What happens next with Brexit could make or break the UK economy

The chances of Britain leaving the European Union with a deal on October 31 are fading fast. That’s likely to leave the country facing a general election which could lead to a ‘no deal’ Brexit or a new coalition government led by leftwinger Jeremy Corbyn that would give voters the chance to remain in the European Union.

Business hates the chaos that would accompany the first of those two scenarios. It would prefer Britain to remain in the European Union but has deep misgivings about Corbyn’s tax and nationalization agenda. A new report published Tuesday by the independent Institute for Fiscal Studies (IFS), an economic research institute, in association with Citigroup, examines the economic consequences of both potential outcomes.

The first scenario, where Britain crashes out of the European Union without a deal that protects trade, would wipe out two years of economic growth, according totheIFS. Prime Minister Boris Johnson insists he wants to follow this path if a deal cannot be secured before the October 31 deadline.

Tensions between Johnson and EU officials are rising, leading to an exchange of views on Tuesday that suggests a deal is out of reach.

“What’s at stake is not winning some stupid blame game. At stake is the future of Europe and the UK as well as the security and interests of our people. You don’t want a deal, you don’t want an extension, you don’t want to revoke, quo vadis?” European Council President Donald Tusk said in a tweet directed at Johnson.

“Talks in Brussels are close to breaking down,” a UK government source also said.

The most likely scenario now is that Brexit is delayed yet again, an outcome that Britain’s parliament has sought to ensure by passing a law requiring Johnson to seek an extension if he can’t get a deal with EU officials.

Opposition parties will then try to force an election in November. If Johnson wins, a no-deal exit is back on. The most likely alternative is a coalition government led by Corbyn’s Labour Party. The IFS report analyzes a scenario where the government holds a second referendum and Brexit is revoked.

No deal, no growth

The UK economy would not grow at all in 2020 and 2021 in the event of a no-deal Brexit, the IFS report finds.

The European Union is the United Kingdom’s single biggest trading partner, accounting for 44% of total UK exports of goods and services in 2017, according to the IFS. UK government research published Tuesday said that businesses would face ￡7.5 billion ($9.2 billion) in additional administrative costs relating to trade each year in the event of a no-deal exit.

Debt is projected to rise substantially in that scenario, climbing to almost 90%of annual economic output for the first time since the mid-1960s, as the government borrows more to increase spending and kickstart economic growth.

Nissan cars are pictured, parked in a lot at its' Sunderland plant in north east England on March 16, 2019. - Carmakers are facing fallout from Britain's decision to leave the European Union, a Chinese economic slowdown and from Beijing's ongoing trade row with the United States. (Photo by ANDY BUCHANAN / AFP) (Photo credit should read ANDY BUCHANAN/AFP/Getty Images)

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But weaker household consumption and declining investment growth would offset the increase in government spending, according to the IFS. Interest rate cuts to zero and quantitative easing worth ￡50 billion ($61 billion) would not provideenough relief, as declining trade also proves a drag on growth.

The economy would expand by just 1.1% in 2022 and the government would be forcedto revert to austerity in order to keep debt under control. Over the longer term, the United Kingdom’s economic trajectory post Brexit would depend on government policy relating to tariffs, regulation and immigration.

Stopping Brexit is best for UK economy

The IFS does not mince words about which scenario would be best for the UK economy: “Revoking Brexit would lead to the best economic outcome,” its report says.

The institute suggests that Brexit could be called off if a coalition of parties led by Labour triumph in a general election. They might hold a second referendum on Brexit, and the public could return a vote against leaving the European Union.

Calling off Brexitwould boost private consumption, which accounts for two thirds of the UK economy. That would, in turn, cause economic growth to accelerate.

Crucially, this scenario assumes that smaller parties such as the Liberal Democrats and Scottish National Party would form a government with Labour, and limit the party’s ability to implement some of its more radical policies.

If fully implemented, Labour’s economic proposals — including widespread nationalizations and handing 10% of large companies’ share capital to employees — would “likely do significant damage to the outlook for UK growth,” says the IFS.

That’s because higher taxes and changes to labor laws favored by Corbyn would make the United Kingdom less attractive to foreign investors and could trigger outflows of domestic capital.

The damage done

The UK economy is already 2.5% smaller than it would have been had voters chosen three years ago to remain in the European Union, according to Citi’s chief UK economist, Christian Schulz.

Even if Brexit were called off, the flatlining of business investment in theUnited Kingdom over the past three years would be difficult to unwind, Schulz said at a media briefing on Tuesday.

“This will stick with the UK economy for a long time,” he said.