The Brexit Endgame

The Northern Ireland problem together with the EU’s negotiating leverage mean that the outcome must be a customs union. A column by Barry Eichengreen.

Barry Eichengreen
«We have the peculiar sight of the Confederation of British Industry effectively endorsing the proposals of a hardline Marxist like Corbyn while criticizing Conservative leader May.»

The only thing about Brexit that is clear is that nothing is clear. Last week Prime Minister Theresa May and opposition leader Jeremy Corbyn both made what were touted as major speeches seeking to re-frame the debate. Unfortunately, neither speech provided much clarity or mapped a path forward.

May coined a new phrase, that the ultimate goal was a new «customs arrangement.» But this was just new wine in old bottles: it was simply a relabeling of the hackneyed concept of Canada-plus (no matter how much Mrs. May, in her verbiage, denies the fact). Canada-plus, to remind you, is a trade agreement, like that concluded between Canada and the EU, augmented by some additional features favorable to the City. The Canada-EU trade agreement goes some distance, though not the full way, toward freeing merchandise transactions. But it offers Canada only limited access for its services. If a Canadian bank wants to sell financial services in the EU, then it has to set up a separately capitalized subsidiary – an expensive proposition – and comply with EU regulation.

Why might Britain get a better deal? The argument in London is that because the EU relies so heavily on the City for financial services, preventing British intermediaries from providing them would devastate Europe’s economy. Unfortunately for Mrs. May, this is not the view of EU negotiators. As they see things, relocating euro-denominated transactions to Paris or Frankfurt would enable the ECB and other euro-area regulators keep better tabs on financial risks. Doing so would enhance the competitiveness and profitability of French and German banks, there being no intrinsic reason why the latter couldn’t do the same deals and underwrite the transactions that are currently booked in London.

Canada without the plus

Nor does mutual recognition of UK and EU financial regulations appeal to EU officials. Regulators may be comfortable with the vigor of UK supervision today, but they have no guarantee that such supervision will be equally robust tomorrow. If they commit to mutual recognition, then there will be little they can do about the problem.

So, whether she admits it or not, Mrs. May is really talking about Canada without the plus.

Four days earlier Labour leader Jeremy Corbyn gave a speech arguing for a modified customs union, as distinct from Prime Minister May’s customs arrangement. Corbyn had in mind an agreement like that between Norway and the EU, where the partner has free access to the Single Market for its exports of goods and also services. Under this model, that partner basically harmonizes its external tariffs with those of the European Union. And to ensure a level playing field, it also harmonizes a range of behind-the-border social policies and product rules affecting things like employment, environment and product safety.

Avoiding a hard border between Northern Ireland the Irish Republic

This model would give UK financial firms access to the EU’s single market, dissolving the principal threat to British industry and finance.  Thus, we have the peculiar sight of the Confederation of British Industry effectively endorsing the proposals of a hardline Marxist like Corbyn while criticizing Conservative leader May.

A customs union would also address Northern Ireland’s needs. The May Government has committed to avoiding a hard border between Northern Ireland the Irish Republic. Avoiding a hard border is a priority of Democratic Unionist Party, the small Northern Ireland party on which May’s government depends. Indeed avoiding a hard border is imperative for any future UK government, since imposing one would put the Good Friday peace agreement at risk. And if there are going to be no border controls between the two halves of Ireland, then tariffs on imports into the island from other parts of the world must be harmonized. Hence, a customs union is essential to solve the Irish problem.

But there are drawbacks to a plain-vanilla customs union. Participation in the single market, as implied by a customs union, requires a country to respect the EU’s «four freedoms.» These include free labor mobility, which Brexiteers are dead set against. Some will argue that this freedom extends only to workers and not their families, but who is a potential worker and who is only a family member is not always clear. This fudge will not satisfy Britons hostile to immigration.

Liechtenstein, Norway and Switzerland are different

Others observe that Liechtenstein has been permitted to opt out of the fourth freedom owing to its small size. But Liechtenstein is really, really small. The UK is a whale by comparison. It is worth recalling that middle-sized Norway has not been permitted to opt out despite the fact that immigration per capita is higher than in Britain.

In addition Norway, as a condition of its customs-union status, is required to make payments to the EU. To save face, it contributes to individual European countries and programs rather than the EU budget, but the financial consequences are the same. Switzerland, with its more limited EU trade agreement, is familiar with both the free-immigration and financial-contribution problems.

Finally, under a customs union the UK would not be able to negotiate trade pacts with other parts of the world or maintain significantly different social policies, product safety regulations and financial rules. Anticipating this, Corbyn proposed that the UK-EU agreement should give the UK a say in future EU trade agreements and regulations. He proposed further that the UK should be exempted from EU rules governing state aid to firms, enabling him to re-nationalize and support significant swathes of British industry while at the same time gaining access to the single market.

No cherry picking

The problem with this imaginary compromise is, as we say in the U.S., that «it ain’t gonna happen.» Allowing a Corbyn government to freely dispense state aid while also allowing public enterprise to export to the EU would steeply tilt the single market’s level playing field against European firms. Nor does the EU have an incentive to give a nonmember state the right to influence its trade negotiations and product market regulations. Doing so would set a terrible precedent. In the past, European negotiators have rejected such solutions as «cherry picking» and as the UK seeking to «have its cake and eat it too.» This would be cake with a cherry on top.

What, then, is the end game? The Northern Ireland problem together with the EU’s negotiating leverage mean that the outcome must be a customs union. For Corbyn, getting there will require moving to the political center. He will have to abandon comrades on the left who are intent on re-nationalizing large segments of the British economy, as well as colleagues to his right who are hostile to immigration and the free movement of labor. For May, it will mean abandoning her «red lines» and turning her back on hard Brexiteers who think that the UK, by leaving the EU, can regain tariff autonomy, promulgate its own regulations and close its door to immigration.

It is not at all clear which of these estimable politicians has the capacity to traverse this minefield. But we have to hope that one of them can. For the alternative – falling out of the EU without a customs union agreement – would be the worst outcome of all.