The UK economy is sailing toward dire straits

At a time of rising U.S.-China trade tensions and a marked slowdown in the European economy, the last thing that the world economy now needs is a deepening in the U.K.’s Brexit crisis.

Yet, it is difficult to see how the U.K. economic and political situation will not worsen meaningfully as the world’s fifth-largest economy approaches its Oct. 31 Brexit deadline.

The primary reason for heightened concern about the U.K.’s immediate economic and political outlook is Nigel Farage’s Brexit Party’s strong showing in last month’s U.K. European parliamentary election.

The corresponding implosion of the ruling Conservative Party, which suffered its worst electoral defeat in more than 150 years, leaves the Conservative Party with little alternative but to choose a hardline Brexiter like Boris Johnson to replace Theresa May as prime minister.

As if to underline the rising risks that the U.K. will soon crash out of Europe, Boris Johnson, the odds-on favorite to become the U.K.’s next prime minister, has indicated emphatically his commitment to have the U.K. leave Europe on Oct. 31 with or without a deal.

It also does not help matters that the Europeans are showing little inclination to renegotiate the Brexit deal that they negotiated with Theresa May nor that the U.K. parliament does not have the necessary time to agree to a new Brexit deal before Oct. 31.

The economic damage to the U.K. economy from a hard Brexit is not to be underestimated. According to the Bank of England and the International Monetary Fund (IMF) such a worst case scenario would almost certainly precipitate a deep economic recession with U.K. GDP likely to decline by more than 5 percent.

It would do so as supply chains would be seriously disrupted and as investors would choose to relocate their operations out of the U.K. and toward the continent.

At this stage, the only real way that a hard-Brexit can be avoided would be for parliament to engineer a successful no-confidence vote in the government before Oct. 31.

That would give the Europeans a credible excuse to make yet another extension to their Brexit deadline and to thereby avoid a hard Brexit that is neither in the U.K.’s nor Europe’s economic interest.

They could do so on the grounds that a new general election would give the UK public the chance to reconsider whether or not they really wanted to leave Europe.

The chances of a successful no-confidence vote before October 31 would not appear to be high. This is particularly the case since it would require many members of parliament to be prepared to accept the high likelihood that they would lose their seats to members of the surging Brexit Party.

Even if there were to be a successful no-confidence vote it would not be without serious adverse economic consequences. This would seem to be particularly the case because investor’s confidence would be seriously shaken by the prospect of a minority government that could be led by a very market-unfriendly Jeremy Corbyn.

The net upshot is that rough sailing seems to lie ahead for the U.K. economy under any plausible scenario. In the worst case and more-probable scenario, the U.K. could crash out of Europe on Oct. 31 and see the world’s fifth-largest economy take a serious hit.

In the best case and less-probable scenario, the U.K. economy would languish for a prolonged period of time in an environment of heightened domestic political uncertainty.

Judging by the relative calm in the U.K. currency market, investors seem to be sanguine about the U.K.’s immediate economic and political outlook.

One has to hope that global economic policymakers do not share the market’s sanguine view of the U.K.’s immediate economic and political prospects and that they are making contingency plans for a hard Brexit on Oct. 31.  

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.