Paul Wallace 10 Jan 2017 09:30am

The long and winding road to Brexit

In March, Theresa May plans to embark on a journey that will take the UK out of the EU. But, says Paul Wallace, the route is unlikely to be smooth, and the destination might not be what some Brexiteers want

Caption: The UK's final destination might not be what the Brexiteers are looking for.

By the spring of this year, nine months after the UK voted to leave the European Union, the departure should be under way. Whether or not the Supreme Court rules that Parliament must vote on triggering Article 50 of the Lisbon Treaty – the formal procedure for leaving the EU – Theresa May has said she intends to do so by the end of March (and MPs voted last month to back her plan, as well as supporting a Labour motion calling for Parliament to “properly scrutinise” government proposals for leaving). The prime minister’s plan is to leave the EU in the spring of 2019.

That neat timetable could easily be hijacked by events, not least delays if the judges confirm the government cannot trigger Article 50 without parliamentary authorisation. But the precise timing of the departure matters far less than the destination. The EU and UK are clearly close economic and political partners at the moment. Simply leaving the union – the main negotiation under Article 50 – will be tricky enough as both sides haggle over a British exit that might well cause acrimony. Yet this looks to be the easy part compared with the task of forming a new relationship that minimises any economic fallout.

Before the referendum, David Cameron’s government identified three options if voters plumped for Brexit. At one extreme, the UK could seek the closest possible economic links with the EU, by remaining in the European Economic Area (EEA) on terms similar to those of the EEA’s three other non-EU members such as Norway. At the other extreme, Britain could trade with the EU on the same terms as other countries outside the union and not covered by its trade deals. That would mean following international rules set by the World Trade Organisation (WTO). Somewhere in between these “soft” and “hard” Brexit options could be a free trade agreement such as the one recently negotiated between Canada and the EU.

May is keen to shift the debate away from these options. Her ministers disavow the dichotomy between a soft and a hard Brexit, insisting that they will negotiate a bespoke deal, a so-called “red, white and blue” Brexit. But the three options are pertinent because they frame what some see as a fundamental trade-off between national control and prosperity. The argument is that the more sovereignty is restored, the more trade and inward investment suffer. This alleged trade-off is most salient in the clash between the political goal of controlling EU immigration and the economic aim of access to the single market.

These constraints mean May can’t pursue the EEA option. Such a divorce would resemble one where an estranged couple continue to live in the same house though in different wings. Those who see the EU as a driver of the UK economy claim this model would do the least damage, because British firms could participate in the single market (other than agriculture and fishing). The snag is political. The UK would lose its ability to influence single-market decisions but would have to implement them. EU citizens would retain the right to live and work in Britain. And British taxpayers would still contribute to the EU budget.

But if a soft Brexit is politically unfeasible, a hard Brexit might be economically intolerable. Reverting to WTO rules for trade with the EU could mean British exporters facing the bloc’s common external tariff, which averages 5.3%, but is higher for some products, notably cars at 10%. May has already revealed that the WTO option is unacceptable. Faced with the threat of Nissan scrapping a new investment at its big plant in Sunderland, she and her ministers appeared to offer assurances sufficient for the Japanese car maker to press ahead with an expansion plan.

May therefore seems most likely to pursue the middle course, which would see a free trade deal with the EU. The crucial decision is where the UK positions itself in this intermediate terrain. The prime minister’s goal will be to regain control over migration from the EU, while keeping as much access as possible to the single market. In order to mitigate any potential economic harm, May might want something more like the EEA than the WTO option. If there is a single template it will be Switzerland’s arrangement with the EU, although this is far from satisfactory.

Any deal depends not only on what the UK seeks but also on what the EU agrees to. The starting-point is unpromising. Before the British referendum, European leaders were unhappy about the EU’s relationship with Switzerland, saying that it had reached its limits. That might make them more reluctant to extend such an approach to the UK.

More important, although Brexit is a blow to what some see as “the European project”, it is also a rare rallying point in a union beset by crises. European leaders cannot find a common approach to migration. Nor can they agree upon reforms to strengthen the still fragile monetary union. As the EU’s chief negotiator, Michel Barnier, made clear in his first press conference last month, one thing that unites the 27 remaining members is that there can be no “cherry picking” by the UK. In short, the remaining EU members might want to make the UK pay for its decision to leave. This is less about being vindictive (though there is considerable resentment at the UK’s decision) and more about discouraging other disaffected states from threatening an exit.

The EU has the advantage of negotiating under rules that favour the club rather than a departing member. Article 50 was drafted to discourage rather than to facilitate an exit. Once invoked by May, the clock starts ticking, to her disadvantage because of the two-year deadline. If there is no deal by then, the UK will automatically leave the Union. That means a delayed hard Brexit, incurring European tariffs and losing access to the single market. The deadline can be extended – but only with the unanimous agreement of the other 27 countries, which can’t be relied upon.

The EU appears to be holding the high economic and financial cards. Whereas the bloc buys nearly half of British exports, the UK accounts for less than a tenth of EU exports. The City is particularly vulnerable since banks will lose their “passporting” rights to sell services throughout the EU. The bargaining over this will be fierce, as financial centres such as Frankfurt and Paris look to gain ground at London’s expense backed by governments eager for a share of the City’s lucrative tax revenues. Naturally, the UK has its own cards to play.

Apart from France, it is the only military power of note in the EU and an important ally to countries in eastern Europe that fear Russian revanchism. And importantly, Brexit will leave a major hole in the European budget. The readiness to carry on making contributions, expressed by some ministers last month, will bolster May’s negotiating position even if it vexes Brexit voters.

Most important, the negotiation is not a zero-sum game since both sides stand to lose. The UK would potentially suffer the most in the short term from a sudden and hard Brexit, but the economic disruption would also hurt the EU.

The potential for ill-tempered talks to produce nothing but rancour, prompting the worst possible outcome, remains high. Despite this risk it seems more likely that the negotiation will eventually focus on a bespoke UK free trade deal similar to the Swiss relationship with the EU. Such an arrangement would mean the British would not have to bow to judgements of the European Court of Justice. Nor would they be obliged to shoehorn new single-market rules into national legislation, as is the case within the EEA. And it allows for an array of sectoral agreements to provide more or less full access to the single market for goods.

Set against these advantages there are some drawbacks. For one thing the Swiss deal means it has to help with the EU’s finances. More troubling for May is the fact that Switzerland accepts freedom of movement and is part of the Schengen area whose members have done away with mutual border controls. Despite these concessions, it lacks access to the single market for most services, including its banks.

The terms of any British deal would differ from the Swiss arrangements but the broad trade-offs are likely to be similar. The UK should be able to secure reasonable access to the single market for goods but will find it harder to achieve the same for financial services. There is a political requirement to restore some control over migration, but that need not entail a complete clampdown. A possible compromise might be to allow the admission of European workers under a work permit scheme more favourable to migrants from the EU than from other countries.

But reaching any deal within two years will be tough. A regular comparison is made with the trade agreement between Canada and the EU, which took seven years and nearly fell at the final hurdle when the Walloon parliament in Belgium temporarily blocked it. In principle, the main negotiation under Article 50 is about the terms of exit. As in any divorce settlement it will mainly be about money, and about how big an exit bill the UK will be charged for liabilities such as unpaid budget commitments.

Some initial estimates in Brussels range between €40bn and €60bn. The wording of Article 50 can be interpreted to envisage a parallel negotiation on the UK’s future relationship with the EU. Yet even if that does get under way, the complexity of its existing status, an entanglement knitted in over four decades of integration, cannot be unpicked in a hurry.

While some seek a sudden, hard Brexit others see a transitional arrangement as inevitable. This could last as long as five years and might feature a temporary extension of British membership of the customs union. That would avoid the peremptory imposition of tariffs in a wrenching hard Brexit.

But it would entail continuing financial contributions and the UK might have to wait longer before it could negotiate new trade deals with other countries, such as India and the US. Even reaching a workable transition arrangement can be tricky as they can have a life of their own.

Even if Brexit does begin in March 2017, political shocks could still rewrite the script.

If, for example, Marine Le Pen wins the French presidential election in May 2017 and tries to also take France out of the EU, this could disrupt any UK/EU negotiations. In the UK, public support for Brexit might fall if living standards are squeezed by the falling pound, with inflation forecast to rise from 0.5% at the time of the referendum to between 3% and 4% in the second half of 2017. The UK has cast off its EU moorings, but the final destination will be worked out en route.