One might think that the Brexit negotiations are already charged enough. However, the conflict between the EU and Great Britain is intensifying due to a new Single Market Act. What are the chances of the long-awaited "light trade agreement"?
After the United Kingdom left the EU on January 31, 2020, there is currently a transition period in which the country and the EU wanted to regulate their longer-term relations. The corresponding talks do not seem to be progressing, which is causing frustration on both sides.
The positions are still far apart on fundamental issues: Great Britain is striving for a free trade agreement based on the model of the agreement between the EU and Canada and rejects anything that it believes would affect its sovereignty.
From the EU's perspective, on the other hand, the UK is demanding more extensive access to the internal market than was granted to all other trading partners. That is why she wants to prevent the UK from undermining existing regulations and thus giving British companies a competitive advantage. For this reason, the EU urges the UK, among other things, to publish the rules that will apply to state aid in the future.
New internal market law intensify Brexit conflicts
In the past few days the search for a solution has been made even more difficult by the fact that the British government has introduced an Internal Market Bill (IMB) into Parliament which, in their view, will "break international law in a very specific and limited way ".
It partially contradicts the Withdrawal Agreement (WA) concluded with the EU in October last year. The reason given by the British government is that this agreement threatens the economic integrity of Great Britain because it establishes a customs border between Northern Ireland and Great Britain.
Now, the Single Market Act stipulates that Northern Ireland will have the same customs regulations as the rest of the country. Another point of contention is the extent of government aid to businesses. According to the withdrawal agreement, the restrictions on state aid will continue to apply after the withdrawal.
The Single Market Act now states that the UK may enact provisions "which (the state aid rules) … shall not apply or modify the effects of any relevant international or domestic law with which they may be inconsistent or inconsistent".
U-turn in British economic policy?
What is the reason for this action by the UK government? Because of course the government was well aware of the risk of a customs border in the Irish Sea when it approved the exit agreement.
The motive is therefore more likely to be found in the other point – the threatened limitation of possible state aid. Because for many in the government, Brexit is a means to an end and not an end in itself.
In their opinion, it opens up the possibility of better positioning the economy for the digital age. Government circles say they want to get rid of the rules on state aid in order to support the industries of the future.
This would mark a U-turn in British economic policy, which was mostly very skeptical of subsidies for certain industries. According to the EU State Aid Scoreboard, British subsidies only corresponded to 0.34 percent of the national gross domestic product in 2018, compared to an EU average of 0.76 percent (Figure 1). This would mean that UK state aid to businesses would remain below the EU average even if it doubled.
Chart 1: Great Britain with low subsidies so far
Internal market law still faces some hurdles
Earlier this week, the UK Parliament approved the IMF on second reading (a law has to be passed three times before it can be submitted to the House of Lords for ratification) with a majority of 77 votes. Despite the protests from within our own ranks, which we heard earlier, this is only slightly less than the nominal majority of the Conservatives of 80 votes.
In order to finally get the law through parliament, the Prime Minister has also offered an amendment to the law. It could be used by parliament to veto if the government plans measures within its framework that "violate any relevant international or domestic law".
Despite this (small) concession, it is still possible that the law will be rejected in the necessary third reading in the lower house or at least be changed in such a way that it is no longer in contradiction to the exit agreement with the EU.
Another hurdle is the House of Lords, where opposition to the bill is very strong due to the impending loss of reputation of the UK. In the end, the Lords may not block the law entirely, but they may at least delay it considerably.
EU calls on Great Britain to recall the Single Market Act
Unsurprisingly, the EU reacted very annoyed to the new British law. It has called on the UK government to withdraw the law by the start of the next planned round of bilateral negotiations, which is scheduled for September 28th to October 2nd.
The British government is unlikely to do that. In this case, the EU threatens to take legal action before the European Court of Justice. So far, however, there has been no talk of breaking off the negotiations. Obviously, the EU does not want to be the first to leave the negotiating table, and thus does not want to be branded as the party responsible for the considerable economic damage that can be expected in the event of a no-deal.
Accordingly, despite the provocation by the IMF, the EU will keep the negotiating lines open for as long as possible.
It remains to be seen whether the EU heads of government will adopt a different position at their summit meeting scheduled for October 15. According to Boris Johnson, an agreement must be reached by then anyway if an agreement is to enter into force at the end of the year. The EU has set itself a deadline of the end of October, which would allow the EU Council and the European Parliament a maximum of two months to review and ratify an agreement.
One thing is clear: even if this somewhat longer deadline is to be adhered to, the rhetoric must be significantly reduced in the next six weeks.
Brexit consequences could be limited
In view of these short deadlines and the current resentment between the negotiating parties, it can be ruled out that there will be a comprehensive trade agreement between the EU and Great Britain by the end of this year. The long-held hope that the consequences of Brexit for trade can be kept within narrow limits will therefore not come true.
Businesses on both sides will have to live with restrictions, border controls and probably tariffs as well.
The risk of a "hard" Brexit increases
The UK government’s recent move has increased the risk that there will be no agreement at all by the end of this year. Then trade between the EU and Great Britain would be subject to the rules set by the WTO. As a result, tariffs would again be levied on trade between EU countries and Great Britain in the future.
However, these are likely to be low. According to an analysis by the Trade Policy Observatory, 56 percent of British imports from the EU are subject to an average tariff of around 1.5 percent. The companies should be able to offset this burden to a considerable extent with somewhat higher sales prices.
A much bigger problem would be the threat of non-tariff barriers, at least in the longer term, which cause much higher costs than import duties. E.g. around 26 per cent of the food consumed in the UK comes from the EU (Figure 2), and half of all UK food and beverage exports go to the EU.
Figure 2: EU major supplier of foodstuffsl
A harmonized labeling system for food products is a key element in ensuring the existence of an internal market for this product. But in the event of a no-deal Brexit, British food labeling will no longer be recognized within the EU (and probably no longer the other way around).
In a simulation carried out two years ago, we came to the conclusion that a "no-deal Brexit" would depress overall economic output by three to eight percent over the next five years (depending on the degree of political adjustment). Given the economic situation that has already deteriorated significantly as a result of the pandemic, a government that wants to be re-elected in 2024 should not actually take such a risk.
The consequences for the EU should not be so serious, but they should also be noticeable, since Great Britain is an important trading partner for many member states.
"Light trade agreement" for Brexit still possible …
We are therefore sticking to our view that both sides actually have an interest in avoiding a Brexit without an agreement. Therefore, in our main scenario, we continue to assume that both parties will end up reaching an agreement that covers a limited number of sectors that are assigned a large economic value (e.g. cars and pharmaceuticals), with negotiations going through November or even could last well into December.
… with many transitional regulations
It is also becoming more and more likely that there will be a number of transitional arrangements. There are already first examples of this in areas such as financial services. Here, both sides will continue to grant the other access to clearing houses after 2020. Negotiations would then continue after December 31st.
This would not mark the end point of the Brexit drama, but only be another milestone in it. So while the chance of a halfway light end to this drama would then also mean that the companies involved in trade with the United Kingdom will not know for a long time what framework conditions they will have to adjust to in the long term.
Pound still under pressure for the time being
Due to the great uncertainty, the pound exchange rates are likely to remain very volatile in the coming weeks, although the British currency is likely to lose ground as the various deadlines approach. The conclusion of a "light trade agreement" associated with various transitional arrangements, as we expect in our main scenario, would certainly allow the pound to appreciate somewhat again.
In the event of a hard Brexit, the BoE would likely take additional action. First and foremost, the bond purchase program is likely to be increased significantly, but a negative key interest rate would then also be possible. Together with the great uncertainty about the economic effects of a hard Brexit, this would depreciate the pound significantly again.
This is what FOCUS Online users say about this article:
- "The British are out. And if they now pass laws that violate international law, it is unlikely to be made understandable to any remaining European that the EU is concluding another treaty on future trade terms with these breachers. So, dear British, keep driving to the left, Pay homage to your queen, count in pennies and pounds, measure in inches, inches and feet and trade with whomever, but spare the EU and its citizens with your egocentric madness. "
- "Well, 'what Johnson is about in the Brexit-Zoff' is actually very clear: to carry out the Brexit. That our politicians and media leaders don't like that and that they are trying to prevent that is just as clear."
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