Brexit and the price of friction

**Kashish Kapoor** (0:04)
In today's episode, we have two interesting stories. In the first one, we will talk about Brexit. It's been a decade since the referendum happened, and we wanted to take a look back at what happened after that and the price of friction. In the second story, we will look at Bank of Baroda's expensive 5700 crore out-of-court settlement in Abu Dhabi. Hello and welcome to The Daily Brief show by Zarodha, where our aim is to cut through the noise and bring you the biggest news in the financial markets in a way that's one level deeper as compared to other news channels. I'm your host, Kashish Kapoor. Today is Wednesday, 8th of July.
Before we start, we'd like to tell you that we have officially launched Subtext. You may have noticed lately that we've been doing podcasts with a variety of guests. All of them share one feature. They're incredibly knowledgeable about a specific niche of how markets work. And we realize that more people should know who they are and what they do, no matter how popular. Now, those episodes found a new home, a separate YouTube channel for Subtext. We will be launching at least one episode each week, even two when we can. We're also on Spotify, Apple Podcasts, and we also have a newsletter if you like to read the transcripts instead. We hope you give our newest baby some love, and we're also open to guest recommendations from you all. Now, let's start with the story. It was an early summer day 10 years ago when Britain voted to leave the European Union. Half the countries celebrated their freedom from the yoke of Europe. The other half despaired. What would this do to the kingdom's relationship with the continent? What would it do to the millions of trade relations that connected the two? Europe surely would not make this departure easy, or all its other members would clamor for an exit. What if single market was violently torn into two, with British businesses suddenly finding a steep tariff wall to climb? What if Welsh lamb farmers and Scottish distilleries suddenly found hefty tax bills waiting at the French border? It would be economic Armageddon. There were fears then of no deal, that Europe, Britain's largest market, would only trade with it on the barest of terms, as if it were any other country. A panic set in. Experts were pessimistic. The UK treasury and many independent forecasters claimed that leaving Europe would drag Britain's economy down substantially in the long run. Most converged on a 4% drop, with things getting worse if the conditions of Britain's exit hardened. In fact, the UK treasury even warned of an immediate recession. Then briefly, nothing happened. There was no recession. By the late 2020, a deal was on hand, the Trade and Cooperation Agreement, called TCA.
It gave the country everything it wanted. Zero tariffs, zero quotas. There was no cliff after all. Britain had escaped the worst, and all that pessimism now felt like empty scaremongering. Those that read concerns were tainted with nickname, Project Fear.
Now, all these years on, they no longer seem so far off the mark. In the years since, the country's GDP turned sluggish. Its exports dropped and its productivity stalled. Brexit clearly broke something. Even if it wasn't clear what.
Before Britain broke out of Europe, few people actually saw the value of what it had. Britain had been woven into Europe for nearly 50 years, with millions of delicate interconnections, many of which were barely visible. A lobster caught off the Scottish coast on Monday would be on the plate in Paris on Tuesday. A restaurant in Manchester could order a German dishwasher and have it delivered the same week. A car plant in the English Midlands could run with almost no spare inventory because they could trust parts to ship in from Europe exactly when needed. It was seamless, a single market with the English channel just being a geographical feature. And then there was passporting, which made London Europe's financial hub. A bank licensed in London could sell its services across the whole continent without reaching out to regulators in Paris or Frankfurt for separate approval. This made the country a financial gateway to Europe. An American bank could set up a regional headquarters in London and serve 27 countries across the continent. This wasn't simply because Britain had tariff-free access to Europe, though that helped. It was because when it came to business, there was no barrier between the two. Britain was bound to Europe through the invisible plumbing of a shared rule book and an open borders. Exporters didn't have to fill forms, prove the origin of their goods or wait for border inspections. This was what Britain had put at stake in the fateful vote. In the first few years though, none of this was touched. One could barely see the economic cost of Brexit. There was only uncertainty. Even as later as 2019, it wasn't clear what fate Britain was headed for. The ground was still moving under its feet. For all one knew, there would be no arrangement to fall back on. That uncertainty bit. Investments stalled, businesses put off decisions that were hard to undo. A striking amount of senior management time in those years drained into contingency planning. Three quarters of British CFOs spent at least some time thinking through Brexit, managing supply chains, wargaming no-deal scenarios, and restructuring taxes. Almost a tenth of them were spending six hours a week on these problems. But there was nothing visible. It's hard to measure the cost of lost time. Perhaps those hours were better spent on new products or business relationships that wouldn't be obvious from the data. If anything, Britain's trade figures looked surprisingly calm. The pound had fallen immediately after the vote, making its goods cheaper. That gave British exports a boost, cushioning the hit that Brexit delivered. This is why perhaps it was easy to dismiss the pessimists, especially once the deal came into sight, and it seemed like the country would ease into zero tariff relationship with the continent. What wasn't apparent though was that the deal still broke the invisible plumbing that tied Britain to Europe. In its place, there came paperwork. Even if exporters avoided custom duties, they still had to contend with the border. Consignments now required forms, certificates and customs brokers. Consider a shellfish exporter that till now just sent their catch over to the mainland.