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The Brexit starting shot has sounded

Economic Report

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  • Brexit has officially started since British Prime Minister Theresa May invoked Article 50 of the Treaty of Lisbon
  • It has become clear that the EU27 will first want to make significant progress on the orderly withdrawal, before starting talks on the future relationship
  • The negotiations will be complex, difficult and time consuming and we foresee various roadblocks in the Brexit process
  • The future for free trade between the EU and the UK does not look very bright, as the UK and the EU are miles apart
  • But, the discussion of the Great Repeal Bill in the UK parliament will give pro-EU MP’s another opportunity to increase their influence on the negotiations in order to soften the hard stance of the British government on Brexit   
  • Both the EU and the UK seem to acknowledge the importance of a transitional deal, although the conditions set by the European Council’s guidelines for a such deal might be difficult to sell to hard line Brexiteers
  • A new Scottish independence referendum or dispute about Gibraltar could further complicate the Brexit process

Brexit has officially started

Last week, British Prime Minister Teresa May invoked Article 50 via a letter to Donald Tusk, formally starting the British exit from the European Union. Although the tone of her letter was more conciliatory than her Brexit speech on 17 January in Lancaster House, the letter did not provide much new information on the British negotiation position. Ms. May’s plans for the UK to leave the Single market and the customs union were repeated, and so was the desire for a deep and special relationship with the EU after Brexit. She played the security-card, which was to be expected, because this is the main bargaining chip of the British. 

EU27 negotiation position: orderly withdrawal first

Next to this, the European Parliament’s draft resolution on Brexit was leaked, and on Friday 31 March, President of the European Council Donald Tusk submitted the European Union draft negotiation guidelines for the Brexit negotiations. It has become clear that the EU27 will not engage in talks about the future relationship, before “sufficient progress” on an orderly withdrawal agreement has been made. It will be the European Council who will determine when sufficient progress is made. Tusk mentioned in the press conference that it will hopefully be in the autumn of this year. This is a setback for May, as the two year withdrawal period is already counting down, and she thus prefers to start negotiations about the future relationship early in the process. The European Council’s guidelines will probably be finalised during the EU summit on 29 April.

Bottlenecks in the Brexit process

The negotiations between the EU and the UK will be complex, difficult and time consuming. Aside from the fact that trade negotiations usually take many years to conclude, there will first have to be an unbundling and a settlement of more than forty years of European cooperation. Next to this, several additional bottlenecks could complicate the Brexit process, while at least agreement on withdrawal and a transition period will have to be concluded within the two year time frame set by Article 50.

Figure 1: Timeline of the Brexit process
Figure 1: Timeline of the Brexit processSource: Rabobank

Sufficient progress on a Withdrawal Agreement

According to the EU guidelines and the European Parliament’s draft resolution, the withdrawal agreement has to cover the protection of the rights of EU and UK citizens, the exit bill, the border in Ireland, and seek to prevent a legal vacuum once the UK leaves the EU. Especially negotiations about the exit bill are expected to be difficult, and could delay the process. The border between Northern Ireland and Ireland is another sensitive, and important, issue. Northern Ireland voted to remain in the EU by 56%, in part due to fears of being faced with a hard border. The issue is particularly worrisome in light of the recent Northern Ireland Assembly election, where unionist parties lost their majority for the first time in history. Following this, the power-sharing talks to form a coalition broke down, possibly threatening the devolution in Northern Ireland. In addition, the Northern Ireland’s nationalist party, Sinn Féin, has called for a referendum about joining Ireland. Another obstacle in the Brexit process is that the withdrawal agreement can only be concluded with the consent of the European Parliament, after approval of a qualified majority of the EU’s remaining 27 member states. The European Council thus has to take into account the resolutions of the European Parliament.  

The outlook for future free trade remains gloomy

A second bottleneck in the Brexit process is the future free trade agreement. In our view, the outlook for future free trade between the EU and the UK remains gloomy. Of course, Theresa May is seeking for a ‘special partnership’ and a ‘comprehensive agreement’ in order to secure free trade and to keep the costs of trade low. However, both the European Parliament and the European Council have stressed that the agreement on the future relationship cannot be more beneficial than EU-membership. It was also repeated that the four freedoms of the Single market are indivisible, which indicates that the UK can’t maintain access to the Single market, unless it accepts the free movement of people. Next to this, the Council has said that it’s not possible for the UK to participate in the EU Single market on a sector-by-sector approach. Another setback for May, who proposed in the UK’s withdrawal letter that the future free trade agreement should cover sectors crucial to the UK’s and EU’s economies. She specifically named financial services and network industries.

Figure 2: UK more dependent on trade with EU
Figure 2: UK more dependent on trade with EUSource: OECD TIVA, Rabobank
Figure 3: EU citizens living in the UK
Figure 3: EU citizens living in the UKSource: ONS, Rabobank 

Of course, a trade deal that provides in free trade would also be positive for European companies that trade with the UK. But when we look at the macro-economic importance of trade, we think it is important to highlight that in relative terms, the EU27 is far less dependent on trade with the UK than the other way around (figure 2). The priorities between the member states will probably differ to some extent. Countries that are more dependent on exports to the UK (figure 4), for example Malta, Ireland and Cyprus, are likely to give priority to free trade. However, the EU27 is often a more important trade partner than the UK, which supports the protection of the EU and the prevention of a domino-effect. In addition, countries with many citizens living and working in the UK (figure 3) are not expected to allow the UK comprehensive access to the single market, while their citizens are not welcome anymore in the UK.

Figure 4: Dependence on export to the UK differs between EU countries
Figure 4: Dependence on export to the UK differs between EU countriesSource: OECD TIVA, Rabobank

Because the future trade deal requires ratification by all the national parliaments of the remaining 27 member states, and the different interests across the countries, we expect that the trade talks will be difficult and that the prospect for future free trade with the UK is not very bright.

Hurdles to a transitional agreement

It is possible that the two year withdrawal period is not sufficiently long enough to finalise a trade deal, especially since the EU only wants to start discussions after sufficient progress on the withdrawal agreement has been made. In addition, a trade deal can only be finalised and concluded after the UK has exited the EU, according to the European Council, and the implementation of a trade deal would take time.

To guarantee an orderly Brexit, both Donald Tusk and Theresa May are therefore open to a transitional agreement. Such an agreement would bridge the period between the moment that the UK leaves the EU and the moment that the new (trade) agreements are finalised and come into effect. The conditions set by the European Council’s guidelines for a transitional deal might, however, be difficult to sell to hard line Brexiteers. This is because the UK has to accept EU regulation, contributions to the EU budget and the jurisdiction of the European Court of Justice during a transition period. In addition, if the UK wants to keep access to the EU single market in the transitional period, it would have to accept all four freedoms, including the free movement of people. These conditions reflect indeed many of the main reasons the majority of the British electorate voted for Brexit. If the UK were to leave the EU without a free trade agreement or a transitional agreement, a so called ‘cliff-edge’ Brexit, this would severely impact European companies trading with the UK and vice versa.

The Great Repeal Bill

The British government will table the Great Repeal Bill in the first upcoming session of parliament, which is in May. The bill is intended to incorporate existing EU legislation into UK law as much as possible. The aim is to avoid regulatory gaps once the UK has left the EU, therefore facilitating continuity for businesses, investors, workers and consumers. Although this might sound straightforward, the process can become complicated, because many EU laws refer to EU institutions or systems that the UK will no longer be part of when it leaves the EU. This would require the UK government to make changes to some laws. To make sure the process is finished in time, i.e. is before March 2019, the government plans to give ministers the power to do this without full parliamentary scrutiny. The discussion of the Great Repeal Bill in parliament will give pro-EU MP’s another opportunity to increase their influence on the negotiations in order to soften the hard stance of the British government on Brexit.   

Once Brexit has actually taken place, the UK government and the devolved administrations in Scotland, Wales and Northern Ireland will be able to amend the legislation as they see fit. However, if the UK is pursuing a comprehensive trade deal with the EU, the room for changes will probably be limited, because the EU will likely require a high degree of regulatory convergence between the UK and EU.

Another Scottish independence referendum

Figure 5: UK is largest Scottish export partner
Figure 5: UK is largest Scottish export partnerSource: Government of Scotland

A second Scottish independence referendum would add an additional layer of complexity to the Brexit process. A majority of the Scottish people do not want to leave the EU; 62 percent voted to stay last June. The Scottish first minister, Nicola Sturgeon, has therefore urged for a second independence referendum, which the Scottish parliament approved last week. Sturgeon wants to hold the referendum before the UK leaves the EU, preferably somewhere between the autumn of 2018 and the spring of 2019. However, the UK parliament in Westminster has to approve a Scottish independence referendum, and currently, it is reluctant to do so before the UK has left the EU. It remains to be seen, however, whether Theresa May will be able to keep it off if pressure from the Scottish people increases.

One obstacle Scotland could have faced in becoming a member of the EU after independence seems to have already removed itself, as the Spanish foreign minister Alfonso Dastis stated that Spain won’t veto a Scottish application to join the EU. This is remarkable, because Spain previously opposed the idea of Scotland becoming an EU member, in order to discourage separatism in Catalonia.

If a Scottish independence referendum were to be held, it remains to be seen whether a majority of the Scottish electorate would vote for independence. One of the issues is whether independence would be economically viable. When we look at the trade interests, we see that the EU is indeed an important export destination of Scotland, but that the rest of the UK is way more important (figure 5).

Dispute about Gibraltar

Disagreement between Spain and the UK on Gibraltar might further complicate the Brexit process and negotiations. Notably, the draft guidelines of the European Council explicitly stated that agreement on the future relationship with the UK would not apply to Gibraltar without Spanish approval. This signals the new, less favourable, status of the UK, as the EU seems to be prioritising demands from its remaining member states over those of the UK.

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Author(s)
Carlijn Prins
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 60033

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