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Brexit Update - Blame games

Economic Comment

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  • Prime Minister Johnson has finally recognized that his Brexit deal entails some uncomfortable trade-offs: we’re getting two borders for the price of one
  • Even though Johnson’s Brexit deal would only lead to limited checks, it is very hard to see why Europe/Ireland would eventually accept such a proposal. EU leaders gratefully accepted the UK’s concession of Northern Ireland alignment, but did not give one iota in return
  • Meanwhile, both the EU and the UK are treading carefully to avoid any blame when things go wrong and count on the UK Parliament to prevent a no-deal Brexit on October 31
  • The EU and the UK will continue talking in the run up to the Oct. 17-18 European Council, but the focus should be on Westminster
  • An election is inevitable and in the interest of each and every party in these negotiations, but it is far from certain that this will solve matters. The three-month extension to Article 50 that is currently being suggested by the Benn Act looks to be too tight. It’s hard to see the UK getting its act together before this deadline

In our Brexit outlook we conjectured that the Battle of Brexit is to be fought in Westminster, not in Brussels. The EU and the UK are treading carefully to avoid any blame when things go wrong, but it remains highly unlikely that a deal will be reached in the next two weeks. This means that there will be yet another showdown in Westminster. We could therefore be in for a very rough fortnight, starting from October 14 when the Queen’s Speech will be held.

What has been proposed?

The UK has finally come up with a proposal that could potentially break the deadlock in the EU-UK negotiations. As expected, the notorious “backstop” has been removed. Prime Minister Johnson argues that the backstop is essentially “a bridge to nowhere”, since he has no interest in any future relationship in which the UK is tied to EU rulebooks. The future relationship should instead be based on an FTA in which the UK takes control of its own regulatory affairs and trade policy.

It is nonetheless a positive development that Prime Minister Johnson has finally recognized that such a Brexit entails some uncomfortable trade-offs. Absent any magical new technological discoveries that currently no one knows about, it is impossible to have 1) an open border on the Irish island, 2) equal treatment between NI and the rest of the UK and 3) the whole of the UK to set its own tariffs on goods. At least to some extent, the current proposal recognizes that this is an impossible trinity: you can’t have all three at the same time.

The broad outline of Prime Minister Johnson’s proposal is therefore that Northern Ireland will align with the Republic of Ireland and the EU on regulatory issues –which creates the need for a regulatory border in the Irish Sea– but also that Northern Ireland will be part of the UK customs territory. This will require a customs border between Northern Ireland and the Republic of Ireland.

This means that we’re now getting two borders for the price of one.

Threat of a hard border remains

Even though the UK asserts that the land border will be virtually free of any physical infrastructure and therefore hardly visible, there will still be designated locations for customs checks. This means that there is also going to be surveillance in border communities and new red tape in Northern Ireland-Ireland trade where none existed before, with all the risks (e.g. smuggling, VAT fraud, vandalism, and potentially terrorism) that are associated with that.

Goods flowing from mainland UK into Northern Ireland would need to be checked to ensure they conform to EU standards. This regulatory sea border is something that the Northern Irish DUP, the unionist party that supports the Tory government, has always forcefully objected to. They have now expressed their backing, but there are strings attached. Before the end of the transition period in 2021 (i.e. after the EU signs off on the deal), and every four years afterwards, the UK will have to give Northern Ireland’s Executive and Assembly (neither of which is functioning right now) a say on what happens next. Do they want Northern Ireland to remain aligned to EU rules, and effectively in the Single Market, or to join the rest of the UK as it sails off into the sunset to do all kinds of free trade deals?

All major political decisions in Northern Ireland have to be taken by cross community agreement, so both Sinn Féin and the DUP have veto powers. How the question regarding alignment is formulated is therefore critical (i.e. what is the status quo?). The current proposal will give the DUP a rolling veto that could be used as leverage. The threat of a hard border remains and will intensify when regulatory standards diverge further as the EU and the UK go their own way.

The EU won't accept this deal

Even though a deal would only lead to limited checks at a selected number of designated facilities, compared to much more intrusive checks in case of a no-deal Brexit, it is very hard to see why Europe/Ireland would accept Johnson’s proposal.

The response of various European leaders appears to be constructive, but is carefully worded to avoid any sort of blame if things go wrong. What else could they do? The European leaders would surely have run into accusations of intransigence if they dismissed the UK’s proposal the moment it arrived on the doormat, while it is very obvious that the proposal crosses several long-held EU red lines. So EU leaders did what they always do: they gratefully accepted the UK’s concession of Northern Ireland alignment, but did not give one iota in return.

From an Irish perspective, it is a matter of principle. The dominant view is that peace in Northern Ireland strongly depends on Northern Irish Republicans feeling connected to the Republic of Ireland, as if they are actually living in the same country. This has been the basis of the success of the Good Friday Agreement. But if they feel that they are slowly being pulled away due to border controls, which could even be ramped up if the DUP eventually makes use of its veto rights, it could be easily argued that customs checks now are a direct threat to peace later. It’s very hard to see the Irish Prime Minister Varadkar signing up to the risk of checks enduring in eternity.

The UK government hopes that the EU/Irish position will evolve in the next two weeks, but we deem that very unlikely. It is clear that the EU has two main strategic objectives: it wants to protect its unity by unequivocally backing the Member States –any movement with respect to the backstop therefore has to originate in Ireland– and by protecting the integrity of the Single Market. This integrity could be at risk: many aspects of the UK’s customs plan remain vague and need to be worked out further after signing the Withdrawal Agreement (e.g. the UK provides no details about how VAT or border checks are exactly going to work). The European project is doomed to fail if any other association agreement with the UK is a more attractive alternative to membership.

A no-deal Brexit is not imminent

The EU also has no incentive to move, despite PM Johnson’s threats to get around the Benn Act. The Benn Act is the law that was passed by Parliament last month and forces the PM to request an extension of Article 50 if there is no new deal with the EU by October 19. We can be sure that PM Johnson will go out of his way to show –with lots and lots of political theatre– that this “Surrender Act” was imposed on him by “Remainers”. He may even seek legal action, even though Attorney General Cox has already said that the Government “can’t get around the act”.

So why should the EU make any significant concessions at this stage? The EU's incentives are not Johnson’s deal or no deal at all. It is this deal or an extension, followed by an election. And this election opens up a wide range of possible scenarios, including revocation of Article 50, a second referendum, or a more compromising political constellation in the UK.

The inflexibility on the EU’s side is precisely the reason why the ostensible support from the ERG and the DUP isn’t worth much. It’s very easy to be in favour of a deal which won’t reach the House of Commons anyway. What we are seeing now is these two groups reluctantly agreeing to Johnson’s proposal –making lots of noise that it is despite their concerns but for the best of the UK’s future– but in the end it’s all to avoid the blame ahead of the inevitable election (“we moved, but the EU was stubborn!”).

The Upside Down

Meetings between the UK and the EU will continue this week, as the diplomats probably want to make sure whether Johnson’s proposal was indeed tactical in the run-up to an election (as we suspect) or a starting point for more intense negotiations. But even if they do conclude the latter, there’s so little time left that it looks to be very difficult to bridge the massive gap between Johnson’s proposal on customs and the role of Stormont, and the EU’s red lines.

Now that Prime Minister Johnson has reneged on many of the things that Theresa May agreed earlier in these negotiations, the EU is likely only getting more convinced in its focus on a legally operable backstop. And if Prime Minister Johnson climbs down, he would immediately lose the frail support from the DUP and the ERG. Brexit has therefore reached The Upside Down: Theresa May crafted a Brexit deal that was palatable to the EU, but unpalatable to her parliament. Prime Minister Johnson’s might now have a deal that parliament can swallow, but is falling well short of the EU’s appetite.

Back to Westminster

So even if the EU and the UK continue talking, the focus will be on Westminster. There will be an armistice, however, as the Government will ask for another prorogation in the run-up to a Queen’s Speech on October 14. This means that Parliament will be suspended after sitting on Tuesday October 8. This is considered a regular suspension and is unlikely to be challenged in the courts.

The Queen’s Speech will be followed by days of debates on the Government’s plans, which eventually culminates into a vote on October 18. The odds are not in Johnson’s favour, as he currently does not have a working majority. If he indeed loses this vote, precedent dictates that the Prime Minister will resign and that a caretaker needs to be appointed. He/she will then request the extension of Article 50 and lead the country to an election. On a more positive note, it would also allow Boris Johnson to avoid lying ‘dead in a ditch’.

The Queen’s Speech debates coincide with the European Council of October 17-18. So even if progress with Europe is being made before or at this summit, there is hardly any time for the Commons to debate and vote for this. The timing of the Queen’s Speech therefore fuels speculation that the deal was designed to be rejected anyway.

Figure 1: Interesting times ahead...
Figure 1: Interesting times ahead...Source: Rabobank

A hung parliament?

Our base case scenario was and is a general election before the end of this year. But we are not convinced that it will yield anything other than a hung parliament (figure 2), especially if there is no cross-party cooperation between the Tories and the Brexit Party or between Labour and the Liberal Democrats. A hung parliament is the last thing that is needed at a time of national crisis – as it only extends the suffocating uncertainty further and further. The PMI’s in figure 3 illustrate how damaging this is, with all three major sectors now showing sub-50 readings.

Figure 2: The country remains divided…
Figure 2: The country remains divided…Source: Macrobond, Britain Elects
Figure 3: … but businesses need clarity, fast!
Figure 3: … but businesses need clarity, fast! Source: Macrobond

Conclusions

The odds of both a deal and a no-deal Brexit on October 31 have slimmed considerably, but the outlook remains ever so murky. But we can draw a few conclusions:

  1. The country is in uncharted waters. There is no script and nobody knows where the show is going. Brexit is a huge clash between reality and deception, with no easy way out.
  2. Both the EU and the UK are treading carefully to avoid any blame when things go wrong and count on the UK Parliament to prevent a no-deal Brexit on October 31.
  3. An election is inevitable and in the interest of each and every party in these negotiations, but it is far from certain that this will solve matters.
  4. The three-month extension to Article 50 that is currently being suggested by the Benn Act looks to be very tight if an election needs to be organized in the meantime. Are three months really enough for the UK to get its act together? We don’t think so.
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Author(s)
Stefan Koopman
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 71 21328

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