UK Options in Brexit Negotiations

In the 23 June 2016 referendum, the people of the United Kingdom (UK) voted for their country to leave the European Union (EU). The UK’s new Prime Minister Theresa May has affirmed her government’s commitment to implement the people’s will. ‘Brexit is Brexit’ she said. She still has not officially started the process of the UK leaving the EU, however. This will only happen when she would formally inform the European Council of the UK’s intention to leave. This will activate Article 50 of the EU’s Lisbon Treaty; which provides for two years of talks to arrange the separation.

Before activating Article 50, PM May wants the UK to first determine exactly what it means by ‘Brexit’. What exactly will it bargain for? Her government is expected to come up with an answer before the end of the year, so that the UK could start the process of leaving the EU.
The UK generally has a choice between two main options.

The general positions of both sides are known. The UK wants to retain (most of its) access to the EU Single Market while getting the right to regulate EU migration to the UK. The EU has said that access to the Single Market is a package deal (i.e. there can be no Single Market a la Carte), and thus there can be no exception made for the free movement of labor.
At first glance, one may  think that these are mere starting positions for negotiations, and that some kind of compromise somewhere in between should be possible.  But the EU has a much stronger position than the UK’s, so it is much more likely that the UK will have to work within the framework set by the EU, not the other way around.

Lesson from the Greek Crisis
During the recent Greek crisis, Greek Prime Minister Tsipras assumed that the Eurogroup (the group of countries which have the Euro as their common currency) ,and the EU as a whole, could not afford to let Greece leave the Eurozone. This was based on his assumption that a Greek exit of the Eurozone (or a ‘Grexit’) will unleash a chain reaction that will put the whole Eurozone in crisis. The Greeks thus delayed agreement on a rescue package until the absolute last minute, in the belief that the EU will end up giving them the money they needed without extracting reform and austerity concessions from them.

During marathon talks on 12 – 13 July 2015, PM Tsipras. was shocked to realize that a Grexit was not that much of a worry to the EU. In fact, there were a number of countries (especially Malta and Slovakia) who wanted to throw Greece out of the Eurozone; and that other countries were open to the idea. Bailing out Greece was becoming too much of a burden for them. Also, public opinion throughout the Eurozone had turned against the Greeks, with a growing majority of people actually preferring Grexit.

Tsipras realized then that accepting the Eurogroup proposal was not the worst possible scenario. Getting expelled from the Eurogroup (and maybe the EU), and economic chaos, were much worse. Thus, he ended up  accepting most of the Eurogroup’s package.

The mistake the Greeks made was to assume that they had a stronger negotiating position than the EU; and that the EU would act as they wanted. Many of the UK’s ‘Leave’ campaigners make a similar mistake.

UK Position is Weak
The ‘Leave’ campaigners said that the UK has the stronger position when it comes to trade talks because it is a big trading partner of the EU. They even said that the EU needs a good deal more than the UK does.

They correctly point out tha the EU exports more to the UK than it imports from it (44% of UK exports are to the EU, while 53% .of its imports are from the EU). What they don’t fully realize is that the EU economy is about 9 times bigger than the UK’s; and that from the EU’s point of view, trade with the UK is only a small part of its overall trade (exports to the UK make up 6% to 7% of EU exports, and only 4% to 5% of its imports). If trade talks were to fail, it would be catastrophic for the UK, but merely an inconvenience for the EU.

The negotiations will  be done by 27 different EU countries, and this further weakens the UK’s position. All countries will have issues with certain parts of the deal, which all need to be addressed. Then, the fact that 11% of all UK imports is from Germany (bigger that its imports from the US, and a full fifth of its total imports from the EU), actually makes things worse for the UK; since it is only Germany which would be a bit worried if the UK bought less its products – only one country out of 27.

Once negotiations start, the parties have two years to come to an agreement. If there is no deal, the EU will just treat the UK like any other country.. This will be quite bad for the UK economy. So, it will be the UK that will be under pressure to make an agreement within two years.

Single Market Access
UK politicians keep talking about negotiating for ‘access to the Single Market’, That seems to be clear enough; but actually, it is not. There is a difference between being part of the Single Market and simply having access to it.  In principle, all countries in the world have access to the EU Single Market – in the sense that they can all trade with the EU, invest in companies within the EU, and have their citizens travel to the EU. Being part of the Single Market, however, entails a deeper involvement in it. It gives the EU countries advantages that non-members do not enjoy. These include the following:
1. Goods that cross internal EU borders will not be subject to tariffs, nor to administrative, technical or other non-tariff barriers. In effect, they will be treated in the same way as locally produced goods  .
2. Their companies could operate all throughout the EU, and be treated the same as local companies.
3. Their companies could hire personnel from all over the EU.
4. The EU negotiates trade agreements with other countries on behalf of all its members.
5. Their companies could bid for government contracts in all EU countries. Big companies, big non-profits and government institutions are required to be open to bids from  companies all over the EU.
6. Licenses to operate that are granted in any member country are valid all over the EU.
7. Diplomas and school credits from any member country are valid throughout the EU.
8. All EU citizens are able to participate in, and benefit from, social security, health and other programs that are open to host country citizens. EU students pay the same school fees as local students.

As part of the Single Market, the UK has become a base for many foreign companies that serve the EU market. This has made London a financial center and a center for internet technology. The UK is the manufacturing base for many foreign auto makers. UK-based service companies have a significant part of the EU market. The UK people and companies have benefitted greatly from being part of the EU Single Market.
This is why the UK wants to retain many of the advantages from being in the Single Market, while taking control of migration into the UK.

The Single Market, however, is an integral whole. It will be extremely difficult for the EU to agree to the UK’s desire to leave out the free movement of labor.  The poorer countries of the EU will not agree to this, especially since they don’t gain much from trade with the UK anyway.

A basic aspect of the Single Market is the body of laws that govern it. UK voters were told that Brexit meant that they would not follow EU laws anymore. But it is impossible to be part of the Single Market without following the laws that govern it.

Another important aspect of the Single Market is the financial contribution to maintaining it. EU countries will not agree to give the UK a free ride. If we take what Norway pays (which participates in the Single Market, but is not an EU member) as an indication, the UK would pay about 6 billion euros a year as administration cost for being part of the  Single Market. This is less than the present net UK contribution to the EUof 14 billion euros a year, but it is still something that many Brexit voters will not like.

If the UK wants to be part of the Single Market, it must:
– accept all the laws that govern the Single Market (including the free movement of labor);
– contribute financially to administering the Single Market.
These conditions would likely be politically unacceptable in the UK; so, it will not be possible for the country to remain within the Single Market. This leaves the UK with two main options.

Free Trade Plus
The more likely option is for the UK to negotiate a ‘Free Trade Agreement Plus’.

A Free Trade Agreement (one which provides for tariff-free trade) between the EU and the UK would be ‘relatively easy’ to make. The problem would be in the details (of course). One such detail would be fishing: if UK fishermen are no longer constrained by EU fishing quotas, other countries may push for a maximum import quota for UK fish, or for the exclusion of UK fishermen from EU waters. There are many such details that need to be hammered out.

The EU and UK could also agree on a transition period during which people and companies who currently enjoy Single Market privileges would continue to avail of them. For example, UK residents already in EU countries could continue to be covered by domestic health care and other social security programs during the transition period. EU citizens in the UK would enjoy similar benefits.

There could be additional agreements made on specific matters, such as:
1. Cross recognition of diplomas and school credits.
2. The free movement of labor for specific sectors (e.g. Internet Technology).
3. Agreements on specific product categories (e.g. for wines and spirits).

European Economic Area
Another option for the UK would be for it to immediately leave the EU with a transition period during which it will remain within the Single Market. This will mean that during this period UK laws will have to continue to be in harmony with the EU’s laws, and that the UK will contribute around 6 billion euros a year to the Single Market administration costs.
This arrangement will be similar to what Norway has with the EU; Norway is a member of the European Economic Area.

This arrangement will give the UK time to negotiate a longer-term deal with the EU, and to have trade talks with other countries. An added advantage of this option is that Scotland will not leave the UK, for as long as the UK stays within the Single Market.

The problem with this is that the Brexit advocates will complain that the UK is effectively not leaving the EU, since immigration will continue as before, and the UK can’t make its own laws on a host of economic issues.

The choice is PM May’s. Will she choose  to immediately negotiate for a Free Trade Agreement Plus; or will she choose the more careful route of temporary EEA status?

 

 

 

 

 

 

 

 

 

The 2-year Transition to Brexit

On 23 June, the people of the United Kingdom (UK) voted to leave the European Union (EU).  The UK and the EU will have two years to negotiate the terms of the separation. (The 2-year period will start when the UK officially informs the EU of its intention to leave; this may be sometime in September) During this period, the British will already feel some negative effects of Brexit (British Exit from the EU).
During the 2-year negotiating period, the UK will remain a full member of the EU, with all the privileges and responsibilities this entails.

The coming two years will not be uneventful, however.

Devaluation. In response to the Brexit vote, the British Pound fell from a rate of 1.50 to the dollar, to a low of 1.33 on 24 June. It may still go down a bit farther. Devaluation is supposed to decrease imports (as they become more expensive) and increase exports (as they become cheaper); but this effect takes 9 months to happen. Inflation is sticky upwards (i.e. prices tend to rise fast but fall very slowly if at all), so devaluation would mean that inflation will increase as a result of devaluation.

Immigration. The Brexit vote will probably have the effect of increasing, rather than decreasing immigration – at least during the 2-year period. EU nationals seeking to work and live in the UK may rush in before the UK actually leaves the EU. British pensioners would delay deciding whether to move to Spain and elsewhere in the EU until the rules for this (e.g. for health care insurance, residency permits, etc.) are clear.

Short Term Grants Only.  EU funding for research, study, small business support, urban renewal , and other projects will need to finish before the cut-off date. As a result, fewer and fewer projects will be supported as the deadline comes closer.

Freeze on Foreign Investments. While the new agreement between the UK and EU is being negotiated, foreign companies would be extremely hesitant to invest in the UK. Foreign Direct Investment will dry up.

Transfer of Operations. Businesses will start the process of transferring some of their operations to EU countries as early as during the negotiation period. For those whose EU headquarters are in London, these offices will be downsized into UK offices. For foreign companies which had set up manufacturing plants in the UK to access the EU market, they will simply set up new plants elsewhere in the EU and downsize their UK operations gradually.

Separation. Scotland will most probably hold a referendum on leaving the UK, so that it can remain in the EU. During the Brexit vote, 62% of Scots voted to Remain, and Remain won in all of its counties. The Scots are mad at England for dragging them out of the EU.
Northern Ireland, which also voted for Remain,  is considering the option of leaving the UK and joining the Republic of Ireland. This will be more difficult for them than for Scotland because the Ulster Unionists are vehemently against leaving the UK. However, if Northern Ireland is allowed to hold a referendum on whether it wants to leave the UK, a majority will vote to do so.
If Scotland (and maybe Northern Ireland) leave the UK, this will have negative economic and political effects on the rest of the UK.

Economic Uncertainty. Nobody knows what kind of deal the UK will finally forge with the EU, or what kinds of political changes will take place. This means that the British economy will be saddled by uncertainty for the next two years at least. This is bad  for the economy. Credit rating agencies have lowered the UK’s rating; making it more expensive for the UK government to borrow money.

And finally, there is Regrexit – Regret at the British Exit from the EU. The online petition calling for a second referendum will not get more than a debate in Parliament; it will not delay or overturn the referendum results.
The growing movement against Brexit will  influence the negotiations between the UK and the EU, by pushing to keep the UK inside the Single Market (including immigration of EU nationals). There could be quite heated public debate on this during the negotiations.

All the above are a list of bad things that will happen before the UK leaves the EU. When the UK finally leaves the EU,  things will get even worse.

A Brexit Timeline

On 23 June 2016, the people of the United Kingdom will vote in a referendum on whether their country should remain in, or leave, the European Union. If a majority votes to leave (or ‘Brexit’, for ‘British Exit from EU’), then the UK will indeed have to leave the EU.
This is one possible timeline for what would happen after the UK votes in favor of Brexit.

24 June to 31 December 2016
On 24 June, the referendum results are declared in the UK:
The UK Cabinet and Parliament decide that the country will indeed leave the European Union by 1 January 2017.

Negotiations between the UK and the EU are held.
They agree to maintain the free flow of goods and services between the UK and the EU; and to allow for visa-free travel between the UK and EU on the condition: that the UK will continue to adhere with EU product standards, financial and employment regulations; and that the UK makes a substantial annual contribution to the EU budget. The contribution would be similar with the arrangement the EU has with Norway (i.e. around Euro 100 per citizen), the UK will contribute Euro 7 billion/year (compared to its Euro 12 billion contribution at present)

The value of the British Pound will decline relative to the Euro.

The EU budget for 2017 and beyond is adjusted to compensate for he loss of the UK contribution by increasing country contributions from 1.23% of Gross National Income to 1.29%.

The UK opts to maintain agricultural subsidies at the same level as that of the EU’s CAP (Common Agricultural Policy), at least for a transition period of 3 years.

EU free trade talks with the US are suspended, because of the pending Brexit.

Foreign investments into the UK are greatly reduced during this period, due to uncertainty over the effect of the Brexit.

2017-2018
UK exports to the EU increases, as well as tourist arrivals, as a result of the Pound’s devaluation. Prices of all goods imported into the UK rise.

British companies are excluded from bidding for government contracts in the EU.
UK goods entering the EU are subjected to border contols, checking of documents and VAT payment.

The number of EU citizens working in the UK reduced by half (from 3 million to 1.5 million),  the number of UK citizens working in the EU are halved as well (from 1 million to 500 thousand)..
The UK continues to allow skilled workers to enter and work, but blocks the entry of unskilled workers. As a result, a lot of  unskilled jobs go to British citizens.
Wages for skilled workers from the EU rise because the Pound has devaluated relative to the Euro. At the same time, unskilled British workers get paid more because of the tighter labor market.

The people of the UK feel that their lives have gotten better as a result of the Brexit.

The UK holds early elections, the Conservatives win.

2019-2021
Foreign manufacturers (e.g. in the auto industry) do not establish new plants in the UK, but instead locate within the EU. Some plants in the UK are downsized.
Multinationals transfer their Europe headquarters from London to within the EU.
Many UK medium-sized service companies transfer to the EU, in order to be able to access the EU market.

The exodus of many companies and the restricted entry of foreign workers cause the UK real estate market to collapse.

UK inflation rises significantly higher than the EU’s 2% (due to higher cost of imported goods, less efficient production, etc).

UK reduces agricultural subsidies to farmers by half. Agricultural production, and exports to the EU, decrease.

The UK signs a free trade agreement with the US. The EU does not.

The UK feels significantly non-EU. The exodus of companies, cut in agricultural subsidies and production, etc are viewed as natural results of asserting sovereignty. (at least, this is what politicians tell the people).

2022-2024
The European Council (composed of the heads of all EU member countries) abolishes the need for unanimity for any of its decisions. Decisions that previously required unanimity will then be decided by qualified majority. This will greatly facilitate decision making.
The Eurogroup (the group of countries with the Euro currency) also decide to abolish the need for unanimity.
The European Parliament acquires the power to supervise the European Commission. The EP could now approve the nomination of individual Commission members, and could depose them by a vote of no-confidence.

UK trade with the EU declines.

The EU welcomes Turkey as a member. Accession talks with Ukraine begin.

Sweden and Denmark adopt the Euro.

EU establishes a Common Energy Policy, which reduces import prices for imported energy (especially from Russia), and coordinates alternative energy development.

EU Finance Ministry is established. The EUFM supervises the implementation of fiscal guidelines across the EU. Tax rates can only vary within limited ranges. Government expenditure.are allowed to vary only within limited ranges. (For example, a country could not have a disproportionately large military budget)
The EUFM issues EU Bonds. These will gradually replace bonds issued by national governments.

Frankfurt grows in importance as a financial center, rivalling London.

The exodus of foreign companies from the UK hurt Scotland the most within the UK; the Scots then pushes for another referendum on independence. In May 2022, the Scottish vote to leave the UK, starting on 1 January 2025.

Being outside the EU irritates the people of Northern Ireland. With the secession of Scotland, they have two EU countries as neighbors; meaning that there are border controls on both sides of their country. Then, the cut in agricultural subsidies hurts them. Both Protestants and Catholics want to secede from the UK and join the EU.

In Northern Ireland, people are inspired by the Scottish example, and demand to also have a referendum on independence.

EU integration accelerates; the UK starts to disintegrate.

2025-2027
The Euro is adopted throughout the whole EU. New members are required to adopt the Euro upon entry.

All EU countries are required to join the Shengen agreement on the free flow of persons.

Scotland becomes independent. It then applies for membership in the EU, and is accepted within a year.

Corsica and Catalonia secede from France and Spain respectively. They are accepted into the EU as new members. Cyprus reunites.

Northern Ireland becomes independent after majority of its citizens vote for it in a referendum. The country then forms a federation with the Republic of Ireland.

Moldova forms a federation with Romania, effectively joining the EU.

Ukraine and Serbia become members of the EU.  EU Accession talks with Bosnia, Iceland Norway, Montenegro, Kosovo, Macedonia and Georgia begin. Association agreements are signed by the EU with Belarus, Armenia, Albania and Azerbaijan.

The name ‘United Kingdom’ is dropped after the secession of Scotland and Northern Ireland. The country is renamed ‘England & Wales’.

The EU is growing to finally encompass all of Europe except for Russia and England & Wales.

 

 

UK Leaving EU. Really?

On 24 October, the British parliament voted on a resolution calling for a referendum on Britain’s membership in the EU. It lost 111-483.  Nevertheless, it was an embarrassing  blow on PM Cameron’s efforts to participate in the Euro discussions (French president Sarkozy refused his entry to a Eurogroup meeting, he told Cameron not to intervene). As a result of the eurosceptic rebellion, the already low reputation of the UK in the EU went down a couple of notches.

It seems that almost half of the people in Britain favor leaving the EU. For them, the EU is the source of all kinds of regulations that only make their lives more miserable. And with the present crisis in the Eurozone, it seems that the British are just waiting for the rest of the EU to implode. So, better get out now, while they still can save Britain from economic collapse, and from a loss of its identity. Or so they think.

But can the UK really leave the EU? Of course it can. It can opt to leave the EU and just be like Norway, Switzerland and Iceland. These countries choose the areas where they would cooperate with the EU. But, if the question is whether the UK will thrive outside the EU? Then the answer will have to be: most certainly not.

Single Market
For the UK, leaving the EU will mean going out of the Single European Market. The consequences of this will not be immediate, since the UK’s present laws are still in harmony with those of the EU; trade will go on as usual for the time being.

But the EU is constantly revising the rules that govern the internal market. And when they change some rules, and the UK doesn’t, that specific area of trade will be affected. So, the UK will most likely keep its own economic rules in harmony with those of the EU, just to keep trade going as usual. But then, in contrast with the present, the UK will increasingly be following rules which it had not helped to formulate.

Many companies would have to reconsider decisions on having their offices and factories in the UK. After all, they had based these in the UK on the basis of the UK as part of the EU. Car manufacturers from Asia, the US, and even other parts of Europe had located their plants in the UK to benefit from its cheap labor AND its access to the EU market. Many of them will surely phase-out their factories and offices when the UK leaves the EU.

London’s role as a financial center will not necessarily suffer with an EU withdrawal. But, as in trade, the UK government will have to follow all EU regulations. Take for example the proposed Financial Transaction Tax now being discussed in the EU. If it is implemented, the UK will have to impose a similar tax, or it will create a barrier to the free flow of finances.

However, no matter how much the UK tries to harmonize its laws with that of the EU, it will still remain a foreign country to the EU. Government procurement, for example, is often open to all companies within the EU. The really big contracts may be open to bidders from the whole world; but the bulk of the contracts are restricted to EU companies. This means that EU companies will have a lot more contracts than UK companies.

UK, the ‘Great Exception’
If the UK leaves the EU, the EU will not only go on with business-as-usual; it will simplify and accelerate its process of integration. The UK has always been the EU’s great exception, opting out of many important agreements and forcing the others to find creative detours. Thus, the Schengen agreement on free travel of persons does not include the UK. The UK is not part of the Eurozone.

With the UK gone, EU decisions will increasingly be done by ‘qualified majority’ instead of ‘unanimity’. The EU will integrate more, and more intensively, with or without the UK. But if the UK were to leave the EU, the EU will just integrate much faster. For example, adoption of the Euro may be made a requirement for a country to fully participate in the EU. And the free travel of persons may also become standard.

If the UK were to decide that it wanted to return to the EU, after a number of disastrous years; it will be faced with a much different EU than it had left. No longer could the UK keep itself as the ‘great exception’. It would have to accept the Euro AND free travel for persons, as part of its EU accession negotiations.

Another function that the EU has, is that it serves as a useful bogeyman when national politicians want to push necessary but unpopular laws. They could always say that they were forced by ‘Brussels’ to do it. If the UK leaves the EU, its politicians could no longer blame Brussels.

To sum it up: stepping out of the EU will mean that there will be more (not less) EU rules that the UK needs to follow; but that the UK will have no say in formulating these rules. It will mean less access to the EU internal market, with international companies transferring to countries inside the EU. It will mean that British politicians have only themselves to blame for the UK’s problems. So, unless the British wish to damage their economy in the name of national pride, they should not leave the EU.