The Truth About Brexit

“Well, that was pretty awesome – and I mean that in the worst possible way.”

– Paul Krugman

Theresa May has now invoked Article 50 and, by doing so, she has triggered the Brexit process at a more formal level. As she said after the letter was handed over to President Tusk:

“It is a historic moment – there is no turning back.”

Almost every day I get another email on Brexit and, interestingly, many of those emails come from readers in countries far away. It clearly isn’t a topic that only preoccupies those of us who live in the UK. We are now almost 10 months into the unknown, and one could - with some right - take the view that, as nobody knows how it will all pan out, what’s the point in writing more about it?

Having said that, one could also argue that we know things now that we didn’t know last summer. I certainly do; hence this follow-up note on Brexit. One disclaimer before I begin. I am a Remainer, so the following may be a tad coloured (but only a tad). I believe the future outside the EU will be a great deal more problematic than most people realise.

Exhibit 1: UK trade balance with other EU countries, 2014

Source:, March 2017

Even if this month’s Absolute Return Letter has a negative bias, I owe to my readers to point out that Brexit is not only bad news. A weak Sterling, for example, will likely give UK industry a major boost, but that is already well advertised by the Brexit brigade and, in this letter, the aim is to focus on what is (largely) kept out of the media.

Exhibit 1 above explains the prevailing attitude amongst the Brexiters I speak to – a view I am confronted with virtually every day of the week. “Why worry? We are a net importer of goods from most EU countries. They [the other Europeans] have a great deal more to worry about than we do, if the free trade agreement is abolished.”

If only life were that simple, but it isn’t. Martin Wolf has produced a series of great articles on Brexit for the Financial Times, where he argues that, although the UK runs a significant trade deficit vis-à-vis the rest of the EU (‘rEU’), UK exports to rEU still account for almost 50% of total UK exports (exhibit 2). No free trade agreement would put those exports at risk.

Exhibit 2: Importance of the UK and the rest of EU to one another (2015 merchandise trade shares)

Source: Financial Times, Thomson Reuters Datastream, March 2017

rEU, on the other hand, is in a far less precarious situation. If one includes intra-EU trading, the UK accounts for only 7-8% of rEU exports (the dark red bars in the lower half of the chart). In other words, trade between the UK and rEU is far more important to the UK economy than it is to the rest of the EU.

Another way to look at things is to look at how many jobs are at risk, should we end up with no free trade agreement between the UK and the EU going forward. OECD provides an estimate as to how many workers are employed in jobs that depend on foreign demand (i.e. exports).

Exhibit 3: Percentage share of total employment embodied in foreign demand

Source: The Daily Shot, OECD, March 2017

If you adjust for the fact that exports to the UK are not that important to rEU (as they aren’t - we just learned that), the only conclusion I can draw from exhibit 3 above is that the UK will put many more jobs at risk than any other EU country will.

What you export also matters

By far the biggest German export article to the UK is - not surprisingly - vehicles (see here), and I would be very surprised if the Brits suddenly fall out of love with their beloved German cars, just because there is no longer a free trade agreement in place between the two countries.

The UK is a very different story. The UK exported £220 billion worth of goods and services to rEU in 2015, whilst importing £290 billion worth in the same year, generating a trade deficit in goods and services of about £70 billion (see here for details). Services alone generated a trade surplus of about £21 billion, though, highlighting the importance of the financial industry for the UK economy - an industry the EU could do significant damage to, if the UK doesn’t play ball in the upcoming negotiations.

Pharmaceuticals also deserve a mention in this context. Being one of the largest UK export industries, it is a critically important industry for the wellbeing of the UK economy. The EU could quite possibly make life very difficult for the UK pharma industry by slowing down the regulatory approval process.

Consequently, I wouldn’t be enormously surprised, if a future without a free trade agreement would hurt UK exports to the EU a great deal more than EU (German) exports to the UK. Only time can tell.