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Avoiding a hard Brexit tops the EU agenda

Avoiding a hard Brexit tops the EU agenda

13-12-2017 | Insight

Avoiding a hard Brexit remains the main priority as EU leaders meet to discuss progress, says Robeco’s Chief Economist Léon Cornelissen.

  • Léon  Cornelissen
    Léon
    Cornelissen
    Chief Economist

Speed read

  • Focus on future trade deal after three sticking points were overcome
  • Talks may center around adopting the Canada or Norway models
  • Transition period an illusion and no one knows what the end game is

The issue tops the agenda of the EU summit being held in Brussels on 14-15 December, with the UK still holding out for continued access to the European single market until a permanent trade deal can be agreed.

It follows a provisional deal struck between UK Prime Minister Theresa May and EU negotiators to overcome the three major stumbling blocks to leaving the EU. The UK agreed terms to recognize the status of EU citizens in the UK and British expats; avoid a hard border between Northern Ireland and the Republic of Ireland; and settle the ‘divorce bill’ which is now expected to be about EUR 50 billion.

However, much still needs to be done if the UK economy is to attract or retain investment, including outlining the shape of a future trade deal which looks like following either the Canada or Norway models, Cornelissen says. The UK government has been anxious to stop UK companies leaving the country for the safer pastures of within the single market in the so-called Brexodus.”

“The main achievement of the deal so far agreed is that it prevents an escalation of a Brexodus next year because companies were starting to panic, but now the risk of a hard Brexit has been reduced,” says Cornelissen.

Major concessions

“The UK has made major concessions, and so the UK will remain a member of the internal market for years to come, but won’t have a say in EU rules after March 2019. It means the UK will be singing to the EU’s playbook for many years, which economically isn’t a bad thing. But there still isn’t any longer-term security, so this will continue to hurt external investments into the UK.”

Cornelissen says that with the major sticking points dealt with, attention will switch to what kind of trading model the UK will seek. “There seems to be only two possible outcomes – the Canada-style agreement or the Norwegian one – and both have their problems,” Cornelissen says. “The Canadian model covers mostly physical trade and not services, and of course the UK is a service economy.”

“Its main advantage would be that it does not require the free movement of people, and so is more aligned with ‘taking back control’ – though it is hard to see how this would be compliant with an open Irish border. The other advantage is that under a Canadian model, the UK wouldn’t be in the single market or customs union, and so wouldn’t have to pay the EU any contributions.”

Will it be no way to Norway, or can do for Canada?

“The Brexit Secretary David Davis has said that the UK will strive for ‘Canada-plus-plus-plus’, but it is unlikely that any of these plusses could be large. One factor that will haunt the UK negotiations is the most favored nations clause under WTO rules. Any additional benefits given to the UK would have to be given to other trading nations as well, so it is doubtful a Canada-plus-plus-plus is viable.”

“The Norwegian model implies continued membership of the single market, which of course is economically the best outcome, as the UK will keep frictionless trade with the EU. The disadvantage is that the UK will have to accept EU rules and the free movement of people. And Norway pays a contribution to the EU which per capita is higher than what the UK is paying at the moment.”

Rock and a hard place

So, which one is best – or the least worst – for the UK? “The UK is basically stuck between a rock and a hard place,” Cornelissen says. “The current UK government would prefer the Canadian option of course, as it doesn’t need to accept the free movement of people and doesn’t pay any contribution to the EU budget. But this would be killing for the City of London, and highly damaging for the UK economy.”

“The best model for both the EU and UK would be Norway, but this is politically difficult as the UK would become an EU vassal state. It essentially remains in the EU without having any say in it, and has not really conducted a Brexit.”

Certainly any deal is better than crashing out without one, Cornelissen says. A survey by Rand Corporation predicted that a no-deal Brexit would cost the UK economy GBP 105 billion over 10 years, removing 4.7% of GDP, and effectively causing years of recession.

Lost in transition

Meanwhile, nobody knows how long any transitional deal will last. “When does this transition end? The UK wants to limit it to two years, but most experts think this is an illusion,” says Cornelissen. “A two-year timeframe could be agreed and then extended later on, and then be switched to become open ended.”

“A more natural point of exit would be December 2020 because the current multi-year EU budget ends then. After that they will have to negotiate with the UK about making new contributions. But even this is probably not long enough as it’s only 22 months from the existing March 2019 exit date.”

“And don’t forget that during the transitional period, the UK will not only have to stick to existing EU rules, but will have to integrate any new rules as well. And there has to be some kind of transition legislation that is accepted by the UK parliament, where May has a very flimsy majority, facing at least 40 hard opponents of the EU in the Tory party. It remains debatable whether this kind of Transition Act is possible, and that remains a risk.”

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