Europe's offer to a post-Brexit Britain

22 June 2016

If Britain votes to leave, it will face three options for exiting the EU. It will also have to embark on two sets of negotiations.

One of the most remarkable things about this referendum campaign has been the dearth of discussion on the various alternatives to EU membership. In Brussels and other EU capitals, decision-makers are drawing up contingency plans for a British vote to leave. Views are emerging on the options to present to the UK, and on the process it would have to follow.

If Leave wins, Britain’s partners are likely to offer just three options: the Norwegian model of the European Economic Area (EEA); the Canadian model of a free trade agreement (FTA); and the rules of the World Trade Organisation (WTO). The EU doesn’t want to give the UK bilateral treaties, like Switzerland has, since it regards the ‘Swiss model’ as broken (the Swiss voted against free movement for EU workers in a referendum in 2014, and may therefore lose access to the single market). Nor will it offer the ‘Turkish model’, whereby Britain would stay in the customs union and have to adopt the EU’s external tariffs (EU leaders assume the UK would not want this model, which would deprive the British of the freedom to negotiate their own trade deals).

Most economists think the Norwegian model would be the least damaging of the three on offer. It would keep Britain out of EU fish and farm policies, and its customs union, but in the single market. The UK would have to follow single market laws (including labour market rules) without having a vote on them, make substantial payments into the EU budget and accept free movement of labour. The mainly pro-EU House of Commons would probably prefer the EEA, as would the City – since ‘passporting’, which allows banks regulated in London to do business across the EU, would continue.

Owen Paterson MP is one leading Brexiteer who likes the EEA. Daniel Hannan MEP is another, though he sees it as an interim arrangement, to minimise disruption while an FTA is negotiated. However, the obligation to accept free movement would make it hard for any post-referendum British government to follow the example of Norway.

The Canada model is probably the most likely option. The EU’s deal with Canada – which took seven years to negotiate but is not yet ratified – is its most ambitious FTA. It will remove many but not all tariffs on industrial and farm goods. But it will give limited access to the single market, as many non-tariff barriers will remain. For example, Canadian car and chemical makers will need regulatory approval from EU authorities before exporting to Europe; Canadian firms will have limited access to European public procurement; and since the deal excludes most financial services, Canada’s banks will need a subsidiary in the EU in order to do business there.

Boris Johnson, the most prominent Brexiteer, has praised the Canada option. He and other fans of an FTA argue that Britain is so important that it could get a better deal than Canada, particularly on services. That is conceivable. However, the UK’s partners are adamant that the price for full access to the single market would be payments into the EU budget and free movement of labour.

The third option appeals to those who don’t want the hassle of a long trade negotiation with the EU: the UK would become a full member of the WTO. However, this would not be entirely hassle-free: the UK would have to propose tariff levels for every item covered by WTO rules, and persuade each of the organisation’s 162 members to accept those tariffs. The UK would then trade with the EU on the same basis as countries like Russia and China. WTO rules set upper limits on industrial tariffs. British car exports would face the EU’s common external tariff of ten per cent. EU tariffs would disrupt the supply chains that currently entwine the British and continental economies. The WTO has done very little to lift non-tariff barriers to trade in goods, or any barriers to trade in services.

Libertarian Brexiteer economists like Patrick Minford like the WTO model. It would permit the UK to scrap more EU rules than the other options. It would also enable Britain to cut its own tariffs on farming and industrial products to zero, as he has suggested, even if other countries did not reciprocate. Minford has admitted that this would remove a large part of Britain’s manufacturing industry. Such a radical step is unlikely to be politically feasible.

The Vote Leave campaign claims that the UK could exit either by article 50 of the Treaty on European Union, which sets out an exit procedure, or by article 48, which covers a revision of the EU treaties. However, Britain’s partners will negotiate only on the basis of article 50. As my colleague Agata Gostyńska-Jakubowska has written, this process is complex and not favourable to the departing country.

Article 50 allows two years for a departing country to negotiate separation. This period can be extended, if all member-states agree. The predominant view in EU capitals is that there should be no extension and that the UK should leave after two years. The presidents of the Commission and the European Council want this ‘divorce settlement’ to be kept apart from an agreement on future trading relations.

The divorce settlement would divide up pension liabilities, properties and other assets, and deal with budgetary questions. It would also cover the rights of EU nationals based in the UK and vice versa. Two years should suffice: article 50 stipulates that the Council of Ministers must pass the deal by majority vote, which means that an awkward government cannot block it (though the European Parliament and the UK Parliament would have to vote in favour).

As for the trade negotiations, the EEA option would be fairly simple, since the rules and institutions already exist (though the UK would have to apply to join EFTA, the European Free Trade Agreement, which is an essential component of the EEA). The FTA option, however, would require complex and detailed talks that could easily last for five years or longer. Each of the 27 member-states would have a veto and some might hold referendums (as the Dutch did recently, when they voted down an FTA with Ukraine).

The UK would want to work on the FTA and the divorce settlement at the same time, for greater speed. But the Brussels institutions – and some governments – want the two sets of talks to be consecutive. Otherwise, officials say, the UK might seek trade-offs between them, complicating the process; and if it wrestled over the trade deal while still an EU member, it would have more leverage than after it had left. But Britain’s best friends in the EU, like Ireland and the Netherlands, may be expected to support the British in their request for simultaneity.

If the two negotiations are consecutive, the cloud of uncertainty hanging over the British economy will be prolonged. And even if they are simultaneous, several years may elapse between the UK leaving the EU and the FTA coming into effect. What rights would British companies enjoy in the interim? If goodwill prevailed on all sides, firms might be granted single market access on a temporary basis, so long as free movement continued.

But goodwill can easily evaporate. Chris Grayling MP, a leading Brexiteer, recently said that soon after the referendum, Parliament should legislate to reject rulings by the European Court of Justice (ECJ), restrict free movement and change the rules on VAT. If a post-referendum government follows his advice and defies the treaties while Britain is still a member, British companies could find themselves excluded from the single market before the UK had left the EU.

In addition to the divorce settlement and the trade talks, a third set of agreements will probably be necessary, covering co-operation on security. Britain will want to find a way of plugging into EU databases that are used against criminals and terrorists, as well as Europol and the European arrest warrant. Britain’s partners would have an interest in allowing it to participate in these institutions, but not in allowing it a say on their rules.

In all these exit negotiations, the other EU governments are likely to apply two clear principles. First, the more the British are willing to accept convergence of their rules with EU rules, and the more they are willing to accept the authority of EU institutions – from standard-setting bodies to the ECJ – the quicker the talks will progress. And second, the other EU governments will not want the exit process to appear too easy, simple or pain-free, lest other countries – whether currently inside or outside the EU – think the ‘British model’ attractive.

Charles Grant is director of the Centre for European Reform. An earlier and shorter version of this article appeared in the Times Red Box on June 20th.