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March 29, 2017

UK triggers Brexit countdown – COMMENT

The UK prime minister, Theresa May, has invoked the EU constitution's 'Article 50' which formally begins the two-year process by which the UK exits the EU. Although trade arrangements are not formally included in the UK's exit terms, they are sure to be the subject of intense discussions.

The UK prime minister, Theresa May, has invoked the EU constitution’s ‘Article 50’ which formally begins the two-year process by which the UK exits the EU. Although trade arrangements are not formally included in the UK’s exit terms, they are sure to be the subject of intense discussions.

The first thing to bear in mind is that there are some very big uncertainties at work here, because an EU member state negotiating to leave the trade bloc is unprecedented. Countries normally apply to join and that is where negotiations naturally come in, for the terms of accession. The UK’s departure is, effectively, a reversal of the conventional negotiation with a nation-state.

The terms of the UK’s separation are governed by the two-year negotiation which will cover areas such as UK budget commitments to the EU, where the UK-EU lines of post-Brexit cooperation will be and reciprocity in areas like freedom of movement and citizens’ entitlements to things like health care, state benefits and visa-free travel. Officials will certainly be kept busy over some complex and arcane details over the next two years. 

It does not cover trade.

The elephant in the room is a post-Brexit trade deal. On the UK side, especially, there will be enthusiasm for starting talks on that as soon as possible (in parallel with the exit negotiations). Trade deals are notoriously difficult to conclude and can take years to nail down (the EU free trade deal with Canada took eight years and ratification among the EU member-states was far from being a formality). On the plus side, this is different to the usual trade deal parameters in that the UK is moving from being inside the single market, with zero tariffs on trade and minimal customs controls to a different arrangement of some sort. The question is, what will the new trade relationship between the UK and the 27 look like? Again, we are in unprecedented territory, but the UK is currently abiding by EU rules and trade terms – in areas like industrial standards. Some observers have looked at other models such as the EU’s arrangements with countries such as Norway and Switzerland, but while they can provide some pointers, the UK’s eventual arrangement is likely to be unique.

Besides the hard economics of trade rules, there is also a wide and uncertain political dimension. The UK has voted to leave the trade bloc, exit the club. It therefore seems intuitive that it cannot continue to get the full benefits of club membership. The other 27 states have to agree on a trade deal with Britain and it far from clear how unified, or not, that collective position will be, or the extent to which the UK’s EU market access conditions will eventually be altered. However, the messages coming out from the EU have been very consistent in terms of the basic principles of the trade bloc in areas such as the free movement of people. Yes, there are scenarios in which Britain maintains membership of the single market or customs union, but the UK government appears to have recognised that they are not politically acceptable at home. The EU has rejected any watering down of freedom of movement  (high levels of immigration were at the core of the UK’s referendum result). Staying in the single market means accepting the judgments of the European court of justice, paying into the EU’s budget and accepting free movement of labour within the single market. These were things that UK voters decided to reject in last summer’s national referendum.

A lesser step, staying in the customs union – like Turkey – means that you sign up to the EU’s trade deals and cannot negotiate your own. Again, this would likely be portrayed in Britain as being at odds with the referendum result and leaving the UK not in charge of its own destiny.

The UK government will want to retain as much of the single market benefits – especially free trade – as it can. The EU’s position will be about retaining the trade bloc’s integrity and its founding principles, such as freedom of movement for people. A compromise position for the UK’s treatment will likely impose some additional costs to UK-EU trade, but the form of that cost will have to be determined.

As far as the UK auto industry goes, the UK government has already made it clear that it wants existing trade arrangements to be retained if possible and that it will act to ensure the competitive position of UK-based operations is not impaired by Brexit. In practice, that means companies will look to extract concessions from London, while also keeping a close eye on how the wind is blowing on trade arrangements and where that leaves the long-term position.

Transitional trade arrangements key

Will a trade deal be agreed by the spring of 2019 when the UK leaves the EU? It could be politically very difficult to secure full agreement by then (there are 27 member states with lawmaking institutions that have to sign-off), which would mean that a ‘transitional’ deal would be necessary to avoid WTO-based tariffs. A transitional trade deal will become, along with the UK’s financial settlement (‘exit bill’), a major focus of discussions. If the transitional trade arrangements are easily agreed and smooth, avoiding the so-called ‘cliff edge’ of tariffs and major customs barriers, companies like Nissan and Toyota will have much more confidence in the longer-term outlook for a UK-EU trade deal that minimises economic disruption – both for the UK and the EU.

The negotiations now have to start in earnest, the clock ticking to the two-year timetable that looks pretty fixed. The UK government does not want to exit the EU in 2019 without an understanding on trade – either a trade deal conducted and agreed in parallel with exit talks, or a transitional deal of some sort. Prolonged uncertainty risks scaring off investment. If a deal or transitional agreement is not achieved, tariffs imposed under WTO rules will add to auto industry costs and raise uncomfortable questions over the UK’s position in a European auto industry with its pan-European supply chains. It may be that the UK government can generate a strategic position that supports the UK’s industry in the light of the new landscape and conditions that it is faced with. Trade will continue, after all. But minimising disruption will ultimately be in the economic interests of all parties.

The fixed two-year timetable appears to put pressure mainly on London, but Brussels would be wise to avoid the economic contagion and fallout that could follow a disorderly Brexit. The EU also has to put its own house in order and settle frayed nerves over the EU’s future. How far can member states be expected to integrate, economically and politically? Just where is the right balance of economic integration and political accountability for this trade bloc (and don’t rule out another Greece-style eurozone crisis in the years to come)? Voter disenchantment with the EU is not only evident in Britain. Answering those difficult and fundamental questions won’t be helped by an aggravated relationship with the UK. The terms of the relationship may change, but the EU and the UK will still have to live together. A compromise Brexit trade deal that is liveable with in Brussels and in London is out there, somewhere. Finding it won’t be easy. 

See also: BREXIT – UK-EU trade uncertainties cloud outlook

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