September 26, 2018
EU doubling down on internal UK customs border
The reason why we have become more sceptical of a Brexit deal is the EU’s continued insistence on a customs border within the UK to avoid one on the island of Ireland. One can technically fudge regulatory controls, VAT declarations, and veterinary checks, but the reality of a customs border cannot be easily made invisible. It is one Theresa May's two red lines, and the one she keeps reaffirming time and again. In her ranking of acceptable Brexit options, no-deal ranks a distant second to her own Chequers framework, but it ranks above any third option. Yesterday she reaffirmed that the no-deal scenario is better than the Canada model. This statement may have confused the Eurosceptics in her party, but only because they have not thought it through. A Canada deal would require a permanent customs border inside the UK as it would unavoidably trigger the Irish backstop if it were agreed in its current form.
Word has reached us that the EU is now firming up its opposition to Chequers in such a way that we see little chance of retreat. Michael Barnier and his team have commissioned a report that suggests the long-term costs of Chequers to the EU would exceed the short-term costs of a hard Brexit.
Bruno Le Maire, the French finance minister, reiterated that Chequers would be the end of the single market and therefore of the EU. May’s own renewed pledge to offer the lowest corporate tax rates in the EU post-Brexit is probably not going to help boost mutual confidence.
Reuters has the story that the EU is working to make on its own attempt to offer a Brexit plan - as demanded by May in her speech. But this plan will be akin to a Canada-style agreement with a few added bells and whistles. Crucially, it will require a customs border inside the UK. May will reject this proposal.
What might favour a no-deal Brexit is the relative proximity between a WTO deal and a third-country FTA. Except for cars, WTO tariffs are not particularly high in most product categories. The UK would have to pay a substantial political price for a mutual reduction in tariffs, which in any case benefits the EU27 more than UK because of its structural trade surplus. Most of the costs of a no-deal Brexit would come down to the frictional costs as a result of the sudden transition in 2019; but it gives the UK government the maximum potential to pursue an alternative industrial strategy. Apart from low corporation taxes, the UK could establish itself as the country for biomedical research due to looser regulations.
What the EU needs to factor into its calculations are the costs of the loss of the UK as strategic partner, and the impact of an economically unrestrained and unregulated competitor across the Channel.
That a no-deal Brexit is now more likely than not is not because anybody specifically wants it, but because it may end up as the lowest common denominator. Sir Keir Starmer, the shadow Brexit secretary, underlined yesterday that Labour would vote against any withdrawal deal that is not its own. That is to be expected. Labour is not going to help May - though a handful of rebels might. The European Research Group also agreed to reject any plan that is based on Chequers.
It is possible that the two sides still reach a deal? For one, events might intrude. The UK might have a new government before Brexit – unlikely but possible. The mood in the UK population might turn against Brexit in a way that has not happened yet. EU member states may change their position once they acknowledge the reality of a hard Brexit which they have not yet. Also, Barnier’s calculations are based on the result of an economic model - the kind of which always overestimated the impact of the single market in the past - against actual losses of income and jobs. We keep noting reports, in the German media in particular, about a second referendum. A hard Brexit would come as a total shock.
The one avenue where we still can see a deal would be a shift in the Tory party’s view on the internal border. It is logically impossible to offer a backstop to both borders - the intra-Irish and the NI/UK border - since the customs border has to be somewhere in physical space. We see at least some possibility of technical triangulation, but it would require both the EU to compromise on the Irish border and the UK on the internal border. For this there is not much time. The EU underestimates the political sensitivity of the internal border issue to the UK, just as the UK kept on underestimating the Irish border issue for a long time.
The biggest driver for a no-deal Brexit could end up being May herself. With the EU rejecting Chequers, and with both Labour and the ERG united in rejecting any deal based on it, May might now conclude that it is in her best interest to let the negotiations run into the ground. Do nothing, keep rejecting whatever the EU proposes between now and the end of March - and step up visible preparations for a no-deal Brexit. If this is her calculation, she takes a huge risk.