November 22, 2016
Towards a transitional deal
There was a period of confusion about Brexit, but some of the outlines are now becoming apparent. The Brexit will be hard because immigration controls leave no choice. The UK will exit the single market and the customs union (and no, the two are not logically linked - you can theoretically be in one or the other, but this won't be on offer). To mitigate the frictional costs that would arise from such a harsh transition, the UK will accept a transitional period, the length and nature of which have yet to be discussed. We would assume that a five-year period, or something along those lines, would give everybody enough time to prepare. And, politically, it would allow the final stage of Brexit to happen before the end of the next parliament, while the formal Brexit moment should happen in 2019, before the end of this parliament.
There is a lot of political and economic logic in this sequence of events, and Theresa May has now officially mentioned that a transitional agreement is being considered to avoid what she called a "cliff edge" Brexit in two years. That would mitigate the frictional costs - which in our view constitutes the main economic risk of a hasty Brexit.
The UK has a few cards up its sleeve in the negotiations. Wolfgang Schäuble yesterday reiterated his fears of a UK corporate tax cuts. He said, curiously but wrongly, that the UK cannot do this while still a member of the EU. As Schäuble knows well, the EU has no jurisdiction over corporate tax rates. A more pertinent argument he made, according to FAZ, is the G20 commitment of avoiding predatory tax practices.
If the EU were to force the UK into a hard Brexit with the imposition of tariffs, then of course the UK will do whatever it can to stop companies from relocating. And that could include tax breaks, state aid of the kind that would be deemed illegal in the EU, and possibly even compensation for tariffs. What we see in the repeated warnings by Schäuble is a real concern that post-Brexit Britain and the US could start a new round of global tax competition, which the Germans consider extremely dangerous politically.
And, finally, we note a tendency of judges to give opinions on either running or even non-existing cases. In doing so, the legal profession is turning itself into a political player, as a result of which we should no longer be surprised by a hostile media reaction. This time, the president of the ECJ, Koen Lenaerts, pronounced that there are many ways an Article 50 process could end before the court, according to the FT. That is trivially true in the sense that everything in the treaty can go to the ECJ. Lenaerts was careful not to go into specifics, but we are wondering why the president of the ECJ accepted to be interviewed and even drawn into such a subject. This comes after the deputy of Britain's Supreme Court commented on the pending appeal by the British government. One gets the impression that the judiciary is up to something rather strange.