As last week’s column explained, Britain’s exit from the European Union (a.k.a. Brexit) will disrupt global wine markets in a variety of ways. British wine drinkers will be affected, of course, but so will consumers and producers in other countries as global markets react, redirect, and seek out new market equilibria.
How much will the global wine market be disrupted? It depends upon exactly how Brexit unfolds. There are good, bad, and ugly scenarios (although, as in the famous Sergio Leone film, the good is really only not-so-bad compared with the bad and ugly story lines).
The British Pound’s swift fall has increased UK wine prices already, as I said last week, but this isn’t the end of higher prices. I expect tax increases to be the next shoe to drop.
Mind the Gap: Higher Wine Taxes
Why would the May government raise wine (or alcohol) taxes? Brexit is going to be expensive. Really expensive. The UK will be on the hook for as much as £50-£60 billion of obligations for EU projects that are currently in progress. These payments may be negotiated to some degree, and are sure to be a point of contention, but they won’t go away. So outflows to the EU will continue.
In the meantime, the UK government will need to staff up domestically to replace government functions currently handled by EU personnel. One estimate suggests that 30,000 new government employees will be needed. Some of the first to be hired will be the trade negotiators needed to negotiate Brexit. Incredibly, the now-defunct Cameron government that called the referendum on EU-membership had no contingency plan for Brexit or staff to implement it ready in case it passed.
Higher expenses will come on line just as the British economy weakens (growth estimates for 2017 have been halved already — from 2.2% growth down to 1.5% — although the economy help up very well in 2016), so tax increases will be needed to span the budget gap. I expect wine/alcohol taxes to be part of that package. Such taxes already account for about 50% of the cost of inexpensive supermarket wine in Britain.
Beyond the exchange rate and tax effects, the impact of Brexit on wine depends upon what kind of Brexit is finally agreed — and there is a wide range of possible agreements (and disagreements!).
Too Good to Be True: Buffet Brexit
Many in the UK would prefer what I call “Buffet Brexit” where the UK government picks and chooses what it wants from the relationship (access to the Single Market, please, and special considerations for the London financial sector) and what it prefers to skip (free labor movement and immigration).
Buffet Brexit would be not-so-bad for wine. The British market would retain free access to European wine markets and also the existing system of tariffs and trade agreements with outside countries. The tax and exchange rate issues would not go away, however, but might be less severe.
Buffet Brexit is, however, the least likely outcome. Probability = zero. If the EU lets Britain dine at the buffet, other members will want the same options and benefits and the union could quickly collapse.
Not-So-Bad: BFF Brexit
I call the second option BFF (Best Friends Forever) Brexit but the more common term is “Soft Brexit.” The UK formally leaves the EU but both sides pledge to stay best friends forever and so exit expenses are minimized and spread over many years, “passporting” agreements are made to allow the UK to remain a major financial hub, and access to EU markets, perhaps through customs union membership, allows continued access to EU markets.
Precedent (the Norwegian model) suggests the Britain would have to pay for the privilege of having market access, however, and remain subject to EU regulations without a voice in setting them.
BFF Brexit might not dramatically change the UK wine market depending upon how trade relations are negotiated. UK sales would still fall, however, creating a global surplus that would spill out into other markets, increasing competition and lowering margins elsewhere.
But even BFF negotiations are problematic. In case you haven’t noticed, trade agreements these days are detailed and negotiations take a long time — some believe it will take 10 years to reach complete agreement!
Even if the UK and EU remain BFFs through all this, the uncertainty the comes with these negotiations will be bad for wine and bad, really, for most sectors the British economy. Probability of BFF Brexit = only 10 percent, mainly because the exit cost conflict is likely to turn friends into enemies. That’s what often happens when couples divorce, isn’t it? And this divorce is very complicated and there is a lot more than custody of Fido at stake.
The Bad: Break-Up Brexit
Break-up Brexit (a.k.a. “Hard Brexit”) is a more drastic option and would have important impacts on global wine. Significantly, this is the option that Prime Minister May seems to favor. Britain would cut ties to the EU, with free access to the single market replaced with WTO “most favored nation” status which, according to the Economist, is a best understood as an open can of worms and not a simple process. Britain would need to start from scratch negotiating deals with its trade partners.
Interestingly, President-elect Trump, who says he hates trade deals, has recently said he would push through a UK-US trade agreement quickly in the case of a hard Brexit. Apparently he hates the EU even more than he hates trade deals. Go figure.
The cost of wines from France, Italy, Spain and other EU countries would jump in the UK as would those from non EU countries when existing trade preferences end. Chile, which has a preferential trade agreement with the EU, would be a big loser at least until a separate trade agreement with the UK is agreed after Brexit talks are concluded.
Break-up Brexit would give UK “Leavers” what they want most — control over immigration and trade barriers — but at a very high price.The impact on the UK wine market would be very substantial and the side-effects around the wine world would be quite large as the markets adjust to the loss of British sales. The UK’s central place in the wine industry would clearly change. Probability of Break-up Brexit = 40 percent.
The Ugly: Train Wreck Brexit
Financial Times columnist Gideon Rachman argues that the most likely outcome is what he terms “Train Wreck Brexit” and I will give it a 50 percent probability, although that’s just a guess.
The train wreck occurs, in Rachman’s analysis, when EU and UK negotiators realize that they just can’t agree on critical elements of the exit deal throwing some issues into the courts (the International Court of Justice in the Hague might have to decide how much the UK owes for transition payments) and other issues into limbo. It could take years and years before the smoke completely clears and in the meantime the uncertainty would have terrible effects.
The train wreck scenario isn’t good for anyone and certainly not good for wine, which would suffer all the problems of hard Brexit plus others due to the lack of a clear path ahead. The stress and uncertainty levels would be high. Scotland might vote to exit the UK to gain some control over its destiny, which would add to the crisis.
Perhaps the threat of the train wreck will be enough to convince the parties involved to find a better solution. Interestingly, it is not clear that the Brexit process can be reversed once Article 50 is invoked. Like the doomsday machine in Dr. Strangelove, the idea seems to be to deter EU exit by making it a total and inevitable disaster. But, that doesn’t work if no one knows about doomsday plan (the Dr. Strangelove scenario) or if voters don’t believe it or just don’t care (Brexit).
As you can see from my speculative analysis, the most likely options are also the most disruptive for the wine industry. Wine prices are likely to rise dramatically in the UK due to the falling Pound, rising taxes, and higher trade barriers. Price-sensitive British buyers will react accordingly, creating a surplus of wine on the global market and disruptive market arrangements generally.
EU wine producers will be hurt the most by lower UK sales and others like Chile, with its preferential access undermined, will also suffer. But the impacts will extend far beyond as the wine not sold in the UK looks for a home elsewhere in the global marketplace. Winemakers in California who never gave a thought to UK sales will find themselves the unintended victims of increased competition.
The odds are that Brexit will be a game changer for wine, but it is hard to know for sure what the new game will look like. Stay tuned.
The Wine Economist takes a break next week — I’ll be at the Unified Wine & Grape Symposium in Sacramento moderating the “State of the Industry” session and talking about Brexit and other wine market issues. Hope to see you there!
In the meantime, enjoy this clip from Dr. Strangelove.