Brexit Success Hinges on Global Goodwill

It is hard not to feel sympathy for British officials tasked with delivering Brexit—and indeed, Prime Minister Theresa May’s promise to “make a success of it”.


Less than two years ago, the civil service carried out a comprehensive assessment of the U.K.’s relationship with the European Union and concluded that, by and large, the current arrangements served British interests pretty well. Now that Brexit has been thrust upon them, they are, by their own analysis, in the realm of dealing with least bad options, a point clearly reinforced by a report from the Institute for Fiscal Studies published on Wednesday.


The respected London-based think tank analyzed the U.K.’s post-Brexit options for a new trading relationship with the EU and concluded that whichever path it chooses is likely to result in a sizable hit to the economy relative to the expected growth in output if it stuck with its current trading relationship.


It estimates the range of likely damage as lying somewhere between 2.5% and 6% of gross domestic product, depending on whether the U.K. opts to retain full membership of the EU single market or to trade with the EU on World Trade Organization terms. It puts the likely cost to the Treasury in extra borrowing at between £24 billion ($31.2 billion) and £39 billion by 2020.


What makes the choice so hard isn't just that all the options are likely to involve the U.K. making politically difficult trade-offs between the degree of access to EU markets it is allowed and its willingness to accept continuing EU obligations such as budget payments and accepting the right of EU citizens to live and work in the U.K.


The bigger problem is that the relative appeal of the various options depends on how the rest of the world—not just the EU—responds to the U.K. demands. This response will remain unknowable until the U.K. formally launches the exit process by invoking Article 50 of the Lisbon Treaty. All that is certain is that if the U.K. is to make a success of Brexit, it will need to draw on vast reserves of global goodwill.


Even the IFS’s worst-case scenario, that the U.K. reverts back to trading with the EU on WTO terms, can’t be taken for granted. To trade with the rest of the world on WTO terms, a country must first have its own schedule of tariffs recognized by the WTO. These are the tariffs that it must levy on all imports from countries with which it doesn’t have a free-trade deal.


The U.K. currently doesn’t have its own tariff schedule because it is a member of the EU’s customs union, which applies a common external tariff across all 28 member states. But agreeing a new U.K. schedule of tariffs is likely to be difficult since the WTO works by unanimity; just to get to the Brexit first base, the U.K. must seek the consent of all 160 members.


Britain’s best option may be simply to offer to adopt the EU tariff schedule unchanged, says Professor Alan Winters of the U.K. Trade Policy Observatory at the University of Sussex. But even this won’t be easy since this would still require the U.K. and EU to come to an agreement on how to divvy up import quotas in sensitive sectors such as agriculture.


The more of the EU’s quotas that the U.K. agrees to take, the easier a deal with Brussels might be to reach, but the bigger will be the hit to U.K. farmers. Meanwhile, there is nothing to stop any WTO member objecting even to the U.K. retaining an unchanged EU tariff schedule.


Without an agreed WTO tariff schedule, the U.K. won’t be in a position to start negotiating new trade deals with non-EU countries, not least because it won’t be clear what it has to offer. But a WTO schedule on its own won’t be enough: Other countries are likely to want to see what deal the U.K. agrees with the EU before starting talks.


This is crucial because the nature of Britain’s future trading relationship with the EU will determine the strength of the U.K.’s bargaining position in other potential trade deals. Will the U.K. remain an attractive base from which to continue to access a wider EU market of 500 million people? Or is the U.K. simply offering access to a domestic market of 55 million people?


Clearly, Britain’s priority will be to maintain tariff-free access to the EU market. But that may be the easy bit. Arguably more important is what deal the U.K. can strike regarding non-tariff barriers.


These include recognition of U.K. regulatory standards, vital to reduce the time exports are held up by customs checks, and so-called rules of origin, which establish how much imported content a product can contain while still qualifying for any preferential tariff. In the modern world, these non-tariff barriers are typically the biggest impediment to trade since they act as a form of tax on exports.


Again, the simplest solution would be for the U.K. to agree to a deal close to what it has already in terms of both market access and obligations in the form of a Norway-style membership of the European Economic Area, assuming other EU and EEA members agreed.


The alternative is a new free-trade agreement with the EU that would have to be agreed sector by sector—a process that could take years. Only then would the U.K. be in a position to go out and negotiate the ambitious new trade deals with the rest of the world that many Brexiters claim is the real prize of quitting the EU—and which might offer some prospect of Brexit success.