising. What better time to start a trade war?

It will come as no surprise to anyone tracking Britain over the past few years that our relations with Europe are still haunting the political and economic landscape despite the Brexit agreement having been sealed 2-1/2 years ago.

No one was particularly happy about the agreement – it was, after all a divisive pact stemming from a divisive vote that broke Britain off from its largest trading partner only through compromise.

Now, the agreement’s weaknesses are beginning to bite.

Let’s start with the flashpoint du jour. Please don’t be put off by the legalese, but it is all down to something called “The Northern Ireland Protocol”.

This is a major dispute pitting London against Brussels, dividing the ruling Conservative party, threatening the peace in Northern Ireland, and risking a raft of damaging tariffs on goods entering the United Kingdom just when the country can least afford them.

Put simply, the protocol was agreed to get around the uncomfortable fact that the island of Ireland is divided between the eponymous European Union sovereign state in the south and the now-Brexited British province of Northern Ireland in the north.

It is supposed to guarantee an open trade border between the two entities, something viewed as crucial to the success of the 1998 Good Friday peace agreement that ended warring between Catholic nationalist and Protestant loyalists in the north.

But to ensure that goods from Britain that don’t meet EU standards or come from, say, Australia or America, do not enter the European Union’s single market by a circuitous route, it has in effect set up a border between Britain and Northern Ireland -- “in the Irish Sea”, as the critics have it.

Needless to say, Northern Irish Protestant parties loathe this, as do many members of Britain’s Conservative party. So, Boris Johnson’s government is preparing to ditch the protocol on its own — abrogating an international treaty — having failed to persuade Brussels to agree changes.

Europe has threatened retaliation: businesses are preparing for a tariff war and a bureaucratic paper onslaught.

Did Somebody Say Stagflation?

Setting aside the rights and wrongs of the dispute — and there are plenty of people of all political persuasions horrified at the idea of an international scofflaw Britain — the prospect of a trade war could not come at a worse time.

The latest GDP numbers made for worrying reading. They fell by 0.3 per cent in April, after a decline of 0.1 per cent in March, combining to create just 0.2 per cent growth in the three months to April.

Services, production, and construction all fell, suggesting a broad, no-excuses decline.

Add to that rising inflation: it was at 9 per cent at last count and is heading for 11 per cent by October, numbers last seen in 1981.

The Bank of England has responded by raising interest rates. They are only at 1.25 per cent, of course, but this is after years of next to nothing and is clearly an indicator of more to come.

The pound, meanwhile, has been weakening versus other currencies, including the Aussie dollar. While this may make investments attractive to outsiders, the reasons for the fall are not comforting.

A rise in tariffs from the EU would slow the economy further, add to inflation, and pressure interest rates. Not a pretty picture.

So, Who’s to Blame?

The rub is that it has not at all been clear up until now how much of Britain’s economic decline is due to Brexit.

The COVID-19 pandemic so changed the conditions in which Britain began its non-EU existence that it is all rather murky. In scientific terms, this is the “mere presence effect”: the pandemic so affects any investigation of the Brexit effect as to render it meaningless.

The government has spent up to £410 billion ($A720 billion) to combat the health crisis, according to House of Commons research. This has helped raise the country’s debt-to-GDP ratio to its highest level since the economically hideous 1960s.

And, of course, our recessionary GDP will not help this ratio even if spending stops. Just ask the Greeks.

But regardless of the pandemic, there are now clear signs that Brexit will be a serious drag on the already battered economy.

Last month, the independent and authoritative Office for Budget Responsibility said that the Brexit agreement will reduce Britain’s long-run productivity by 4 per cent relative to remaining in the EU.

Exports and imports, meanwhile, will both be around 15 per cent lower long-term than had we stayed.

Just to add salt to the wound it added that the main off-cited benefit of Brexit, new free-trade agreements allowed to be negotiated outside the EU (such as the recent one with Australia), will “not have a material impact”. 

So, at the moment, the evidence is that we in Britain may well have shot ourselves in the foot, economically speaking, by leaving Europe.

And some might argue that by risking a trade war with our erstwhile partners over Northern Ireland, we are now taking aim at the other foot.