Immediate Problems Facing Brexit

Right now, Brexit seems to be tied in all manner of delays and legal knots.  With an urgent need in the economy to settle trade arrangements as quickly as possible, these have made things look even less certain than in the first shock after the votes were tallied.  Britain’s economic prospects consequently look even worse than they had.  But this situation, though troublesome, impinges only on the immediate future.  Over the longer-term, Brexit also offers Britain opportunities denied it as a member of the European Union (EU).  This week’s post takes up the current challenges.  The one following will take up these longer-term opportunities.

Relatively recent news has added two issues to an already long list that obscure needed economic clarity.  In one, Britain’s high court has concluded that the referendum was insufficient to settle the matter.  Parliament must debate the issues and vote before any negotiations can begin.  No doubt the judges are right.  Britain’s constitution identifies parliament as the only body that can undo what parliament did.  But the court’s decision will delays matters and raise unsettling questions even where there is little doubt about the direction of the ultimate vote.  Meanwhile, the European side has recently brought up the question of some €25 billion that Britain owes the union.  It seems that the EU over the years has shifted some €200 billion in loans to members for various reasons, what the EU refers to as the “reste a liquider.”  EU sources claim that the €25 billion is Britain’s share and the country must discharge this liability until anything else can settle.

These matters, complex as they are, seem like a minor glitch compared with the timing and nature of Britain’s departure and subsequent trade negotiations.  Britain’s new foreign minister, Boris Johnson, and UK International Trade Secretary Liam Fox, recognizing Britain’s economic need for an expeditious settlement, have expressed a desire to combine negotiations on Britain’s exit from the union, under Article 50 of the Lisbon Treaty, with subsequent trade arrangements.  On the EU’s side, however, Danuta Hubner, chair of the European Parliament’s constitutional affairs committee has resisted such an approach.  She insists that Britain will first have to negotiate withdrawal, a process that could take two years or more, before it begin negotiations on future agreements.  Adding to the complications, other EU officials with influence on the negotiations have remained coy on the matter.

Ambiguities also surround coming negotiations with trading nations outside the union.  The EU has established 33 preferred trade agreements with 62 countries, covering some 13 percent of British exports.  While Britain was an EU member, it was included and so enjoyed tariffs from 7.4 percent before the treaties were signed to some 2.4 percent presently.  Now these arrangements are in doubt.  Adding still another complication, the EU seems to have negotiated two very different sorts of treaties.  Some it signed alone for all its members in what the legal jargon refers to as treaties established with its “exclusive competence.”  But some treaties were established under what the lawyers refer to as “mixed competence.”  In these, both the EU and each member state signed.  Legal opinion is confident that Britain will need to re-negotiate the first sort of treaty.  It could, however, claim the “mixed competence” arrangements for itself, even after separation, except that the lack of precedent makes a final settlement on even these treaties ambiguous.

If all this was not unsettling enough, it has become increasingly clear that Britain, can use neither the Norwegian nor the Swiss model to guide its new relationship with the EU.  These two nations stand apart from the EU but nonetheless have negotiated special trading rights.  Many had hoped that Britain could establish similar relationships.  That now seems unlikely.  Both these countries have secured their trading position by bowing to EU strictures and rules.  Norway, for instance, pays dues to the EU up to 87 percent of full membership.  Both Norway and Switzerland have agreed to open their borders to open migration from EU residents.  For Britain to follow a similar path, it would have to go against the wishes of its voters.

Perhaps of even greater concern is the now uncertain future of Britain’s critical financial services sector.  At more than 10 percent of the economy, it is more important to Britain than it is to any other major economy.  It is where Britain’s greatest comparative advantage lies, relative to Europe and the world generally.  The country’s prosperity is intrinsically tied to it.  While Britain remained an EU member, “passporting” allowed its consultants and financial institutions — banks, investment houses, insurance firms, investment advisors, and business services providers — the ability to leverage this advantage across the entire EU.  Firms could set up branches, representative offices, or reach out from London to potential clients in any member country and offer their services without the need to acquire the licenses and pass the regulatory tests required of firms from outside the EU.  Because the city of London, as the British call this sector, had well-established connections and expertise relatively rare on the continent, British firms have dominated this large and lucrative business to the great benefit of the British economy.  Many City firms, fearing the loss of this business, are unwilling to wait through what now seems like an endless series of delays.  They are already making plans to move parts of their business out of London onto the continent to the immediate detriment of British employment, income, and growth prospects.

There can be little doubt that all this uncertainty will weigh against British growth for the foreseeable future.  But as in any divorce, the ultimate effect of Brexit will depend on how the principals involved live the rest of their lives.  Over this longer view the separation may offer Britain opportunities that EU membership would have blocked.  Next week’s blog will investigate this more optimistic take.

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