What does London’s new mayor mean for Brexit?

London has elected its first Muslim mayor. It’s a development that many see as reflective of the city’s tolerance and capacity to embrace differences. Will the election of the pro-trade and pro-Europe Sadiq Khan ultimately prove a crucial turning point in the Brexit debate?

LondonAndTheBrexit

The city’s citizens have good reason to vote for openness. London is built on trade. Trade has largely contributed to today’s wealth and the rise of many cities, regions and nations. Although trade growth has been moderate since the Global Financial Crises, reestablishing trade barriers might lead to significant negative effects.

The United Kingdom has its own currency and enjoys a high degree of economic sovereignty, which would hardly be enhanced by Brexit. Whether the wave of refugees seeking save harbour in the UK would slow down post-Brexit remains a question mark. What’s more certain is that trade barriers regularly increase the price of imported consumer goods, the prices of materials and parts to local production as well as industrial assets, and consequently the prices for goods produced in-country, for internal consumption or for export.

Four scenarios for Brexit

What would Brexit entail? Answering this means formulating the possible positions the UK could take after an exit from the European Union (EU). The scenarios include: (1) complete independence, (2) loose association with the EU, and (3) broad harmonization with the EU – the exit could also be structured in a gradual and staged way. Finally, (4) the UK could join another zone, such as the North American Free Trade Agreement (NAFTA).

The choice between these options would determine the extent and nature of future trade barriers and the level of impact on society and economy within the UK, in respect to the exchanges of goods with EU members, with countries and blocs the EU has agreements with and finally with other blocs and nations.

If the UK stayed largely harmonized or associated with the EU, little change would occur. Under all the other scenarios, procurement, manufacturing and distribution networks would possibly need to be adjusted – immediately or over time, partially or even drastically.

How would Brexit impact business?

Looking at the cross-border movement of goods, the costs of trade to the economy as well as the impact on cost structures and consumer prices depend on the conditions in four key areas of trade facilitation: (1) border administration, (2) market access, (3) telecom and transport infrastructure, and (4) the business environment. Brexit would affect three of the four areas, namely border administration, market access and business environment.

Tightened border administration extends the time goods travel, slowing down deliveries while increasing the cost of transport. In addition, border controls reduce the reliability of the supply chain as the time required for possible inspections is unpredictable. In time-critical industries, this would force companies to hold buffer stocks and re-design logistics systems.

State investments in hyper-efficient customs clearance facilities, combining technology with smart procedures, can smooth away some of the negative effects. These approaches include pre-clearance processes based on pre-submitted customs information, or ensuring goods carry digitally and instantly retrievable information which can be used to let them clear customs while passing the border – probably a longer shot.

A curb on innovation?

The second area affected by the potential Brexit would be market access. Controls and regulations to structure which companies can sell and operate on the national market is often linked to the protection of local industries. This protection eases the pressure on local companies to innovate and drive serious programs to improve competitiveness.

Third, the business environment would be affected too: changes could occur in the area of investment policy and the hiring of foreign workers. The UK government would potentially need to negotiate trade terms and agreements with many partners – a costly process which can take years. In the meantime, the local and foreign companies operating in the UK might be faced with significant uncertainty.

In order to compensate for the cost and price increase, the UK government could consider tax cuts and subsidies to ease the pressure on consumers and manufacturers. Otherwise, the rising cost of production could trigger the gradual migration of UK manufacturing towards lower cost locations and increasing dissatisfaction among consumers and citizens.

Uncertainty, reduced competitiveness and job cuts

Uncertainty, reduced cost competitiveness and potential measures to protect local industries can lead to the gradual retreat of foreign players. Job losses and increasing dependency on imports would be the consequences. Over time, protected UK industries might fall behind the foreign players due to reduced cost optimization and innovation pressure and hence competitiveness.

In the short run, some sectors would be able to reap some short-term benefits. Logistics for example would be under pressure to redesign logistics concepts and build new distribution centers. However, this short-term revenue booster is to be considered economic waste. Instead of making the supply to the local economy and society easier and more fluid, investments would flow into efforts to cope with additional administration, regulation and procedures.

Logistics – in common with many sectors – would suffer in the end. For example, as the customers of the logistics and supply chain service providers put pressure back on suppliers, the effect would be shrinking margins. This is particularly challenging at a time when cash and financing needs for newly required investments would be well on the rise.

Referendum

It remains unclear what position the UK would take in the event of a Brexit. What is clear is that the additional layers of work and cost caused by tightened border administration, regulated market access and a deteriorating business environment would result in additional burdens and disadvantages for companies, and especially for consumers and citizens.

While initially, some industries would reap benefits, soon the negative repercussions risk spreading across all stakeholder groups – government, business and society.

Let’s hope that the election of Sadiq Khan will be followed by more enlightened public sentiment towards globalization, the importance of stress-tested trade blocs and the accomplishment of new agreements like the TPP and TTIP.

This blog was originally posted on the World Economic Forum Agenda.