The U.K. Plots Its Brexit Course

December 19, 2016

Forecast

• Despite political friction between them, Britain’s government and Parliament will reach an understanding on the Brexit process, and the United Kingdom will formally announce its intention to leave the European Union in 2017.

• The United Kingdom will push to preserve its tariff-free trade with the bloc on as many goods and services as possible while trying to retain its autonomy on immigration.

• A transitional agreement that would buy time to negotiate a permanent settlement and allow businesses to adapt to the new reality will be part of the discussion.

 

Analysis

It has been nearly six months since British voters decided that their country should leave the European Union. Despite the initial resolve of some Brexit opponents to ignore the outcome of the nonbinding vote, the question today is no longer whether the country will exit the Continental bloc but what the divorce will look like. The British government is busy working out its strategy for negotiating with Brussels over the terms of its departure, but leaders in London are far from unified in their goals for the talks.

Prime Minister Theresa May has vowed to invoke Article 50 of the Lisbon treaty, thereby triggering the formal process of negotiations with Brussels and the remaining 27 EU member states, in March. But in light of a pending January decision by the Supreme Court on whether Parliament’s approval is needed before official notice of a Brexit can be given, that deadline could be delayed. Most legal experts expect justices to affirm the November ruling by a London high court that Parliament must have its say before May can act. Even so, the trigger to begin the exit process will likely be pulled before the year ends.

In anticipation of this outcome, the British government has reached a deal with lawmakers: It will share its negotiation strategies with them in early 2017, and in exchange they will authorize May to act. The agreement, which is nonbinding, is the product of the government’s desire for political reassurance that the Brexit will start smoothly. Some officials have cautioned against disclosing too much of their strategy, fearing it would weaken London’s bargaining position, so Parliament is unlikely to receive a detailed plan. But even if May’s Cabinet shares only the outlines of its strategies and goals, that would probably be enough to answer some pressing questions about Britain’s future relationship with the bloc.

The most important point that will likely be revealed is how the United Kingdom will try to shape its ties to the EU internal market, an area in which people, goods, services and capital move freely. Membership in the internal market goes hand-in-hand with accepting EU workers, a chief grievance for many who voted to leave the union as a way to limit immigration. Other requirements of remaining in the internal market include contributing to the EU budget, accepting the bloc’s regulations and, potentially, submitting to the supremacy of the European Court of Justice. These concessions would probably irritate British voters and lawmakers who opted to leave the bloc as a way to regain national sovereignty. On the other hand, membership in the internal market would ease concerns in Scotland and Northern Ireland, where a majority of voters wanted to stay in the European Union. It would also allow financial companies operating in the United Kingdom to continue selling their services to the rest of the bloc without requiring authorization in each country.

The British government is divided on the internal market question, and Parliament’s push to be more involved in negotiations with Brussels only complicates matters. If serious disputes over Brexit strategy arise within the government, or between the government and Parliament, May could decide to seek early elections in the hope of getting a clear mandate on what the terms of the Brexit should be. The fact that her Conservative Party is popular — and the opposition is weak — could make this option even more tempting.

But she will not make the decision lightly, considering the recent unpredictability of elections in the United Kingdom and elsewhere in the world. In fact, it would likely take a major political crisis for May to even consider the move. Right now, there is no indication that disagreements within May’s Cabinet, or between the Cabinet and Parliament, have reached that point. And even if she were to hold an early vote, it would only delay the Brexit rather than derail it.

 

What Kind of Brexit?

London’s Brexit strategists have said they will not model the United Kingdom’s future with the European Union on any existing relationships the bloc has with countries outside it. Broadly speaking, the United Kingdom has four options: stay in the EU internal market, stay in the EU customs union, reach a free trade agreement with the bloc, or trade with it according to World Trade Organization rules and tariffs.

Given the country’s strategic needs and domestic constraints, the government is likely to pursue two of them. It might choose to leave the EU internal market, reaching a comprehensive free trade agreement with the bloc that includes as many goods and services as possible while gaining full control over British immigration policies. The recently signed deal between the European Union and Canada, which liberalized trade between the two in around 99 percent of goods and a large list of services, could serve as a reference for negotiations. London, however, would probably try to win an even more comprehensive agreement.

The second most likely option involves leaving the EU internal market but staying in Europe’s customs union, in which member countries share a system of tariffs and import quotas that apply to nonmembers. Membership in the customs union would allow the United Kingdom to preserve an independent immigration policy (Turkey, for example, participates in Europe’s customs union and follows its own immigration policies). But it would also preclude Britain from signing free trade agreements with third parties. In this context, the United Kingdom would protect its tariff-free access to the European market but would not be able to trade freely with the rest of the world. About 45 percent of its goods and services exports go to other countries in the European Union, while 53 percent of its imports come from the bloc.

A trade deal for goods should be easy for EU members to accept because of the bloc’s trade surplus with the United Kingdom in that area. But reaching an agreement on services, in which the European Union has a deficit with the United Kingdom, could be tricky. It will be difficult, for example, for Britain to preserve the status quo in its financial services sector. Some EU members hope to capture the financial business that will relocate from the United Kingdom after it leaves the union. Though the city of London will no doubt remain an attractive destination for banking and related businesses, some companies in the financial sector will probably have to move at least some of their staff and activities to the Continent.

 

Timing Is Everything

The clock will start running once the United Kingdom triggers Article 50, making the amount of time that the Brexit talks consume crucial. The two sides must negotiate two different things: the terms of Britain’s departure from the European Union, and the terms of their future relationship. London will probably try to hold the two negotiations simultaneously since the Lisbon treaty gives EU members two years to hash out the terms of their departure once they have officially announced their intent to leave. At the end of the negotiation period, the departing country automatically ceases to be an EU member, regardless of whether a deal has been struck.

If that happens, London could find itself on the outside of the European Union without a framework to guide its connection to the bloc. Even if London and Brussels quickly reach a deal on the terms of its departure, the period set by the Lisbon treaty probably would not be enough to establish a comprehensive future economic relationship. (The free trade agreement between the European Union and Canada took almost a decade to negotiate and ratify.) The treaty does say the negotiation period can be extended, but it would require unanimous support from the remaining 27 member states, which could put the United Kingdom in a weak negotiating position. Individual EU members could threaten to veto an extension to exact concessions from the United Kingdom or make demands on the European Union that are not directly linked to the Brexit talks.

Because of the broad economic and political impact the Brexit will have, many sectors of the British economy are pushing for a transitional agreement with Brussels. This would buy time for the government to negotiate a permanent settlement and would give companies more time to adapt to the new reality. On Dec. 12, Chancellor Philip Hammond told lawmakers that an interim deal would be needed to avoid disruption that could hurt Britain’s financial stability. But hard-line Brexit proponents think such an agreement would reduce the country’s urgency to leave the union and would keep Britain mired in the bloc indefinitely. So, even if there is a transitional deal, London will be under pressure at home to give it a clear expiration date.

Should the United Kingdom opt to seek a free trade agreement with the bloc, negotiating parties will have to address the status of Northern Ireland, the only area of the United Kingdom that shares a land border with an EU member. If the United Kingdom leaves the internal market, border controls would probably have to be reinstated to police immigration and customs between Northern Ireland and the Republic of Ireland. This would undermine the ideal of a united Ireland that became possible after the 1998 Good Friday Agreement. Governments in London, Belfast and Dublin are therefore likely to seek a special arrangement concerning Northern Ireland. In addition, momentum for Scotland’s push for secession will also likely build, although another independence referendum seems unlikely in the near future.

The final part of London’s Brexit strategy will be to initiate free trade conversations with countries outside the European Union. As long as the United Kingdom is a formal member of the European Union, it cannot unilaterally sign free trade agreements. But the British government is already laying the foundations for bilateral trade ties. As part of this strategy, May visited China and India in November, and Hammond made trips to Japan and South Korea on Dec. 15-16. Crafting deals with these countries will take time, but the United Kingdom, with an eye on its future, is trying to broaden its trade options as it prepares for a post-EU world.

 

— The U.K. Plots Its Brexit Course is republished with permission of Stratfor.