The UK's exit (Brexit) from the European Union (EU) is to be seen from a wider context of the UK economy's incomplete recovery from the 2007-08 global financial crisis (GFC) and the aftereffects of Covid-19. The initial cost of Brexit will be a significant slowdown of the UK economy with the strong possibility of a recession which now has become a certainty with the Covid-19 outbreak. As for the EU, the picture is equally pessimistic as many observers expect about 10 per cent decline in its GDP this year. Also, the major economies in the EU have been performing very badly even towards the end of 2019.
Major European economies like Germany, Italy, UK, France, Spain and others are facing serious stress right at the moment as a consequence of the pandemic. Now Covid-19 has created an almost existential threat to the EU itself. Italian Prime Minister Giuseppe Conte already warned that the risk of the EU collapsing over the corona virus crisis 'is real'. Many observers believe this may prompt the UK to play hardball negotiation tactics with the EU.
Meanwhile, both British Prime Minister Boris Johnson and EU Chief Brexit Negotiator Michael Barnier had a brush with Covid-19 and recovered. Covid-19 has now engulfed both the European continent and the UK. The end of 2020 deadline for a trade deal to be finalised was already tight even before the Covid-19 pandemic prompting Michael Barnier to indicate to negotiate any request for a delay. Even the IMF also weighed into the debate by suggesting to extend the transition period which is due to end on December 31. But the UK government remains firm that it will not seek or agree to any request for extension of the transition period. The reason is partly because it will involve massive payments to the EU to deal with the impact of Covid-19 pandemic. And that is clearly not in the interest of the UK. But from the EU side, some observe that the UK is taking a high-stake gamble and suggest that it will not result in a trade agreement. This suggests a strong possibility of no-Brexit deal.
Covid-19 may have sidelined the post-Brexit talks for a while but talks are back again as Michael Barnier recovered from Covid-19 infection, through tele conferencing. The UK negotiating team seems to be quite positive about the probability of a trade deal before the end of the year. Both sides are continuing with video conferencing often involving about 200 officials. Michael Barnier accused the UK of running down the clock by slowing the discussions on important issues but believes the difficulties could be ironed out 'if there is realism and mutual respect'. The way the negotiation is progressing, it looks like there is much lack of that at the moment.
However, Brexit's medium to long run success will be judged on its economic impact, especially its impact on UK's trade relations. But Brexit is not yet done as Britain has moved into an 11 month transition period when Britain technically remains within the EU's rules and must pay it dues to the EU budget. This transition period ends at the end of this year. The EU now accounts for close to half of UK's trade and that makes it important for the UK to successfully negotiate a trading arrangement with the EU.
The UK's exit from the EU marks a steep change in its economic relationship with the bloc. The UK will now be moving out of the close integration with largest trading partner (the EU) and entering into negotiating on a new trade arrangement with the EU. But the exit from the EU also at the same time opens up potentials for reopening the opportunity to negotiate trade deals directly with other countries, like the USA.
The Covid-19 outbreak, however clearly demonstrated that the EU lacks any collective identity as reflected in the lack of support from other EU countries for Italy and Spain and the break-down of the talks on the ''Corona Bond" clearly exposing its North-South divide.
Now a range of different trade opportunities and arrangements are possible between the UK and the EU and other countries such as the USA. The choice of trade arrangement with the EU will involve a complex set of talks between both parties as the UK is opting out of the current arrangement and negotiating new arrangements for future trading relationship with the EU.
The European Commission has suggested that the UK faces a choice for its trading with the EU - to become a rule taker like Norway or a standard free trade agreement partner like Canada. But both types of trade agreements have their own problems from the UK perspective. The Norway Model makes the UK as the rule taker without any voting rights as to how the rules are made and implemented. Such an arrangement would be politically unsaleable to the British public. The Canadian model of free trade does not cover much of trade in services.
The UK enjoys trade surplus in services while suffers from a deficit in merchandise trade with the EU. Services accounted for 41 per cent of UK's exports to the EU in 2018. In fact, the UK is the second largest exporter of services in the world only after the US. Therefore, any such arrangement ( the Canadian model) would severely restrict market access of UK services to the EU market and that would inevitably cause negative impact on the UK economy (the services sector accounts for 80 per cent of the UK economy). In services trade, non-tariff (regulatory barriers) barriers matter more than tariffs.
There is also a third model, the Switzerland model. Switzerland has entered into a network of agreements with the EU which allows sector by sector deal in the single market, without any supervisory mechanism to enforce them. As the UK is looking for a middle ground between Norway and Canada or a mixed deal, the Switzerland model possibly looks quite attractive to the UK. But the model is no longer popular with the EU because of its lack of institutions and oversight, therefore it is unlikely to agree to such an arrangement with the UK. If the UK insists on maximum control over its trade relations without any constraints imposed by EU institutions and rules, it will face significant opposition from the EU. In short, it means that the UK must have the freedom to diverge from EU rules and regulations.
Trade agreements around the world in the post-1995 period are not so much about tariffs and border controls but about what is called non-tariff barriers (i.e. regulatory barriers) to trade which include health, safety, environmental and product standards and rules relating to investment and public procurement.
It appears the UK government is fairly clear about what it does not want but has failed to articulate what it wants. That appears to be the main obstacle for the UK to put forward a concrete proposal on the relationship it wants with the EU. The EU accounts for almost half of the UK's exports to and 10 per cent of its imports from the EU. Such lopsided trade gives the EU a significant leverage over the UK in negotiating the new trading arrangements. However, one must not lose sight of the Rotterdam Effect. This is a situation where goods exported to one member country (say the Netherlands or Belgium) are destined for another country outside the EU.
At the end of the day size matters and if the UK continues to insist on regulatory divergence, it might end up eliminating tariffs (which in any case has been very low among developed countries to a few percentage points only) but not regulatory barriers for goods, that is unlikely to lead to a deal with the EU.
The US is the next focus of attention to work out a new trade deal once the UK is out the EU. The UK's 19 per cent of exports went to the US in 2019 making it the second largest export market for the UK after the EU. The UK always claims it has special bond with the US. There has been a growing optimism that this bond would further strengthen once the UK leaves the EU. But in the week the UK left the EU, both countries seem to have encountered problems on a number of fronts, especially on issues relating to the UK's decision to buy Huawei 5G telecommunication equipment from China. The US Secretary of State Mike Pompeo on his visit to London just before the Brexit happened, however, reassured that Huawei would not impede the bilateral relation between the two countries. It also appears that it would not affect negotiation on a free trade deal with the US either. Pompeo also said that the US would put Britain 'at the front of the line' in its trade relationship.
A comprehensive trade deal with the US may not be difficult to negotiate as the US usually follows particular template in negotiating trade deals with other countries. The UK possibly will not find it difficult to sign up to most of this document. But problem will arise for the UK to where product and environmental standards diverge between the EU and the US. If the UK wishes to follow the US standards that will stand in the way of successfully negotiating a trade deal with EU.The way out of this impasse might be to negotiate a much less comprehensive trade deal with the US. But during the election year President Trump is unlikely to take up the trade negotiation deal with the UK. The problem for President Trump is now further compounded by the current Covid-19 situation affecting the US economy and its impact on the likely outcome of the election result in November this year. For other major trading partners, the UK can just follow the existing EU template (which the UK follows now) to enter into a trade agreement.
Muhammad Mahmood is an independent economic and political analyst.
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