It has been four years since the United Kingdom voted to leave the European Union. But since then, Brexit has been all talk. Yes, the U.K. legally withdrew from the EU on Jan. 31, 2020. But in the ensuing so-called “transition phase,” the U.K. has remained an EU member in all but name. British firms have still been free to do business on the continent, and Germans have been able to move to London for work.
But by Dec. 31 this year, when the transition period is over, Brexit will be a reality. The negotiations on post-Brexit economic relations between the EU and the U.K. are entering their final stages, and both sides are upping the ante. British Prime Minister Boris Johnson has said crashing out of the EU without a trade deal would be a “good outcome.” The EU, for its part, has underlined that it wants an arrangement but not at all costs.
Meanwhile, the British press and financial markets react to every muttering from the negotiation table with increasing frenzy as Oct. 15—the day Johnson is scheduled to meet EU leaders in Brussels—approaches. There is no more time for preliminaries. If there is to be a trade agreement signed and ratified by the end of the year, this is the moment when the major obstacles to a deal have to be overcome.
The suspense is high. But the wrangling over “deal” or “no deal” obscures the larger picture: Regardless of the negotiations’ outcome, the U.K. is already headed for a “hard Brexit,” meaning a sharp break in relations with the EU. No matter what, the British and European economies are in for a painful decoupling.
The agreement London and Brussels are currently negotiating boils down to a classic free trade agreement with some add-ons. It does away with tariffs and quotas for industrial and manufacturing goods as well as food products between the United Kingdom and the EU.
The deal is key for the United Kingdom’s agricultural sector, particularly the fishing and food processing industry. The EU’s average tariff on these products is high, rising up to 24.5 percent on confectionary, for example.
But on the whole, the deal is small fry. The free trade agreement still leaves British firms’ at a significant competitive disadvantage in the EU’s 448-million-person market compared with their EU rivals.
First, the deal does not foresee a customs agreement that would prevent the imposition of burdensome import/export procedures at the border between the U.K. and the EU. This will be a challenge to the United Kingdom’s manufacturing sector, which often relies on the import and export of intermediate goods in supply chains spread all over Europe. The British government expects that trucks might have to wait up to two days to cross the Channel to Europe—a major delay for just-in-time manufacturers.
Second, the agreement doesn’t do away with so-called technical barriers to trade. The EU’s single market is not just a customs union. Like the United States, the EU is a market with one set of rules, from product to safety standards, and a common framework to enforce them. For instance, a good certified in Ireland can be exported to all EU members just as a product made in Michigan can be sold in California.
But from January onward, British firms wishing to sell across the Channel will have to pass separate EU regulatory checks and obtain new certifications proving their goods. To do this, many of the firms, for instance in the pharmaceuticals and chemicals industry, will need to open up a subsidiary in the EU. Europeans compete fiercely to host these U.K. subsidiaries.
Big corporations can deal with the hassle. But for many of the United Kingdom’s exporting small and medium-sized enterprises, of which 82 percent do business with the continent, access to the EU market will be out of reach.
Third, the deal leaves the United Kingdom’s all-important services sector with nothing. For services, any deal would most likely not go much beyond what is found in other standard free trade agreements. In turn, service companies, the crown jewel of the British economy, will face a significant deterioration in their EU market access compared with today.
British banks and financial institutions—such as Barclays, Lloyds, and Coutts—have already sent a letter to thousands of their clients on the continent that they will have to close their accounts due to Brexit. They’ve decided that the cost of opening up branches in the EU to continue servicing them was just not worth it. Elsewhere in financial services, Ernst & Young estimates that 7,500 jobs and $1.55 trillion in client assets have already been moved from London to the continent.
And many other British financial service providers, such as the entire industry surrounding investment funds, simply don’t know what market access rules the EU will apply to them from next year onward. As of 2021, their European business model depends on the goodwill of the Europeans. Brussels will be able to decide on a whim if it wants to close market access to non-EU countries, including the U.K.
And history shows that the EU is not shy in using its leverage to obtain political concessions. Brussels has threatened to ban EU customers from doing business with the Swiss stock exchange in order to obtain political concessions. These threats and the corresponding legal uncertainty explain why Switzerland’s banking industry has moved many of its services to Frankfurt and Madrid in past years.
Deal or no deal, on Jan. 1, 2021, the U.K. will become the European country with the weakest trade links to the 27 EU member states. The free trade agreement under negotiation does not even come close to the arrangements that Norway, Switzerland, Turkey, and even Ukraine have with Brussels. British exporters will have no better access to the EU market than, say, Japanese or South Korean firms.
So even with a deal, the world will witness a historical anomaly: the purposeful economic disintegration of two liberal market economies in peace time. The decoupling will be painful for both. But for the U.K., whose economy has contracted during the COVID-19 pandemic more than all the major European economies, including Italy and Spain, the coming year will be dire.