Canada-Dry: Where next for UK-EU Brexit talks?

Amid talk of a UK-EU trade deal, many seem to have forgotten that the divorce talks need to happen first. Kirsty Hughes, Senior Fellow at Friends of Europe, explains that both processes are unlikely to run as smoothly as some might like to believe. She notes that Theresa May faces a range of complex challenges in the Brexit negotiations which her speech failed to mention. 

The UK remains on course to trigger Article 50 and start the two-year Brexit process in March. Theresa May’s big speech on her Brexit plans set out the goal of establishing a new UK-EU free trade deal.

What her speech didn’t do was set out any detail on the Brexit divorce deal, which has to come before any new trade deal. But it gave some clarity for the future trade deal: the UK will not be in the single market, it will not stay in the EU’s customs union and it will not stay under the European Court of Justice (ECJ).

The Brexit talks will be like no others: no full member state has ever left the EU (only Greenland, part of Denmark); no complex, expensive divorce deal like this has happened before.

Nor is the EU or any other major trading nation in the habit of doing trade deals that re-introduce, rather than reduce, tariff and regulatory barriers. Yet this is what the future EU-UK deal will by definition do – given both May’s demands, and the EU’s own rules and political stance on the upcoming talks.

Canada-dry anyone?

The Brussels reaction to May’s speech was low-key. Her threats impressed no one. Her apparent wish for special deals by sector are rejected out of hand – both due to the Brussels mantra of ‘no cherry-picking’ and because WTO rules rule out sectoral deals if they aren’t offered to all countries.

But Brussels knows very well how to negotiate a basic third-country trade deal; it’s just done that – after seven years – with Canada (amongst many others). And if that’s the end goal, then there is, at least, some clarity there.

Of course, the Canada trade deal barely covers services. And anyone hoping for a ‘Canada-plus’ deal that gives the UK a better services deal than Canada is likely to be disappointed. The EU27 may offer some form of ‘regulatory equivalence’ to different service sectors. But this is unilateral – a one-way offer from Brussels which can be withdrawn. The EU deal on regulatory equivalence with the US on financial services took four years to sort out.

‘Canada-dry’ is what will be on offer: talks aimed at ensuring almost no tariffs on goods. Getting there will require agreement on handling any regulatory divergence between the UK and EU in future, mutual recognition processes for some goods, procedures for inspecting goods to ensure they do meet EU standards (and vice versa for the UK), and enforcement/dispute procedure rules. Rules of origin will also make a come-back in UK-EU trade – so that third country imports into the UK do not get round the EU’s common external tariff – adding significant bureaucratic headaches to UK-EU trade.

Canada-dry – not so sweet

Such a free trade deal could hit many problems and challenges on the negotiating trail.

Barriers to trade will abound: Currently, forty per cent of UK service sector exports go to the EU. With new barriers in place, these exports will surely fall.

Non-tariff barriers, rules of origin and other customs procedures will undermine those sectors that currently rely on cross-border supply chains, especially those that depend on low cost and just-in-time connections from the UK to other EU member states.

Some sort of border between Ireland (in the customs union) and northern Ireland (outside the customs union) is inevitable – even if it can be managed to the level of camera checks on lorries’ number plates and some random pull-over process on some but not all traffic (as at the Norway-Sweden border – but those two countries are both in the single market).

There is no special customs deal available: The UK as a third country outside the EU cannot be part of the EU customs union, and May says she doesn’t want to be anyway but she will explore some partial deal. The EU view is clear – an individual customs union deal, like Turkey’s could be feasible. But outside the EU’s common external tariff and common trade policy, there is no special deal to be done – just a standard customs cooperation arrangement. Companies with just-in-time supply chains will need to relocate.

Canada-dry or WTO? Ratification of a Canada-dry trade deal is not guaranteed. It is likely to be a so-called ‘mixed agreement’ especially if it adds in foreign policy, security, and other issues – and will require ratification across the EU 27, not just in the Council of Ministers and European Parliament in Brussels. Wallonia almost upset the EU-Canada deal last year.

Trade deals cannot be negotiated quickly. Nor can the EU27 formally negotiate a trade deal with the UK until it has become a third country (presumably in March 2019, after the two year Article 50 deadline for the divorce talks expires). Any talks before that will be informal.

Divorce first, Canada-dry second: And the divorce talks will come first. Whether the UK yet has a detailed list of the complex range of areas that will need to be covered in those talks is unclear – but at this stage hopefully it does. The EU is certainly busy drawing up its own list.

Once it gets the UK’s Article 50 notification, the European Council will need to issue guidelines and principles for the talks. Then the Commission will draw up a more detailed negotiating brief – and take that as recommendations to the Council of Ministers for its agreement. This may all take a couple of months after which the EU27 will be ready to talk.

Ratification before March 2019 – by the UK and European parliaments, and by the European Council – may take up to 6 months. So divorce talks will need to be sewn up in about 16 months – it’s a big challenge, and one where there will be little room for more than outline informal talks on a free trade deal.

Talks will cover budget issues (assets and liabilities) – with figures of a UK bill of €40-60 billion being mentioned, these talks will be tough and bitter. The UK will need to leave a whole array of EU regulatory agencies (from drugs to nuclear material to a host of others) and sort out its own new regulatory processes. The rights of UK citizens in the EU, and EU citizens in the UK will have to be covered. There is much to disentangle.

Getting to a transitional deal looks tricky: Both sides are admitting in occasional statements that some sort of transitional period will be necessary. The EU27 are unlikely to agree this early on – so uncertainty will continue. A transition requires an idea of the final trade deal aimed at; and it requires the divorce deal to be complete.

The EU27 will demand that if the UK wants to stay inside any EU programmes or areas for a transitional period that they will fully respect EU rules, including the role of the ECJ. Will the UK sign up to this or not?

The transitional period might also be staggered – for instance it could take a year for economic actors on both sides to get ready for new customs and rules of origins rules. But it could take four years (or longer) to negotiate a Canada-dry trade deal – and if that deal included tariff-free trade in goods, there would be no point putting tariffs on in the interim period from 2019 on.

The EU will want a clear end-point on transitional arrangements, probably at most four years. So if a free trade deal takes longer than that to negotiate, the UK could still face a cliff-edge, where it has to revert to WTO rules for a few years.

WTO politics too: The UK will in any event have to agree its new WTO schedules for various products that have tariff-quota deals, where the UK is currently part of EU schedules. Experts differ on how straightforward or how potentially complex and political this process could become. Falling back onto WTO trade rules but without having sorted out the UK’s own schedules would be the ultimate Brexit train-crash.

Freedom, what freedom? 

In taking back control, the UK will in many ways lose control. As a third country, it will have no say on EU rules and regulations that its companies and citizens will have to comply with to trade with and in the EU. It will have no say on services regulations or the EU’s offer on ‘regulatory equivalence’.

Theresa May’s threats to introduce defence and security issues into the Brexit talks did not go down well in the EU27. And the more that UK ministers threaten a ‘tax haven’/Singapore-style regime unless the EU offers them a nice deal, the more the EU will insist on guarantees from the UK on issues from social and environmental standards to public procurement and state aid.

The EU27 are not going to sign a trade deal only to find that rather than a reasonably level-playing field, the EU27 are facing a low-tax, low regulation UK.

Can Scotland hope for a differentiated deal?

Amidst this complex divorce followed by new trade negotiations, can Scotland still hope for a separate deal letting it stay in the EU’s single market? This looks increasingly unlikely. Any deal would need to be requested at the start of the talks, since many of the divorce issues (from free movement to regulatory agencies to budget contributions) would need to be factored in from the start, if the aim were a different deal for Scotland within the overall UK deal.

Outside the EU’s customs union, companies in Scotland will face rules of origin and other barriers just as those located elsewhere in the UK – though a single market deal would mean Scotland faced none of the non-tariff barriers that the UK would face. And if a Canada-dry trade deal were negotiated there would be no tariffs on goods, simplifying Scotland-rest of UK trade.If Scotland chose to be independent in the EU, it would be part of the EU’s free trade deal with the rest of the UK. All the differences in non-tariff, regulatory, and enforcement barriers between the UK and EU27 would then apply between the rest of the UK and Scotland.What sort of special deal may be factored in to help Ireland/northern Ireland relations remains to be seen – Scotland should not rely on that deal either being directly replicable (though it might be) or sufficient to ensure smooth continuation of economic relations between Scotland and the rest of the UK.

A hard Brexit and tough talks ahead

There are long and tough talks ahead. Disentangling the UK from the EU is a vast and complex task, even if goodwill is maintained on both sides – and tempers will surely fray at various points.

To the extent Theresa May has now given greater clarity on the direction of travel, many companies will now be looking at their investment plans, and at their supply chains, and deciding whether to choose EU27 destinations in future. Many EU27 citizens will surely take their skills elsewhere. The UK is going to become a more closed economy, May’s rhetoric on a global UK notwithstanding.

On a broader, geopolitical perspective, while the EU grapples with both internal and external problems in its neighbourhood, including the implications of the Trump presidency, the UK will become a more distant, less-involved partner. One thing looks certain: it will be a bumpy road ahead.

Kirsty Hughes is a Senior Fellow at Friends of Europe and sits on the UCL European Institute Advisory Board.

NoteThe views expressed in this post are those of the author, and not of the UCL European Institute, nor of UCL.

This article first appeared on the Centre on Constitutional Change blog as is reposted here with permission.

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