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Mapping Out the Cost of Brexit

Author(s): Patrick Low

Date: Mar 31, 2017

Theme(s): Trade & Investment

Publications: Opinions & Speeches

Fellow Patrick Low examines Britain's options after its government invoked Article 50 earlier this week.

Prime Minister Theresa May has triggered Article 50 of the Lisbon Treaty, formalizing the UK’s decision to leave the European Union within two years. This is the most momentous decision taken by a British Government since the country went to war almost seven decades ago.  It will affect the lives of many millions of people.

Some believe Brexit is a monumental error, a wanton act of self-harm. They fear that Brexit will diminish Britain and its standing in the world, reduce incomes and jobs, and possibly even break up the United Kingdom.

Others are delighted at the decision, yearn for a clean break and believe that departure from the EU will offer up a long-awaited opportunity to renew “Global Britain, a great trading nation,” free from a hobbling, declining Europe – a Britain able to take its rightful place at the top table unshackled and independent.

This polarization in perceptions of reality has embittered debate in the UK and elsewhere, and divided families. Triggering Article 50 will not assuage the tension, and much depends upon how rancorous the separation proceedings prove to be.

The signs so far have not been promising, although the tone of the Prime Minister’s “Dear John” letter to Donald Tusk, President of the EU Council, was in some respects a little more emollient. Over the eight months since the referendum on Brexit, sharp words and warnings have been exchanged between Britain and other European nations. Time will tell whether the UK and its erstwhile union partners will be able to put passion aside and tease out arrangements to the mutual advantage of all concerned.

Success will be challenged by the numerous complexities involved in resetting the relationship. These are becoming increasingly apparent as the days of reckoning approach, especially to those who so enthusiastically embraced Brexit. Theresa May has said the Government wants a clean break from the single market, the customs union and the institutions of the EU, such as the European Court of Justice.

This looks like what has been referred to as a hard Brexit. In truth, the softer the Brexit the sillier it looks to have started the process in the first place, which does not leave much of an alternative to a hard Brexit. For those who believe this road leads nowhere good, the dream of a reversal of Brexit beckons, but politically this is improbable, even if it begins to look more and more like the wisest course of action.

A hard Brexit is going to be dramatic and jolting. It is difficult to see either side coming out ahead under this scenario. As the much smaller party, Britain has considerably more to lose. It will have to reorder the nearly 50 percent of its trade flows that go to the EU, while the latter are looking at less than 10 percent of their trade transactions.

Absent a sensible trade deal that apparently can neither be a single market nor a customs union, the World Trade Organization may become the sole arbiter of the trade relationship. But the rights and obligations of the UK and the remaining EU states with the other members of the WTO still have to be worked out – a potentially challenging task in itself.

The UK hopes to avoid sole reliance on the WTO by proposing a “bold and ambitious” free trade agreement. In reality, there are no free trade agreements that guarantee free trade – there are always exceptions. More significantly, a free trade agreement does not ensure the avoidance of administrative red tape and delays at the border, as a customs union largely does among its members.

In addition to the UK’s relationship with the EU, another 50 or so preferential agreements with third parties are EU deals outside the WTO which Britain will not automatically be part of after its exit. What will be done with those, and how successful will Britain be in negotiating other free trade deals?  Trying to do this with Commonwealth countries and the United States is unlikely to be the love-fest some of the Brexit camp like to suggest. And they will take years to conclude.

Tariffs, however, are only one rather small part of the story. Take foreign investment. The UK has been a favoured location precisely because of privileged access to the rest of Europe. How much will these investments and the UK’s large financial services sector haemorrhage outside the EU?  Will the European investment “passport” survive, allowing any foreign investor to enter the UK as well as any EU state once established in any one of these jurisdictions?

Even more significantly, standards, regulations and border procedures are increasingly the cutting edge of access to markets, with great potential to augment trade costs. Controlled borders and non-uniform standards – or at least standards that are not mutually recognized – will be a new feature of trade between the divorced EU parties, unless the UK is prepared to maintain existing arrangements when it comes to standards, and ensure continued compatibility over time.

A recent report by the British House of Lords has estimated that Britain will need to submit to or replace up to 34 discrete EU regulatory bodies. These cover many arcane matters in much detail, in fields such as agriculture, energy, transport and communications. Business falls apart without rule books that manage these areas of activity. British officials are starting to acknowledge that they will need to adhere to EU regulations in some of these areas, at least for a time, because the UK neither has the time nor the expertise to do otherwise.

Hard-core Brexiters will bridle at this, deriding it as an unclean break. Theresa May and her leading Brexit Ministers have repeatedly stated that a bad deal is worse than no deal. Apart from the fact that the UK Government has not even attempted to estimate the costs of a no deal outcome, no deal may simply be beyond the bounds of manageable disruption.

The EU, speaking with one voice, insists that the Brexit break must be negotiated before a post-Brexit relationship can be discussed. For the separation talks, various EU figures have suggested that the UK will need to pay over between 40 and 60 billion Euros to extinguish it membership obligations. Britain claims the sum is excessive.

The British demur at such a large number, and they are also anxious to convince the rest of the EU to work in parallel on both Brexit and post-Brexit arrangements.  It is likely to prove challenging to achieve either of these objectives.  Already, Chancellor Merkel of Germany has publicly rejected parallel action.

In her letter to Donald Tusk, the Prime Minister explicitly linked the post-Brexit economic relationship with the security relationship.  The attempted linkage is motivated by the premise that in this relationship Britain has a stronger hand.  Reactions have been swift and angry both in the UK and on the continent, characterizing the ploy as blackmail. This is not a good start.

Looming behind all these complications is another potential tragedy. It is the possibility that Scotland will seek separation from the United Kingdom. Ireland too is in a precarious position, considering the land border and the history of strife between the north and the south.  Scotland, Ireland and Wales all voted to remain, and Westminster disregards these wishes at its peril.

The two years prescribed by Article 50 for reaching a deal will pass quickly. A strong spirit of co-operation based on mutual respect will play a huge role in shaping the outcome. How likely is that spirit to be forthcoming?

 

To read more about Brexit, please click here. The views expressed in the reports featured are the author’s own and do not necessarily reflect Asia Global Institute’s editorial policy.