Understanding the Transatlantic Economy: Brexit - Part I

The decision of the United Kingdom to leave the European Union (“Brexit”) by abrogating its 45-year old treaty relationship with the 27 other European countries that came together to create the EU is one of the most significant geostrategic events yet in this still-young 21st century.

The decision, which becomes effective on March 30, 2019, could unleash the greater potential of the United Kingdom, as some of its proponents claim. But it could also have catastrophic consequences if the U.K.’s departure exacerbates the centrifugal forces that have been at work in the EU since the financial crisis a decade ago, potentially leading to a return to the armed conflicts in Europe that the EU was created to end.

Despite the still small probability of this latter outcome, its consequences are drastic enough that political leaders in the European Union and the United Kingdom have an obligation to their citizens to manage Brexit as constructively as possible.

This requires, in the first instance, that the United Kingdom openly acknowledge that it is indeed invalidating its treaty relationship with its 27 European counterparts, and rending apart the legal framework that has governed political, economic, and social relations among them for decades. This is considerably more serious than “leaving the EU.” Acknowledging the seriousness of this, the U.K. must explicitly accept that it has remaining obligations under this international legal framework that it must fulfill.

This lack of calling “Brexit” by its proper name, however, has unfortunately also muddled thinking in London (and elsewhere) about how to achieve its stated vision of a new “deep and special” relationship with the EU member states.

In this, the other EU member states are correct in insisting that Brexit is a two-step process. They want to see how trustworthy the U.K. is (after it decided to rip up a major international agreement with them) before they contemplate what sort of successor legal relationship they will have with the U.K. in the future.

Some of U.K. Prime Minister Theresa May’s government statements go in this direction, including, most importantly, the March 29, 2017 letter that formally notified the EU of the U.K.’s intent to withdraw from the EU Treaties.^[1]  But the prime minister and other senior British leaders have shied away from using the word “abrogate.” Given the United Kingdom’s traditional leading role in creating the current international legal order, they hopefully understand the seriousness of that action under international law.

This lack of calling “Brexit” by its proper name, however, has unfortunately also muddled thinking in London (and elsewhere) about how to achieve its stated vision of a new “deep and special” relationship with the EU member states. The United Kingdom’s decision to unilaterally terminate its legal relationship with 27 other EU members underscores that there is only one Brexit — a “hard” one, under which the U.K. legally becomes like any other third country. In that strictly legal sense, there is no “transition” out of the EU. ^[2] Only after internalizing that this is the new starting point in its relations with the EU and its member states can the U.K. begin to make the case for having a better relationship than those other third countries.

If the U.K. understands and accepts it has obligations in terminating the current legal relationship, then the second prerequisite for properly managing Brexit is for the EU member states to acknowledge that it is in the interest of all parties — including them and their citizens — to maintain as strong as possible a relationship with a country that has been their colleague and counterpart for decades.

There are, of course, many aspects to this, but the two sides must critically focus on how the United Kingdom and the European Union can construct a new legal framework governing (the majority of) ^[3] their economic relations after the United Kingdom formally leaves the EU.

Contrary to general belief, constructing this legal framework — in the form of a truly ambitious and comprehensive EU–U.K. free trade agreement (FTA) — can be done before March 30, 2019, when the two-year period for terminating the application of the treaty expires, if the EU side acknowledges that the United Kingdom does indeed start from a different point than other third countries, having been an EU member for nearly half a century with an exemplary record in terms of implementing EU law and regulation.

Such an agreement would have three main parts governing:

• market access that would allow businesses in the U.K. and EU to continue buying and selling goods and services to each other (including to each other’s government agencies), and to continue investing as well, without additional costs or restrictions, recognizing that the two sides are already so deeply integrated through the U.K.’s long participation in the EU Single Market that there is no rationale for rules that detract from the access both side have had;

• regulatory cooperation between the two sides on the levels of safety required for the goods and services traded between them, knowing the U.K. and EU will have precisely the same requirements on the day the EU Treaty ceases to apply, and that afterward any good or service sold to the other must meet the importing jurisdiction’s legal requirements;

• other rules that may apply to the trade and investment relationship between them, including with respect to the protection of intellectual property and investments, subsidies and other state aids, and potentially even such things as general provisions on labor and environmental standards.

Concluding such an EU–U.K. FTA by 2019 is not only technically doable, it is the only option that makes sense. Given that the starting point of this exercise is that the United Kingdom, as a legal matter, reverts first to being just like any third country, all options — whether a customs union relationship such as Turkey has with the EU, or membership in the European Free Trade Area (EFTA) and in the European Economic Area (EEA), or any form of “transitional” arrangement — require the U.K. and EU to negotiate and conclude a new legal agreement between them. In addition to being arguably just as difficult to negotiate as a full FTA, each of these approaches in some form requires the United Kingdom to continue to accept obligations it was expressly trying to escape when it decided to withdraw from the EU Treaty, and as such each would presumably need to be replaced in the near future. Going through this negotiation process twice unnecessarily keeps the wound of the U.K.’s abrogation of the EU Treaty festering, increasing political and economic uncertainty and exacerbating the geostrategic dynamics Brexit in any event creates.

Some in continental Europe will argue that concluding a “favorable” trade agreement with the U.K. would “reward” it by reducing the costs of treaty abrogation and might thereby encourage other countries to leave the EU as well, also accelerating centrifugal forces.

Perhaps.

But it will quickly become apparent — to the U.K., and to anyone else — that even the most ambitious FTA that can be constructed will not be as advantageous as membership in the EU.

• First and perhaps most important, the “sovereignty” the U.K. ostensibly gains by leaving the EU is so constrained by reality as to be almost illusory. One of the first principles of international trade is that the products and services one country exports to another must always comply with the importing country’s rules. Given proximity, Europe is and will remain the U.K.’s single most important trading partner. Indeed, for many British businesses, selling to the EU economy may well be more important that selling to the U.K. market, which is less than one-fifth the size. Yet, as noted, any good or service a British business may want to sell to the EU must comply with EU law and regulation — which they do today, given that the U.K. currently subscribes to EU rules. So while a newly “liberated” U.K. may adopt laws and regulations that differ from those of the EU, that will only complicate the lives of those businesses who will still have to comply with EU rules to sell to the EU — sales that now account for 13% of total U.K. output.

• Second, and as important, the U.K.’s decision to leave the EU means it no longer has a direct say in what EU law and regulation requires. Ironically, this destroys one of the U.K.’s crowning achievements in the EU, the Single Market Treaty of 1987, under which EU members — at the U.K.’s urging — made the sovereign decision that they would work together to make rules jointly so their businesses would face only one set of regulatory requirements in selling throughout the EU. The EU’s Single Market makes the EU far and away the world’s most ambitious free trade agreement, and it has succeeded well beyond former British Prime Minister Margaret Thatcher’s wildest imaginings — trade among the EU member states in goods alone exceeded €3.1 trillion in 2016, almost double the €1.7 trillion of EU goods exported outside the EU. In choosing to abrogate its treaty with the EU, the U.K. has opted to leave this deep and comprehensive FTA and to become instead a “third country;” in so doing, it joins the “Coalition of the Excluded” — countries like the United States, Norway, Switzerland, Japan, and all others that sell to the EU but have no say over EU regulations.^[4] Virtually every member of that “coalition” would have preferred the U.K. to stay on the other side of the fence; it helped improve the quality of EU regulation. Now the U.K. will join them in being a rule-taker, rather than a rule-maker.

• Third, virtually any other trading regime the U.K. and the EU might have entails, at the very least, significant additional administrative costs, as goods and services sold to the U.K. and the EU will now have to document compliance with the governing rules and regulations (inside the EU, compliance is assumed), as well as with the provisions of the new trading regime.

The U.K. will thus bear significant costs from its decision to terminate its treaty relationship with the remaining EU countries. Only the citizens of the U.K. can decide whether these costs are worth the sovereignty supposedly gained. But the citizens and governments of all other EU member states have now been forewarned: being on the outside is not all it is meant to be.

Accordingly, the remainder of the EU should be willing to enter into a strong trade agreement with the U.K. as part of its effort to mitigate the consequences of Brexit, knowing that the U.K.’s sovereignty gain is limited, that U.K. businesses will still need to meet EU rules, and that the U.K. will no longer have any say in those rules. That is cost enough.

The U.K. and the EU can conclude a trade agreement within the 18 months remaining before March 30, 2019, without any need for a “transitional arrangement” that itself would be difficult to negotiate. This is technically doable, with the right understanding of the scope of the agreement, the starting point of the relationship between the two sides, and the structures needed to address the critical question of the regulatory standards both sides need to meet to continue selling to each other. Other papers in this series will address these issues in detail.

But while an agreement is doable, whether it will be done is another matter. If not, politics, and politicians will be to blame.

Peter Chase, a Senior Fellow with the German Marshall Fund of the United States, was a 30-year career US diplomat specialized in international economic policy issues, whose assignments included tours at the US Mission to the European Union, US Embassy London, the Office of the US Trade Representative and the US Senate. He also served between 2010 and 2016 as the US Chamber of Commerce’s Vice President for Europe, based in Brussels.