Mind your step
Theresa May fires the starting gun for what looks likely to be a hard Brexit, taking Britain out of Europe’s single market Oct 8th 2016
GIVEN that Britons voted on June 23rd by 52% to 48% to leave the European Union, Theresa May had to say something about Brexit at her first Conservative Party conference as prime minister. By choosing, unusually, to open proceedings on October 2nd, she hoped to park the subject for the rest of the week, letting her big speech on October 5th dwell on the broader theme of “a country that works for everyone”. No such luck. In practice she just advertised the fact that Brexit will be the issue that makes or breaks her government.
The essential problem that Brexit poses for her is clear. On the one hand, she wants to keep the economic benefits of facing no barriers to trade in the world’s largest single market, the EU. But on the other, her 27 EU partners are not willing to agree to this unless she also accepts the single market’s obligations, including free movement of workers and a plethora of EU regulations. The dilemma has come to be known as “soft” or “hard” Brexit. Soft Brexit means giving priority to the single market at the price of accepting some limitations on control over borders and laws, as well as contributing to the EU budget. Hard Brexit puts the emphasis on taking back such controls even if that means walking away from the single market.
Mrs May, who had previously kept silent about her plans, offered the mostly Eurosceptic party faithful two juicy titbits which were interpreted as leaning towards a harder Brexit. The splashier but less significant one was a plan to include a “Great Repeal Bill” in next year’s Queen’s Speech. Contrary to its portentous title, this would actually be more of an unrepeal measure, since it would incorporate into British law the whole gamut of current EU legislation. It would also pave the way for scrapping the 1972 European Communities Act, which gives effect to EU law, as soon as Britain leaves, but this is little more than a statement of the obvious.
More important was Mrs May’s promise to invoke Article 50 of the EU treaty, the legal route to Brexit, before the end of March 2017. Some advisers favoured postponement until the French presidential election next spring, or even the German election in September, partly because Britain will lose bargaining clout as soon as it kicks off the negotiations. Yet Mrs May suggested that those who wanted to put off Article 50 were in reality closet Remainers seeking to subvert the democratic choice of June 23rd. Since Article 50 sets a two-year deadline for a deal, after which a country departs unless all 27 other members agree to extend the time limit (which is unlikely), her decision means that Britain should leave by the end of March 2019.
Mrs May presented these two promises as necessary to give business the certainty it needs in the period up to and beyond Brexit. Yet she ducked the key question of what future relationship Britain will have with the EU, which takes 44% of Britain’s exports. And in her remarks to the conference in Birmingham, Mrs May only increased businesses’ worries. She talked of Britain becoming a “fully independent, sovereign country” that once again had the freedom to make its own decisions, from how to label its food to the way it controls immigration, adding that it was not about to leave the EU only to return to the jurisdiction of the European Court of Justice.
What matters about these statements is that they sound incompatible with remaining in the EU’s customs union and single market, pointing to a hard Brexit under which Britain leaves both.
Because it eliminates not just tariffs but non-tariff barriers, the single market is hugely valuable. Most economists say a hard Brexit would be far costlier than a soft one that put Britain closer to the situation of a country like Norway, which is not in the EU but in the European Economic Area. EEA members accept free movement of labour and observe single-market rules in which they have no say—implicitly accepting the European court’s jurisdiction. Switzerland, which is in neither the EEA nor the single market, still has to accept free movement, as well as most EU regulations. Both countries also pay into the EU budget, which would be unpopular with Brexiteers, although Mrs May has not ruled out some British contribution post-Brexit.
Dismissing these existing models, Mrs May talked of securing a bespoke agreement with the EU. She said she wanted to keep free trade in goods and services, and promised British companies maximum freedom to trade with and operate in the single market. Yet these objectives may prove impossible to square with the Brexiteers’ goal of “taking back control” of Britain’s borders, laws and the money it pays the EU. That is why the odds of a hard Brexit are rising.
There are other reasons. One is the feisty mood in Birmingham of Tory Brexiteers, who were ecstatic over Mrs May’s speech. Many insisted that, even if a bilateral free-trade deal were desirable, Britain had nothing to fear from trading with the EU under normal World Trade Organisation (WTO) rules, just as America, China and other countries do. Remainers lay low at the party conference (even though the prime minister was herself one). And although Mrs May praised her predecessor, David Cameron, the name of George Osborne, his former chancellor, who has said that Britons voted for Brexit but not for hard Brexit, was barely mentioned.
Another is that, contrary to the prognosis of Mr Osborne, the economy has performed tolerably well since the referendum. The index of manufacturing activity rose in September to a two-year high, and the stockmarket is close to its all-time record. Brexiteers crow that doomsters were wrong about the short-term risks of a vote to leave the EU, and they now say economists are just as incorrect to warn of large output losses after a hard Brexit. Many welcome the fall in sterling since June as a boost to exporters—and one that more than outweighs any tariffs if Britain reverted to trading on WTO terms.
Divorce is seldom happy
Yet there have been some warning shots. The pound fell to a 31-year low against the dollar after Mrs May’s speech, reminding investors that Britain still has a huge current account deficit (see chart). Philip Hammond, her chancellor, talked of a “rollercoaster ride” ahead, adding that Britons did not vote for Brexit to make themselves poorer. Although consumption has held up strongly since June, growth forecasts for next year have been reduced, and many investment plans are on hold.
A striking example came when Carlos Ghosn, the boss of Renault-Nissan, a carmaker, said he could not commit himself to expanding Nissan’s plant in Sunderland, the biggest in Britain, unless the government guarantees compensation if it faces tariffs of 10% on exports to the EU, which takes two-thirds of the factory’s output. Lobbies from the food industry to the City of London are increasingly vociferous in warning about the dangers of a hard Brexit. Leaving the single market could cost 35,000 jobs in finance, according to Oliver Wyman, a consultancy.
One other reason why a hard Brexit has become more likely is the stiffening attitude of other EU leaders, each of whom has a veto over any subsequent trade deal with Britain. Many thought Mr Cameron was unwise to promise an in/out referendum. But they understood the politics that drove him to it; many have Eurosceptics of their own to reckon with and several have experience of losing referendums. Although immediately after June 23rd some hoped British voters might be induced by the economic fallout or deeper reflection to think again, most now accept Mrs May’s dictum that “Brexit means Brexit”.
Yet many on the continent are irritated by the naive attitude of some of Mrs May’s Brexiteer ministers, and especially by their assumption that, as her foreign secretary, Boris Johnson, likes to say, Britain can both have its cake and eat it. Mr Johnson may be right to argue that free movement of labour is not economically necessary to a single market, and Britain has long complained that the single market in services is incomplete. But other EU countries still see the “four freedoms” of goods, services, people and capital as the cornerstone of the entire European project. That is why they insist on EEA countries accepting all four, with minor derogations. There is also a big difference between a generous offer to countries that might one day join the club and the less generous one suitable for a country that has voted to leave.
Such thinking has led Britain’s European partners to two firm conclusions. First, they cannot allow cherry-picking, by which they mean letting Britain have membership of the single market while rejecting free migration and budget payments. And second, an exiting country cannot be allowed to end up in a better position than it was as a member. Evidence of how strongly EU countries feel came in their condemnation of a proposal for a “continental partnership” by analysts from France, Germany, Britain and Belgium that suggested a new multi-tier model that would give Britain privileged status in the single market, and some influence over its rules (the diagram above shows how Europe is structured now).
The fear is that if the EU gives way on its principles, other countries might follow Britain’s example. In fact, although some Brexiteers once gleefully suggested that Brexit could lead to the collapse of the EU, this looks unlikely. Other countries have too much political capital tied up in the project and too much to lose economically to risk walking out. Yet populist parties in France, Italy, Sweden and eastern Europe are watching Brexit closely, and some are calling for referendums of their own. There is some concern over the Dutch, who have elections in March and seem deeply disillusioned with the EU.
Some Brexiteers claim that other countries secretly share their aversion to Brussels, its excessive red tape and unlimited EU migration. They cite Nicolas Sarkozy, who is running to be France’s next president and has talked of a new treaty to repatriate powers and limit free movement. Yet the appetite for a new treaty is tiny. Many countries are hostile to any concessions for Britain that would seem to be giving in to blackmail. And the concern in other countries over immigration is not about EU migrants, but about those from the Middle East and Africa.
The other countries also dismiss claims by Brexiteers that, because the EU sells more to Britain than the other way round, Britain has the whip hand in negotiations. EU exports to Britain make up 3% of the EU’s GDP, whereas British exports to the EU are worth some 12% of British GDP. In financial services, in particular, other countries are keen to poach back the lucrative business of euro clearing and settlement, and none sees why a country outside the single market should have “passporting rights” that allow financial firms to trade freely out of London. British suggestions that a system of “regulatory equivalence” should qualify meet hollow laughs: the moment that British regulation deviates from the EU’s, equivalence will be lost. As for the claim that, because German carmakers want tariff-free access to the British market they will argue for the same deal for British firms, this would be strongly opposed by carmakers in Spain and France that would welcome an edge over their British rivals.
Unbalanced bargaining power
One big problem for Mrs May is the unequal bargaining power between Britain and the EU. She and her officials had hoped to negotiate informally before Article 50 was triggered. Liam Fox, the international-trade secretary, has been scoping out free-trade deals with third countries. Yet the first has proved all but impossible, partly because the others know that the Article 50 process suits them better than Britain. As for free-trade deals, Brussels notes that Britain cannot legally embark on any until after Brexit; indeed, there is talk of suing if Mr Fox goes too far in seeking deals with what one official dismisses as “planet Earth and other planets”.
The complexity and size of the new deals Mrs May must strike to make Brexit a success is daunting. Charles Grant of the Centre for European Reform, a London think-tank, says the prime minister needs to plan for six broad sets of treaty arrangements. The first is the Article 50 negotiation, meant to be completed within two years, which will cover such matters as pensions for British Eurocrats and MEPs, dividing up EU assets and working out what to do with the European Medicines Agency in London. This deal needs approval from a qualified majority of EU members, minus Britain, and a majority in the European Parliament.
Second is a new trading arrangement with the EU. If it is not based on membership of the single market, this must be a special deal, similar to Canada’s (still unratified) free-trade agreement. Brexiteers say a deal with Britain should be easier, as the two sides start as part of the same market. Yet the Canadian agreement does not include all goods, and it excludes financial services. A free-trade deal with the EU is likely to require unanimous approval by all EU members and ratification by national and regional parliaments, which may be especially hard in countries such as Romania or Poland that have to accept limits on the free movement of citizens to Britain.
Third are replacements for the EU’s existing free-trade pacts with some 53 countries. This is not straightforward: South Korea says its deal with the EU was based on Britain being in the single market, so it will not wish to grandfather any concessions into a bilateral agreement with Britain alone. Mr Fox also wants to negotiate deals with countries like America, China, India and Australia that have none with the EU. But these countries will want to know what trade arrangement Britain has with the EU first. And they will not wish to jeopardise their planned deals with the EU.
Judging by experience, both a trade arrangement with the EU and free-trade deals with third countries will take far longer than two years to negotiate. In some cases talks cannot even begin until after Brexit. So the fourth and perhaps most pressing requirement for Mrs May will be an interim, time-limited measure to fill the gap between Britain’s exit under Article 50 and the entry into force of new trade arrangements. Prolongation of the present relationship could be one option; temporary membership of the EEA another. Without such a deal, Britain would revert immediately to trading under WTO rules, implying tariffs. But interim deals can be as hard to negotiate as final ones, partly because some fear that they can become near-permanent.
In any event a fifth requirement is for Britain to resume full membership of the WTO, to which it now belongs merely via the EU. That is less simple than it sounds. In many areas, it can be achieved by simply inheriting the EU’s tariff schedule, at least initially. But Britain will have to divide up import quotas and other trade preferences with its EU partners, which may not be straightforward. The WTO always proceeds slowly and by consensus among its 163 other members, any one of which could obstruct the British.
Finally, Britain must find a way to replicate its commitments to co-operate with EU partners in intelligence, policing, counter-terrorism and foreign policy. These matters ought to be uncontroversial, as even Brexiteers see good arguments for them. In her previous job as home secretary Mrs May put security co-operation at the heart of her case for staying in the EU. Yet some measures, such as the European Arrest Warrant, still attract opposition in her party. And although efforts can be made to keep working together, the vital institutional sharing of information and analysis is likely to be lost post-Brexit.
This intimidating list of requirements leads to two conclusions. The first is that negotiating Brexit and its consequences could take several years. That is why some analysts put such emphasis on the need for an interim solution that avoids the risk of Britain falling off a cliff at the end of the Article 50 process. Mrs May and her team will have to focus on this issue soon after invoking the article. They may need to keep paying into the EU budget to win better terms.
The second is that neither side is ready for the challenge of such complex negotiations. David Davis’s Department for Exiting the EU is brand new, though it has grown fast. Mr Fox is short of experienced trade negotiators. Mr Johnson’s Foreign Office has been pared to the bone recently. The civil service is now expanding again, at considerable cost to the taxpayer. There will be turf wars among these three Brexiteers and between them and the chancellor of the exchequer. One diplomat says gloomily that for 30 years Britain’s EU policy was run by Foreign Office officials and then for 15 years by Treasury mandarins. Now it is run by Home Office people who know a lot about immigration and security but nothing about economics.
There will also be differences in Brussels, however. The European Commission has picked a former French foreign minister and commissioner, Michel Barnier, to take charge of the negotiations. The European Council has a former Belgian diplomat, Didier Seeuws. And the European Parliament has chosen a former Belgian prime minister and keen EU federalist, Guy Verhofstadt. These three can be expected to have disagreements over the best way to handle Brexit. It is evident from this that Brexit will be a process, not a single event. And that is why it will haunt Mrs May’s government. The cabinet battle over the concessions needed to secure barrier-free access to the EU’s single market may well pitch the Treasury against the three Brexit ministers. Mrs May will then discover what many predecessors have: that, despite the vote on June 23rd, the issue of Europe still divides her party and her government. Tories at this week’s conference might have contemplated the scene outside, as swathes of central Birmingham are being demolished. Birmingham has more than once torn down its city centre, only to find the replacement unsatisfactory. There is a risk of something similar happening with Brexit