Team Brexit: Theresa May's new Cabinet has to decide how and when (and, maybe, whether) to take the U.K. out of the EU.
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By Geoffrey Smith
September 24, 2016

Three months after the U.K.’s momentous vote to leave the EU, the sky still hasn’t fallen in on Europe’s second-largest economy. But with the summer vacation over and the politicians back at their desks, the immense difficulties of what lies ahead are becoming clearer by the day.

First, the good news: After confidence plummeted in the immediate aftermath of the July vote, it rebounded in August as the first hard data showing life carrying on more or less normally. In September, the Office for National Statistics said in a report that the economy was holding steady: “There has been no sign of a major collapse in confidence and, within the data that is available, some indicators of strength.” Banks such as Credit Suisse and JP Morgan have quietly walked back from forecasts of a recession this year.

But as policy makers hash out the details of what the Brexit would look like, it’s looking increasingly likely that another shoe has yet to drop. The Organization of Economic Cooperation and Development, a Paris-based think-tank, said Wednesday that while Brexit wouldn’t hit the economy as quickly as it had predicted, it would hit it harder: it revised up its forecast for growth this year by 0.1 percentage points, to 1.8%, but cut its forecast for next year by a sizable 1 percentage point, to only 1%. Apocalypse postponed, not cancelled due to lack of interest.

Billions could hinge on the details of the deal that the U.K. eventually negotiates with the EU.

If and when the process starts, it will be long, hard, and wickedly complex. All three of the senior “Leave” campaigners who were given appointed ministers to shape the post-Brexit arrangements have now been publicly rebuked by new Prime Minister Theresa May for daring to suggest that the process is easier than it actually is. She distanced herself Friday from Foreign Secretary Boris Johnson, who had told Sky News that he expected May to invoke the now-notorious ‘Article 50’ of the EU Treaty (which triggers the start of a two-year period to negotiate settlement terms) early in 2017, and to complete talks within two years.

It’s long been thought that they only way to move forward with a quick and orderly exit would be to follow an already existing model: such as for the U.K. to stay in the Single Market like Norway, or in a customs union like that between the EU and Turkey, or to revert to the lowest common denominator of the World Trade Organization’s tariff schedules. But the first two are politically unacceptable to Britain, allowing no check on immigration, no escape from EU budget contributions and no recourse against the European Court of Justice’s rulings. The third is inconceivable for all the damage it would do to a trading relationship worth 350 billion pounds ($455 billion) a year. It’s for this reason that the only decision taken by May so far is to reject an “off-the-shelf” deal and aim to negotiate a completely new one.

The U.K.’s ideal has always been to maintain frictionless access to the EU’s Single Market while being able to reject three obligations: the right of free movement within it, the supremacy of the European Court of Justice in governing it, and contributions to the EU’s budget. But the one thing that European leaders could agree on, after an ill-tempered brainstorming session in the Slovakian capital of Bratislava last week, is that they will never allow the U.K. to adhere only to the terms of membership that it likes—calling it blatant “cherry-picking.”

Billions could hinge on the details of the deal that the U.K. eventually negotiates with the EU. Some of the countries that are the biggest inward investors into Great Britain are already rethinking their relationship with it. The Japanese foreign ministry pointedly warned during the recent G20 summit that its companies could leave for the Continent unless the U.K. remained extremely integrated with Europe (far more so than the Brexit would likely allow). While Brexiteers like Johnson, David Davis (Secretary of State for Exiting the EU), and Liam Fox (head of the newly-created Department for International Trade) argue that losing unfettered access to the Single Market can be more than compensated for by opening new markets, here are two problems with that theory. Firstly, the U.K. will not be legally free to sign new trade deals until it is no longer bound by EU rules; and secondly, no other country will be in any hurry to deal with the U.K. until it knows how the U.K.’s trading relations with Europe will look.

Knowing that gives the EU a very strong hand in negotiations, once they start.

By contrast, Theresa May has relatively few cards to play. A big one though, is the size of the U.K. market. The EU’s huge trade surplus with the U.K. is a major boost to an economy that is struggling to move past the industrial age. According to research published by the think-tank Civitas Friday, trade with the U.K. underpins 6 million jobs across the EU. Germany’s trade alone with the U.K. is 4% of its GDP. Great Britain is, for example, the biggest buyer of German cars at a time when the German auto industry is facing mounting challenges from electric vehicles, an area where it lags its Japanese and U.S. competitors. (Of all the conciliatory noises coming from Europe, the most conciliatory have come from Germany and, more specifically, from its powerful business lobby.)

At worst, the Brexit negotiations could amount to a slow-motion train wreck. There doesn’t seem to be any way around months and even years of extremely hard and detailed bargaining over a completely new kind of arrangement settlement. That can’t help but affect business confidence, and consequently investment. Hence the OECD’s forecast for a delayed impact on the U.K. economy.

But, as the influential Brussels-based think-tank Bruegel argued recently, “An exceedingly unfavorable deal would be liable to damage everyone and would not achieve cohesiveness within the EU itself.” Warning that if the U.K. and EU became embroiled in “unprincipled bargaining” it could hinder not just their futures, but the entire world economy.

That warning is worth taking particularly seriously. Bruegel’s paper, which suggested a moderate version of cherry-picking that effectively sacrifices the EU principle of free movement, was intriguingly co-authored by an adviser to the French Prime Minister, a former rival and senior party colleague of Germany’s Angela Merkel, and a former deputy governor of the Bank of England.

Expect many more trial balloons floating through the back channels and corridors of power between now and the end of the year. And in the meantime, hope that the U.K. consumer remains optimistic—and oblivious to the risks of how badly wrong it can all still go.

 

 

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