Thursday, February 20, 2020

Looking ahead at negotiations on the future EU-UK relationship

Published in the magazine of Dutch think tank Clingendael


Following the ratification of the Brexit Withdrawal Agreement both by the UK and the EU, the UK has formally left the EU at the end of January. Now, it has entered a ‘transition’ stage, effectively outsourcing its trade policy and regulatory powers to Brussels until the end of 2020, in return for full and unrestricted market access. Nothing will  really change until then.

From March on, negotiations on the future relationship will commence. Fundamentally, the EU wants the UK to align as closely as possible, fearing that the UK would otherwise emerge as a ‘competitor’, as Angela Merkel has put it. The EU side is also sceptical that the negotiations can be sorted by the end of 2020. The UK is on the other side stressing it wants to use its newly gained regulatory independence to the greatest extent possible, as Prime Minister Boris Johnson is ruling out an extension of the transition period.
How will these positions be reconciled? Of course, nobody can predict the future, but if both sides implement Brexit in a responsible manner, it means gradual and flexible divergence. This means that the EU concedes that the UK will be able to continue to enjoy great market access, even if it diverges on certain areas, very much like Switzerland. The UK on the other hand would thereby concede that it will only gradually diverge, as it will continue to align, in exchange for EU market access. Industry will rightly wonder why the UK would already sacrifice market access in order to gain the right to divergence when on the 1st of January, the UK won't have changed many rules anyway. Many will rightly wonder if it isn't responsible to coordinate changes to UK regulation with the EU, in order to minimize the market access the UK loses in return for diverging, which is of course important in order to reap the benefits of Brexit. The UK could for example commit to align until 2024, just ahead of the UK general election, so Brexiteers can be certain the UK wouldn't be locked into this arrangement indefinitely, while it enables time to rethink many of the EU rules the UK has now enshrined domestically. In this way, the UK would enter some kind of Swiss arrangement, which ultimately will end in a Singapore-style Brexit, at least if the Brussels regulatory machine refuses to restrain itself, which makes regulatory aligment for the UK unattractive.
What will the future relationship look like?
One thing is for certain: the UK wants to leave both the EU’s single market and customs union. Theresa May’s great failure was to underestimate the importance of leaving the customs union, and agreeing a Brexit deal whereby the EU would be able to veto whether the UK would get its trade powers back. This stance was inspired by businesses understandably fearing disruption to their supply chains. But it should always have been considered unrealistic for the world’s fifth largest economy to outsource its trade powers to Brussels until further notice. This mistake has since been rectified by Boris.
Is there any precedent for a country leaving the EU’s single market and customs union? Apart from Algeria in 1962, Greenland in 1985, and St Barts in 2012, not really. But there is a precedent of a non-EU country that wanted a close relationship with the EU, but at the same time refused to join its single market and customs union.
That country is of course Switzerland, which decided in 1992 in a referendum not to accept the status of Norway as a ‘regulatory vassal’ or ‘fax democracy’, as former Norwegian PM and current Nato chief Jens Stoltenberg once dubbed his own country (where officials sit by the fax machine waiting for the latest directive from Brussels to arrive). It basically then took five years, from 1994 until 1999, to negotiate which EU rules the Swiss would align with and the degree of market access that would be granted in return. A package of seven sectoral agreements was signed in 1999 – all related to single market access. Like Norway, Switzerland isn’t part of the EU’s customs union. Tariffs on Swiss-EU trade mainly apply to agriculture.
It will be a challenge to negotiate a ‘zero tariffs and zero quotas’ arrangement between the EU and the UK in less than one year, but this kind of agreement would only determine whether tariffs are due on goods that are being traded, not whether those goods are able to enter the market at all. Financial services also wouldn’t be covered.
Therefore, the real question is if there is time for the UK to negotiate a Swiss-style ‘pick and mix’ arrangement for market access? Having five times as many staff working on something – as there would be five times less time available – would speed things up and any arrangement could be implemented ‘provisionally’, meaning it would partially enter into force before national parliaments in the EU have approved it. At this point, Boris should perhaps wonder if the importance of sticking to his promised timetable is worth it – and implementing the exit from ‘vassalage’ in phases instead of in one go could save him face.
Another question is why the EU would relax its opposition to Swiss-style ‘cherry picking’ of market access. Its claim that this somehow endangers the functioning of the single market is quickly debunked by the fact that such an arrangement has been working just fine between the EU and Switzerland for almost twenty years. Whether Switzerland agreed to freedom of movement of persons as well as part of the package is irrelevant. If the UK rejects freedom of movement, it would simply have to ‘pay’ for this EU concession with reduced market access.
Sure, there have been tensions in the EU-Swiss relationship lately, with the EU cutting off market access to the Swiss stock exchange last summer, when the Swiss refused to sign up to a role for the ECJ and to take updates of EU regulations automatically. It must be said that this escalation, which didn’t cause much damage in the end due to Swiss countermeasures, was partially fuelled by the EU’s desire to set an example to the UK. And the tensions weren’t the result of a dysfunctional Swiss-EU model, but because of the EU’s attempt to increase its control over regulations in Switzerland.
It’s very hard to see any alternatives to the Swiss ‘pick and choose’ model for the EU-UK relationship. This model strongly resembles Theresa May’s Chequers proposal, which was previously called the ‘three baskets approach’. Here’s why there are few other options. Suppose the EU sticks to its current stance, and so forces a cliff-edge event, dismissing the UK’s offer for ‘selective rule-taking in return for selective market access’ because the UK refused ‘full rule-taking in return for full market access’ (which would have meant letting the EU regulate the City of London, the biggest financial centre in the world). EU businesses keen to see the chemicals trade and manufacturing supply chains undisrupted would be up in arms. It would also be strange to see the EU, which otherwise goes around boasting about how it is a ‘regulatory superpower’ – because other countries adopt its regulations – dismiss the UK’s offer to do just that, because the UK would only take over part of the regulations. Will the EU risk its £94bn trade surplus in goods to simply avoid making yet another negotiation U-turn? Political gravity is likely to prevail here.
A key question is naturally also whether Boris will reheat the Chequers deal again. Opinion seems to be divided here, with some arguing that Boris will prioritise the timetable and stick to his promise of not extending the transition, at the price of aligning more closely to the EU than one would expect, which will be easier given his comfortable majority. The prospect of possible job losses due to loss of EU market access and regulatory divergence, would push Boris to aligning even more closely.
Others argue that the election result is a vindication of those desiring to diverge in terms of regulation, to fully exploit the benefits of ‘taking back control’ as soon as possible. The thinking here is that prioritising the timetable will actually result in the UK opting for a more divergent approach. This is because there would simply be no time for a ‘mixed agreement’, which basically allows for a deal whereby the UK is more closely aligned, but which would also need to be ratified by all EU member states. An agreement which falls under EU exclusive competence alone is easier to fudge in such a short time period, but only allows a looser relationship.
Both sides make strong arguments and we’ll probably know sooner rather than later what the intention of Boris is. We’ve already seen reports that he will legislate to ‘block’ an extension of the transition period. In the longer term, it is very likely that the UK will opt for more regulatory divergence, which is in line with Boris Johnson’s own strong preference for divergence from the EU.
The reason for that is quite simple: one only needs to take a look at the new European Commission. Dutch EU Commissioner Frans Timmermans, who was responsible for the ‘better regulation’ agenda in the previous Commission and who only achieved disappointing results, is now pushing the so-called ‘European green deal’, which contains a raft of new EU initiatives for more regulation and imposes all kinds of more stringent targets – not to forget wild spending plans.
One example: imagine the UK ends up agreeing to align with EU chemical regulations, like REACH, after Boris listened to the concerns of the UK’s chemical industry, who are keen to keep EU market access (after having made huge investments to comply with REACH) and are wary of competition from outside of the EU. After a number of years, however, the EU may update REACH. That this update is likely to be more stringent, especially after it has gone through the European Parliament, is not hard to predict. If the UK rightly decides not to accept this update, this may well force it to give up part of its EU market access, something that would then need to be renegotiated. Remember: Brexit means perpetual negotiation.
To summarise, even if Boris opts for the softest of soft future relationship models, the EU’s regulatory zeal is likely to drive the UK to diverge in terms of regulation, thereby truly becoming the ‘competitor’ Angela Merkel fears. And so it would be the EU that would drive the UK toward becoming a ‘Singapore on Thames’ (even if Singapore is actually not as deregulated as sometimes assumed).
Last but not least, the regulatory competition resulting from all of this would not only benefit the UK, which would be able to attract new business and research, it is also likely to put more pressure on the EU’s regulatory machine. European companies may urge the EU to abandon regulations similar to its burdensome, unpredictable GDPR data regulation in case the UK offers digital service providers a more comfortable regulatory environment. Prominent European researchers have already warned that an ECJ ruling on gene-editing ‘will end innovation’. In the future, if the UK decides to adopt a more innovation-friendly approach, companies and researchers may consider moving there, in turn putting pressure on EU regulators to change tack.
Forget about the money that the UK will save as a result of no longer having to contribute to the – largely wasteful – EU budget or how the UK will manage to open more markets than the EU. The real benefit of Brexit will be to be released from the burdensome Brussels regulatory machine. Just as Brussels is partly to blame for Brexit, it may well ultimately drive the UK to more regulatory divergence than would have been the case otherwise.
Will the EU be divided during the trade negotiations?
This question is easy to answer. The EU is divided in every single trade negotiation. There always is a protectionist camp and a free trade supporting camp, and sometimes when a ‘pro-free trade’ country happens to host an industry which may face more competition after a trade deal, that country quickly jumps into the protectionist camp. There is little reason to believe it would be different here.
What would be different from a classic trade negotiation is that the purpose of this negotiation is not to open up new markets, but instead to protect ongoing trade as much as possible and reconcile this with the UK diverging in terms of regulation. The stakes for companies in an ordinary trade negotiation tend to be lower. Then, it’s about gaining new possible business or defending a market against new competition. In the EU-UK negotiation on the future relationship, it will be life and death for some companies, as they may need to lobby against being partially or fully shut out from the market where they currently operate.
In an ideal world, the UK would have remained a member of a trade-friendly EU, focused on its core business of scrapping trade barriers. But if there is one great benefit of Brexit, it is how regulatory competition will eventually enable an environment where different regulatory zones can experiment with their own approaches for the great challenges of today.
It’s likely that the UK will have to rethink the timing set forward by Boris, while the EU will eventually need to grant it Swiss-style selective rule-taking in return for selective market access. That would still closely align the UK to the Brussels regulatory machine, but due to the EU’s apparent willingness to continuously give in to its instincts favouring ever more regulation, the UK will ultimately end up as what has been described as ‘Singapore-on-Thames’.

Monday, February 03, 2020

What are the opportunities and challenges of Brexit for both the UK and the EU?

Published by The Telegraph and Doorbraak

How will Brexit affect the United Kingdom? How will it affect the European Union? As with everything, there are opportunities and challenges. Hereunder I provide an overview.

Opportunities for the UK

One of the main benefits for the UK is that it will be able to break free from the shackles of the Brussels regulatory machine. With Open Europe, we have estimated that not less than two thirds of the impact of regulations in the UK results from rules decided at the EU level. Even Brussels acknowledges that its top-down, one-size-fits-all approach is in need of reform. Hence the launch of its “Better Regulation” programme in 2014, which has yielded only disappointing results.
A second main benefit is that the UK will be able to beat the EU when it comes to securing trade access to the rest of the world. To be fair, the EU has done a pretty decent job here lately, having secured deals with Canada, Japan, Southern American countries and Vietnam, so in all likelihood, Britain’s first preoccupation will be to now safeguard this trade access negotiated by the EU before it can focus its attention on convincing the likes of America, India, Israel, and China.
Thirdly, and politically perhaps more visible, is that the UK will no longer need to contribute to the – largely wasteful – EU budget. Then the UK may well opt to “pay to play”, which is what the likes of Norway and Switzerland do.
Fourthly, Britain will have greater control over migration. The EU’s regulatory framework has bound the UK government’s hands when it comes to controlling family reunification for non-UK citizens and social benefits for EU citizens.

Challenges for the UK

The most important downside of Brexit is that the EU is likely to restrict current EU-UK trade in case of UK regulatory divergence. The EU could, of course, simply make its own regulatory framework more attractive for businesses, to challenge UK competition, but it prefers protectionism.
With Open Europe, we have estimated that whether the UK benefits from Brexit not only depends on safeguarding market access to the EU but also on how successful the UK is in compensating the loss of market access with making the UK economy more competitive, which includes deregulation, and with convincing non-European partners to open up trade.
British businesses that are dependent on trade with the EU are likely to be wary of regulatory divergence, rightly fearing the resulting loss of market access. Therefore, ultimately, the UK may decide that aligning with the EU’s costly “REACH” chemical rules, its petty MIFID rulebook for financial services, or its innovation-killing GDPR rules for data may still be worth it, given the attached market access to the EU.
An even more burdensome update of any of these acronym-bearing regulations may however change the trade-off and drive the UK to full-on Singapore-style divergence. Indeed, the EU recently announced proposals for yet another batch of top-down EU regulation, under the label " European green deal ".

Challenges for the EU

This doesn’t need much explanation. When the second biggest economy of the EU, which is also the second biggest contributor to the EU budget as well as a nuclear power leaves the club, it is not something to celebrate - not that this has led to much introspection in Brussels. The market access restrictions which the EU will impose as a result of UK regulatory divergence will also hurt EU businesses and consumers, given that trade is mutually beneficial.
The latter is often forgotten by pundits, but the discussion on fish and financial services will be a useful reminder of that: British companies will want to continue to be able to sell their fish in the EU market, while many EU companies depend on sophisticated British financial services, such as financial clearing.
Yet, in the public debate, one often hears that the UK would have the absolute “upper hand” on fish, while the EU would not have to care about UK financial services access to its market.

Opportunities for the EU

For free market supporting EU countries, the loss of the UK as a strong voice supporting these kinds of policies, is regretful. However, over the years, the UK has actually not been able to stop all that much EU over-regulation. It’s the most outvoted member state, something which ultimately also resulted in Brexit.
Perhaps the UK may be more influential outside of the club than inside. As Swedish centre-right MEP J├Ârgen Warborn puts it: the UK’s “ambitious goals for its business climate are one of the best things that can happen to Europe right now”, as “for far too long, issues of business climate and the conditions for European entrepreneurs have been missing on the agenda in Brussels.”
He’s correct, of course: every time the EU will come up with yet another plan for business-unfriendly regulations, the business community will simply point at the UK and its more innovation-friendly attitude.
It will be quite amusing to see how this year’s discussion on the EU’s seven-year budget will bring the reality home to the even the most extreme Eurocrat that EU spending cuts will really be hard to avoid, given the loss of the UK’s contribution.  Some EU budget austerity is a great thing for EU citizens, given how EU spending has been documented to support organized crime in parts of Southern and Eastern Europe. The precedent of Brexit will also be invoked every time there are plans for yet another round of power transfers to the Brussels level.
In an ideal world, the EU would reform to an organization focused mainly on scrapping barriers. However, Brexit may yet trigger more fundamental reform of the European Union than the UK could ever have driven from inside the club.