November 2017

By Pero Jolevski

“Brexit,” the June 2016 public referendum by the UK electorate to leave the European Union, has raised serious questions about the future of the country’s economic relationship with the EU. As a member of the EU, the UK currently enjoys free trade with, and open access to, the markets of its fellow EU member states—as well as non-EU member states that have established free trade agreements with the union.

Amid mounting concerns about this uncertain future, the UK Parliament recently passed a motion ordering Prime Minister Theresa May to release 58 “secret studies” that were conducted to assess the economic damage that could occur as a result of Brexit. Already, UK suppliers of industrial goods for export are struggling to secure contracts past March 2019 with their EU trading partner companies, causing supply chain issues. According to a study by the Chartered Institute of Procurement and Supply, 63 percent of EU supply chain managers who work with UK suppliers said they expect to move some of their supply chain out of the UK as a result of Brexit, while 40 percent of UK companies said they are looking to replace their EU suppliers.

The question now is, how will the UK choose to structure its economic and trade relationship with the EU, post-Brexit?

One scenario would see the UK join what is known as the European Economic Area (“EEA”), an agreement which provides for the free movement of persons, goods, services, and capital within the “European Single Market” (the 28 EU member states, plus Iceland, Liechtenstein, and Norway), including the personal freedom to choose residence in any country within the area. An EEA would ensure continued regulatory harmony between the UK and the EU, including tariff-free trade.

While this scenario is seen as offering a less disruptive transition for the UK, joining the EEA would also cede significant control over the UK’s affairs to Brussels, a prospect that is deeply opposed by Brexit’s original proponents. A more restrictively structured EEA would exclude financial services from the agreement, which would result in UK financial institutions having to establish subsidiaries outside of the UK in order to continue to conduct business with the EU, and vice versa for EU banks without subsidiaries in the UK.

Another, albeit more complicated, trade deal scenario would see the UK leave the EU but remain in the what is known as the European Union Customs Union (“EUCU”), similar to Turkey’s status as a non-EU member. While the EUCU sets the tariff rates for imports to the EU from other countries, the UK’s financial services sector, which accounts for over 7 percent of the country’s GDP, would find itself in a disadvantageous position because the EUCU excludes the services industry.

The UK could also negotiate a stand-alone trade deal with the EU, similar to the European Free Trade Association (“EFTA”), a regional trade association and free trade area between Iceland, Lichtenstein, Norway, and Switzerland. EFTA operates with the EU and its members are part of the European Single Market, in which the free movement of goods, capital, services, and labor—the “four freedoms”—are protected. However, EFTA members are not part of the EU Customs Union.

Nevertheless, a stand-alone free trade deal the likes of EFTA would give more negotiating power and flexibility to the UK. With such a deal, the UK would not have to be part of the EEA and, as an alternative, could negotiate a series of bilateral agreements with the EU enabling it access to the internal market. Doing so would also enable the UK to maintain its “invisible” boarder (no checkpoints or immigration controls) between Northern Ireland and EU member state Ireland.

In the event that no formal, structured economic relationship between the UK and the EU is becomes feasible, the World Trade Organization’s rules for cross border trade would take jurisdictional relevance. However, such a scenario would seriously damage British exporters, given the complex tariff and tax rules that would ensue.

There continues to be significant uncertainty regarding the future of the UK’s trade and economic relationship with the EU. Remaining in the European Single Market until a potential comprehensive trade deal with the EU can be hammered out would be among the most efficient and least detrimental of options to the UK economy.

At the present juncture, the next step is for the UK government to propose an option on how to move forward.