Media  Global Economy  2020.01.27

How will the Tories' resounding victory affect UK-EU talks? : With Brexit sure to happen, will subsequent negotiations flounder?

The article was originally posted on RONZA on December 15, 2019

The Conservatives' election win was an own goal for Labour

In the general election recently held in the UK over the issue of Brexit, the Conservative Party routed the Labour Party.

Still the UK seems to remain divided equally between Brexiteers and pro-Remainers. In the national referendum three years ago, the former and the latter gained 52% and 48% of the vote, respectively. In more recent opinion polls, pro-Remainers outnumbered Brexiteers only by a slight margin.

At the outset of the election campaign, more than a few political analysts expressed uncertainty, doubting whether either the Conservative Party or the Labour Party would be able to win a majority on its own. Against the odds, the Conservatives, who had called for an exit from the EU, overwhelmed Labour.

Why the landslide victory? Let me identify some of the reasons from a Labour perspective. The Tories' win seems more like an own goal for the Labour Party rather than a feat of British Prime Minister Boris Johnson.

First, while the Conservative Party clearly called for an exit from the EU, the Labour Party, which includes legislators both for and against Brexit, equivocated on this issue. Labour thus failed to serve as a magnet for pro-Remainers.

Second, the Brexit Party wasted no time in forging a Leave alliance with the Conservatives, declaring that it would not field their candidates in any electoral districts where the Tories had an incumbent seat. By contrast, a pro-Remain alliance did not materialize as the equivocal Labour Party became increasingly reluctant to electorally cooperate with the pro-Remain Liberal Democrats.

British general elections are held under the single-seat constituency system. In each constituency, the candidate who grabs more votes than any other even by the slightest margin will be elected. Suppose three candidates run in an electoral district where pro-Remainers constitute a majority. If Labour Candidate A, Liberal Democrat Candidate B, and Conservative Candidate C get 33%, 33%, and 34% of the vote, respectively, Candidate C, a Brexiteer, will be elected.

The third reason is Brexit fatigue among the British public. They were in the mood for an early political solution to the Brexit quagmire that had lasted for three and a half years. There is even a news program which promises not to discuss Brexit.

Despite all this, Labour proposed that London renegotiate with the EU to conclude an exit deal that would be different from Johnson's, and hold a new referendum to decide between the new deal and the remain option. If this proposal had been adopted, the dither and drift would have continued.

Fourth, Labour, which was defensive over Brexit, tried to focus on domestic issues. Some Labour MPs called for improving social security. Yet Labour Party leader Jeremy Corbyn, a radical socialist, laid out an anachronistic agenda, notably the nationalization of infrastructure sectors. This invited a backlash from the British public.

Finally, what Johnson did to Labour was what US President Donald Trump did to the Democrats in the 2016 US presidential election.

A key factor in Trump's election win was that he successfully proselytized pro-Democrat voters in the Midwest Rust Belt region, a traditional stronghold for the Democratic Party, arguing that trade and immigrants steal job opportunities from American workers. Corbyn and others in the Labour leadership had no idea that a similar thing would happen to them. In the UK general election, Labour lost the "red wall" across the Midlands and the north of England--the long-time bedrock of the party's support--to Johnson.

Labour was unprepared despite the precedent in the US. Both the US Democrats and the UK Labour Party lost workers in the steel, coal, and other declining industries to their respective opponents, the Republicans in the US and the Conservatives in the UK.

In Scotland, however, the pro-Remain Scottish National Party won 48 of the 59 seats up for grabs, crushing the Conservatives. It would have been a toss-up though if Labour had formed a pro-Remain alliance with the Liberal Democrats. The Liberal Democrats, which some analysts predicted would increase their seats significantly on a pro-Remain ticket, lost badly, with the party leader losing her seat.

Johnson's exit agreement bill was likely to pass Parliament even before the general election. Still Johnson risked his political life to go ahead with a general election.

Johnson, the winner in this gamble, can now maintain his premiership for the next five years. Not only that, he now enjoys a stable government in which his party alone has an overwhelming majority in Parliament. Johnson will unlikely face the kind of fate former Prime Minister Theresa May suffered. Her exit deal with the EU was voted down three times in Parliament.

Ensuing FTA talks between the UK and the EU

At any rate, the election result undoubtedly means that the UK will leave the EU on January 31.

The UK is set to hold negotiations over a free trade agreement (FTA) that will determine its relationship with the EU in the transition period that will expire at the end of 2020. During this period, the UK will remain within the EU's customs union and single market. The transition period can be extended for two years until the end of 2022 (if the UK and the EU so agree by July 2020). Still, such an extension is unlikely because Johnson's Conservative Party promised to get Brexit done by the end of 2020.

No deal during the transition period until the end of 2020 would mean there would be no agreement between the UK and the EU in January 2021, creating the "no-deal Brexit" situation.

Regarding this prospect, many "experts" and some in the media claim that UK-EU negotiations will be no mean feat and that such talks cannot be concluded in one year. They cite difficulties associated with financial services as well as the fact that FTA talks normally take several years to conclude due to the conflict of interests. (The Japan-EU FTA talks took more than four years to conclude.)

The Financial Times on November 20 reported two conflicting views. Boris Johnson and European Commissioner for Trade Phil Hogan say that given the UK's 46 years of EU membership, 2020 negotiations will not take so much time. A European Commission senior official, on the other hand, says that with little experience in trade talks, British negotiators will face an uphill battle and that EU member states will urge the European Commission to take a very hard line. Which view is right?

What's on the agenda for FTA talks?

Generally speaking, FTA negotiations address two major areas of trade.

The first area is goods.

Negotiators primarily seek to eliminate--or at least reduce--tariffs. A rule of thumb is to eliminate 90% or more of the tariffs in terms of trade volume or the number of items. Countries that have protected their farm sector with high tariffs, like Japan, will adamantly oppose the reduction and elimination of farm tariffs.

Tariffs on goods, especially farm produce, constitute the most politically sensitive and thorny part of any FTA negotiation although the contribution of agriculture to GDP is small. The service sector is the largest contributor, followed by manufacturing and agriculture. (In Japan, these sectors accounts for 70%, 20%, and 1%, respectively.)

In fact, the proportion of agriculture, forestry, and fisheries combined in GDP is quite small in developed countries. It stands at 1.2% for Japan; 1.6% for France, the largest farming country within the EU; 0.6% for the UK; 0.9% for the US, the top farm exporter in the world; and 2.6% even for Australia.

What matters for a nation's economy is totally different from what matters in free trade negotiations. Such negotiations may be prolonged or bogged down not because of their considerable implications to the economy or any technical difficulties involved. A case in point is the Brexit negotiations over border issues between the UK and the EU in October. The talks addressed technically difficult issues but they only took one week to conclude.

Negotiations over agriculture, a small contributor to GDP, boil down to two simple issues: to what extent tariffs should be reduced and to what extent import quota should be expanded. Nevertheless, agriculture has assumed the most important position in trade negotiations. This is because the farm sector does matter politically for the countries involved.

Each country has an exact limit to which it can concede in light of its internal political situation. Farm exporting countries make demands beyond the defense line that importing countries have set as their acceptable limit in order to maintain their agricultural production levels. This often stymies negotiations. In other words, trade negotiations can flounder because both exporting and importing countries usually need enormous amounts of time and effort to persuade their domestic industries and otherwise reconcile conflicting interests in their respective countries.

The second area to be addressed in free trade talks is services.

Trade liberalization in services is addressed based on two principles. One is most-favored-nation treatment, the principle of treating any nation equally in international trade. The other is national treatment, the principle of treating foreign businesses equally for domestic firms. The WTO essentially requires member states to stick to these two principles as far as trade in goods is concerned. When it comes to trade in services, however, the issues of how far a country concedes to its trade partner or what exceptions can be made with respect to these two principles are all subject to negotiation. In short, the WTO allows member countries leeway for negotiation in trade in services.

A free trade agreement may also address standards and regulations, food safety, sanitary and phytosanitary measures, government procurement, intellectual property rights, investment, and state-owned enterprises.

The EU's requirements for the UK

Are there any special circumstances surrounding the UK-EU talks? According to the FT article of November 22, the EU requires the following of the UK.

Michel Barnier, who is the EU's chief Brexit negotiator and will take charge of UK-EU FTA talks, argues that the further the UK aims to diverge from EU rules, the more restricted its access to the EU market will be. His argument is that if the UK adopts more lax regulations than EU rules in such aspects as worker protection and the environment, the competitiveness of British products will increase. Accordingly, the EU will either restrict its market (by raising tariffs) or call on the UK to adopt regulations that are equivalent to the EU's, according to Barnier.

German Chancellor Angela Merkel concurs. She warns that the UK will become a competitor for the EU.

What the EU requires is a level playing field. This is something the US usually demands in trade talks. However, such restrictions make the UK wonder why it has opted for Brexit in the first place. Brexit is designed for the UK to recover sovereignty from Brussels and regain the freedom to establish laws and regulations on its own.

In relation to financial services, the European Economic Area (EEA)--which comprises 31 countries including the EU members--has a system called the single passport. Under this system, financial service providers that have obtained a business permit in one country within the EEA are free to do business in any of the other countries in this economic area. Thanks to this system, many financial institutions have a business hub in the City of London for their operations in Europe.

The question is whether the EU will allow the UK to maintain this system after Brexit. In the financial services sector under the EU's free trade deals, the EU judges whether other countries have regulations equivalent to its own and grants market access only to countries that have passed such an equivalence assessment. At issue is whether the EU will acknowledge such equivalence in the British financial system.

Apart from FTA negotiations, the FT article says that the EU will strongly demand continued access to UK fishery waters as this is a top priority for France, Spain and Denmark among the EU members.

Because of all these reasons, the FT article concludes that negotiations between the UK and the EU will be a difficult and lengthy process.

The crucial aspect that eludes "experts"

However, the FT article overlooks the most important and fundamental aspect.

The overlooked aspect is that since the UK is within the EU at least for now, goods are traded between the two sides totally tariff free and British financial institutions are operating under the same conditions as those for their EU counterparts. In other words, the UK is currently in a situation that can be described as a complete free trade agreement with the EU. (This is perfect free trade in goods and services--a level which no FTA, including the TPP, has attained.) Write this into a draft agreement, and the deal is done.

This is not like the FTA between Japan and Australia, where the two countries had to start negotiations from the position of having different tariffs and having not yet abolished them. Although Japanese and EU negotiators reportedly took four years to conclude the free trade pact, they were in full-fledged negotiations for a period of only one year after Tokyo had concluded TPP negotiations. Likewise, Japan-US trade talks took only one year to conclude.

The backstop arrangement that May agreed with the EU was a measure to be taken if no agreement was reached during the transition period until 2020. The solution to the Irish border issue that Johnson agreed with the EU in October was not the backstop arrangement in a no-deal scenario but a package of measures in anticipation of a future deal between London and Brussels. In short, the thorniest issue in 2020 negotiations has already been settled.

Flaws in the EU's argument

Let me briefly comment on the argument made by the EU.

First of all, regarding the level playing field, the EU cannot call on a sovereign state to continue abiding by EU rules. Conversely, the EU may not be allowed to adopt regulations more lax than those in the UK in light of the reciprocity principle. Would that be acceptable to the EU?

British and EU negotiators may end up drafting a deal while referring to the chapters on such issues as trade and labor, and trade and the environment in both NAFTA and the TPP. If I were Johnson, I would remind EU leaders of the fact that the EU did not demand regulations equivalent to its counterparts as part of its FTA with Japan.

The EU allows three non-members--Iceland, Liechtenstein, and Norway--to adopt the single passport system. Based on the principle of most-favored-nation treatment, the UK can demand the same arrangement as long as it maintains financial regulations equivalent to the EU's. The two sides may disagree on what constitutes equivalence and to what extent the EU will allow the UK to diverge from EU regulations. Yet if the UK is in dire need of the single passport system, it has only to adopt the same regulations as the EU's in the financial sector.

Regarding Euro business, many financial institutions are relocating their European hub from London to the Continent in anticipation of Brexit. In substance, Brexit is already being launched.

More importantly, negotiations to strike an FTA or the like, which involve different aspects--such as trade liberalization in goods, trade liberalization in services, intellectual property rights, and investment--end up reaching agreement as a package even though these aspects are negotiated separately. As far as financial services are concerned, it is the EU that may grant market access to the UK. As for fisheries, their positions are the reverse. If the EU is tough on financial services, the UK has only to take a tough stance on fisheries.

Some may think that a loss in financial services would be disproportionate to a gain in fisheries because the two sectors are quite different in economic scale. However, as I have discussed, the relative importance of any item subject to trade negotiations is measured by its political implications, not by its economic value. For example, assess to UK fishery waters is of extreme political importance to France and Denmark.

In terms of the timeline, if the UK and the EU both want to avoid a no-deal exit by all means, they have no choice but to strike a deal by the end of 2020. If both parties think of 2020 as the unequivocal deadline, intense negotiations and an appropriate political schedule to that end are all they need.

It may be worth adding that not only Barnier but also former EU leaders such as Jean-Claude Juncker and Donald Tusk disliked the idea of Brexit in the first place. In fact, during the recent UK general election, where Brexit was the central issue, wily and crafty leaders of the European Commission warned of the possibility of a no-deal exit after the successful Brexit at the end of January 2020. They said even if the UK leaves the EU at the end of January 2020, ensuing negotiations may flounder. They made these remarks apparently because they wanted the British public to give up on Brexit, not because they really believed what they said.