The good, the bad and the ugly of the Brexit deal

Now that the European Parliament has voted to ratify the trade deal between the European Union and the United Kingdom, which was already in place provisionally, it’s worth taking a look at the first few months of its implementation, what’s good about it, what’s problematic, and where things could be improved.

The good:

Just before Christmas, the EU and the UK agreed an eleventh-hour deal on their future relationship. This came days before January 1st 2021, when the UK, which had already left the EU formally at the beginning of 2020, lost full market access to the EU as it then also left its customs union.

The major benefit of having a deal, as opposed to the dreadful “no deal” scenario, is that tariffs and quotas on EU-UK trade are avoided, at least for now. There are some important caveats here, however, which are outlined under the “bad” aspects of the deal.

Another good aspect of the deal is that the UK will be able to conduct its own trade policy. This means that the UK will in theory be able to agree trade deals with countries that the EU has failed to agree a deal with. Open Europe, the British think tank which I used to represent in Brussels between 2008 and 2020, has estimated that the greatest opportunities for more trade for the UK are with India, Canada, and Israel. Of course, also a U.K-U.S deal would be a great success, provided both sides can put aside at least some of their protectionist instincts when it comes to agriculture. UK trade success may in turn also put more pressure on the EU to close trade deals.

A key benefit of Brexit is that it will unleash at least a degree of regulatory competition. From now on, the UK is able to opt for different approaches when it comes to regulating chemicals, data and financial services. The UK managed to avoid the EU’s attempt to force it to “dynamically align”, which would have meant that the UK would be forced to take over all relevant EU regulation, as is the case for Norway, Liechtenstein and Iceland, even if the UK will no longer receive 100% of the market access these three non-EU states enjoy.

For years, Britain has been frustrated by the EU’s tendency to come up with ever more burdensome regulations that were decided under the pretext of opening up trade. Simply scrapping protectionist elements in national regulations or mutually recognizing each other’s regulations could have done that trick as well.

Regulatory competition is a good thing for Britain. However, it also benefits the EU. Whenever the EU considers to come up with a new regulation, people will warn not to make it too stringent, as this may risk becoming less competitive than the UK.

In this way, regulatory competition should prevent quite a bit of innovation-hostile regulations, of course in theory and over the longer term. To have competitive approaches can lift up everyone, which has been evident in the Covid crisis, where the EU was put to shame in the light of Britain doing it better. In that respect, a good case can be made that if the UK would still have been an EU member state, it would have been harder to resist staying out of the EU’s joint procurement scheme, which has led the UK government presenting the UK’s speedier vaccine administration as a Brexit win.

An important brake on “regulatory competition” is that the deal foresees that countermeasures may be imposed after all, following an arbitration procedure, if it could be demonstrated that regulatory changes have caused “significant divergence” carrying “material impacts on trade and investment”, when it comes to labour or environmental rules, or alternatively subsidy control. That’s quite a high bar to disable regulatory competition, which is good. Also, when it comes taxation, both parties are largely free to do as they please. However, we’ll still need to see what these so-called “non-regression” guarantees will mean in practice. Initiatives like low-tax and low-regulation “free ports” should definitely be easier for the UK to implement now than when it was an EU member state.

Even if any significant UK divergence would somehow be reined in by the EU’s “non-regression” guarantees, we will still witness material regulatory divergence. This because the European Commission simply cannot stop itself from issuing ever more intrusive regulations. The latest plan is to ban “unacceptable” uses of artificial intelligence, which according to industry voices, involve “unhelpfully vague” “loose definitions like ‘high risk’” and amount to “an ambiguous, tick-box approach to regulation that is overseen by individuals who may not have an in-depth understanding of AI technology”. In case the UK opts not to follow this approach, which reminds of the EU’s GDPR rules, which are “getting in the way of digital innovation” according to Axel Voss, a leading German MEP belonging to Angela Merkel’s CDU, there is nothing the EU can do, given that this is obviously not covered by “non-regression”, as the UK hasn’t done anything.

In any case, it is a good thing that it will be an independent arbitration court, chaired by someone who’s neither an EU or UK citizen, to make this crucial decision whether tariffs can be imposed or not, and not the top EU Court, something which the EU had been pushing for. The EU’s excuse to do so was to avoid that no other judicial instance than the ECJ would make final interpretations of EU law. According to some, there is still a possibility that the ECJ will make trouble over this. Fundamentally, however, it’s downright bizarre for the EU to have attempted to impose the ECJ as an arbiter. Imagine if the United States were to push the U.S. Supreme Court forward as the arbiter to resolve EU-US disputes in the context of an EU-US trade deal. The failure of the EU to do so may have implications for the EU-Swiss relationship, where the EU may now be forced to drop a similar demand to let the ECJ serve as the judicial arbiter, something which the Swiss resist. Also in Norway, leading opposition figures have already called it a better deal than the one Norway has. If this dynamic ultimately increases trade openness and regulatory competition on the European continent, that’s a good thing.

Furthermore, it is also good that a deal was reached on fisheries access, as many jobs on both sides of the Channel depend on this, with also UK fisheries strongly relying on their ability to export to the EU.

Another nicety is that the wasteful EU budget will now be deprived of the annual estimated 10 billion euro net contribution coming from the UK. This is not just a saving for UK taxpayers, it also is a good thing for EU citizens, as it slightly reduces EU funding, which tends to prop up autocratic tendencies in Eastern Europe, crony special interests in agriculture or organized crime, while hurting, rather than benefiting the countries that are net receivers, according to a 2016 CEPR study, which concludes that “EU structural funds [are] negatively correlated with regional growth”.

Last but not least, the avoidance of “no deal” is also good for Northern Ireland. The current tense situation is partially the result of the provision in the Northern Irish protocol to have more regulatory and customs checks between Great Britain and Northern Ireland, which nevertheless continues to remain an integral part of UK customs territory, in order to avoid a hard border between Northern Ireland and Ireland. While accusing the UK of dragging its feet to implement these checks, the EU has begun legal action against the UK over its alleged breach of the NI Protocol, which as opposed to the rest of the Brexit deal is subject to the ECJ.

Recently, a softening of the tone has been visible, as the UK has also provided more specifics on how it will implement checks. At the end of the day, the EU will simply need to accept that plaguing trade between Northern Ireland and Great Britain with bureaucracy “to prevent goods slipping into the EU single market”, does not make any sense when the ports of Antwerp and  Rotterdam, the big access gates to the EU’s single market and customs union, are “leaking like a sieve”, according to Antwerp’s Mayor, as only about 1% of containers is being checked.

According to Northern Ireland’s chief vet, Northern Ireland is currently doing more checks on products of animal origin moving across the Irish Sea – between Great Britain and Northern Ireland – than France at its external border, also specifying that his staff are doing 325 documentary checks every day and Rotterdam, one of the busiest ports in the world, is only doing 125.

In sum, the EU acquiescing to very modest intra-UK checks is the wisest option here.

The bad:

The Covid crisis has masked it to a degree, but the new regulatory framework for EU-UK trade that entered into force from January, is truly burdening businesses and consumers with a lot of new bureaucracy.

First of all, there are the burdensome rules of origin” requirements.  Goods only escape tariffs if it is certain that a satisfying percentage of these goods derive from either the EU or the UK. Chinese goods imported into the UK and only undergoing minor changes in order to then be exported to the EU do not qualify for an exemption from tariffs. This is defined by the so-called “rules of origins”.

Secondly, a whole lot of new customs bureaucracy, including export declarations and import declarations, is now plaguing EU-UK trade, hitting online retailers and their consumers, for example, also due to the new arrangements for VAT, which is already burdensome without Brexit. For Flanders, which has intense trade with the UK, the damage has been felt, as exporting to the UK is estimated to have become 5 percent more expensive. This while the UK hasn’t even fully activated all of the new trade bureaucracy.

Thirdly, even if goods comply with “rules or origin” requirements and all customs bureaucracy, they may still face tariffs in case an arbitration panel deems that the UK or the EU have violated their regulatory “non-regression” duty. 

Fourthly, even if goods comply with customs bureaucracy, they may simply not comply with EU single market requirements, which causes market access to be restricted. This has been a big problem for the UK’s fisheries industry, as for example Scottish fishermen have been struggling to get their fish to the EU market. If nothing changes, permanent market damage may be done.

A major downside of the fact that the UK has not become some kind of “fax democracy”, as former Norwegian PM Jens Stoltenberg once called his own country, which is forced to take over all relevant EU rules, is that the UK no longer has the same market access as before.

First and foremost, this is an issue for financial services.

Even if the City of London, together with New York the world’s leading financial center, only has 25% of its trade with mainland Europe, and even if, within the EU, services trade has not been opened up as much as goods trade, this is a step in the wrong direction. In early January, it emerged that suddenly, not less than 6.3 billion euros in stock trading that took place in London was shifted to EU trading venues. This amounts to 45% of the volume of stock that would have gone through the City of London. Think tank “New Financial” estimates that Brexit has now led to more than 440 UK financial services providers to the EU, mostly benefitting Dublin (with 135 relocations), ahead of Paris (102) Luxembourg (95), Frankfurt (63) and Amsterdam (48). Also more than £900bn in bank assets, worth roughly 10% of the entire UK banking system, are being moved. In job numbers, however, New Financial considers this “relatively small”, while specifying that “the bigger issue is not so much jobs leaving the UK but new jobs in the EU being created in future that might otherwise have been created in the UK”.

An important element to mention is of course that refusing to grant the UK regulatory equivalence ultimately also hurts many EU companies in need of liquidity, which has become more pressing due to Covid. Despite Brexit, London remains the EU’s financial artery.

Many decisions on market access for financial services still need to be taken, and it’s likely to remain very political, despite an agreement in March to create a “Joint UK-EU Financial Regulatory Forum”.  The French government just threatened to restrict City of London market access to the EU, stating  “retaliation measures” are possible if the UK does not “deliver licenses [and] authorisation to access their waters for fishing”. European Commission chief Ursula von der Leyen has issued a warning on her turn that  “we will not hesitate to use” trade tools against the UK, which are foreseen in the EU-UK trade deal, “if necessary”.

Also non-financial services providers – from ski instructors to musicians – will be face a lot more restrictions from now on, unless the EU of course loosens up, as it should. Lacking are proper mutual recognition of professional qualifications or solid provisions for temporary movement of services suppliers, particularly intra-corporate transferees. Then, given that EU countries are already very protectionist towards other EU member states, it’s unlikely they will be keen to reopen business with the UK anytime soon, even if this all hurts EU consumers.

The end of uncontrolled freedom of movement provides the UK with a greater ability to control migration and the extent to which people have the right to social benefits. If only the UK had been allowed to impose some more control over this, Brexit may not have happened. It remains to be seen in practice how high the hurdles will be for EU citizens to move to the UK and for UK citizens to reside in EU, when things have settled down, but that they face a lot more bureaucracy, is a certainty. UK proponents of restricting freedom of movement from the EU have maintained, that this will ultimately deliver more solid support of migration in the UK. There is some justification to be found for that. According to 2018 Open Europe polling, 56 per cent of British agree with the idea of “controlled migration” while only 36 per cent support simply “reducing the numbers of people coming into the UK”. If the UK government follows this, UK restrictions for EU citizens should be modest, all in all.

The ugly:

The first few months of “real Brexit” have been rather rocky, which was compounded by the Covid mayhem. Things seem to be improving, however. UK exports to the EU have recovered significantly from their January fall, even if they still remain below the levels of 2020. Imports from the EU still haven’t rebounded significantly, although some are optimistic they will.

Some barriers will be dealt with, either through softening implementation or through industry adaptation. Other barriers will be here to stay and only new agreements between the EU and the UK will be able to tackle them.

Free trade is about trust. In an ideal world, industrialised countries should simply trade each other without restrictions, while mutually recognizing each regulations and even scrapping any restrictions on migration, provided that there aren’t any big risks of excessive migration flows.

In the real world, however, trade is heavily regulated, and to open it up requires making messy trade-offs. Sometimes, adopting heavy regulation for the sake of preserving trade makes sense, for example in the case of the UK maintaining EU REACH chemical regulations in place, to not disrupt the chemical industry. In other cases, for example when the EU would come up with a much more burdensome variety of those REACH regulations, that trade-off may alter. Market access to the EU may no longer be worth complying with the new burdensome rules.

Looking from that perspective, the deal isn’t bad, but there are clearly opportunities to improve it.

An obvious place to start are to tackle the new “non-tariff barriers” now plaguing EU-UK trade. As Financial Times journalist Peter Foster sums it up: “a bureaucratic curtain has descended.”

Here, both sides can and really should make an extra move.

However, one EU official was quite straight about it, when telling the FT:

“You can’t expect the UK to remain the food import hub for the EU. It’s not sustainable, and makes no sense in the mid-to-longer run.”

This summarizes what we’re up against: deep-seated protectionist instincts, assuming there is no cost to imposing all kinds of trade barriers, while merely looking at the short term benefits of shielding certain industries, ignoring the opportunity cost.

Are British sausages now so much more dangerous than when the UK was a member of the EU? Obviously not.

Agriculture and fisheries have become a focal point of where the EU-UK trade framework could be improved. Some in the UK would be all right with aligning UK agricultural standards to those of the EU. The idea here is that this would alleviate a lot of the trade bureaucracy and non-tariff barriers for fisheries and agriculture, while the UK wasn’t going to diverge much in this area from EU standards anyway. The main drawback would be that this would make it hard to agree a deal to open up agricultural trade with the U.S., but then the question is if this wasn’t going to be hard anyway.

This is more or less what the Swiss have agreed with the EU, even if Swiss-EU agricultural trade is burdened with tariffs, unlike UK-EU agricultural trade.

An alternative, which would respect the current British government’s sovereignty concerns, would be to exempt EU-UK trade in this area from health certificates or inspections, something similar to the arrangement New Zealand has with the EU.

Mutual recognition should go further than just agriculture or fisheries. It could also include recognising conformity assessments – with the EU accepting certificates by UK-based testing labs that UK produced products meet EU requirements.

In a nutshell, a whole lot of messy deals and trade-offs will need to be made, in order to protect and stimulate trade as much as possible. Perpetual EU-UK negotiation is now the way forward and the full entry into force of the “EU-UK Trade and Cooperation Agreement” is only the first step.

Already in 1496, London and trade powers on mainland Europe agreed a trade deal, the so-called “Intercursus Magnus“, which went very far for the standards of that period, bolstering economic ties.  Even if the EU-UK trade deal imposes new hurdles on trade, instead of scrapping them, it forms a good basis to refuel the EU-UK trade relationship, now however in a context of regulatory competition, something which will ultimately prove a boon to innovation.