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Thursday 02 November 2017

Brexit: A note from a small island

On Thursday the 16th of March 2017, the European Union (Notification of Withdrawal) Bill received Royal Assent in the UK parliament thereby passing into UK law. This conferred upon Theresa May, the UK Prime Minister, the permission to trigger article 50 of the European Union Treaty and formally start the two-year process of the UK’s withdrawal from the EU.

We therefore enter a period during which the UK will seek to negotiate an exit agreement which is unanimously agreed to by the remaining 27 members of the European Union (EU). Should we not reach an agreement then the Prime Minister Theresa May, went on record stating that ‘no deal’ would be better than a ‘bad deal’. Somewhat disconcerting, however, was the subsequent admission of the Brexit Minister, David Davies, that his department had not made an economic assessment of the consequences of not making a deal. I will return to the significance of this admission later in this article.

UK negotiators led by Mr Davies then entered into a period of negotiation with representatives of the EU led by Mr Barnier. Mr Davies and his team supported by pro Brexit politicians and sections of the British media that support Brexit then started a concerted campaign of creating a positive image of what a post Brexit trading relationship with the EU would look like.
This option popularly referred to as ‘soft Brexit’ promised a post Brexit nirvana in which Britain would not be a member of the European free trade area or the customs union but we would enjoy ‘frictionless’ trading arrangements with our previous partners in the EU. The EU, not unreasonably argued, that they would not enter into any negotiations regarding post Brexit trading relationships until they had negotiated the terms of Brexit! 

The terms of Brexit now create political problems for the UK government. Firstly, Britain has existing commitments to the EU which it must pay. This would seem to be a reasonably easy issue to resolve. Place a number of accountants in a room, agree what numbers need to be added together and come up with a number.
But herein lies a big internal political problem for the UK, if that number is large, say EUR 60 bn, then UK politicians are faced with going back to the pro Brexit voters and telling them that Brexit, which was supposed to save us from large payments to the EU, involves a large payment to the EU. And if the UK negotiators try to get a lower settlement this will slow down the process of negotiation and the UK is keen to get a deal on trade post March 2019. So this is the first ‘hard truth’ that UK Brexit negotiators have to tell the UK population, leaving the EU will cost, and the divorce bill will not be small.

The second issue that has to be examined before post Brexit trade talks can be entered into, is the status of EU nationals who are currently living and working in the UK. An extreme Brexit position would be that they should all go home. Politicians who agree to EU workers staying risk upsetting the pro Brexit electorate. This has resulted in confused announcements from the UK government which state that EU nationals can (probably) stay if they have been in the UK for five years or more.
  
However, the UK government does not want to guarantee the employment rights of those workers or their right to health and unemployment benefits. Furthermore, if EU workers are to have employment and social welfare benefits living in the UK post Brexit we do not want them to be determined by the EU or the ECJ. Not unsurprisingly this has created uncertainty amongst EU nationals working in the UK, with some EU workers already choosing to leave the UK and workers who would have come to the UK in ‘normal’ times deciding not to do so. This has already started to place strains on a number of UK industries which rely on migrant workers, most notably the UK health service.

Finally, there is the issue of the island of Ireland. All parties both the EU and the UK appear to want the border between the Republic of Ireland and Northern Ireland to be as frictionless as possible. Initially the UK position was that this would be the case because we would negotiate a frictionless post Brexit settlement between the UK and the EU. The EU has since countered with a suggestion that a frictionless border may exist on the island of Ireland but NOT with the rest of the UK. This is a fascinating negotiating ‘game’: the EU is potentially creating a free trade back door into the UK via the Republic of Ireland and Northern Ireland. While at the same time saying that there will be no free trade agreement with the UK mainland.

So where is the UK psyche at this point in time? 

I would argue that there is a growing realisation that the EU will not progress to trade talks until the terms of Brexit are agreed. The pressure on the UK government is being further increased by UK companies, most of whom have been planning for a ‘hard Brexit’ since the vote to leave was cast. Companies have done this on the basis that if you plan for hard Brexit then you are not going to be unpleasantly surprised.

That said, these companies are now openly saying that unless the UK Brexit negotiators are able to move their discussions, on a Brexit settlement and future trading relations with the EU forward, UK companies will start to put in place their plans for a hard Brexit as of January 1 2018. In some instances, this means that a number of large companies currently located on the UK mainland will start to move parts of their operations into mainland Europe.

So, what would be the consequences of a ‘hard Brexit’? 

That is the UK leaving the EU and adopting WTO tariffs for all trade between the UK and the EU and those countries with which the EU has trade agreements. In addition, a hard Brexit scenario would assume that the regulatory environment in which UK countries traded with the EU would at best be in line with current EU regulations and in some instances worse. The most obvious example of the latter being the loss of ‘pass-porting rights’ for UK banks. The EU pass-porting system for banks and financial services companies enables firms that are authorised in any EU or EEA state to trade freely in any other with minimal additional authorisation.

Monique Ebell has estimated that the impact of a movement from the European Economic Area to a WTO regime would result in a 60% reduction in UK exports to the EU and we currently export 40 % of our total service exports to the EU. Hence in the long run, there would be a 24% reduction in total UK exports of services. The impact on exports of goods would be of a similar magnitude in that exports of goods to the EU would fall by between 35-40% but we export a greater proportion (56%) of our total goods exports to the EU, hence total exports of goods would fall by 23%, according to Ebell’s analysis.

It would therefore appear to be critical that as part of the Brexit negotiations that the UK is able to negotiate some preferential access to EU markets. Therein lies the nub of the issue, to get access to the markets of the EU be it via a customs union or free trade agreement there are significant negotiating hurdles to be overcome. Firstly, the EU are likely to insist that the UK accepts the four pillars of the EU which relate to the freedom of movement of goods, services, capital (so far so good) and labour, now we have a problem! Given that the Brexit vote was closely aligned to a desire to control the freedom of movement of labour (people) then this is a negotiating point which it is difficult to see either side conceding on. Secondly access to the EU is likely to require the UK to make a contribution to the EU budget, this is a loaded political issue in both the UK and the EU and again it would be difficult to see a course that could be steered through this issue on which all parties could agree.

Where does this leave UK and EU businesses? 

I would suggest in a position where it would be sensible to plan for a hard Brexit.

- Assess the impact that this has on your sourcing strategies and costs. Evidence from surveys undertaken by the Chartered Institute of Procurement and Supply (CIPS) in the UK, would suggest that companies on the European mainland are further ahead in their thinking in this respect than UK firms are. 

- Examine ways in which exposures to potentially more complex (from a regulatory perspective) and costlier (from a tariff perspective) imports from the EU can be ‘on-shored’ and alternative supply chains can be configured in the UK and with non-EU suppliers. The two-year period of negotiation will pass quickly, there will be endless speculation about the outturn, I would suggest that you plan for the worse case and hope to be pleasantly surprised.

What do I think the outcome will be? 

In the first instance, I think there will be a transition period. It will be impossible to conclude all negotiations by March 2019 and a transition period of two years is most likely. The introduction of a transition period also introduces a non-trivial probability that there could be a second vote, where hopefully the UK would vote to remain! However, the possibility of a transition period has created an interesting dynamic in UK politics with hard-line Brexit supporters accusing the government of not fulfilling the will of the voters and suggesting that we should Brexit in March 2019 irrespective of how painful it might be.

Indeed, one member of the government asked a University Vice-Principal for a copy of a European Studies Syllabus this week because he suggested that UK Universities were too pro-remain. Fortunately, the University Vice Principal refused so some semblance of academic freedom still remains. In conclusion as the old Chinese proverb (curse) states ‘may you live in interesting times’, we undoubtedly do, what we now need to do is somehow find a route to a future which will benefit us all.

John Glen is a Senior Lecturer in Economics at the Cranfield School of Management. He specialised in teaching micro economics, industrial organisation and is the author of several papers relating to competition policy, and deregulation.

Interview collected by the International & European Institute.

 

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