RaboResearch - Economic Research

Brexit update: squaring the circle

Economic Report

  • The UK government published a long awaited White Paper on the blueprint for the post-Brexit EU-UK relationship 
  • The content is in line with recent announcements, but also provides welcome clarity on the intended outcome by the UK government to both the EU and the private sector
  • The UK proposes a hybrid structure that keeps the UK in a quasi-internal market for goods and a quasi-customs union with the EU; it further diverges in most services sectors and maintains close ties on other aspects such as safety
  • The approach of staying close in some sectors and diverging in others is likely to be seen as cherry-picking by the EU; further concessions probably needed to reach a deal
  • The proposal maintains the UK Brexit red lines, while also aiming to prevent a hard Irish border and to protect UK’s economic interests; some past EU comments also seem incorporated
  • The result is a complex hybrid structure parallel to EU’s institutions that raises questions about bureaucracy, efficiency and costs
  • It also does not provide a waterproof solution for preventing a hard Irish border, the main hindrance to progress in negotiations with the EU in recent months
  • The path to a soft Brexit in 2019 is marked by several hurdles, including the approval of an eventual deal by the UK parliament
  • Thus, the paper provides clarity but not certainty. A ‘hard Brexit’ remains a possible outcome

The White Paper

On 12 July the UK Government published a much awaited White Paper on the desired blueprint for the post-Brexit relationship with the EU. A statement on the Chequers Agreement had already been published the cabinet on 6 July, but this document finally provided the details that had been lacking since the start of the negotiations and that kept both the EU and the private sector in the dark. The government has labelled the blueprint a “principled and practical Brexit”. Principled because it brings back home control of “UK’s laws, borders and money”, and practical because it was designed to work for both the EU and the UK.

Nothing surprising, but an important step forward

The White Paper is very much in line with recent statements and expectations on the envisaged EU-UK economic partnership post-Brexit. In that sense, it wasn’t a surprise. The UK intends to remain in the internal market for goods and in the customs union, but both in an adjusted form. With respect to the internal market for goods, the UK will only follow the part of the EU common rulebook that eliminates border friction and the rules are to be legislated by the UK government. The UK suggests a “combined customs territory” with the EU, but it also wants to set its own trade policy on goods that are meant for domestic consumption. The proposal envisages a close partnership in highly regulated sectors and on security. The paper provides great detail on the UK’s objectives and the structures and operational design to achieve that, which is a first. For example, the paper is fairly clear on in which sectors the UK wants to maintain very close ties with the EU and where it wants to diverge. It also provides details on how this would translate in practice, regarding implementation, oversight and enforcement. That should provide more clarity to both EU negotiators and other relevant stakeholders, though the private sector has been quick to highlight the document lacks information about relevant aspects such as the EU VAT system. Nevertheless, this proposal should represent a good basis for further negotiations with the EU.

UK red lines still there

The red lines that the UK has set out in the Brexit negotiations have not been compromised with this proposal:

  1. Immigration. The UK wants to take back control of migration and wants to offer the EU what they would offer to future close trade partners. Softer rules or cooperation would be restricted to specific objectives in order to facilitate intra-corporate transfers or to attract talented people.
  2. Reduced contribution to the EU budget. Financial contributions by the UK are limited to those agencies and institutions that the UK want to make use of.
  3. Own trade policy. As the UK applies the EU tariffs for goods that are destined for the European Union – or the highest of the UK and the EU tariff when the destination can’t be robustly demonstrated – it can pursue an own trade policy on both goods and services.
  4. No ECJ jurisdiction. The UK intends to follow most of the EU common rulebook for goods and few other areas such as state aid. To accommodate this while bringing court jurisdiction back to the UK, the paper proposes a parallel structure for enforcing EU law: a joint committee and binding independent arbitration. The European Court of Justice would be the interpreter of EU rules and the case law of the ECJ would be respected, but “the court of one party cannot resolve disputes between the two”.

Still cherry-picking

The paper makes a clear distinction between goods and services, intending to stay close on the first and diverge on the latter. There are exceptions to both. With regard to goods, not all EU legislation will be adopted by the UK, but only those parts that are necessary for avoiding friction at the border. For that purpose the UK also want to continue participating to the EU agencies for Aviation, Medicines and Chemicals. However, in food and agriculture, regulation that is related to domestic production will not be implemented, so the UK will leave the Common Agriculture Policy and the Common Fishing Policy. Regarding services, there are sectors where the UK wants to maintain close ties, such as the reciprocal territory access for aviation and road transportation. Or the facilitation of tourism and short-term business travel, which wouldn’t encounter much friction post-Brexit on the back of a no visa and a Registered Traveller Scheme. The EU is likely to regard the UK proposal as cherry-picking and a threat to the integrity of the internal market. To reach a deal, further concessions are probably needed.

On financial services

On financial services, the UK has given up on passporting rights and on mutual recognition of legislation. However the current proposal intends to maintain the current status quo as much as possible while allowing for divergence later on. The model set up for this purpose is an extended equivalence model called “reciprocal recognition of equivalence”. The basis is equivalence, which allows access to each other’s markets on some financial services (not specified which, but more than between the EU and the US) as long as legislation leads to the same outcome. The problem with equivalence is that it can be unilaterally withdrawn with a notice of around 30 days, which makes access to the market unpredictable. To reduce this risk of sudden loss of access to the financial services market, while at the same time allowing for divergence (“flexibility”), the UK proposes a treaty based arrangement (procedures, systems, cooperation on legislation, supervision, etc.) that would regulate the withdrawal of equivalence. As a result, the withdrawal could no longer happen abruptly as it would have to be subject to a predetermined process that allows for consultations, for the other party to adjust, for a transition period, etc. The shift towards equivalence is in line with past EU proposals, but it is questionable whether the EU will be willing to expand the regime to a broader set of services than in the case of the US and to set up the tailored system the UK is proposing.

No waterproof solution to the Irish border

It seems that the intention to continue following the EU rulebook on goods and several other aspects is mainly driven by the objective of preventing a hard border between Northern Ireland and Ireland. The EU rules are to be legislated by the UK parliament who reserves the right to diverge from the EU while accepting the consequences for operation of the future relationship. This right to deviate means that a hard border might still be needed at a later stage after all, when such divergence occurs. Hence, the plan is not bullet proof and hence not the backstop the EU demands.

Complex parallel structure

The proposal of the UK tries to align several objectives: maintaining the UK red lines, avoiding a hard Irish border, pursuing the UK’s economic interests and incorporating some of the EU’s comments. In other words: the White Paper attempts to square a circle. To achieve that, the UK government proposes a very complex hybrid structure that runs parallel to current EU institutions. This raises questions about the consequences for bureaucracy, efficiency and costs. And on top of that the structure could prove to be temporary, as the UK preserves the right to diverge or even step out of this structure when seen fit.

Not out of the woods yet

Nevertheless, the White Paper represents an important step forward given the higher level of clarity it provides on the aim of the UK government. However, this is just a basis for further negotiations and there are still many hurdles on the path to a soft Brexit in March 2019. For one, the EU prioritises the withdrawal agreement above the future relationship, which is intended to be an appendix to the agreement and only defined in big lines. The EU has often stated that negotiations on the future relationship are to commence once the UK steps out of the EU. Moreover, the proposal still does not provide a full solution to the Irish border, which is where negotiations on the withdrawal agreement got stuck. The EU is estimated to react on the White Paper Friday 20 July. Then there are also domestic hurdles. First, Brexiteers are likely to mobilise against PM May, as illustrated by their amendments to the cross-border taxation bill the prime minister decided to accept. The amendments do not render the White Paper unfeasible, but they limit the room for negotiations with the EU. The risk of a leadership challenge against PM May by the hardliners persists despite these concessions. Moreover, PM May’s tactics in recent parliament votes has damaged the relationship with pro-EU conservatives. These recent political dynamics make it more challenging for PM May to get an eventual deal through parliament. Meanwhile, a hard Brexit still remains a possible outcome.

Alexandra Dumitru
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO

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