February 01, 2018
How Brexit can still go badly wrong
We were optimistic about the first stage of the Brexit negotiations, but not so optimistic about the second stage. We are now getting into the phase where differences among EU member states are beginning to surface, and where the EU is now trying out the old British trick of having your cake and eating it - with known results. Three stories in the UK newspapers this morning underline the acute difficulty. The UK does not want to guarantee citizenship rights during the transition. And the EU wants to keep control over the British tax system after Brexit, but it refuses a deal on financial services. There could be compromises on each of these points, especially on free movement, but we are alarmed to read that the EU wants a combination of a Canada trade deal on the one hand, and on the other hand tight controls of regulatory policy in the UK, including tax policy. Since this is so obviously unacceptable to the Brits - not only to the Tories - that this is going to be a real stumbling block, probably the biggest of all.
The FT reports this morning that the EU reserves the right to impose sanctions against the UK if it were to undercut the EU's level of taxes or regulatory standard post-Brexit. These are unprecedented safeguards, as the article points out. The EU sees the UK as too big and too close to offer it a vanilla Canada-style trade agreement. In other words: the EU has its own definition of Canada-Plus. It wants a trade deal supplemented by clauses that essentially deprive the UK of any fiscal or regulatory autonomy post-Brexit, forever. The biggest issue seems to be corporate taxation, tax exemptions, and employment regulations. This is going to be a very tricky issue in the upcoming discussions, because it appears to be a red line for France in particular. Of all the issues out there, we see this one as a genuine stumbling block in the sense that it could frustrate an Article 50 agreement.
This is especially so in the context of another FT story yesterday, according to which the EU rejects any separate trade deal for the financial sector. We are not surprised to read this, as we always warned that the UK would face a binary choice between a simple third party trade deal or customs union/single market (associate) membership. According to the article the EU decided that the appropriate framework for the financial sector after Brexit would be regulatory equivalence, but this only affects a small category of sub-sectors - banks are not included - and provides a highly uneven regulatory environment for the UK.
It is, of course, possible that the two sides agree a deal whereby the EU perseveres with an agreement that prevents dumping by the UK in exchange for a deal on financial services. But even such a compromise would be hard to accept for the UK, because it would undermine the whole idea of Brexit. If the UK were prevented from seeking out its own competitive niches after Brexit, the whole idea of Brexit would be rendered absurd. In this case, we expect to hear the argument gain ground that a hard, cliff-edge, Brexit might be preferable. We think that the chances of a hard Brexit are rising again.
Another potential source of conflict is the rights of EU citizens during the transition. The Guardian reports that Theresa May has ruled out freedom of movement during the transition, but we see the possibility of a compromise here. There will be discrimination between EU citizens in the UK who arrive before Brexit and after Brexit, in the sense that only those who arrive before Brexit will enjoy future guarantees of their status. Those who arrive later would enjoy total freedom of movement during the transition, but not necessarily beyond.