Without a Brexit deal, we could find that we’ve walked off a cliffby George Magnus / March 29, 2017 / Leave a comment
The British government has now formally given notice under Article 50 of the Lisbon Treaty of its intent to leave the European Union—the most important economic and international relations decision since the end of the second world war. After the nine months of post-referendum hiatus, Prime Minister Theresa May’s government now has to negotiate the terms of our exit from and future relationship with the EU, prevent the disintegration of the UK—especially now that Nicola Sturgeon has called for a second independence referendum—decide which laws to keep, modify or reject, and keep the economy out of recession while mitigating the adverse consequences of Brexit on living standards.
Nothing is pre-ordained, but the chances are high that it will be a hard Brexit or even a Wile E Coyote moment—that is, the UK will tumble out of the EU as off a cliff, without an agreement about a future relationship and possibly without an agreed divorce settlement. If that were to happen, then the economic outlook would be markedly worse, despite what many Brexit cheerleaders have been asserting without rhyme or reason.
Article 50 (aka divorce) negotiations have to be concluded within two years, or else the UK will leave the EU without agreement regardless. This hard Brexit becomes all the more likely because, realistically, there is little more than a year to get things done.
France will hold presidential and National Assembly elections in May and June, and therefore won’t have a government that can negotiate until the summer. Germany will then hold national elections at the end of September and might not have a coalition government in place until the end of November. Moreover, EU negotiators have said that the approval process of any deal by the European Parliament and by member governments means that there has to be something on the table before October 2018.
The starting point is complicated further by a difference in approach. The UK wants to negotiate the divorce in parallel with a new free trade agreement (FTA), while the EU insists that the former must precede the latter. Though there may be some scope to compromise on procedural issues, there is no possible way that an FTA can be negotiated by 2019, let alone sooner.
The UK has limited negotiating leverage. The government says it wants to avoid a hard Brexit with its attendant economic and legal quagmire for companies and citizens. But the Prime Minister has also said that she will walk away from any deal that isn’t satisfactory. The EU holds all the cards. It just has to wait until 2018 or 2019 and call the UK government’s bluff. The Brexiteer argument that a hard Brexit would also hurt both parties economically is true but for the EU, nothing is more important than its existential integrity. Boris Johnson’s pitch that the EU needs the UK to buy its passenger cars and prosecco works for stand-up comedy, not for serious analysis.
An FTA is going to take a lot of time and a lot of horse-trading. Tariffs are important but not as key as non-tariff barriers, such as regulatory and competition conditions, public procurement, intellectual property rights, state aids and state enterprises, labour and environmental standards, rights of establishment, and legal and jurisdictional matters such as the European Court of Justice’s authority in matters pertaining to the single market.
But before even getting to that point, both sides will have to get to grips with the contentious terms of their divorce. These revolve around things like regulatory arrangements, the UK’s participation in ongoing projects in research, education and science, the rights of EU citizens living in the UK and UK expatriates living in the EU, the UK’s position in agreements supervised by EU institutions, and pensions payable to EU staff members including those of UK nationality.
As is well-known, the EU has “billed” this divorce settlement at €60bn, including also commitments to projects not yet started and contingent liabilities, for example loans to third countries. Unsurprisingly, the UK’s response has been sharp, with critics insisting that there is no legal basis for the charge. Doubtless the lawyers will argue the points, but ultimately, this is going to come down not so much to law than to goodwill on both sides.
In the end, though, there are only three likely outcomes.
First, and least disruptively, the UK and EU could agree on the terms of divorce, and having sketched the outlines of an FTA, they could then agree a transition period during which both sides would agree that the UK would phase itself out of the EU over several years. After all, when the UK joined the Common Market in 1973, negotiators agreed a seven-year period of transition, allowing the UK time to integrate.
It would make sense for a phased exit to happen, allowing all parties and businesses time to adjust to a new set of commercial arrangements. A transition deal would be acceptable to Parliament and to UK businesses, and constitute the least troublesome option for the government in terms of the courts and the constitution. Yet an alignment of interests between the UK and the EU to reach such a deal would still be extremely difficult.
Even if one were acceptable to the British and EU governments, there is a distinct probability that Conservative MPs in the Brexit vanguard, many of whom favour a hard Brexit, might object. Recently, backbench MPs instantly rounded on Chancellor Philip Hammond, regarded as a Remainer at heart, for his National Insurance proposal for the self-employed, prompting a U-turn. It was a timely reminder of their capacity to dish out similar treatment to a prime minister seen to be “going soft” on Brexit.
Second, there could be a hard-fought but ultimately agreed divorce settlement, but no trade agreement or intent to proceed with one. This would bring economic and legal uncertainty that would affect the economy badly. It would see the UK fall back on trade agreements in the context of its membership of the World Trade Organisation (WTO)—but only once all 164 WTO members had approved the UK’s newly crafted “schedule of commitments,” a statement detailing the terms of how the UK trades. The UK would then be subject to WTO rules and jurisdiction, face the EU’s common external tariff rates, including on cars and clothing, and have to negotiate agreements on services trade on a case-by-case basis. The WTO is known as a fallback option for good reasons—it is no substitute for the single market.
I have written before at some length about the precarious position of world trade and the difficulties of doing trade deals nowadays. In an environment increasingly determined by protectionism and President Donald Trump’s zero-sum game approach to trade, it will be a big stretch for UK trade deals with economically significant countries to compensate for leaving the EU. Neither the BRICS nor the Commonwealth countries come even close, while the United States is not about to do the UK any favours.
Third, in a variant of the second outcome, Article 50 negotiations could collapse well before 2019 in an environment of acrimony. The UK would face an even harder Brexit, and fall back on the WTO option. The economic and political climate though would very likely entail a plunging economy, and send business and investment into a protracted funk. It might well entail the imposition of emergency controls over the movement of capital out of the UK, an investment strike, the disruption of commerce, uncertainty over contracts and rights, and a meltdown in financial markets.
Nothing can be taken for granted now that the UK has crossed the Article 50 Rubicon, and two quite plausible risks could emerge. Both would have significant consequences.
By mid-May, France might have elected Marine Le Pen as President, after which her National Front Party would be expected to build on its two parliamentary representatives in the June National Assembly elections. If she were able to get the Assembly to vote for a Frexit referendum which she then won, Brexit would become a rounding error in the disintegration of the EU. A lot of UK voters would feel as if they had dodged a bullet.
Alternatively, and closer to home, imagine that by 2019 the UK had lapsed back into recession—a possibility made more likely if the Article 50 exit process doesn’t go well. After all, expansion has been going on for 31 quarters, 2.5 times the length of the average expansion between 1952 and 1992, although still half as long as the protracted and unique expansion between 1992 and the start of 2008. In Brexit Britain, coming to terms with a Trumpian zero-sum world, a UK recession could have a profound effect on public opinion.