The superficially conciliatory tone of Theresa May‘s Art. 50 letter was supposed to mollify her 27 EU partners. By stressing how important it was for her that the EU should flourish in the future, she aimed at getting her cake and eating it, too, i.e. to leave the EU but obtain access for specific sectors. President Tusk‘s answer in his draft proposal to his 27 colleagues gave the appropriate answer: first exit, then negotiations on future relations. And, as a sweetener, the offer of a transition period after exit in which to clarify the details of the future relationship. We will see what the EU-27 will make of this draft in their end-of-April meeting.
The UK position has been laid out at leaving the internal market and the customs union and regaining „sovereignty“ by shedding the jurisdiction of the European Court of Justice. Politics (sovereignty) is supposed to trump economics, i.e. at this point the UK is prepared to pay a heavy economic toll as a price for „taking back control“.
Without going into the details of the various forecasts about the effects of Brexit on the UK economy (the GDP forecasts range between -6% and +4% for the medium run), a number of economic facts should be borne in mind during the negotiations.
1. Since the referendum (June 23, 2016) the exchange rate of the pound has fallen by around 15% , to the delight of exporters. While during the past few weeks the exchange rate has been stable, its medium term effects are that the depreciation will increase import prices and inflation, thus eroding the purchasing power of UK citizens and making the high import content of UK manufacturers more expensive.
2. We know that 46% of UK exports go to the EU: if we add those countries with which the EU has free trade agreements, 63% of UK exports now can be traded tafiff-free. Leaving the customs union will incur tariffs on the average of 4.4%, ranging from more than 30% for agricultural products (dairy products 52%!), to 10% for cars, 5% for car components, 4% for chemicals, unless a new free trade agreement is concluded. To make this bulk of goods exports up through deals with other countries, will take a lot of time and optimism, let alone the vast task of concluding more than 60 agreements to replace those of the EU, plus others. There are no more British trade negotiators left after the EU Commission has been doing all the work for the last 40 years.
In addition, we know that British manufacturers are integrated into European supply chains: 40% of British exports are relevant imports. These will become more expensive, endangering the competitiveness of British exporters. (May‘s agreement with Nissan that after Brexit they could trade with the continent as before, duplicated with a number of other firms, will be hard to implement and be very expensive!).
3. Control of EU-migration was arguably the key rallying cry for the Brexiters. In 2015 UK net immigration stood at 330.000 (as interior minister May had supported then PM Cameron‘s promise to get net immigration down into the ten thousands), 180.000 came from the EU. This number has fallen in 2016. However, a number of sectors has complained to Ms. May that they rely nearly exclusively on (East) European labor: agriculture, restaurants and hotels, construction, and also banking). The mood in parts of the UK has soured as a number of physical attacks on non-English speakers recently have shown. For the EU, access to the internal market requires free movement of labor: difficult negotiations ahead!
4. The charge of EU over-regulation was also important in the Brexit campaign. However, according to OECD, after the Netherlands, the UK is the country with the second-lowest intensity of regulation in the OECD. Remember Ms. Thatcher‘s deregulation harvest which seeped into parts of the European Union? On the continent, nobody has heard of „zero hour contracts“, where „employees“ are not guaranteed work but need to remain available. Bank Santander recently ran employment ads „You will be guaranteed and paid for at least one hour per month, i.e. 12 hours per year“. Over-regulation?
The Confederation of British Industries has calculated that the UK will need to create 34 new regulatory agencies, in order to replace EU institutions (e.g. regulating air traffic, nuclear oversight, pharmaceuticals, and many more).
Leaving the EU, UK airlines will lose landing rights in Europe and abroad, and will have to negotiate for that; leaving EURATOM, the UK will not be able to source fuel for its reactors or transport nuclear waste anywhere. Many more examples exist.
What is frequently overlooked is that British exports to the EU will need to fulfill technical and safety standards of the EU, as well as competition rules, rules on state aid and tax compliance, with or without a new deal. The European Court of Justice will still supervise compliance, thus full „sovereignty“ will only be gained by not trading with the EU.
5. May promised that in the future no more money will be transferred to the EU. But she knows full well that the UK will have to fulfill its commitments towards the EU budget until the rest of the ongoing financing period (2020). At present, the UK pays around 14 bill € into the EU coffers, and receives around 5 bill €, mainly into the agricultural sector and the regions (0.5% of Wales‘ regional product is financed by the EU). Many other obligations for joint projects remain.
As a first approximation, the EC has calculated an exit bill of 60 bill € in order to settle all these obligations: clearly this is a number to be negotiated. Still, in the medium run, there is about 8.5 bill € (net contribution) which the UK government will „save“. However, if they make up domestically the around 5 bill € they had in reflows, the UK might step up its „industrial“ policy, its „Northern powerhouse“, its nuclear industry and other commitments.
For Austrians: with Brexit, Austria will also lose its EU budget rebate of around 100 mill € annually, something to be reckoned with in the beginning negotiations of the next medium-term financing framework, effective from 2021 which will have to solve the question whether, who, and how this 8.5 bill shortfall will be made up. Negotiations should give rise to a renewed evaluation of the EU budget, both on the expenditures side, but also on the revenue side. Brexit should be used as an unwelcome occasion to restructure the EU budget from scrap.
6. The strongest card in Ms. May‘s hand is the UK financial sector: it makes up 12% of UK‘s GDP and has an export surplus of around 750 mill GBP. Much of the EU‘s financial transactions are conducted via London, because there are institutions and competence unmatched anywhere on the continent.
However, UK financial institutions will lose their „passporting rights“ with leaving the internal market, which allowed them to trade freely in all of the EU. British financial institutions have already started to move some personnel and some functions on the continent, where an intensive acquisition competition has begun in France, Germany, Belgium and also Ireland, to house these leavers. However, the European Banking Authority has made clear that token relocations will not be acceptable, that only fully capitalized banks with a full range of products and personnel will be allowed to do business in the EU.
To me it seems highly unlikely that the European Central Bank, as guarantor of financial market stability in the EU will accept UK-located banks regulated by the Bank of England to conduct sensitive business for the EU. While in principle „regulatory equivalence“, i.e. regulatory structures assessed as equivalent to those in the EU, can be agreed with third countries, it is doubtful whether the ECD, and the EU negotiators will accept this for „third country UK“, because in cases of conflicts of interest between financial market stability in the UK or in the EU, the Bank of England cannot be relied upon to promote „European“ stability at the expense of UK stability. This poses another very tricky point of negotiation.
A whole range of other economic issues remain. Also, the sheer volume of negotiations necessary to disentangle 40-year old grown structures, both on the UK and the EU side, is staggering. There is the danger that preoccupation with Brexit negotiations will crowd out other important issues, both on the UK and the EU side. And my point is: it is very hard to believe that all that immense effort will make the material situation of EU citizens any better than under an EU regime.
To sum up: also economists must realize that in these dangerous times symbolic, emotional „arguments“ can be whipped up and will trump and dominate material ones. I was so wrong in my assessment before the referendum that the UK citizens, denounced in German as a „Krämernation“ (a nation of shopkeepers), would vote for the pocket book, Instead, 52% of those voting (around 37% of the electorate) voted for „sovereignty“. Frightening! Even more frightening, that the interests and rights of the „other 63%“ are utterly ignored. The mindset of those countries where „inner-takes-all“ voting reigns, also seems to allow the meagre margin of 600.000 votes, to trample the vote of 2/3 of the electorate, in order to impose the will of the „majority“.