Dr. Alan Riley - 20/07/2016

1.0  Introduction: Hard and Soft Brexit Options

The Prime Minister is clear that ‘Brexit means Brexit’. However, there are a range of options and interpretations as to what Brexit may ultimately mean. Hard Brexit is taken to mean that Britain not only leaves the EU but also leaves the single market. So, no membership of the European Economic Area, no subscription to the four freedoms of goods, services, capital and labour, and no participation in the single common customs tariff. Soft Brexit could mean some form of associate membership of the EU, EEA membership or remaining a Member State within a reformed EU. Most versions of soft Brexit envisage subscribing at least to the four freedoms if not the common customs tariff. This paper sets out what the hard and softer Brexit options really involve and what can practically be delivered.

Hard Brexit can be achieved, but will take considerably longer than the two-year period envisaged by its proponents. It requires the UK to negotiate as a first priority an upfront exit procedure with the rest of the EU. Britain would then have to negotiate in parallel a separation and trade deal with the EU. It would, in addition, need to develop an industrial strategy to ensure that it could make the most of its new trading arrangements where the focus would inevitably have to be more on trading in goods than services. The UK would also face a period of time, post exit, where it would have to negotiate its new WTO schedules of commitments with the other 161 WTO members. It would therefore need as part of its upfront deal with the EU the capacity to trade under the EU’s WTO schedules of commitments until it had negotiated its own WTO schedules. This is a formidable and lengthy task for the British state to take on and for British industry to adapt to.

The other option that is therefore examined is soft Brexit. This would involve the UK keeping as close as possible to existing single market arrangements. Such a soft Brexit would minimise trade disruption, be implemented more quickly than hard Brexit, and reduce the burden on the UK and the EU in what they would have to negotiate. This soft Brexit option looks difficult to deliver because of the requirement to accept free movement of people both under EEA and EU law rules.  

However, one way of re-thinking soft Brexit is to see the Brexit vote in a European context. The whole EU faces a swelling populist surge of discontent driven by fears over globalisation, immigration, migrancy, security and the EU’s over-reach.  One option which is worth London, Berlin and Brussels investigating is whether a European settlement is possible which addresses those discontents and which would permit the UK to remain a close partner of the EU.

Whatever option is ultimately chosen, the British Government and its advisers need to think strategically and be prepared for the most substantial diplomatic, political and economic effort since the Second World War.

2.0. Delivering Hard Brexit

The argument here is that if Britain is to undertake a hard Brexit the UK has to recognise that the effort to deliver it is substantial and will take a considerable period of time. It will take more than the two-year period envisaged in the withdrawal mechanism contained Article 50 of the Treaty on European Union (TEU)[1], it is more likely to take five years. Britain will also need to develop in parallel a world-class industrial strategy to prepare the British economy for life outside the EU, which will also take several years to execute. However, as a result of negotiating an upfront agreement on the terms of the exit mechanism, Britain will be able to move far more easily, with far less disruption, from a world of EU negotiated trade relationships to one in which the UK has developed its own trade relationships.

2.1. Hard Brexit: The Work of Sisyphus

Article 50 TEU provides for a two year period in which the terms of separation would be negotiated by a putative withdrawing Member State. At the end of the two-year period the withdrawing Member State would be deemed to be no longer a Member State, whether or not negotiations had been concluded. While the period for negotiation can be extended by unanimity of all the other Member States, the practical reality is that such an extension is unlikely.

Much of the media commentary has focussed on the two year period as the time it will take for the UK to exit the European Union. In fact it is very difficult to see how the UK will be able to exit the EU in two years. When Greenland left the then EEC in 1983 it took three years to negotiate and ratify its exit, despite having only a population of 50,000 and only one main product: fish. Aside from the size of the UK, as well as the multi-products and services that the UK exports into the Union, the Union itself has significantly expanded in its competences since 1983. The likelihood therefore is that the separation negotiations will take more time to complete than the Greenland negotiations.

The second major factor in affecting the timeline is the need to organise, in parallel with a separation agreement, a trade deal with the EU. This parallel trade deal would be vital for the British economy, as the EU states still provide a market for 45% of UK exports. Again, the time period for doing such a trade deal is likely to take much more than two years. It is vital for the uninterrupted flow of trade that the UK seamlessly moves from trading rights exercisable under the EU Treaties to trading rights exercised under the UK-EU trade agreement. As Lazowski, has also pointed out, any parallel agreement will also require consent and ratification of all Member States through their own constitutional requirements. This will further extend the time period that will be required to complete any separation and trade deal[2].

The importance of ensuring seamless trading arrangements for all exports (not just exports to the EU) post-Brexit also impacts on the exit time frame. Although the UK is a member of the WTO, its trade agreements were negotiated by the European Commission as part of a series of common EU trade schedules of commitments. There is an EU schedule of commitments for each of the WTO agreements for agriculture, industrial goods and services. The UK would have to establish separate schedules for each agreement.

The major difficulty here is that it is unlikely that the other 161 state contracting parties to the WTO will accept a straight ‘delete and replace’ of the EU’s schedules of commitments deleting the reference to the EU and replacing it with the UK. They may not unreasonably take the view that the EU schedules were agreed for the world’s largest market. A different deal will have to be arranged with the UK in respect of the creation of its own independent schedules of commitments. Given that the WTO operates by consensus, those deals will take some time to negotiate. Whilst it will not take the UK the time it took Russia (20 years) or China (15 years) to enter the WTO, it may take the UK a time period not unlike that of Bulgaria and Romania. It took those states, who were already members of the WTO, four years before they were able to be integrated into the EU services schedule after joining the EU.

Britain would at least remain operating under the WTO EU schedules until its membership of the EU ceased. It is unlikely however that the UK, in parallel with its separation and EU trade negotiations, will also be able to negotiate its own WTO trade schedules at the same time. Most of the other 161 WTO member countries will not be prepared to initiate detailed trade negotiations until the UK has sorted out its trading position with the EU. Hence, detailed negotiations will only be opened on UK exit from the Union and after the EU-UK trade agreement has been put in place. This is again not an entirely unreasonable position for WTO members to take as they need to be able to see what the trade relationship between the UK and EU looks like in order to be able to calibrate their bids for access to UK markets effectively. However, as a consequence, if it loses WTO access the UK could face significant trade disruption in the interregnum from the end of its EU membership and being able to establish its own independent WTO trade schedules.

Nor can the UK easily rely on rapidly signing bilateral free trade agreements (FTAs) instead of WTO arrangements. It is true that some FTAs can be negotiated relatively quickly. For example, China negotiated a FTA in three years with South Korea but the trade liberalisation that was actually achieved was limited[3]. Furthermore, for states with highly developed market sectors, FTAs are also more likely to take much longer to negotiate. For instance, Japan and Australia took seven years to negotiate their FTA. Delay in negotiating FTAs is not just a consequence of the likes of the EU having 28 Member States and therefore consensus being required on agreeing the ‘EU line’ being difficult to obtain and time consuming. It is also the sheer level of complexity and interests on both sides of any major trade deal that have to be worked through. This is true for the 28 state EU and a third party state agreeing a FTA, or two entirely non-EU states. One of the longest recent trade deals that is now set for ratification is that between China and Australia. This FTA took 10 years to negotiate.

A further problem in respect of FTAs is that some states, such as the United States, do not negotiate FTAs with states that do not have legally binding WTO schedules of commitments. It would appear that, unless this requirement can be waived, then it may well be difficult to conclude FTAs with major states until the UK’s independent WTO schedules have been established.

The first point that has to be recognised in organising a hard Brexit is that Article 50 is not fit for purpose to organise a safe and secure exit from the EU for the United Kingdom. The two-year period is insufficient to make the necessary separation arrangements. In addition, the European Commission has indicated that the UK cannot negotiate a trade deal in parallel with its separation agreement. This latter point is a political decision. There is in fact no legal restriction in Article 50 that would prohibit a deal to be negotiated in parallel.

At a minimum, before triggering Article 50 the UK government needs to achieve an upfront agreement that provides for at least a five year period in which to negotiate a separation agreement. It also needs to agree with the other Member States and the Commission that a trade agreement with the EU would be negotiated in parallel with the separation agreement.

Given the problems discussed above in relation to Britain’s non-EU international trade and the UK’s full access to the WTO, the UK would also need to maintain its WTO EU trade schedules until the UK had agreed with all WTO members that it had agreed its own independent trade schedules. The UK would also have to negotiate an arrangement with the other EU states whereby it would retain access to the EU’s schedules for a time period after it had left the EU and until it had established its own schedules.

The advice to the British government is therefore that it should seek the following upfront arrangements. First, a longer time period than two years for Article 50 negotiations. Second, parallel negotiations to be opened with the separation negotiations in respect of the UK-EU trade agreement. Third, an agreement to maintain the UKs EU WTO schedules until the UK had negotiated its own independent trade schedules with other WTO members.

The importance of ensuring uninterrupted British capacity to trade across international borders cannot be underestimated. As the historian Robert Tombs has pointed out, the principal reason for the collapse of British staple industries in the 1920s and 1930s was the redirection of British business and people to the war effort from 1914 to 1918. During the war years, American and Japanese businesses entered international markets once dominated by British businesses; once competitors were established in those markets the British were never able to return on the same scale as before the war[4]. There is a danger with hard Brexit that, if there is a failure to ensure interrupted free flow of trade, Britain could once again see a significant loss of market access which would never be able to be fully repaired.

One major question flowing from this analysis is whether the EU institutions and the Member States will be prepared to negotiate an upfront agreement on the procedures and timings of the Brexit process. The advice here is that the UK should seek to negotiate an upfront agreement and be prepared to take some time to get such an agreement.

The UK has in fact little to lose from waiting and seeking an upfront negotiating agreement. The main leverage that the Brussels institutions and some of the Member States hope will force Britain to the negotiating table and trigger Article 50 is the economic uncertainty created by the Brexit vote[5]. It is certainly the case that the Brexit vote has caused the UK economic damage already, and that the uncertainty as to Britain’s future trading status undermines foreign investment and trade relationships. However, the economic uncertainty created by the Brexit vote is limited in comparison with the effect of triggering Article 50 without an upfront negotiating agreement, which would result in the UK exiting the Union within two years, and then being faced with years of negotiation after exit to establish EU and full WTO trade relations, while having limited trade access in global markets. Furthermore, as discussed below, the UK can take steps in the meantime to stimulate the economy and undertake the economic re-structuring necessary to prosper in a post-Brexit world.

The EU institutions and those states who are unwilling to consider the sort of upfront agreement envisaged above would then have to consider the consequences of a standoff between the UK and the EU for themselves and the EU as a whole. The British economy will stabilise after the initial chaos and panic. The UK government will also take steps to stimulate economic activity and re-balance the economy. Furthermore, as it becomes clear that, even if the EU is willing to negotiate Brexit on reasonable exit terms, the negotiations will take half a decade or more, the British and European business community and international investors will come to realise that nothing will change in terms of trading relationships in a significant time horizon. This recognition will also have a positive impact on short to medium term business and investor stability.

Meanwhile the Union will face having to deal with a continuing stand-off between the UK and the EU, with a number of Member States supporting the UK. In addition, the Union will have to deal with the continuing Eurozone crisis; the migrant crisis; the threats from ISIS, the continuing problems stemming from the invasion, occupation and annexation of parts of Ukraine. Furthermore, within the Union, political relationships are becoming ever more strained by surging populists, nationalist, anti-EU and anti-establishment forces.

In such a context, the Union and those Member States most reluctant to engage with the UK in a broad upfront agreement will have to consider what is in their true best interests. Engaging with the UK and agreeing reasonable terms on which to negotiate exit is the optimal strategy for both with the United Kingdom and the EU. Alternatively, the Union can set itself on a path of conflict with the United Kingdom as well as UK’s allies within the Union. This is only likely to divide the EU further, weakening its capacity to act and undermining its credibility internally and externally.

2.2. The Advantages of a Five Year Hard Brexit Process

A willingness to stand off from triggering Article 50 until a credible exit procedure has been agreed, and a recognition that a hard Brexit separation and trade agreement will take five years, has a number of advantages for the UK. As discussed above such a procedure is much more likely to result in Britain maintaining a near seamless pattern of trading arrangements. The UK will be able to switch without too much disruption from its current arrangements to the new EU-UK trade agreement and to its own independent trade schedules under the WTO.

In addition, a five year period would give British industry more time to adjust and start developing new trading strategies in a world where it would have less access into the European single market. With more time to adjust, for instance, it would be more likely that Britain could keep more of its single market contingent business. For example, access to the services market, where Britain is particularly strong, would be limited once the UK was no longer a Member State. With a likely five year time period to negotiate exit, British businesses would have the time to establish EU based services operations so that they would be able to operate within the single market. While their operations would now be in the EU, the UK would still benefit from the profits repatriation: the business would not actually be lost.

Equally, over a five year period, British industry would be able, whilst still undertaking business on its existing European trading platform, to begin to develop strategies to trade on international markets where the UK would largely be relying on WTO rules. Having a time period to adjust would allow business to develop opportunities with the minimum disruption to trade.

Even with the most seamless transition from EU to non-EU trading arrangements there will be disruption to Britain’s international market access. Most notably this will affect UK access to the global services market. The UK is globally the third largest exporter of services. Post-Brexit it will be difficult to sustain this high level of export of services as our market access is eroded. This is principally because the WTO, on which so much of British trade will depend, prioritises market access for trade in goods, not services. Even with any FTAs the UK has managed to agree there is likely to be significant restrictions on trade in services. This is in part because opening services markets usually takes much more time for parties to deliver. Therefore the UK may well be willing to sacrifice access to services markets in order to get a FTA agreed.

This is where having a five year or so time period provides the UK government with the opportunity to re-balance the British economy, so that it is capable of operating in a world where it has more market access for goods rather than services. To achieve such a re-balancing will require a proactive industrial strategy which encourages investment in high value added industrial sectors which can be traded internationally. A mix of tax and regulatory reform measures will be required. The UK will also have to consider more interventionist measures to stimulate the manufacturing sector. For instance, by establishing a series of state commercial banks to feed capital to manufacturing industry.

By having a five year or more time period to enhance its capacity to sell high value added goods, the UK will be able to cushion the effects of its exit from the EU. There are also additional benefits, notably that an active industrial strategy can help heal the social divisions which came to the surface in the referendum campaign. Such active industrial measures over the next few years may also assist the UK in maintaining the Union with both Scotland and Northern Ireland.

3.0. The Soft Brexit Option

The hard Brexit option will require a Churchillian level of response from the British state for it to be successfully delivered. There is first, the prospect of an initial standoff with the EU institutions and some of the Member States over the procedure to negotiate the UK’s withdrawal from the Union. Second, there is a follow on five year period where the UK has to negotiate both its separation and trade agreement with the EU. Third, there is then a subsequent five year period to settle its terms for full independence within the WTO, whilst at the same time seeking to negotiate as many FTAs as possible. Fourth, whilst at the same time as negotiating these trade deals, the UK would have to develop and execute a world class industrial strategy to re-balance the economy to cope with a post-EU single  market access world in which it would be trading.

One option therefore to consider is whether a soft Brexit option would be possible. The argument here is that the more of the single market the UK continues to apply, the less that will need to change. As a consequence, the burden for the state and for British industry would be significantly reduced. In addition, the time period for such a deal would be far less than five years.

The difficulty however, is that in any ‘single market’ deal the UK would be faced with the EU demanding that the four freedoms are applied in full. This would include freedom of movement, which was one of the principal drivers for voters who voted leave. This is why it is difficult to see any difference in being a member of the EEA or the European Union, both would require the UK to apply free movement in full[6].

There is much truth in the British charge that some Member States prioritise free movement of people, however, they do not take such a sacrosanct view of free movement of services. Although the UK benefits substantially from free movement of services, it remains the case that over 60% of the EU services market remains closed. Given that Britain has a comparative advantage in the services market, it also in part explains why the UK runs a significant EU trade deficit, as the UK is fully open to EU traded goods, but EU services markets remain substantially closed.

It remains unlikely that the UK can shift the argument on free movement solely relying on the unequal application of different pillars of the four freedoms. What may well turn out to be a practical way forward for Britain and the other 27 Member States is to see Brexit in its European context. The argument here is that the drivers which led to the Brexit vote are found across Europe. Discontent from the downsides of globalisation, concern at intra-EU immigration, external migrant flows, security, and the over-reach of the EU institutions.

One soft Brexit route which is worth Brussels, Berlin and London investigating is where Britain and the other 27 Member States agree a new European settlement which seeks to address those discontents. This would have all the advantages from the UK’s perspective of being less burdensome and less time consuming than a hard Brexit while addressing the concerns of leave voters. From the rest of the EU’s perspective, such a deal would keep the UK close to the EU in some form of associate membership or EEA member. Such a European settlement would also allow the Member States to tackle head on the discontents that now exist across Europe, which threaten the mainstream democratic political parties and potentially liberal democracy itself. Such a settlement would make it more difficult for the likes of the Front National or ADF to gain any more headway and prepare the ground for a counter-attack by Europe’s mainstream political parties.

It is not too difficult to sketch the outline of such a settlement. It would include the following elements

Security in Globalisation: This element of the settlement would include an agreement to bolster the EU’s trade defence procedures against unfair trade; it would include creation of a foreign investment review procedure and a programme to assist areas which had suffered as a result of globalisation.

Free Movement: This would include a number of measures to restrict free movement across the Union, including a surge break. The underlying aim would be to keep as far as possible to the principle of free movement, while protecting communities from large scale movements. It is worth noting that if the UK does leave the single market in its entirety with no free movement, it will no longer be the principal absorber of workers from southern Europe or from CEE states. It is likely therefore that the immigration flows will be diverted into those remaining Member States with economic growth, recreating the political problems that existed in the UK in other countries.

Non-EU Migrants. This would involve a battery of measures, including creating a more formidable security operation in the Mediterranean to suppress trafficking; greater support for a border protection force; funding migrants near their home countries and the establishment of free trade enterprise zones in neighbouring countries to stabilise those countries and support migrants.  The UK could take a significant role in developing the EU’s response to the migrant crisis. It already is one of the largest funders of support for migrants who have left their home countries but who remain outside the EU.

Security: Given the security threats facing the Union from Narva Castle on the Russian/Estonian border to the gates of Gibraltar, the Union could create an enhanced security package. Again this could include a major British role, reinforcing its military presence on the continent and in the Mediterranean Sea.

EU Reform: The reform package would seek to ensure that the EU focussed its activities on where there was a compelling European reason to act. It would also seek to return powers to the Member States and strengthen substantially the role of the national parliaments in scrutinising proposed EU legislation.

The soft Brexit option would require a broad European settlement. It is clearly something that the European Parliament would have difficulty with, as well as some Member States. On the other hand the populists are at the gates, the discontents are real and the external threats that the EU faces are considerable. A European settlement could keep Britain close to the EU and fully engaged, whilst at the same time providing the other Member States the means to challenge and then reverse the populist surge.

4.0. Conclusion: Hard or Soft:-Considering the Options

Both options are difficult to deliver. Hard Brexit will involve an enormous effort by the British state and industry to ensure a successful outcome. The state will have to operate on multiple levels in trade and separation negotiations over several years. The Foreign Office and International Trade Departments will have to expand rapidly in order to protect the UK’s interests globally. Equally, the British footprint in Brussels and all EU capitals will have to expand as the UK loses its access to the EU institutions.  Meanwhile at home the UK will have to begin to develop and then execute an industrial strategy to re-balance the economy in order to ensure British business benefits from its new trading arrangements.

Hard Brexit is a formidable task to deliver successfully. So however is soft Brexit.

Given the political imperative against the free movement of persons, the UK cannot simply exchange free movement of persons for single market access. Hence discussion of EEA over EU options is unlikely to be the route the UK can take to keeping single market access.

The only way this paper suggest to keep Britain close to the EU is for Britain and other European states to view Brexit in its European context. The discontents exposed in the referendum are European discontents widely shared across the continent, which need to be addressed. A general European settlement which addressed those discontents could provide a structure within which the UK might be able to be a close partner of the EU. The form of that close partnership, be it associate membership, membership of the EEA or membership of a reformed EU would be another issue up for discussion, but it of secondary importance to the ability of Britain and the other EU Member States to be able to agree on the need and shape of a European settlement.

It is unclear if Britain will end up taking on the Sisyphean task of hard Brexit or whether it will be possible to construct a European settlement which can keep Britain close to the EU, while increasing the EU’s capacity to deal with European discontent. The latter would probably be preferable, in terms of minimising disruption, maintaining the unity of the West and tackling internal and external threats across the continent and beyond. However, it may well be that hard Brexit is in fact now the only viable option as the other EU states and the UK will be unable to agree on the terms of a viable European settlement.

 

 

 

 



[1]The most comprehensive analysis of the process of withdrawing from the European Union can be found in the House of Lords Select Committee Report, European Union Committee, The Process of Withdrawing from the European Union (2016) 11th Report of Session 2015-2016, HL Paper 138, 4th May 2016. See also Lazowski, Procedural Steps Towards Brexit, (2016) CEPS, Brussels, 16th July 2016.

[2]Lazowski, ibid.

[3]Schott and others, An Assessment of the (South) Korea-China Free Trade Agreement, (2015) Petersen Institute, Washington DC. This paper is worth reading for anyone seeking to understand the complexities of international trade negotiations. The scale of commitment of both parties to negotiate sector by sector, and product by product and conformity by conformity, gives some sense of the time and effort it takes to negotiate a modern trade agreement.

[4]‘In 1913 Britain had been the world’s biggest exporter of manufactured goods…During the war production had been diverted to the war effort, cutting deliveries to overseas customers. They had found other suppliers or built their own factories. America and Japan had moved into British markets in South America and Asia tripling exports during the war years’ Tombs, The English and Their History: The First Thirteen Centuries, (2014) Penguin, Chapter 16, The Twenty Year Truce.

[5] It has been argued that the EU could deploy a series of legal manoeuvres within the Treaties to bring pressure to bear on the UK to force London to trigger Article 50. However, on closer examination the two main approaches identified provide Brussels with little leverage. The first would be to seek to suspend the UK’s voting rights under Article 7 of the EU Treaty. This can be invoked only where a Member State seriously and persistently breaches the principles on which the EU is founded, liberty, democracy, human rights and fundamental freedoms, and the rule of law. It also requires a four-fifths majority of the Member States for Article 7 to be invoked, which would be difficult to construct. Furthermore, Brussels would actually need grounds to invoke Article 7, as the UK does not seriously and persistently breach liberty, democracy and human rights principles, and will apply EU law in full until it is no longer a Member State. Even if a majority could be put together to trigger Article 7, would be open to challenge and defeat by the UK in the European Court of Justice. Ironically, the Court would be forced to find that it was the EU Council which was breaching the EU’s general principles of law by abusing its power in seeking to rely on Article 7 with no justification. Such an attempt to invoke Article 7, followed by defeat of the EU Council in the ECJ would be likely to inflame much of the populist, anti-Brussels forces across the continent.

[6]There has been some discussion of Lichtenstein’s rights under the EEA to restrict free movement. It is true that there is a restriction provision in the EEA agreement. It is also the case that the EU has the capacity to take retaliatory measures if the restriction provision is deployed. While Lichtenstein has deployed the provision, the EU has taken no action. However, this is no precedent. The crucial fact is that Lichtenstein has a population of less than 40,000. For larger state entities the EU would find such a step intolerable and retaliatory measures would be taken.