UK: Brexiting Is Easy, Getting The Right Deal's The Hard Part

Last Updated: 11 July 2016
Article by Ian Stewart

The decision facing UK voters in the polling booths on 23rd June was deceptively simple – to remain in or to leave the EU.

Now comes the hard part. It falls to politicians to interpret the vote and turn it into some sort of reality.

That reality could yet leave the UK as a member of the EU. Yesterday former Prime Minister Tony Blair said that the UK "should keep our options open" on leaving the EU and suggested that as the implications of Brexit emerge the "will of the people" may shift.

Though the front runner for the Conservative leadership, Teresa May, described it yesterday as "a destabilising factor", an early General Election cannot be ruled out. Given the political surprises of the last ten days who could be sure that such an election would confirm the vote to leave the EU?

But for now, at least, the most likely outcome seems to be that the UK will leave the EU. All the contenders for the Conservative Party leadership appear to be committed to taking the UK out of the EU; Conservative Party members who will elect the new leader also strongly favour exiting the EU.

The new leader of the Party and Prime Minister will be elected in just over ten weeks, on 9th September. He or she will face an epic balancing act - to interpret the meaning of the referendum, to weigh it against what is economically desirable and politically workable, and to turn it into a negotiating plan.

The trade-off facing a Prime Minister in the event of a Brexit vote has long been apparent. At its heart is Britain's desire to retain access to the Single Market while imposing controls on EU migration. Free movement of people is one of the four pillars of the EU, enshrined in the 1992 Maastricht Treaty.

Battle lines are emerging. Last week the German Chancellor, Angela Merkel, reminded the UK that EU members could not "cherry pick" the parts of the Single Market that suited them and ignore those that didn't. At the same meeting Mr Cameron told his fellow EU leaders that people had voted for Brexit because of concerns about migration.

The choices facing the UK form a spectrum. At one end is sovereignty and control of immigration, at the other full access to the Single Market. There is no perfect solution; everything depends on what the UK regards as vital and what the EU is prepared to agree.

In the last week there has been some talk in the media that the UK should pursue a so-called "Norway option" by joining the European Economic Area (EEA) along with current members Norway, Liechtenstein and Iceland. Such an arrangement would largely maintain the status quo in terms of access to the Single Market in goods and services and movement of capital. It would also allow the UK to strike its own trade deals independently of the EU. For these reasons I would imagine many business groups see EEA membership as the least disruptive alternative to EU membership.

Such advantages come at a price. Most importantly, EEA membership involves the same commitment to free movement of people and the provision of welfare benefits to EU citizens as being a member of the EU. If the referendum vote were a vote against free movement EEA membership, as currently constituted, is not the solution.

The EEA has other drawbacks from the point of view of a UK government committed to leaving the EU.

EEA members accept EU regulation but have no influence over them. They must meet EU 'rules of origin', which impose controls on the use of products from outside the EU in goods which are subsequently exported within the EU. (The costs involved are considerable. US research suggests the cost of border formalities to determine the origin of products amount to at least 3.0% of the value of the goods concerned, a far higher cost the average 2.3% tariff countries, such as the US or Australia, pay to access the Single Market under the rules of the World Trade Organisation). EEA members must also implement EU rules on employment, consumer protection, environment and competition policy, limiting the UK's ability to "take back control" outside the EU. Finally, EEA members pay a fee to access the Single Market, albeit at a somewhat lower rate than the cost of full membership.

A second, widely canvassed alternative is the Swiss option membership of the European Free Trade Area. The advantages are that it allows comprehensive access to the Single Market in goods and, like the Norway option, would allow the UK to strike trade agreements independent of the EU. It offers a rather more distant relationship than the EEA, partly because it provides greater independence in policy areas including social and employment law.

But, like the Norway option, the Swiss route of EFTA membership requires free movement of people. This element was challenged by Switzerland's decision, in a close referendum vote in 2014, to impose controls on EU migration. In an episode that has uncanny parallels with Britain's Brexit vote, the Swiss have been trying for two years to secure some limits on EU migration while maintaining access to the Single Market. The European Commission shows few signs of conceding on free movement of people, leaving some Swiss newspapers arguing that the Swiss and the UK should make common cause in securing a deal.

The Swiss option shares two further drawbacks with the Norway model in that Switzerland must accept EU regulations without having any say in them and are subject to the EU's rules of origin. Even more significantly for the UK, Swiss access to the EU market in services is restricted, particularly for financial services. Despite extensive negotiations on the matter, there is no general agreement on the free movement of services between the EU and Switzerland; Swiss financial services providers must generally establish a subsidiary or branch in the EU in order to provide cross-border services. Finally, Switzerland's arrangement is the product of scores of bi-lateral agreements which, according to the think Open Europe, took almost a decade to put in place.

If the UK cannot reach an agreement with the EU on immigration the UK might be left with no choice but to exit the Single Market. Countries outside the Single Market sell into it, albeit on more restricted terms than members. This takes us to options three and four.

Option three is for the UK to trade with the EU as a member of the World Trade Organisation, creating a similar relationship to that which the US, Australia or China have with the EU. UK exports to the EU would be subject to Most Favoured Nation tariffs set under WTO guidelines. In 2013, the EU's trade-weighted average MFN tariff was 2.3% for non-agricultural products, a level which does not seem prohibitively high. However average tariffs on some goods, particularly agricultural produce, such as dairy products, sugar and confectionery, and animal products range between 20% and 30%. Tariffs on cars are 10%. This would raise the cost of exporting to the EU for UK firms, though it would also allow the UK to levy reciprocal charges on EU imports. Nonetheless, operating under WTO rules China, India and the US conduct a thriving bi-lateral trade in goods with the EU.

A further downside of the WTO route is that many restrictions on trade in services that are forbidden within the EU remain applicable to firms outside the EU. Thus under WTO rules UK services would face higher levels of non-tariff barriers such as domestic laws, regulations and supervision. The House of Commons library concludes that, "the level of market access [for UK services] would generally be far more limited for UK exporters" under the WTO than as a member of the EU.

Given that, in 2014, services made up 37% of total UK exports to the EU this is a material drawback to the WTO option.

Our final option, number four, also involves leaving the Single Market, with the UK negotiating a preferential trade agreement with the EU. This is sometimes referred to as the Canada option after the Comprehensive Economic and Trade Agreement (Ceta) negotiated by the EU and Canada. (The deal has not yet been ratified). Ceta gives Canada preferential access to the Single Market but leaves it facing costly rules of origin requirements. Services are only partially covered and a Ceta-type deal would not give UK financial services the EU market access they have now. It would be hard for London-based banks to get "passporting" rights for their services in the EU - rights that they value hugely now.

Even a cursory examination of alternatives to EU membership demonstrates that there are no easy choices. The UK can leave the EU and, if it seeks the Norway option, hope to maintain current access to the Single Market. But it is unlikely to be able to do so and impose controls on free movement of people from the EU. If that is an overriding aim the UK will probably have to leave the Single Market and operate under the rules of the World Trade Organisation or strike a trade deal with the EU. Both options would impose costs and complexity on UK exporters and would restrict UK service exports to the EU, particularly exports of financial services.

But that isn't quite the end of the story. The EU's trade surplus with the UK may create an incentive on the part of the EU's big exporters to go for a deal which keeps trade flowing. After all, EU has, on occasions, interpreted its own rules flexibly as when some countries were allowed to join the euro without meeting the exact criteria. And outside the Single Market the UK might be able to secure bi-lateral trade deals more quickly than the EU can, which is negotiating on behalf of 27/28 nations. The recent EU/Canada deal was, for instance, delayed by Greece's insistence that it be granted exclusive rights to use the term "feta" for the salty cheese it produces. Nor should we lose sight of the fact that many countries export successfully to the Single Market without being a member of it.

Much is possible, but little is certain. Perhaps the best guide to the type of trade deal the next Prime Minister aims for with the EU will come through in the language used during the leadership campaign. The more emphatic the winning candidate is about accessing the Single Market the more likely we are to go down the Norway or Swiss route. If the winning candidate stresses immigration during the leadership campaign it's more likely to be a WTO or Canadian route.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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