The Brexit crunch approaches

Thorny issues remain unresolved as the transition period comes to a close. Yet the hurdles to a deal are not insurmountable

Standpoint Magazine

How is Brexit going? First, it’s worth zooming out. The UK officially left the EU on January 31. But more than four years on from the EU referendum, and with less than three months left of the Brexit transition period, the nature of the UK’s future relationship with the EU hangs in the balance once again. 

Unless a compromise is reached by New Year’s Eve, a no trade deal departure beckons—a cliff edge that both sides are ultimately keen to avoid. Life would go on but it would undoubtedly be disruptive to trade in both directions. It would also represent a diplomatic rock bottom for UK-EU relations, which might be difficult—and take years—to rebuild.

In recent weeks, things haven’t been looking promising. The political theatre and rhetoric on both sides has at times suggested that the negotiations are destined for failure. The Prime Minister has questioned whether the EU is negotiating in good faith, accusing Brussels of threatening the possibility of “blockading food and agricultural transports within our own country”. Meanwhile, the European Commission has sent the UK a formal notice of legal action in response to the government’s Internal Market Bill. This is the legislation that would enable Ministers to override provisions in the Northern Ireland Protocol which were previously agreed under the UK-EU Withdrawal Agreement last year.

The truth is that this process was always likely to end in a last-minute crunch. Years of bad-tempered negotiations and political drama have drained the well of trust on both sides. However, the hurdles to a deal are far from insurmountable—if political leaders on both sides want one.

One might have assumed that over 40 years of economic integration between the UK and Europe would have made for a relatively easy path to a trade agreement. Trade negotiators usually have to contend with powerful vested interests opposed to tariff liberalisation. But in this case the vast majority of businesses on both sides of the Channel want to maintain tariff-free trade. The UK and the EU will have almost identical regulatory regimes on January 1, 2021, so surely both sides could agree to recognise the rules in each other’s jurisdiction?

Alas, this is not a traditional trade negotiation. First and foremost, Brexit is a constitutional issue for both Brexiteers and Brussels: “Take back control” was not simply an effective campaign slogan. Equally, the EU’s view is that the UK’s legal independence must come at a high price in lost market access. All new trade arrangements will flow from these political realities.

Early on, the EU presented the UK with two models for the future relationship. Norway-style membership of the EU’s single market—abiding by the panoply of EU rules and regulations—or a looser, Canada-style free trade agreement, with greater friction at EU borders and greater freedom for the UK to chart its own course. Theresa May’s attempt to split the difference was publicly rebuffed by EU leaders at a Salzburg summit in September 2018 and led to ministerial resignations at home, including that of the current Prime Minister.

Since Boris Johnson’s election victory—on a mandate to “Get Brexit Done” and diverge from EU rules—the only plausible outcomes for the UK-EU relationship have been a Canada-style free trade agreement or none at all. Right now, the odds stand at about fifty-fifty between the two. 

The biggest outstanding hurdles to securing a free trade deal are fishing rights, rules on state subsidies and the governance framework of the agreement. The government’s big parliamentary majority and its willingness to refuse a “bad deal” have undoubtedly had the effect of shifting the argument towards the UK position on these issues. Equally, the EU has refused the UK’s more ambitious demands on market access for services and rejected the argument that car components from Japan used on UK assembly lines should be considered British. (This means some UK car exports could still face tariffs, even under a trade deal.)

Fishing’s political symbolism—in coastal towns from Boulogne to Grimsby—is outsized compared to its economic importance to either side. Ultimately, it’s not likely to be the deal-breaker. But the EU has so far turned down the UK’s request to move to a new regime of annual quota negotiations—a model the UK has just agreed with Norway.

On the other hand, the eight EU member states with significant fishing fleets will completely lose access to UK waters if there is no agreement at all, so cutting a deal is clearly better for them than the default, even if it falls well short of the EU’s initial position that its boats should retain the same access rights as they enjoy now.

Those in the know say the UK has offered a transition period under which EU fleets’ catch would be phased down over a number of years. This could point towards a compromise in which the UK regains a much greater share of future catch opportunities but EU fishing communities are assured of their rights over the medium-term.

Aside from fishing, agreeing a framework for the use of government subsidies, or “state aid” in EU parlance, is the major stumbling block. The EU appears to have walked back from its initial position—clearly unacceptable to the British government—that the UK should continue to be bound by EU state aid rules into the future, with the European Court of Justice having the final say in terms of enforcement.

So far, the UK has chosen not to spell out its bottom line. Senior figures in the Johnson administration clearly view industrial policy and strategic investment as important levers in delivering the domestic agenda to “level up” the regions of the UK and help them catch up with prosperous London. But how much of a problem could this be?

Well, the EU side should note that, traditionally, past governments have refrained from major interventions in the economy—and that the UK would need to radically increase its state activism to reach the levels of its continental competitors. According to the European Commission’s “State Aid Scoreboard”, the UK spent state aid equivalent to 0.34 per cent of GDP in 2018, compared to an EU average of 0.76 per cent. Meanwhile, France spent 0.79 per cent, slightly above the EU average, and Germany spent a much larger 1.45 per cent.

At a minimum, the UK will need to comply with World Trade Organisation (WTO) rules, but these fall far short of the requirements of the current EU regime. A UK statement in September simply said that it “does not intend to return to the 1970s approach of trying to run the economy or bailing out unsustainable companies.” The statement did add that “the UK will adhere to any international obligations on subsidies agreed under future free trade agreements.” So there’s a glimmer of light here. It should be possible for the UK and the EU to agree to principles on subsidies that would prevent trade distortion, such as commitments not to guarantee the debts of struggling companies or provide open-ended state bailouts.

But this issue is bound up with the broader question of how any commitments made in the trade agreement will be enforced. The EU wants an independent UK regulator to police decisions on subsidies. It also wants a new UK-EU dispute settlement mechanism that would enable either side to retaliate against any subsidies deemed to be trade-distorting by taking countermeasures, such as imposing tariffs. There would be a price to pay for high levels of state aid, in other words.

The prospect of the EU using such measures as a political tool to secure leverage over other areas of an agreement cannot be discounted. The UK should therefore seek to limit this potential for “cross-retaliation”. But in the final stages of negotiations, the primary objective from the UK’s perspective should be to depart from the EU’s desire to micromanage the UK’s subsidy policy by treaty. Dispute resolution mechanisms of this kind are not uncommon in trade agreements.

The final piece of the puzzle is the recent row over Northern Ireland. In short, the Northern Ireland Protocol, agreed last year, avoids a North-South border on the island of Ireland by giving Northern Ireland a special economic status—within the UK’s customs territory, but in regulatory alignment with the EU single market for goods. A UK-EU Joint Committee was empowered to iron out the practical details of how various provisions on customs procedures and tariffs are implemented, with the UK arguing for a light touch.

The UK believes that the EU is refusing to negotiate sensible easements to Great Britain-Northern Ireland trade in order to secure leverage in the free trade agreement negotiation. Hence the Internal Market Bill, described by the Government as an “insurance policy” to be used in the event that negotiations fail to address its concerns. What the Bill does, for better or worse, is illustrate that Brussels’ leverage is limited. Under the Protocol, it is UK officials and agencies who will be tasked with enforcing the rules. But realistically, how plausible is it that the UK would do so zealously in a scenario where there is no trade agreement and the EU is also insisting on a maximalist interpretation of the Protocol?

What the recent row has demonstrated is that a negotiated settlement on the Northern Ireland Protocol and the wider trade issues should be preferable for both sides compared to an acrimonious breakdown in the UK-EU relationship. Indeed, the controversy over the Internal Market Bill and the EU legal action against it could be entirely defused if a negotiated agreement can be reached.

The coming weeks may throw up yet more drama. No one can say whether a deal will be reached or not. But there is a plausible path to a deal and the outcome now rests on political decisions to be taken in London, Brussels, Paris, Berlin and Dublin. 

 

Stephen Booth is Head of the Britain in the World Project at Policy Exchange.

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