How to get a Brexit deal (if the UK wants one)

Hardly a week goes by without confirming my suspicion that Brexit is revealing the extremism that hides beneath the UK’s reputation for calm reasonableness. But Prime Minister Boris Johnson has not yet used up his ability to shock.

The government’s announcement that it will violate the treaty Johnson himself won an election for and entered the country into only eight months ago is the international norm-exploding equivalent of last year’s unlawful prorogation of parliament. It is also deeply mendacious to claim that the EU withdrawal agreement and its Northern Ireland protocol was premised on a future relationship deal being agreed — it was, in fact, written precisely to cover the possibility that there may not be one — or that its consequences were unforeseen.

But it bears remembering how last year’s stand-off with parliament ended: with Johnson respecting the law (on both prorogation and a Brexit deadline extension) and conceding to EU demands for the withdrawal treaty while proclaiming a great negotiating victory.

What the man has done in the past seems the best guide to what he will do now. This is someone who wants power first, adulation second, and who prioritises being liked by those on whom his power depends most. That remains the ultra-Brexiter contingent of his party who, in turn, seem more taken with performative politics than substance (otherwise, they would not have celebrated the withdrawal agreement they now criticise). I doubt that Johnson wants an outcome — no trade deal — that in one fell sweep would devastate UK farmers, fish exporters and auto manufacturing workers. My guess — nothing more — is, therefore, that this week’s acrobatics, deeply damaging as they are, will primarily serve as domestic political cover for making concessions in order to get an agreement with the EU.

If this is right, the question becomes what a compromise could conceivably look like. The two big outstanding issues are fish and state aid rules for company subsidies. Fish is the more manageable one: a question of dividing scarce resources is something where two parties can meet in the middle.

The harder nut to crack is state aid. Here both sides have incompatible positions that seem irreconcilable. The EU wants to prevent the British from using state subsidies to unfairly improve UK companies’ competitive position against EU ones. The UK does not want another jurisdiction to constrain its industrial policy. The two sides are also far apart on the substance of their preferred state aid rules: the EU’s regime is by default restrictive — state aid needs justification and advance approval — whereas the current UK government seems much more tempted to subsidise businesses it likes.

The seed of a solution may lie in the withdrawal agreement’s Northern Ireland protocol. It obliges the UK to comply with EU rules for any state aid measures “which affect trade” between Northern Ireland and the EU — but only those. This delineation was always going to be difficult and contested, but it could also be a basis for satisfying the legitimate demands of both sides: preventing UK state aid that distorts trade in the EU’s market, while leaving the UK free to do anything it likes if it does not create unfair advantages for British companies exporting to the EU.

As a starting point, consider the following purist model that would extend the Northern Ireland protocol’s delineation to trade between the UK as a whole and the EU. Assuming for the moment — admittedly a huge assumption — that a definition can be agreed on what distorts trade with the EU, let anything on the distorting side of the line be subject to EU state aid rules, and let the UK do whatever it wants on the non-distorting side of the line. (A refined version would be a homegrown but equivalent state aid regime for the EU trade side of the line and something a bit more constrained than complete discretion on the domestic side.) What would be the implications of such an agreed “dual regime”?

Politically, it could work for Johnson’s government once it decides to switch back from provocative to celebratory mode. It could explain that it takes back full sovereignty, but that, of course, exporters to the EU have to comply with EU rules also on state aid — just like their exported goods must satisfy EU regulatory standards. After all, nobody argues that having to meet EU requirements on goods sent there infringes UK sovereignty. For the EU, it would prevent unfair advantages for British companies in the European single market, even if it could not stop the UK from gaining an advantage by subsidising its exporters in third markets (though those third markets might). Nor, of course, could it limit whatever industrial policy the UK would pursue domestically.

Economically, however, this would add further costs to UK businesses. Because trading with the EU — potentially even indirectly — would exclude companies from a presumably more generous UK state aid regime, some UK businesses may opt to withdraw from the EU market (and from sales that are deemed indirectly to affect EU trade) altogether, or limit themselves to exporting either to Europe or to other regions only, or split up into separate entities for the two purposes, or relocate production for the EU to an EU country. This would be messy and costly. But the mess and its costs would be of a piece with the readjustment Brexit is already going to cause.

A final implication is that this would hit Northern Ireland particularly hard because of the region’s closer entanglement with the EU market. But that, too, has always been the logical consequence of a wider British divergence from the rest of Europe. Since Johnson’s Conservative and Unionist party has proved it is neither conservative nor unionist, this should not come as a surprise.

All of the above assumes agreement on the most difficult issue of all: how you define what affects EU trade, and, just as important, who gets to decide this and how. That question is, of course, at the heart of this week’s political pyrotechnics, and the EU will need even greater reassurance now on ironclad dispute resolution and enforcement mechanisms. But look at it the other way round: if an understanding can be found on how and where to draw and enforce the boundary, it is easier to see how the rest could fall into place. If the relationship talks are going to be successful, this, it seems, is where the work needs to be concentrated.

Other readables

  • The New York Times surveys the surge in US food insecurity and finds that one-third of American families with children report not having enough food.

  • Brad Setser explains the latest patterns in international trade, by far the biggest element of which (“decoupling” be damned) is the $1tn asymmetry in China-US trade.

  • Even if Europe avoids another coronavirus downturn and the recovery continues, much damage has already been done to corporate Europe. In a column this week, I argue that a big recapitalisation programme for European businesses is urgently needed.

Numbers news

Line chart of $ per € showing Euro shies away from the $1.2 level

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