Brussels prepares for a hard Brexit

Insight
Charles Grant
21 November 2016

Dismayed by the noisy and vocal forces that are pushing Theresa May towards a hard Brexit, the EU institutions expect the UK to face a significant drop in cross-Channel trade and investment. 

For the time being, there is a surprising degree of unity among the 27 governments, the European Commission and the Council of Ministers. All agree that there must be no ‘pre-negotiations’ with the British, until Article 50 is invoked. They also agree that the ‘four freedoms’ are indivisible: if the UK restricts free movement of labour, it cannot expect to enjoy free movement of capital, goods and services.

If anything, the stance of the 27 has hardened in the last two months, for several reasons. First, the tough line on the EU that Theresa May took at the Tory party conference – supplemented by even tougher ministerial pronouncements – was closely observed in national capitals. Second, the aggressive British press reaction to the High Court ruling that triggering Article 50 requires Parliamentary involvement, and the government’s slowness to defend the judiciary’s independence, shocked some governments. And third, when Donald Trump won the US presidency, European leaders expected Britain to react more positively than most; but they still considered Foreign Secretary Boris Johnson’s gushing praise for the president-elect tasteless and over-the-top. 

These events have contributed to an erosion of the good will that EU leaders feel towards the UK. They reckon that UK politics is being driven by emotion rather than reason and that there is not much they can do to prevent a hard Brexit.

Some Britons expect the Germans and Donald Tusk, the president of the European Council, to safeguard their interests in the forthcoming negotiations. That is probably a mistake. The Germans have adopted a harsher position since the summer. They know that a hard Brexit would be somewhat injurious to their economy, but they think the British would suffer much more. And German leaders think that what matters most is keeping the 27 together and protecting the institutional coherence and integrity of the EU. They follow the French in thinking that if Britain was allowed ‘to have its cake and eat it’, by restricting free movement but staying in the single market, Marine Le Pen would benefit. She and other populists could point to the British and say that they were doing fine outside the EU.

As for Tusk and the Council of Ministers secretariat, their line reflects the national capitals and is no softer than that of the Commission (the Commission will conduct the Brexit negotiations on behalf of the EU, but the 27 will keep a close watch, working through their representatives in the Council of Ministers).

Most of the key people in the Brussels institutions have low expectations of what can be achieved in the Brexit negotiations. Indeed, some foresee a serious risk of the Article 50 talks breaking down and of Britain therefore pursuing a very hard, WTO-rules-only, exit. The expectation that May will be pushed around by the Tory party right wing explains some of this pessimism. One specific worry of EU officials is that the UK and its partners may be just too far apart for a transitional deal – covering the period between when Britain leaves the club, and when the future UK-EU free trade agreement (FTA) comes into effect – to be viable. 

The transitional deal will be negotiated at the same time as the Article 50 divorce settlement, on the same legal basis. The officials responsible for the Brexit talks say that a transitional deal could keep the UK in the customs union and parts of the acquis communautaire (the single market rulebook). But they insist that during the transition the UK would have to accept free movement and European Court of Justice (ECJ) rulings. They know that this may be politically unacceptable for May. The officials also insist that the transition be time-limited, to no more than two or three years, to encourage the UK to get a move on with negotiating the final FTA. 

Reports of May’s meetings with other prime ministers are doing nothing to lift the pessimism in Brussels. Officials hear that she is unwilling to engage much on substance, reluctant to go beyond her speaking notes and seemingly concerned not to pursue courses that could upset Tory right-wingers (British officials present at these meetings insist that such reports are untrue).

Two crucial decisions that the British government has yet to make are whether to leave the EU customs union, and what kind of deal to seek for the City of London. 

On the first, Brussels officials are puzzled by May’s comment in October that “the way you deal with the customs union is not a binary choice”. They worry that 10 Downing St may imagine that the UK can stay in the customs union, or parts of it, while striking FTAs with other countries. And the UK’s mysterious deal with Nissan, which gave the firm (so far unknown) incentives to commit to new investments in Sunderland, makes officials wonder if the government is toying with the idea of a customs union just for the car industry.

But of course if Britain stays in the customs union it is not free to make trade deals with other countries that cover goods. And it would be illegal to be in a customs union which covered just one or a few sectors, such as cars: WTO rules state that customs unions (like FTAs) have to cover most trade in goods between two entities. 

Everyone in Brussels expects the City to suffer from Brexit. Officials say it is inconceivable that the UK could keep ‘passporting’, which allows UK-regulated financial institutions to do business across the EU without being regulated by each national authority. That is because passporting goes with single market membership, and nobody thinks the UK can stay in the single market, given its wish to reject free movement and ECJ rulings.

As for ‘equivalence’, a poor man’s substitute for passporting, the Commission has embarked on a process that will tighten the rules. It will become harder for a non-EU country like the UK to claim equivalence, and thus the right for firms based in it to do business in the EU. Commission officials claim, not entirely convincingly, that this tightening is not being driven by a desire to be tough on the Brits. 

The Commission has a point when it says that the rules on equivalence work in different ways in different areas, on different legal bases, and that consolidation and simplification would be desirable. But its proposed new ‘principle of proportionality’ means that the rules will be applied more strictly to countries with financial systems that could destabilise the Union, such as the UK or the US, than to others, such as New Zealand. France is driving this hard line on financial services and nobody is resisting.

Brussels officials note that UK ministers appear unable or unwilling to say very much to reassure the City about its future.

Though these officials currently have minimal contact with their opposite numbers in the UK, they are ready to pass on advice. They urge the British to keep their Article 50 letter very short, and avoid going into specifics. If May produced concrete demands, many of them would quickly be shot down. They add that it will be very hard for the 27 to agree on a unified response to the British letter (in the form of European Council guidelines for the negotiations); the less that letter says, the easier it will be for the 27 to reply. And that will save the British time. Officials think the EU will need at least two months to respond to the British letter. And given that the European Parliament will take time to ratify the Article 50 deal, there will only be about 15 or 16 months for real negotiations.

Several officials advise the British not to focus too much on the final FTA, for the time being. They think the Article 50 divorce settlement and the transitional arrangements will be incredibly difficult to pull off. Their own energies are currently focused on those two deals. However, other officials argue that the transitional deal cannot be fixed until everyone knows what the final FTA is likely to look like: a deeper, more comprehensive FTA would enable a ‘thicker’, more generous transitional deal.

There is a real fear in some capitals that May will try and turn Britain into ‘Singapore in the North Atlantic’, undercutting the EU with lax social, fiscal and environmental policies. Recent reports that Britain would cut corporation to 10 per cent if it did not get a good deal from the EU have only reinforced such concerns. So the 27 will certainly insist, during talks on the transitional deal and the FTA, that if the UK pursues ‘dumping’, for example through radical tax cuts, they will have the right to respond by curbing market access.

Some officials think the arrival of Trump could help the UK to get a good deal on foreign, defence and security policy; the 27 will understand that they need the considerable contribution that the British can offer in these areas. But others say that structured EU-UK links on foreign, defence and security policy will probably have to wait for a few years; the acrimony of the divorce will make them difficult to establish. 

In any case, there will be several obstacles to UK involvement in Justice and Home Affairs co-operation, as Camino Mortera-Martinez points out in the CER December-January bulletin: Britain would have to accept a role for the ECJ; joining the European Arrest Warrant is a legal impossibility for a country outside the EU; and UK data protection rules would have to be equivalent to those of the EU (as the ‘safe harbour’ affair has shown, the EU can be difficult to deal with on this issue; it has forced the US to change its data protection laws). 

Might all these Brussels officials be too gloomy? Could Brexit end up being softer than they imagine? It is still possible that May’s government could decide to remain in the customs union, avoid stringent restrictions on free movement, contribute to the EU budget and accept a role – at least during a transitional period – for the ECJ. But she would have to be prepared to take on and upset hard-line Brexiteers. 

She would be more likely to do so if businesses said more loudly what they are already saying in private, on the postponement of investments and the transfer of jobs out of the UK; if the Treasury was prepared to face down some of the other ministries; if the economy followed the pound downwards; and if the forces in Parliament favouring a soft Brexit – which amount to a majority of MPs – concerted their efforts to shape the government’s Brexit strategy.

Charles Grant is director of the Centre for European Reform.