The Brexit chicken game - Research

At last, there are signs a sense of reality is dawning on the EU’s negotiators about the futility of trying to force the UK to agree to a divorce settlement before talking about trade. However, there are still vestiges of a hope that Britain won’t leave the EU after all. Donald Tusk, the current European Council President, indicated it was still an option as recently as this week, but these hopes are wishful thinking.

It has taken thinly-veiled threats from the UK to leave without a deal, unless actual trade talks commence by next month. You can be certain the point has been made more forcefully to EU leaders in private, as well as at the negotiating table, than admitted in public. The EU’s problem is Brussels desperately needs Britain’s annual net contribution of €8bn, which is almost the entire annual cost of running the Brussels establishment. Brexit is nothing short of a disaster for the EU’s finances, and the EU is desperate for Britain’s money. Therefore, negotiations from the EU’s side have been frozen and unable to move onto the subject of trade. Impasse. A game of chicken, to be lost by the first to panic.

The British negotiators have deliberately presented themselves as willing to be helpful. They have insisted Britain will meet her legal requirements, though they must be itemised and justified. And that will not include funding the broader EU budget, amounting to €238bn on commitments incurred but not paid for, which is the basis of Brussels’ claim on Britain. Nor will it fund Brussel’s own budget shortfall, which is most likely where any money paid over will go first.

Brussels foolishly has made no contingency plans over its finances. Theresa May in Florence offered a transition period of two years, intended to alleviate Brussels’ insolvency problem. There was no mention of a divorce settlement by the British in Florence, because Britain’s legal advice is that there is no basis for such a claim. An offer of a transition period could be delivered by Mrs May, but a settlement without a legal basis for it is out of the question.

The EU’s negotiating position reflects a belief that Britain is considerably worse off without a trade deal. It seems the EU team still didn’t get the message in Florence, so now EU member states are being shown by Britain she is prepared to walk away from a trade deal, and rely on WTO rules. Contingency plans are now being openly discussed in the UK, and even being planned. The effect on 58 different business sectors is being assessed, not on terms set by the Remainers, but more constructively regarding the true situation. These are likely to be released in due course, at a time set by the negotiations. Lobbyists are liable to be side-lined, in favour of more positive messages.

Only this week, it appeared that hard-pressed dairy farmers are finding new export markets for fresh milk in Qatar and China. According to a farmer interviewed by the BBC, he was told by the Chinese it is far easier to negotiate trade with one country than with twenty-seven. While this subtle change in emphasis is taking place, the British strategy is to continue to stress the damage the EU does to itself without free trade with Britain post-Brexit, and that she will continue to work constructively to prevent this outcome. It is likely to be followed next year by a drip-feed of trade agreements with other countries provisionally agreed and ready to be signed.

The success of the British strategy has muted criticism in Westminster from the Remainers. This is obvious in Parliamentary debates, where the House listens to David Davis and finds it hard to criticise his approach without appearing foolish. Sir Kier Starmer, Labour’s Shadow Secretary of State for exiting the EU, has a particularly difficult task leading for the Opposition.

It must be exasperating for committed Europhiles, whose vision for Britain’s future in Europe have been frustrated. This week, a cross-party delegation consisting of arch-Remainers Nick Clegg, Ken Clarke and Lord Adonis, of the Liberal-Democrats, Conservatives and Labour respectively, made the journey to Brussels to meet the EU’s negotiators. They will have been told of the damage that Britain is doing to Europe by leaving. But that’s not an argument easy to sell in Westminster, when the obvious rejoinder is these staunch Remainers care more about the EU than the UK.

The British negotiators have sensibly played down the damage to the EU’s finances in public. They have been careful not to react to provocations from the other side. They are holding their nerve in this game of chicken. The Westminster luvvies have been critical of Mrs May’s botched election and the weakness of her position as Prime Minister, and have unsuccessfully tried to drive wedges between the Remainers and Brexiteers in the Cabinet. What we have witnessed so far is a reasonably successful management of public expectations, which will continue to the point where the British public understands no agreement is an acceptable outcome.

Where do we go from here?

The EU’s problems became magnified by the recent German elections, which reduced Angela Merkel’s authority. It had been assumed by everyone that Germany would make up for much of the loss of revenue after Britain’s leaving, but that must now be in doubt. Increases in the French contribution might be restricted in turn if Germany hesitates.

Reducing costs is not something the EU is familiar with either. Therefore, it seems likely that Britain’s contribution to Brussel’s spending will have to be made up by all the other 27 members, as well as Britain’s share of the EU’s €238bn spending commitments in the member states, which before the Brexit referendum were assumed would be paid.

However, that is no longer Britain’s problem.

The strength of the British position should encourage her negotiators to be patient, relying on signals and avoiding ultimatums. One such signal could well be the delay of the third reading of the EU Withdrawal Bill. The third reading of a bill is the debate over the details in a bill before it passes into law, and over 300 amendments on this one have been tabled so far.

There are two broad purposes behind the bill: the first is to replace EU legislation, so that British consumers and businesses continue to be bound by existing EU regulations after Brexit, and the second is to signal to the EU that trading and manufacturing standards will be maintained to EU standards. Therefore, there should be no practical impediment to free trade with the EU. Delaying the third reading is likely to be projected at the negotiating table as giving Britain the option of amending the Bill in its current form, as a contingency for no deal, to give British manufacturers a competitive advantage in global markets. After all, compliance with regulations in foreign countries is the business of exporters, not governments.

In this game of chicken, it is unlikely the British will back down, and tensions will therefore increase. As Brussels stares into the abyss of insolvency, the British await the detailed invoice for her alleged obligations to be presented. There isn’t one, so it won’t be. Brussels is likely to escalate the war of words in frustration, while the Brits remain cool and upbeat. And the more this process goes on, Brussels will make fools of themselves in the eyes of British voters, and public support for a clean Brexit could move towards totality.

That support will not be restricted to the voting public, but to businesses as well. Manufacturers based on the continent, with lucrative UK markets and supply chains to boot, will urge their governments and Brussels towards a tariff-free deal. The City of London is already changing its view. Banking will remain in London. If you want to distribute investments in the EU, you set up an EU-based subsidiary in Dublin or Luxembourg to do so. And as for EU threats to move euro clearing out of London, they are likely to remain that and no more, because it is market users, not governments, who determine these things.

The City has seen all this before. The Remainers in the City, arguing gloom and doom post-Brexit, are the same people who argued Britain must join the euro, or die watching all European business migrate to Frankfurt and Paris. It didn’t happen, and won’t now. Instead, all the major Eurozone banks upped their presence in London. Most of the noise, about job losses and the rest, was and now is little more than lobbying for the protection of vested interests.

The outcome

Trade negotiations have not yet started, so complex issues, such as the application of most favoured nation rules by the EU in the event of continuing free trade with Britain, have yet to be addressed. Under the WTO’s Article XXIV, preferential rules offered in one free trade agreement between two customs territories should be offered to others with FTAs with the parties concerned. The only free trade agreement the EU has is with South Korea. However, Canada’s Comprehensive Economic and Trade Agreement, which is still provisional, has MFN clauses in it.

These are potential obstacles to a free trade agreement for Britain, but they are not insurmountable. Furthermore, it appears that an FTA can be agreed with Britain so long as the extension of preferences to Canada and South Korea are under discussion. Under discussion with the EU can take forever, and the MFN rules are routinely bent.

It boils down to a willingness between the EU and the UK to continue trading after the customs union is over. There are therefore three potential outcomes.

An agreement is struck at the last moment allowing free trade to continue, perhaps with minor modifications.
Sufficient progress is made to convince Britain that an interim extension of up to two years is justified to finalise agreements.
Britain walks, and relies on WTO rules.

The EU’s vested interests will doubtless lean heavily towards the second outcome, while Britain’s preference is likely to be the first, with the third becoming increasingly attractive. If Britain settles for an interim period, it will be little more than a compromise to give Brussels two years’ worth of fees. That compromise looks unnecessary. The cleanest outcome is to opt for free trade with everyone, free of any tariffs, but at the moment this is probably a political stretch too far.

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