May’s Brexit-plan less rosy than outlined
- In this piece we take a closer look at some of the key points in Theresa May’s long-awaited speech held last Tuesday
- Our overall conclusion is that although it has brought clarity as to where the Prime Minister stands, we see considerable hurdles when it comes to the execution of these plans
On 17 January, more than six months after the British people voted to leave the European Union (EU), British Prime Minister Theresa May laid out her plan for Brexit. The upshot of this: the UK is heading towards a hard Brexit, i.e. leaving the single market. Potentially, this could have a large negative impact on UK trade and the economy. Nevertheless, financial markets responded positively with the pound making its largest one-day-gain vis-à-vis the dollar since 2008 (figure 1).
Our aftertaste of this market reaction is that it was probably driven by the fact that there is finally more clarity about the UK’s Brexit-plans. Another explanation is that the Brexit-plan May laid-out could be relatively positive for economic growth in the UK. We believe, however, that there are many hurdles when it comes to the execution of her plans, and that the post-Brexit situation might be less rosy than outlined by Ms. May.
For hard Brexiteers there was much to cheer about, as the UK will take back control over EU-immigration. Moreover, May wants to end the jurisdiction of the European Court of Justice and wants to be able to close bilateral free trade agreements. As a consequence, May understands that the UK can’t remain a member of the single market. Besides, a bonus of leaving the single market is that the UK can stop paying into the EU budget.
EU won’t accept cherry-picking
To protect British export and economy, May proposes to reach a free trade agreement with the EU that gives “comprehensive access” to the single market. Her goal is to keep as much free trade in goods and services as possible. But securing such a trade deal might prove to be very difficult. Given the need for national parliaments to ratify any deal, the time window for negotiations is a lot less than the maximum time allowed (two years). In practice we may be talking 1.5 years, which is not a lot for such a complicated process.
A key concern among EU partners is that the UK would just be cherry-picking the best of the EU-single market: the UK would continue to benefit from free trade with the EU, but without the disadvantages that come with full membership. Various European leaders have already stated that cherry-picking is off the table, though the official negotiation strategy of the EU is still unclear. Of course, a trade deal that provides in free trade would also be positive for European companies that trade with the UK. But a deal that meets all the wishes of the UK could cause a domino-effect, which would lead to more economic damage than the Brexit alone. As a result, we expect the EU to prioritize protecting the EU and we therefore view it as unlikely that the EU will give the UK comprehensive access to the single market, without the UK accepting the free movement of persons and the jurisdiction of the European Court of Justice. Without extensive access to the internal market, UK’s trade and economy are expected to suffer.
The complexity of trade deals
To strengthen the British economy, May wishes to seek trade deals outside Europe. It is true that the UK would probably be able to conclude a bilateral agreement much quicker than the EU could, because the UK doesn’t have to take into account the wishes of the other 27 member states. And, of course, the promise by Mr. Trump to draw up a trade deal with the UK “quickly” after Brexit received a positive reception at Downing Street.
In order to secure free trade with a large part of the world, the UK has to negotiate bilateral trade agreements. Because the UK and a large part of the world’s trading nations are a member of the WTO, the WTO’s rules come into play. These rules stipulate that granting a trading partner a special favour (such as a lower customs duty rate for one of their products), would oblige the UK to do the same for all other WTO members. The reality is that concluding trade treaties often takes years, so that any benefits to the UK would only be felt in the long term. This is especially true if it turns out that the UK is not allowed to start official trade negotiations with third countries while it is still a member of the EU. In addition, for a relatively small country such as the UK it will be difficult to win favourable terms in treaties with large countries such as China and the USA. A large block like the EU is better positioned to protect the interest of its members.
Leaving the Customs Union and free trade are irreconcilable
Moreover, in order to be able to close free trade agreements outside the EU, the UK has to leave the European Customs Union. As a result, tariffs will be introduced (unless otherwise agreed) and non-tariff trade barriers such as delays and procedures at borders will rise. As this would harm British trade, May wants to pursue some form of customs agreement with the EU in order to minimize these trade barriers. It remains to be seen, however, whether it is possible to agree upon abolishment of tariffs and border controls, without the UK applying the same external tariff as the EU. Another drawback from leaving the customs union is that the 57 existing trade deals the EU has with third parties will cease to apply to the UK. British exports to those countries will see an increase in trade barriers after the Brexit (unless the UK is able to close favourable trade agreements with these countries).
A transition period is not certain yet
Ms. May has furthermore opted for some sort of transition period to prepare and implement the new deal after the two-year negotiating period ends. Although this would be in the interest of British and European companies, the formal EU-withdrawal procedure does not cover a transition period. This will therefore have to be part of the negotiations and thus is still very uncertain.
Parliament can vote on the final deal, but that’s not a game changer
The relatively positive market reaction Ms. May’s speech drew this week may also come from the commitment of the Prime Minister to place the final Brexit-deal to a vote in both houses of the UK parliament. But this is less significant than it sounds. Strictly speaking, parliament could stall the deal. To prevent this, May might be urged to come with a more business-friendly trade deal (i.e. secure access to the internal market), as the majority of parliament prioritizes access to the single market over control of migration. However, if parliament voted against the deal it risks ending up with a Brexit with no deal in place, a so called ‘cliffhanger Brexit’. Also, because it is not clear yet if invoking Article 50 of the Lisbon Treaty is irreversible, giving parliament a vote on the final deal does not necessarily mean that Brexit can be prevented at that stage.
Can lower taxes compensate for losing access to the internal market?
May ended her speech by saying that no deal is better than a bad deal, as outside the EU, the UK will be free to lower taxes to attract investors. It remains to be seen however, if lower taxes can compensate for losing access to the EU internal market. Many US and Asian companies located in the UK, like for example financial institutions, do not only produce for the British market, but also export to the EU. Besides, with the current status of UK government finances and the level of government debt, the room to cut corporate tax bills is likely to be limited (figure 2). At least, without increasing personal tax bills. But imagine what the general public would say to that: “We were promised lower health care costs, but now we end up with higher personal tax bills to allow a more beneficial climate for our companies.” Altogether, this ‘tax haven’ argument looks like a red herring.
Can the Supreme Court’s ruling change May’s Brexit-plan?
The Supreme Court is expected to rule this month whether Ms. May has the power to invoke Article 50 of the Treaty of Lisbon, without the prior approval of parliament. If the Supreme Court mandates a role for parliament, May’s end-March 2017 deadline for invoking Article 50 might not be met. Parliament even has the power to prevent Brexit, although at this point it seems unlikely that the Commons or the Lords would vote against triggering Article 50, as they would be blamed for voting against the referendum decision. If legislation is required to exit the EU, parliament will probably have more say in the negotiation strategy of the UK. The majority of Members of the House of Commons (MPs) is pro-EU and they are likely to give priority to access to the Single Market.
Altogether, then, Theresa May’s speech has brought more clarity, which is to be applauded, whether viewed from the UK or from the EU’s perspective. Yet, when it comes to the execution of her plans we see a couple of hurdles. Certainly not a bed of roses.
 The WTO has 164 members, which covers a great deal of the world.
 Because goods move freely, i.e. without tariffs and border controls, in the Custom Union, the EU applies a common tariff on imports from outside the Custom Union. The EU thus takes care of trade agreements with third countries and individual countries in the Customs Union are not allowed to close bilateral free trade agreements with countries outside the EU.