Thursday, June 07, 2018

A pragmatic plan for Brexit

Published on CapX 
There really only are two different ways of implementing Brexit. The first is for the UK to simply leave. No deal, no negotiations.
That this would be a costly option should be obvious. One estimate puts that  cost at half a million jobs in Britain and 1.2 million in mainland Europe. Brexiteers who claim this would be Britain’s best bet make their case by expressing hope that it may convince the EU to grant more favorable terms. That is, at best, a risky strategy. At worst it would be catastrophic.
The second option is to negotiate Brexit. On this approach there really aren’t as many workable options as the public debate would have you believe.
Staying in the single market is unrealistic as it would degrade Britain to a “vassal state”. Staying in a common customs union would deprive Britain of freedom to trade and wouldn’t avoid disruption at the border. The debate badly needs an injection of common sense.
That is where Open Europe’s new proposal for a negotiated, pragmatic Brexit comes in. As I’ll explain, it is an outcome which Remainers, Brexiteers and the EU27 should find to be an acceptable compromise.
In this proposition for the future EU-UK economic relationship, we look at the key challenge as to how secure market access for both British and European companies. Our proposal involves close alignment with the EU on goods but divergence on services.
Market access and regulation for goods
Many companies outside of the EU choose to adopt EU goods regulations. Therefore, it makes sense for Britain to remain close to the EU in terms of goods regulations. Under the Open Europe proposal, Britain would take over EU rules voluntarily, as Switzerland does, but not automatically, as Norway does.
When the EU came up with its costly REACH chemical regulation, they did not automatically apply to Switzerland. The Swiss have the right to say “no”, at the risk of losing a degree of market access, and we think this model would fit Britain well when it comes to goods trade.
Why would Brexiteers agree to this? Surely it entails a loss of sovereignty?
Hardline Brexiteers will be less than enthusiastic. They will surely claim that goods trade is extremely important for the UK economy, so to give up sovereignty here isn’t reasonable.
That’s not quite right. Goods only accounts for a small part of the British economy. Eighty per cent of economic activity in Britain is services.
These Brexiteers have remarked that smaller companies that don’t export surely shouldn’t be hit by heavy EU regulations and should instead be free to enjoy the benefits of light touch UK regulations.
To deal with this objection, we suggest that the UK only really follows EU goods regulations in highly-regulated sectors. In less-regulated sectors, we think an enhanced mutual recognition agreement could do the trick.
Sure, some sovereignty is traded, and we don’t enjoy the full force of regulatory competition. But that is a tradeoff for something that is very valuable indeed: access to the EU market. Given that half of UK goods exports are directed to the EU market, this makes sense.
Would the EU agree to this? Brussels would surely enjoy imposing rules on the UK. More seriously, many of the manufacturing companies that are based in the UK and that are vulnerable to disruption of their supply chains, are European companies.
Nevertheless, the EU isn’t biting yet. When Britain came up with a version of this – then dubbed “the three baskets approach” — the Commission dismissed it, warning that this is “not compatible with the principles in the [European Council] guidelines.” It really wants Britain to take over all of its regulations, also those on services, despite the fact that in the past it has compromised on this with Switzerland and that there is so much “pick and choose” in the whole operating system of the EU it is simply odd to hear EU officials proclaim that some flexibility would pose a “risk for integrity and distortions to proper functioning of [the] internal market”.
Has the German refusal to open up its services market somehow damaged goods trade between Italy and Spain? Hardly. Yet many pundits, often out of hostility to Brexit, swallow the Commission’s questionable logic without thinking it through.
Market access and regulation for services
When it comes to services, Open Europe’s proposal basically assumes it will be very hard for Britain to agree to the EU’s “market access in return for taking over all our rules”. Therefore, we think it makes more sense for the UK to accept reality and try to limit the disruption from losing a degree of services market access. The latter is possible by trying to conclude a deal that goes further than the existing equivalence regime for financial services.
Ideally, a wide-ranging mutual recognition agreement for financial services should be agreed, or failing that, an expanded equivalence. In everyday language: when a financial or non-financial product has been regulated or supervised by the UK, the EU should deem it trustworthy with as little hassle as possible, and vice versa.
Why would remainers agree with this? One thing prevails here: “opportunity cost”. Eighty per cent of the UK economy is composed of services and only about a third of Britain’s services exports go to the EU27. The global services market is expected to be growing a lot in the next few decades. However protectionist the EU may be, the EU market is very unlikely to be greater than the global opportunities offered by boosting UK services as a result of being able to set one’s own regulations.
In selected areas where losing access to the EU’s services market really is a very big deal, as for example when it comes to financial clearing, the EU, which at the moment permits US clearing activity, can be expected to be flexible.
Restricting UK clearing houses would fragment the clearing market and badly affect finance opportunities for companies in mainland Europe. More in general, if the EU were to cut off access to the world’s leading financial centre which happens to be at its own doorstep, this would hit EU consumers, but then it’s not certain of course how much the EU realises this.
What’s more: the EU’s services market hasn’t been opened up sufficiently and that is a bad thing. In a Brexit context, it is a good thing, as it means that the damage from losing the EU’s financial passport is smaller than assumed.
As we’ve made clear in an earlier research paper, the EU’s financial passport is mostly important for banks. It’s less vital for asset management and least of all for insurance firms.
You wouldn’t know it given the energy devoted to the customs union debate, but customs checks represent only a fraction of procedures that take place at a border. Most of these are regulatory controls on goods, or checks on agriculture and food. Our solution for goods would thereby also soften border crossings.
Unless one thinks it’s sustainable for Britain to let the EU negotiate market access to the UK market when discussing trade deals with China, India or one day even Russia, while Britain would then need to get permission from these countries to get the access the EU negotiated to their market, it is a no-brainer for Britain to leave the customs union.
That’s to say: at least at some point, given that the challenges of working out customs formalities may well justify that the UK remains somewhat longer under the EU’s external tariff regime. Britain can then leave the common customs arrangement with the EU on the day deals concluded with Australia, India and hopefully the US enter into force, when it will then also be able to scrap tariffs to benefit UK consumers.
Not even Norway, the non-EU country that is institutionally closest to it, has joined a common customs union with the EU. In order to deal with the Irish border and other challenges, we pointat the many precedents in the world that serve to minimise friction at the border – without denying that there is likely to be more friction than at the moment.
Surely, the EU may itself realise that it is better to conclude a sustainable arrangement with Britain rather than one which will come under fire. What we advocate with Open Europe is that the EU and Britain conclude an extensive Free Trade Agreement including zero-tariff and zero-quota trade.
EU regulations that have nothing to do with trade
It is important that Britain makes sure the EU doesn’t once again pull off its trick of selling its many regulations that sometimes have little do with trade as measures relating to open up trade. We think regulation covering employment, taxation and the environment should not be subject to intervention from the EU.
Brussels needn’t fear that Britain will suddenly engage in a regulatory “race to the bottom”. The strength of Jeremy Corbyn should be enough proof that Britain isn’t as “neoliberal” as sometimes claimed.
Surely the UK shouldn’t take over all kind of non-trade related EU rules and, who knows, that may lead to questioning how necessary those rules really are.
Obviously, the EU’s plans for “level playing field agreements” carry a risk in this regard, so here, Britain must issue a strong and firm message: thanks but no thanks.

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