Bri­tain ne­go­ti­ates its EU exit with a weak hand

The Pak Banker - - OPINION - Leonid Bershidsky

As the UK's new prime min­is­ter, Theresa May, met with Chan­cel­lor An­gela Merkel of Ger­many on Wed­nes­day to open in­for­mal Brexit talks that Euro­pean Union lead­ers in­sisted would not take place, the key ques­tion con­cerns the strength of the ne­go­ti­at­ing po­si­tions.

Both May and Merkel are no-non­sense lead­ers, and their in­ter­ac­tion won't be driven by emo­tion: It'll be about how much the EU and the U.K. need each other. Those fa­vor­ing the UK's with­drawal of­ten as­sumed that the EU would even­tu­ally al­low Bri­tain ac­cess to the com­mon mar­ket with­out also re­quir­ing un­fet­tered free move­ment of la­bor.

The U.K., they have pointed out, is the world's fifth-big­gest econ­omy and the ninth-big­gest ex­port econ­omy -- who would want to worsen the terms of trade with a part­ner this big?

It would only be that sim­ple, how­ever, if Bri­tain agreed to an off-theshelf op­tion -- Nor­way-style mem­ber­ship in the Euro­pean Eco­nomic Area, which im­poses many EU rules and fi­nan­cial obli­ga­tions but gives ad­her­ents an "emer­gency brake" on the EU's "four free­doms" -- the free move­ment of peo­ple, goods, ser­vices and cap­i­tal. Such a deal would be rel­a­tively easy to ne­go­ti­ate be­cause it wouldn't re­quire much change from the sta­tus quo, but Brex­iters might not ac­cept it.

EEA coun­tries -- Nor­way, Ice­land and Liecht­en­stein -- have been tak­ing in more immigrants from EU na­tions than the U.K. rel­a­tive to their pop­u­la­tion.

If the ready-made so­lu­tion is not ac­cept­able, Europe and the U.K. will need to ne­go­ti­ate a trade deal from scratch. One could ar­gue that the U.K.'s trade deficits with the EU's big­gest economies -- Ger­many, France, Italy, Spain, Poland and the Nether­lands -- would be a pow­er­ful ar­gu­ment in fa­vor of giv­ing Bri­tain good ac­cess terms be­cause these coun­tries would sup­pos­edly de­rive greater ben­e­fit from con­tin­ued free trade than the U.K. would. Yet this sur­plus is in goods alone; for some of the U.K.'s trad­ing part­ners, losses in that areas could be eas­ily off­set by gains from ex­clud­ing U.K. ser­vices ex­ports. Bri­tain has big ser­vices trade sur­pluses with most EU coun­tries (France and Spain are ex­cep­tions be­cause they are big tourist des­ti­na­tions for Bri­tons). The ne­go­ti­a­tions will have to go sec­tor by sec­tor, and there will have to be com­pro­mises and trade-offs -- some prob­a­bly painful to the U.K., be­cause, on ag­gre­gate, it prob­a­bly has more to lose from bar­ri­ers with Europe.

Last year, Open Europe, a re­search or­ga­ni­za­tion with branches in Brus­sels and Lon­don, at­tempted to cal­cu­late Brexit's im­pact on the U.K. ex­port sec­tors. Here is a ta­ble that sum­ma­rizes its con­clu­sions:

In some sec­tors, such as au­to­mo­tive, Europe's big­gest na­tions are vul­ner­a­ble to the pos­si­ble shrink­age of the U.K. mar­ket. Ger­many had a sur­plus of 28.3 bil­lion eu­ros ($31.1 bil­lion) in au­to­mo­bile trade with the U.K., and the auto in­dus­try can't be ig­nored by Merkel given its huge lob­by­ing power in Ber­lin. There's no telling how a pos­si­ble 10 per­cent tar­iff on these im­ports could re­duce sales, and Ger­man car com­pa­nies rely on in­te­grated Euro­pean part sup­ply net­works that would be dis­rupted by cus­toms bar­ri­ers. Ger­many and, to a lesser ex­tent, France, which also has a car trade sur- plus with the U.K., would be in­ter­ested in keep­ing the cur­rent terms.

That is prob­a­bly May's strong­est bar­gain­ing chip -- but it doesn't mat­ter to most EU coun­tries as much as it does to Ger­many and France, and a deal would need the con­sent of all re­main­ing 27 union mem­bers. Tar­iff­free car im­ports to the U.K. mar­ket wouldn't be as valu­able to Europe as the ab­sence of bar­ri­ers to in­sur­ance and fi­nan­cial ser­vices would be to the U.K. Ser­vices make up about 40 per­cent of the U.K.'s to­tal ex­ports, and 37 per­cent of that goes to other EU coun­tries. But the U.K.'s po­si­tion could be eroded. Lon­don is a tra­di­tional fi­nan­cial cen­ter that at­tracts in­ter­na­tional banks. Once bankers con­sider other op­tions -- and they are al­ready do­ing so -- Ger­many, Lux­em­bourg and Ire­land could rel­e­gate the City to the role of an off­shore cen­ter with­out full ac­cess to the Euro­pean mar­ket.

The po­ten­tial dam­age to the U.K. fi­nan­cial sec­tor takes away much of May's bar­gain­ing power, and both she and Merkel know that be­fore talks even be­gin. The U.K. can hardly go into sec­toral ne­go­ti­a­tions with the EU with­out hav­ing de­vel­oped some kind of so­lu­tion for the City. That in­creases the pos­si­bil­ity of an off-the-shelf deal, no mat­ter how much anti-im­mi­gra­tion Brex­iters hate it.

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