July 22, 2016
The Brexit compromise
If you think through the various Brexit choices for Theresa May, there are in fact not that many good real-world options. She can't go back on the referendum without simultaneously destroying her premiership and her party. She can't possibly want a hard Brexit in 2019, and risk a major economic recession one year before an election. She cannot opt for the pure Norway model, given the promises made during the election campaign. And free-trade agreements will take a lot longer than two years to negotiate. That leaves a single feasible option we highlighted before: a transitional EEA memberhip to be followed by an FTA later.
We haven't often cited the conservative Adam Smith Institute in our briefing, but they are spot on in their analysis of the situation. The transitional EEA is really a no-brainer. The transition deal respects the referendum result. Britain would no longer be in the EU after two years. It would be outside many EU policy areas, including agriculture. It would avoid a sudden rupture and respect existing trade relationships; it would give time for trade negotiations, and for companies to adjust to the new situation. There is one piece of information we would like add: we are confident that the EU would offer Britain a transitional EEA simply because this would minimise the economic fallout - which is at least as big for the eurozone as for Britain given the eurozone's extreme vulnerability to even the smallest shocks. While free trade agreements require a full ratification procedure, we are fairly confident that a transitional EEA agreement can be concluded within the Art 50 parameters, which would only require a qualified majority in the European Council to take effect. It is, in fact, the only deal that can be negotiated in two years because there are not many details to negotiate.
The ASI paper is probably wrong in one important aspect: the transitional EEA agreement does not, in practice, provide the power to curb excessive migration volumes. Even if it included an emergency break - which we doubt - it would trigger immediate reprisals if those were used. There is no way the EU would allow Britain complete membership in the single markets for goods, services, and capital, but with controls over the free movement of labour. We find it interesting that British discussants always get back to this point, hoping that there is some kind of a technical fix to the immigration problem. The FTA will allow Britain to control immigration, but would leave the UK outside the single market. President François Hollande also made that clear in his talks with Theresa May yesterday.
Kevin O'Rourke makes the point that even erstwhile Remainers seem to have accepted the argument that there are too many Europeans in Britain - an argument that does not stand up to scrutiny. That mindset will lead to a hard Brexit because it is not consistent with EEA rules (he does not discuss interim arranagements, but the final outcome). He concludes that
"...for Remainers not to make the case for EEA membership, when they had previously been in favor of remaining in the EU, is an astonishing abdication of responsibility."
Paul de Grauwe urges the EU to provide clarity on what potential leavers should expect - which is a straight choice between the Norwegian model or a stand-alone position in which the exiting country would negotiate its own trade agreements. Clarity is essential for those wishing to leave the EU. Clarity can only happen if the EU categorically excludes a privileged trading relationship.
The transitional EEA option is consistent with all of the above in the sense that you get one regime, and then the other regime, but nothing in between. But don't count on lower costs. Currently the annual per capita contribution to the EU's budget are £130 for Norway, and £220 for the UK. We don't think the EU would agree to a cut in the UK's net contributions during the transitional phase. If a transitional EEA were agreed, it would be on the basis of existing agreements.
The decision on the future of Britain's relationship with the EU is essentially one for May and her Conservative Party. The opposition is nowhere, and is not going to resurface in time to influence the outcome of this debate. It is worth reading Denis McShane who notes that the Labour party has a record of a long opposition spells after a period of government. He predicts the worst of all outcomes from a pro-European perspective: Jeremy Corbyn will remain leader. He will lose the 2020 elections. And the party will not split given the prevailing contempt for the LibDems after they decided to join the Tories in a coalition in 2010. The only good news is the UKIP will probably not eat into the Labour share of the vote, unless Europe is a major election issue. We would add that, in this scenario, Labour is unlikely to challenge Britain's EU exit in 2020 out of fear of an electoral backlash.