Big Ben

Post-Brexit negotiations: time is running out

The transition period, during which the European Union (EU) and the United Kingdom (UK) can negotiate their future trade relationship after Brexit, expires at the end of 2020. If they fail to reach an agreement, there is a renewed threat that the UK will make a hard exit from the single European market. Time is running out, as neither side appears willing to yield. Is it still possible to reach a ‘bare bones’ agreement?

UK Prime Minister Boris Johnson ramped up the pressure shortly before the start of the latest round of post-Brexit negotiations in early September. Once again, he raised the threat of a hard Brexit. He believes that a trade deal needs to be in place before the EU summit in mid-October so that there is time to ratify it before the end of the year. Although he says that he will do everything possible to secure an agreement, he does not believe that the UK economy would be harmed by leaving without a deal, which would mean following basic World Trade Organization (WTO) rules. Johnson accused the EU of making untenable demands, while the EU’s chief negotiator Michel Barnier said that the UK was being inflexible.

Another problem is that the government in London has proposed a law, the Internal Market Bill, giving it the power to override the Northern Ireland Protocol. This would be in breach of international law. The Protocol is a key part of the main Brexit agreement and stipulates that Northern Ireland will be part of the UK customs zone but all relevant EU single market rules will apply there. The UK government says that if the negotiations break down, the new law will protect the integrity of the UK’s single market. However, the EU regards adherence to the Brexit agreement as a necessary condition for reaching agreement on a trade deal.

Meanwhile, the actual sticking points in the trade talks remain unchanged. The EU’s call for a level playing field and the issue of fishing in British waters are the main points of contention. Union Investment’s economists do not believe that fishing rights will sink the trade deal. The key point is agreeing on a government aid regime for companies that does not breach the EU’s unfair competition rules. It is clear that such an agreement can only be reached if both sides are willing to move their position.

Observers appear increasingly worried that the negotiations could fail. However, Union Investment believes that a deal is in the political interests of both the EU and the UK. There are two reasons for this. Firstly, the EU reached consensus on a recovery plan in July and was thus able to quickly find a solution to a pressing problem. This means that Brussels now has room on its political agenda to devote itself to the Brexit issue. Secondly, the Johnson administration is battling a strong headwind less than a year after its emphatic election victory.

Just a few weeks ago, the government in Westminster still appeared to be planning to let the adverse effects of a hard Brexit get lost amid the collapse of the UK economy triggered by the coronavirus pandemic. This now looks almost impossible. Although the UK economy slumped by 20.4 per cent in the second quarter compared with the previous quarter, thereby contracting more than any other industrialised country’s economy, signs of economic recovery are emerging in the UK.

Deeper economic slump in the UK than in any other industrialised country in the second quarter of 2020

Real gross domestic product in the second quarter of 2020
Deeper economic slump in the UK
Source: Macrobond; As at 15 September 2020

Moreover, Boris Johnson urgently needs success on the domestic political front because his reputation has been severely dented by his mismanagement of the coronavirus crisis in the UK. The negative consequences of a hard exit from the EU would primarily hit poorer constituencies that traditionally vote Labour. In the last election, Conservative candidates only won in these areas because people supported Brexit. If they are particularly affected by economic turmoil created by a disorderly departure from the EU, the Conservatives would be at risk of losing their new-found majority again. Johnson therefore needs to reach a trade deal with the EU in order to avoid these negative effects.

If an agreement is reached – which Union Investment’s economists still believe will be the case – it will only be rudimentary, however. There is not enough time for a more complex deal. This means increased costs for companies on both sides of the Channel, but they are likely to be higher on the UK side. The main companies affected would be manufacturers of clothing, electronic equipment and optical devices as well as providers of postal and telecommunications services. Another good example is the chemical industry, which would suffer particularly badly. The chemicals used in the UK are registered in the EU. In future, they will have to be registered in the UK as well. UK companies require a letter of access in order to purchase the information about the substances that is needed for the registration process, and they have to do this for each individual chemical used in, for example, the UV filters found in sunscreen. The cost per chemical substance can be as much as €340,000. Furthermore, companies will inevitably have to make changes in their sales markets and supply chains.

Tariffs are not the only costs that will be incurred as a result of Brexit – example of the chemical industry

Cost of the letters of access for UV filters used in sunscreen

Tariffs are not the only costs
Source: Financial Times; As at 15 September 2020

Union Investment’s economic outlook for the UK is therefore muted, even in the event of a ‘bare bones’ trade deal being reached. Another negative factor beside the unknown outcome of the trade talks is that the deterioration of the labour market situation is likely to take its toll on consumer spending. The fallout from the pandemic is expected to hit the labour market even harder in the autumn and winter of this year, above all because the job retention scheme expires at the end of October 2020.

In this environment, it is likely that the UK and EU will sign a trade agreement at the last minute in order to avoid an even worse economic scenario. Provided that the two sides trust each other, it is also conceivable that the most important parameters – such as tariff exemptions – will be implemented on the basis of such an agreement as a first step, followed by the phased introduction of other, non-tariff-related arrangements.

 

As at 15 September 2020