1. Brexit : Here’s how difficult the disengagement will be

Brexit : Here’s how difficult the disengagement will be

Extricating the UK from its 43-year association with the EU will prove difficult from a trade point of view

By: | Published: October 10, 2016 6:18 AM

When the UK voters cast their ballots for or against remaining in the EU, the choice seemed simple. Remaining in the EU was the status quo and the then prime minister, his chancellor of the exchequer and many others had warned that exit would be costly in terms of economics. Leaving the EU would mean losing access to the large single market. But the voters were more concerned with the issue of open borders with EU which meant UK had no control over migration. Whatever the economic effects of migration (largely positive), perceptions were against any uncontrolled migration.

The positive argument for exit was that withdrawing from a customs Union, which the EU is, would free the UK to engage in free-trade agreements with all the countries of the world although it will lose the favourable access to the single market.

Thus, the argument, drastically simplified, was this: Access to the EU single market carried the bad effects of uncontrolled migration. Leaving would get rid of the migration problem and there could be unlimited benefits of universal free trade.

The decision to leave—Brexit—was a shock. David Cameron resigned as prime minister and was quickly replaced without having a new election. The new prime minister, Theresa May, has declared that Brexit is Brexit. This means there will be no second referendum or reconsideration. The UK government will pursue Brexit so as to make it most beneficial to the country. It is simple to say that, but the mechanics of Brexit are forbiddingly complex.

The UK joined the European economic area (EEA)/the European common market in 1973. It was a successful customs Union at that time. The UK believed that joining the common market would enhance growth and modernise the nation. The UK had an instrumental approach to the common market. For the other members, being a single market was just a step along the way to an ‘ever closer Union’. The EEA first became the European Community, and then the European Union. It established a single market with free movements of capital, goods, services and labour. All EU countries, except the UK, abolished border controls over their citizens’ movements. A single currency, the Euro, was established. More members were recruited when the enlargement took place after the collapse of the USSR.

The result is that the EU is much more than a single market. It has a common regulatory regime for manufacturing and services as well as for human rights. The UK itself has incorporated nearly 7,000 laws and regulations passed by the European Commission into its own law. Manufacturing has a multinational supply-chain nowadays. These chains traverse multiple EU countries, but obey a unified regulatory system. For financial services, banks of one country have to get passporting facilities to each EU country where they want to operate.

Thus, the UK now finds that Brexit is not simple or straightforward. The UK has to invoke Article 50 of the Lisbon Treaty, the Constitution of the EU, to initiate the negotiations to leave the EU. The other parties are the European Commission, the European Parliament and the 27 members of the EAU who form the European Council. The time limit for the negotiations is two years.

The catch is that until the UK exits the EU, it cannot start free trade talks with any country. The UK is not itself a member of the WTO but EU is. So, the UK has to join the WTO after exiting. Thus, after two years of negotiations, the reconstruction of trade arrangements has to commence. That may take anything up to five to seven years.

But the issue of the financial services is vital for the UK, especially the City of London. It is not clear what the negotiations will yield. The idea that the

UK will get all the benefits of free access to the single market while rejecting free movement of labour has proved too optimistic. Rival European financial centres—Frankfurt, Paris, Vienna, etc—will want to play tough so they can take business away from London.
The punchline is that extricating the UK from a forty-three year association with a dense and intricately designed trading system is not going to be easy. Even estimating the total time till the new equilibrium is established is difficult. It may be anything between 5-15 years.
Of course, along the way, the EU could change as well. There are elections in France and Germany next year and a constitutional referendum in autarky this December. These events could change the dramatis personae negotiating with the British. The cohesion of the EU could also be under strain if the economic costs of the Euro become unbearable for the members if the Eurozone. Thus, the negotiation itself can be dynamically unstable itself, and not just due to the complexity of the issues. We shall all watch the process closely and learn from the outcome of a multi-player, multi-dimensional game.

Meghnad Desai

The author is a prominent economist and Labour peer

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