What the Heck Happens After Brexit?

February 17, 2020 Topic: Politics Region: Europe Blog Brand: The Buzz Tags: BrexitTrade DealBritainUnited KingdomChinaAmericaEuropean Union

What the Heck Happens After Brexit?

Can London get the trade deals it needs?

Three and a half years after the Brexit referendum, the United Kingdom is making its long-anticipated departure from the European Union. But this, of course, isn't the end of the geopolitical saga that has swept headlines since British citizens first voted to leave the bloc in June 2016. While politicians in Brussels and London agreed to the terms of the Jan. 31 exit, now comes the even bigger task of outlining their future bilateral relationship. Though if the countless Brexit negotiations over the years tell us anything, it's that the upcoming discussions between the European Union and the United Kingdom are bound to yield even more rounds of drama in 2020. At the end of the day, however, the desire to end the uncertainty plaguing both economies will ultimately keep London and Brussels coming back to the negotiating table.

The Next Phase of Brexit 

The United Kingdom will stop participating in the European Union’s institutions and decision-making process starting Feb. 1. But Brexit's overall impact in 2020 will remain primarily political, as the United Kingdom will remain in the EU single market (the area where goods, services, people and capital move freely) during an implementation period until Dec. 31. Yet while the immediate economic impact on companies and households will be minimal, the prospect of the United Kingdom leaving the single market without a trade deal in 2021 means that businesses and individuals will still have to make preparations for a potential no-deal exit next year.

The European Union and the United Kingdom will use the implementation period to negotiate their future relationship. According to a political declaration that Brussels and London signed in October, their future relationship will have a comprehensive trade agreement at its core, plus additional agreements on areas such as foreign policy, defense and security. Brussels believes 11 months will not be enough to discuss all the issues on the table and has pushed for an extension of the implementation period. But the British government has said it will not ask for more time, even if it means having to trade using costly World Trade Organization (WTO) tariffs starting Jan. 1 of next year. London has until June 30 to request an extension of the implementation period. Given that the formal trade talks will begin in March, this gives London and Brussels only four months to decide whether enough progress has been made and whether the current timeline should be extended.

The Hurdles to a Catch-All Deal

The European Union and the United Kingdom are both interested in reaching a comprehensive free trade agreement to minimize Brexit-related disruptions as much as possible. However, the negotiations will face numerous obstacles, including:

Standards and rules. The EU single market has a series of rules to ensure fair economic competition between the bloc’s member states. This includes standards for goods and services, and rules on issues such as state aid to companies, environmental standards and taxation. London wants to move away from some of these rules so that it can become more competitive but has not given any details. The European Commission wants the United Kingdom to remain closely aligned with the single market, fearing that London will compete with the European Union by, for example, granting state aid or tax benefits to some companies or by lowering environmental and labor standards to become more attractive to foreign investors.

The European Union will insist on including a clause in the deal to make sure that neither side moves back from current levels of regulation, while the United Kingdom will push for vaguer promises of future regulatory alignment. Even if London and Brussels agree on this issue, they will have to decide on how the regulatory alignment will be supervised, how disputes will be dealt with, and how sanctions for violating the agreement will be implemented. London's decision on regulatory alignment with the European Union will have long-term implications because close alignment with the single market could make it harder for the United Kingdom to sign free trade agreements with countries that have different rules.

Financial services. This will be a key issue for the United Kingdom, where the financial services sector represents around 7 percent of the country's economic output and around 3 percent of all jobs. To be able to sell its financial products in the European Union, Brussels will demand London remain aligned with the bloc's regulatory and supervisory framework for the sector, under the so-called equivalence mechanism, though this will be problematic.

The European Commission grants equivalence rights to the financial sectors of non-EU countries for 12-month periods, and Brussels has the right to withdraw these rights with only a 30-day notice. London will want a more long-term settlement that reduces uncertainty, and Brussels will probably ask for concessions on other areas in return. In addition, equivalence rights cover many financial activities but exclude important operations such as lending or deposit-taking. This means British banks would have to keep offices in EU member states to perform those activities in the bloc.

A compromise will be possible if the Commission accepts to grant equivalence rights to the United Kingdom for a longer period, which is reasonable considering that many EU countries will want to preserve their access to the expertise and resources of companies in the United Kingdom's financial sector. But Brussels will not give up the power to end Britain's access to the European Union's financial sector if London moves away from the bloc's financial rules in a significant way. This is one of the areas where a deal may not be reached by mid-2020, and where temporary arrangements could be made to buy the negotiators more time.

Fishing rights. Countries such as France, Spain, Ireland, Belgium and Denmark want to preserve their access to U.K. fishing waters after Brexit. But the British government has promised British fishermen that this will not happen. From a purely economic point of view, it would make sense for the United Kingdom to break its promise and reach a "fish-for-financial services" deal with the European Union, though such a move could be politically costly for British Prime Minister Boris Johnson.

While fishing represents a very small part of the British economy (less than 0.1 percent), it has a high symbolic meaning in the country and is particularly important for coastal communities in Scotland, where many voters are already unhappy with the British government and want a new independence referendum. There is a precedent for what a compromise could look like: Norway, which is not a member of the European Union, agrees with Brussels on annual quotas for fishing in each other’s maritime areas.

Other Issues on the Table 

Transportation. Another important issue to be discussed in the coming months is the future of transportation by land, sea and air. Under single market rules, EU member states recognize each other's driving licenses. The European Conference of Ministers of Transport, meanwhile, issues haulage permits, while the European Working Time Directive regulates commercial drivers' labor rights (such as their resting time). Similar rules and institutions exist for air and maritime freight. London and Brussels want to preserve as many of these mutual recognition rules as possible. But failure to reach a deal, or the use of transportation as leverage during negotiations to obtain concessions over other, more controversial issues, could create obstacles for an agreement and severely disrupt supply chains in the European Union and the United Kingdom starting in 2021.

Data. The European Union and the United Kingdom will also negotiate how data will move between them. Brussels will push London to comply with EU norms such as the General Data Protection Regulation, which sets high standards for the protection of privacy in the Continent. This is a particularly critical issue for companies in sectors such as health care and insurance, which frequently transfer personal information about their clients as a part of their operations. But while the British government wants to establish a data deal, Brussels' demands for legally binding reassurance could leave room for pause in London.

Most Likely Outcome

A limited trade deal. Considering the depth and complexity of the upcoming negotiations, a single, comprehensive agreement covering every aspect of the economic ties between the European Union and the United Kingdom is unlikely to be signed and ratified in 2020. As the June 30 deadline approaches, sectors of the British economy that fear a no-deal exit on Dec. 31 would severely undermine their operations (such as the financial and automotive industries) will increase pressure on London to ask for an extension of the implementation period.

But even if the United Kingdom does not ask for an extension, it will not necessarily mean the beginning of trade under WTO tariffs in 2021, as a limited deal covering most goods and a reduced number of services is possible by the end of the year. For those sectors that are excluded from the main deal, temporary agreements to buy the negotiators more time are also possible. The final EU-U.K. relationship will thus most likely be defined by dozens of agreements on specific issues rather than a single, comprehensive document.

More Brexit uncertainty. A limited trade deal combined with several temporary agreements would prevent a "hard Brexit" on Jan. 1, 2021. But it would also keep some degree of uncertainty since the bilateral deals could still be scrapped, should the European Union and the United Kingdom start implementing different rules, norms and standards for goods and services. Under a limited deal, this looming prospect would continue to adversely affect the British economy by prompting households and companies to continue delaying some of their investment and spending decisions until there's a clearer picture of what the permanent economic relationship between the European Union and the United Kingdom will look like.

Implications of U.K.-U.S. Trade Talks

The United Kingdom will also hold concurrent trade talks with the United States in the coming months. Trade between the two countries is robust. The United States accounts for roughly 13 percent of the United Kingdom's exports of goods, and 24 percent of its exports of services. Britain is also a large receiver of U.S. foreign direct investment. And Brexit has granted opportunities for expanded U.S.-U.K. trade in areas where tariff and non-tariff barriers were high because of Britain’s EU membership (such as financial services, food, chemicals and vehicles).

But while both countries are interested in reaching a deal, U.K.-U.S. trade negotiations will also face obstacles. The United States will push to include agri-food products in the deal, which involves London accepting products that are currently illegal under EU rules and controversial among British consumers, such as genetically-modified crops and hormone-treated beef. The White House will also pressure the British government to remove, or at least reduce, state aid for companies. In addition, many in the United Kingdom are concerned that a trade deal with Washington would enable U.S. medical and pharmaceutical companies to bid for contracts in its National Health Service, which they fear could lead to higher prices for consumers.

There could also be political obstacles. The United States, for one, is against European countries introducing higher taxes on large digital companies, most of which are American. But the United Kingdom has plans for such a tax. The Trump administration has also called on its EU partners to ban Chinese telecommunications giant Huawei from participating in the development of their 5G networks because of security concerns. London, however, recently authorized Huawei to oversee its 5G rollout, albeit with significant restrictions. The White House could demand London change its position on both of these issues before a trade deal can be implemented. Washington may also ask the United Kingdom for greater alignment with its foreign policy, which could create more problems (Britain, for example, supports the Iran nuclear deal, which the White House now rejects following its withdrawal from the pact in May 2018).

EU Negotiations Take Priority

For the United Kingdom, its trade deals with the United States and the European Union are not mutually exclusive. But the parallel negotiations will force London to make strategic decisions. Closer alignment with the United States would mean opening up some sectors of the British economy that are currently protected by EU rules, such as the automotive industry. But in other cases, closer British alignment with U.S. regulations would lead to greater divergence from EU rules by creating non-tariff barriers to trade between the European Union and the United Kingdom. Agri-food products and financial services are clear examples of this situation, as Washington and Brussels have different standards that create barriers to bilateral trade.

While U.S. trade is important, minimizing immediate economic disruptions caused by Brexit will remain London's top priority in the coming months. Indeed, roughly 45 percent of the United Kingdom's exports go to the European Union, while around 53 percent of its imports come from the bloc. For this reason, an EU trade deal that preserves as much as possible the economic ties London already has with its European neighbors will probably happen faster than a U.S. trade deal.