Britain and the European UnionThe six flavours of Brexit

JUST over a year has passed since Britain voted to leave the European Union and Theresa May subsequently became prime minister. Nearly four months have elapsed since Mrs May invoked Article 50 of the EU treaty, setting a two-year deadline for Brexit that will expire on March 30th 2019. The clock is ticking. And at first blush there has been much activity: a big speech by Mrs May at Lancaster House in January; several government white papers; bills introduced in Parliament; and the start of formal Brexit negotiations in Brussels.

Yet for all this activity, almost no progress has been made towards deciding the form that Brexit should take. That is largely because the government is ambiguous over what it wants. Even issues that seemed settled in the Lancaster House speech have resurfaced since Mrs May lost her slim parliamentary majority in a snap election she called for June 8th.

This is the political backdrop to the Brexit talks in Brussels. The second round started this week between negotiating teams led for the EU by Michel Barnier, the European Commission’s point man, and for Britain by David Davis, the Brexit secretary. Mr Barnier, who has a mandate approved by European governments, is focusing on the terms of the Article 50 divorce: specifically, the rights of EU citizens in Britain and vice versa, how to avoid a border between Northern Ireland and the Irish republic, and Britain’s exit bill.

Only when he can report “sufficient progress” on these will he be allowed to start discussing the long-term trade relationship between Britain and the EU. And making progress will not be easy. An initial British offer to give EU citizens broadly the same rights as Britons was met with complaints that it was insufficiently generous. The Irish border question, which has been elevated to top-level diplomatic talks, has no obvious answer. And although Britain has conceded that it faces an exit bill, its size is highly contentious. This week’s round of talks concluded with little progress on any of the three main topics.

It is the long-term relationship that matters most. Because Mrs May and Mr Davis insist that the only interpretation of the referendum is that Britons voted to take back control of borders, laws and money, they are pursuing what is known as a hard Brexit: Britain must leave both the EU’s single market and its customs union, end free movement of people from the EU and escape from the oversight of the EU’s supreme court, the European Court of Justice (ECJ). Instead it will forge a “deep and special partnership” with the EU, including a comprehensive free-trade deal.

Yet Mrs May’s election setback has raised questions over whether her hard Brexit should be softened. Although Labour’s leader, Jeremy Corbyn, backs ending free movement, his manifesto also talked of keeping all the benefits of the single market. A week ago he refused to rule out staying in the single market after all. Meanwhile some ministers think the customs union should be rethought. The latest row is over Euratom, Europe’s atomic-energy treaty, which Britain will leave on exiting the EU, but which some Tory MPs think it should rejoin as an associate.

Mrs May’s lack of a majority in either house means that the role of Parliament, which had been sidelined, will be crucial. The government has just published its EU withdrawal bill and is promising at least seven other Brexit bills, ranging from immigration and agriculture to trade and customs. Getting all these through unamended will be extremely difficult. Opposition MPs talk of fighting the government all the way, with the help of perhaps a dozen Tory rebels, rather as happened to John Major when he was trying to ratify the Maastricht treaty in the 1990s. There is no clear parliamentary majority for a hard Brexit, so delivering one will be very challenging, to say the least.

The cake problem

Why is there so much confusion? One answer is simply that extracting Britain from a 44-year marriage is horrendously complex. But the deeper point is that voters were never told the truth about the trade-offs inherent in Mrs May’s version of Brexit. Brexiteers promised that, in the words of Boris Johnson, now the foreign secretary, Britain could have its cake and eat it. It would be possible, they claimed, to escape EU regulation and the ECJ, leave the single market, walk away from the customs union and save £350m ($450m) a week in budget contributions—while still retaining the benefits of being an integral part of the world’s biggest trade block.

This misleading claim explains why the other 27 EU countries were apprehensive about the government’s approach to Brexit. Although they preferred Mrs May, who campaigned on the Remain side, to other Tories, they also knew that her main experience of the EU came in 2013, when as home secretary she negotiated Britain’s opt-out from a raft of justice and home affairs measures and then chose which ones to opt back into. That cherry-picking approach was quite specific to that particular dossier; it cannot be done by a country turning its back on the club altogether. The EU 27 are determined to stop any attempt at repeating it with Brexit.

Talk by various ministers in London of no deal being better than a bad deal also went down badly in Brussels. A Brexit without a deal would certainly be bad for the EU. But it would be much worse for Britain: goods would back up with no customs agreement, air travel would stop without an aviation deal, tariffs and non-tariff barriers would appear overnight. The EU also frets over Mrs May’s belief that her predecessor, David Cameron, failed to win enough concessions in his EU negotiations because of his unwillingness to walk away. In Brussels, the bargaining power is seen as being on the EU’s side, not least because of Article 50’s two-year deadline.

Menu by menu

This is reflected in the EU’s approach to Brexit, which is to insist that future relations must follow one of a number of fixed-price menus. Each menu has advantages and disadvantages; each has a few side dishes that can be added at the margin. But what is not permitted is to go à la carte. Mr Barnier underlined this recently when he declared that it was not possible to leave the single market but retain all its benefits, nor to quit the customs union but keep frictionless trade.

The first menu is full membership, which the Brexit referendum rejected. Second is membership of the European Economic Area (EEA), which links Norway, Iceland and Liechtenstein to the EU. EEA members are fully integrated into the EU’s single market for most goods and services, but not for agriculture and fisheries. They are not in a customs union with the EU, which allows them to strike free-trade deals with third countries, although this means their exports are also subject to rules-of-origin inspection. But single-market rules require them to accept the EU���s four freedoms of movement of goods, services, capital and, crucially, people. They also have to observe laws which they have no say in making and which (at least implicitly) are enforced by European judges. And they make contributions to the EU budget almost as large as Britain’s, on a per-person basis.

The third menu is a Swiss one. Along with Norway, Iceland and Liechtenstein, Switzerland is a member of the European Free Trade Association (EFTA), but it is not in the EEA. It has two sets of complex bilateral deals with the EU that give it privileged access to the single market for goods, though not for agriculture. But it is outside the market for most services (including financial services). It is also outside the customs union. It too has to observe the free movement of people, and to accept most single-market laws. And it makes a big contribution to the EU budget.

Mrs May’s insistence on taking back control of borders, laws and money means that she has ruled out both these menus. Yet some frills could be attached to make either more appealing. EEA countries have an “emergency brake” to block the free movement of people, though it has never been used. Liechtenstein is allowed to set quotas for EU migrants. The Swiss are not, but they may be allowed to ensure that most jobs are offered first to Swiss citizens. As for budget payments, they are smaller than for full members and are mostly dressed up as research funds or aid to eastern Europe. But Britain would struggle to get a deal like that of Switzerland. The EU dislikes the complexity of the arrangement and would be unlikely to replicate it for the far bigger British economy.

The fourth menu might be called Turkish. Like San Marino and Andorra, Turkey is not in the EEA, EFTA or the single market, but it has formed a customs union with the EU for non-agricultural goods trade. This forces Turkey to apply common external tariffs fixed by the EU, but that brings the advantage that there are no barriers or rules-of-origin checks on exports to the EU. If Britain were to form a customs union with the EU, it could try to add some services as well (Turkey and the EU are negotiating an upgrade of their own customs union to do just that). The advantage of being in a customs union but not the single market is that it dispenses with the EU’s four freedoms, budget contributions and the ECJ. It would also prevent the return of customs controls at the Irish border.

The main disadvantage of the customs-union option is that it precludes free-trade deals for goods with third countries. In effect, it would do Liam Fox, the international-trade secretary, out of a job. Yet some argue that barrier-free trade in goods with the EU is worth more than any number of hypothetical future free-trade deals with third countries being touted by Dr Fox. To quote the words of one MP, “We export more to Ireland than we do to China, almost twice as much to Belgium as we do to India and nearly three times as much to Sweden as we do to Brazil. It is not realistic to think we could just replace European trade with these new markets.” This was Mrs May, speaking in April 2016.

Fifth is the menu that the prime minister herself favours: a deep and comprehensive free-trade deal. Examples include the association agreement with Ukraine and two simpler trade deals with Canada and Japan, the latter not yet concluded. This would preserve tariff-free access for most goods and could even cover some services (though not usually financial services). It would mean no free movement, no automatic adoption of EU regulations and probably no ECJ, though some dispute-resolution mechanism would be needed. The disadvantage is that free trade is not the same as frictionless trade. There would be customs controls and rules-of-origin checks, many services would not be covered and there would be non-tariff barriers thanks to differential regulation.

The final menu, which would also be likely in the end to follow from no deal, is to revert to trading with the EU under World Trade Organisation rules. This is not totally straightforward, because although Britain is a WTO member its tariff and import schedule is set via the EU, and having a schedule of its own would require dividing up the EU’s import quotas for things like New Zealand butter. Trading on WTO terms implies small tariffs on goods such as cars and pharmaceuticals and larger ones on farm products. It does not cover services. Non-tariff barriers would remain. And there is the WTO’s most-favoured-nation principle, which allows discriminatory trade practices only in an approved free-trade area. This means that, if Britain and the EU agreed to avoid mutual 10% tariffs on cars, they would have to offer the same deal to other countries.

It will cost you

The Brexit menus share two characteristics. One is that, except for the EEA option, they would take time, perhaps several years, to negotiate.

The second is that all would impose losses on the economy. Brexiteers rejected the Treasury’s projections for the cost of Brexit last year as “project fear”. But the Centre for Economic Performance at the London School of Economics has remodelled the trade consequences. It concludes that the hardest form of Brexit, a reversion to WTO terms, would cut trade by 40% over ten years and reduce annual income per person by 2.6%. A softer version like the Norwegian model would cut trade by 20-25% and reduce annual incomes by 1.3%. And these are just static effects. There would also be dynamic negative effects from lower investment and slower productivity growth.

Britons are unprepared for such a hit to their incomes. And the more distant Britain’s relationship with the EU, the bigger the income loss. This is a crucial trade-off that Mrs May’s government has been reluctant to acknowledge. Britons face a choice: to minimise losses from Brexit, they must cede some sovereignty to the EU, while to maximise freedom from Brussels, they must accept a larger drop in incomes.

What makes this choice harder is the state of the economy. Immediately after the referendum Brexiteers crowed that the doomsters were wrong: the economy had not suffered and confidence remained high. Yet in the first quarter of 2017 Britain fell from being one of the fastest-growing economies in the EU to the slowest-growing, partly because of uncertainties over Brexit. Higher inflation, caused in part by a fall in the pound, is eating into real incomes. It is no wonder that Philip Hammond, the chancellor, is demanding that the economy should be given higher priority in the Brexit negotiations. Labour is also arguing for a “jobs first” Brexit.

Nor is trade with the EU the only problem. Before even getting into new trade deals, Dr Fox must find a way to replicate the 35 free-trade agreements that Britain currently has via the EU with 53 countries. The raw arithmetic is that some 44% of British exports go to the EU, 16% to countries with which the EU already has a free-trade deal and about 20% to America. Donald Trump may have promised an early deal with Britain, but experience shows it will be neither easy nor quick—and Mr Trump may then be long gone.

Third countries need to know the terms of Britain’s trade with the EU before making bilateral deals. Monique Ebell of the National Institute of Economic and Social Research, a think-tank, calculates that downgrading from single-market membership to a free-trade deal with the EU would reduce British trade by about a fifth, whereas free-trade deals with the four BRIC countries plus America, Canada, Australia, New Zealand, Indonesia and South Africa combined would boost it by just 5%.

Next is the question of EU regulators, of which Euratom is but one. Some 35 EU regulatory bodies govern such things as medicines, aviation safety, environmental rules, financial services and phytosanitary standards. All come under the ECJ, so if that remains a red line for Mrs May Britain must set up a new set of regulators of its own. These would largely have to replicate the EU’s rules to maintain regulatory equivalence. Most companies prefer to stick with the system they know, and many fear that setting up British regulators would not only take time and money but also force them to obey two lots of rules, not one.

There is much else to do. Sorting out what powers repatriated from Brussels should go to the devolved administrations will be testing; the Scots say they might hold up the EU withdrawal bill, and Labour supports them. Hundreds of treaties on matters ranging from air transport to data sharing must be renegotiated with third countries. Ways must be found to co-operate in scientific research, foreign policy, defence, security, counter-terrorism and intelligence. All of these raise yet again the issue of the ECJ, which has jurisdiction over data-sharing and various justice and home-affairs measures, including the European arrest warrant.

Sic transit gloria

One conclusion is that all this cannot possibly be dealt with by March 2019. To give the European Parliament time to ratify the Article 50 divorce, its terms must be agreed by around October 2018. Businesses that have to plan ahead, such as airlines, need certainty long before that. Without a deal allowing them to fly after Brexit, airlines might have to stop selling advance tickets. Banks and others want to know the rules they will face by next spring. And that points to something else, which has long been assumed in Brussels and is slowly being accepted in London: that there must be a transition period after March 30th 2019.

Yet it will not be simple to arrange one, because negotiators will want to know the ultimate destination, at least in principle, before agreeing the terms for a transition. Business lobbies and, quietly, the Treasury, are pushing to stay in both the single market and the customs union during transition, to minimise disruption. The simplest idea would be to prolong the status quo for three or four years, but that would not satisfy those who are keen to get on with leaving. An alternative might be temporary EEA membership, but Brexiteers might fear that the temporary arrangement would become permanent.

Transition will be key to making Brexit less disruptive. But on its own it will not resolve the dilemmas facing the government. For that, more honesty, less inclination to tar any critics as seeking to subvert democracy and greater readiness to acknowledge Brexit’s trade-offs are required. One other thing is certain: those who said the only way to take the EU off Britain’s political agenda was to have a referendum have been proved utterly wrong.