We know we are leaving the European Union but we don’t yet know how. The IoD’s head of Europe and trade, Allie Renison, outlines the various options for Brexit and explains what each might mean for British business as it begins to go it alone
On Wednesday 29 March the prime minister will serve notice on the European Union of the UK’s intention to leave. The clock will be ticking down towards the two-year cut-off point when, barring an agreement to extend negotiations, we will leave the EU. Over the last year, since David Cameron formally announced the in-out referendum, Britain has been subjected to wall-to-wall coverage of the issue. The vote generated an almost unprecedented amount of attention, with the spin, claim and counter-claim of political campaigns raised to a new level.
That is all over. Now the real business of negotiations begins on everything from security co-operation to fishing rights, from financial services regulation to migration rules. Having been legally and economically interwoven with the EU for 44 years, we shouldn’t underestimate how fiddly some of these talks will be. Nor can we ignore the political challenge of negotiating with 27 other members, each with its own aims and agenda.
But these challenges are not insurmountable if the UK focuses on constructive negotiations in areas of mutual interest. As a body representing tens of thousands of directors across the UK, we at the IoD see it as our responsibility to put across your needs from the negotiations, and make recommendations to the government on the options for our future relationship with the EU. These are early days, and at this stage it is a good idea to stay open-minded about how to manage the exit process in a way that minimises disruption, and gets us to a place where business can continue to trade and collaborate with companies across the channel.
The Brexit vote signalled that the country wanted to change the balance, with the UK less closely tied to the EU, and more available to look to the rest of the world. We know some of our members are already shifting their focus beyond the EU, and longer term, there are exciting prospects in a more global, outward-looking UK. But getting Brexit right has to be the top short-term priority.
What IoD members think
As with every significant political issue that affects the economy, we have surveyed IoD members several times in the months since the referendum to take the temperature of the business community. We attach huge importance to getting a good Brexit because, after general economic conditions, the current uncertainty over our future trading relationship with the EU weighs heaviest on your thoughts – above crucial business issues including skills shortages, taxes and regulation (table 1, below).
The good news is IoD members are learning to live with the political uncertainty. Business confidence took a knock in the immediate aftermath of the Brexit vote, falling from 62 per cent saying they were optimistic for the next 12 months in March, to 46 per cent in July, just after the vote. Happily, that has rebounded, and by January, optimism had regained nearly all the lost ground, back to 60 per cent (table 2, below).
The fact that the economy has held up well since the referendum, growing faster than the US last year, gives us hope that businesses will hold their nerve during negotiations, rather than aggressively cutting investment and hiring. But for confidence to hold up, companies need to see government pulling out all the stops to smooth the path out of the EU, and clear progress towards a new trade agreement that minimises tariffs and other barriers.
The newly formed Department for International Trade is laying the groundwork for trade agreements with countries such as the US and Australia, which can be formalised post-Brexit. In the short term, IoD members are clear a new trade deal with the rest of the EU – which accounts for almost half of our exports – is the first order of business (table 3).
One of the immediate complications that Theresa May faces by triggering Article 50 is the existence of not one set of negotiations to be conducted, but two. The EU treaties lay out how a country can leave the union, but they are vague on the trading framework that comes after. This is a problem because no country has ever invoked Article 50 before, so there are no precedents to be followed. The UK will have to set one, so our negotiators will need to mix pragmatism with a dash of creativity. We look at what the ‘British option’ might look like in more detail below.
So far the European Commission, the administrative branch of the EU, seems to want to separate these two negotiations. This raises the possibility that we might not be able to start on the trade agreement until the exit deal is finished. Two years is not a long time to complete both sets of talks, especially if we are forced to do one after the other. So the government’s first move must be to talk to the other EU members and strike a deal, ensuring that either both sets are conducted at the same time or that there will be transitional arrangements between the exit deal being agreed and the new trading terms coming into effect. Put simply, it would be very disruptive for business if we left the EU as soon as the withdrawal agreement was signed, without having a deal on our new trading relationship in place.
We could of course negotiate a deal for this new relationship from outside the EU. There would, though, be a steep fall from the current level of deep economic integration, where goods, services, capital and people can move with few barriers, to the base level of trading on World Trade Organisation (WTO) terms while business waited for talks to finish. The WTO has had some success over the years in getting countries to reduce tariffs on imports, and has tried to lower barriers to trade in services (which often come as regulations designed to protect native companies or professions). But it is in no way comparable to the level of access UK firms currently have to EU markets.
We start from a position of full EU membership, and it would be a herculean task for companies that trade with the EU to quickly switch to a WTO basis. It would also seem unnecessarily painful if we plan to sign a new deal on close trade cooperation anyway, as is suggested. So enough time must be left for a trade deal to be agreed. That means persuading the EU to extend negotiations, if necessary, beyond the two-year deadline stipulated in Article 50.
IoD members agree that getting a good deal is much more important than a quick one, but we don’t want the talks to go on forever. So we suggest an extension of up to two years in which we’d continue trading on the same basis. We also don’t want to start the negotiations, with the uncertainty that entails, only to turn back halfway. Politicians from all parties can help here, by ruling out a second referendum in the next parliament.
Once a new trading set-up is agreed with the EU, the government has said there will be an implementation period, giving “businesses enough time to plan and prepare”. This will be essential for business to adapt to the new relationship.
Based on feedback from members, we suggest the government focuses on the following in its negotiations:
• Tariff-free trade in goods – currently there is no charge for exporting or importing to and from the EU. If the EU brings in tariffs after Brexit it would make our exports less attractive, and drive up costs here, assuming the UK reciprocates.
• Minimising customs delays – alongside costs from tariffs, new paperwork or procedures that hold up the movement of goods would be painful for British firms.
• Avoiding discrimination against services exports – minimising the pain for the services sector, which comprises around 80 per cent of the UK economy, is just as important as protecting goods exporters.
• Minimising bureaucratic hurdles to employing EU citizens – around 40 per cent of IoD members have at least one EU member of staff, and it will continue to be an important source of skills. The UK has record high levels of employment and employers are experiencing difficulty finding the right people. Measures to improve the skills of the UK workforce are needed, but they should happen alongside a sensible immigration policy which responds to the needs of the economy.
• Continuing participation in some EU R&D schemes – research in areas such as advanced manufacturing and schemes such as Horizon 2020 is improved by international cooperation, and we will want to remain part of some programmes.
• Maintaining rules on competition – the EU has sometimes been too heavy-handed in blocking state aid (when governments subsidise or protect companies or sectors with regulation, distorting the market), but the UK should maintain the principle that free and fair competition works best.
• Enforcement of contracts – post-Brexit, the UK will no longer be under the jurisdiction of the European Court of Justice, so another method is needed to settle disputes between companies doing business across the new border between the EU and UK. Dispute resolution systems are common in modern trade agreements.
• Stability for regulation – government plans to transpose the EU law into UK law through the great repeal bill. Post-Brexit, the government can look at simplifying red tape, but it should do so in an orderly fashion, so the rules don’t change too quickly, creating disruption.
The way forward
So, how do we fulfil these priorities? During the referendum campaign we were introduced to the Norwegian and Swiss models as potential blueprints for the UK’s future relationship with the EU. Both countries have a close relationship to the EU, without being members. Both, for example, are members of the single market, and follow the rules on product standards and employment that come with that.
The prime minister has made clear that, after Brexit, we will leave the single market. So we will have to look at alternatives. As the only country to have left the EU in this manner, it seems probable we will end up with a new relationship that doesn’t look exactly like that of Norway, Switzerland or any other country.
The government has also said it intends to leave the EU customs union, the agreement that allows goods to move around the EU without checks at internal borders. This always seemed quite likely, as remaining inside would mean the UK accepting jurisdiction of the European Court of Justice, something the prime minister has made clear would be unacceptable.
It is possible to have a customs agreement with the EU while not being a member, as is the case for Turkey. The Turkish deal removes most, but not all of the checks and hold-ups companies face in moving goods, while allowing it to still sign trade deals with countries outside the EU. This situation is different to the UK’s, however, as Turkey is notionally on the path to joining the EU, while we are heading in the opposite direction.
The IoD would support the government in pursuing a new customs agreement with the EU. As a full member, we currently follow the same customs rule as other EU countries. Ideally we should be able to continue on this basis, in return for the EU not imposing lots of new red tape for goods at the border.
A comprehensive free trade deal
Customs procedures and tariffs are only one small part of the issue, of course. The UK has world-class financial, legal and professional services, and ensuring good access to EU markets after Brexit is just as important for them as it is for manufacturers. So it is welcome that the government is pursuing “an ambitious and comprehensive free trade agreement” with the EU.
The price of ambition is that such a deal will be complex and take time to complete. For example, the Comprehensive Economic and Trade Agreement that the EU has finally approved with Canada took eight years to negotiate. The UK and the EU are starting from a position of operating on the same set of rules, which will mean less preliminary work, but the two-year timeframe set out in Article 50 is still very taxing. This makes it all the more important that UK government seeks an early agreement from its EU counterparts that talks can be extended if needed.
For services, trade barriers mainly come in the form of rules on doing business, so the new deal will require close cooperation between the EU regulators in different sectors, such as finance or medicine, and their UK counterparts. Selling services abroad is reliant on key staff being able to move around with few restrictions, and British firms will be greatly helped if the government is able to agree visa-free travel for both UK and EU citizens. This is separate from permanent residence rights.
The new UK-EU partnership deal should be set up as a ‘living’ agreement, taking where we are now as the starting point, but with the potential for the details to change in future as our relationship shifts. As part of the talks, the government should also give strong consideration to re-joining the European Free Trade Association (Efta), which stands one step back from the EU, but could be a useful way to access the other trade agreements Efta has signed with countries such as India.
How can businesses prepare?
Ideally, the government will adopt the important economic priorities outlined above, and give business a road map for a smooth Brexit, avoiding as many bumps as possible. If we get an early accord with the EU that there will be no vacuum between agreeing the terms of Brexit and the new trade deal coming into effect, it will do a great deal to reassure companies. If this is followed by staggered communication on the progress of the negotiations, including agreement on areas such as reciprocal rights for UK citizens living in the EU, and vice versa, there is every chance business confidence can be maintained throughout.
But business leaders do not operate on the basis of hope – they work on calculation using the facts available. We know that many IoD members are already talking to suppliers and customers about the possible effects
of trading disruption, and that some of you are looking at reducing your exposure to the EU, or offsetting it with other markets.
For our part, the IoD will be making the case strongly to ministers for good customs and trade agreements with the European Union. Members should, however, prepare for the worst-case scenario, with the UK doing no specific deal and having to fall back on WTO rules, and facing greatly increased customs requirements. We go into more detail on the preparations you can make in our new paper, Navigating Brexit.
The referendum bombarded Britain with a whole range of jargon and acronyms. This is what are some of the main terms mean
Article 50 Section of the Treaty on European Union (as amended by the Lisbon Treaty in 2007) that sets out how a country leaves the EU. Once the UK notifies the European Council that it wants to withdraw, there begins a two-year negotiating period, after which the UK will cease to be a member. That is, unless the other members agree to extend talks.
European Commission Brussels-based administrative arm of the EU. The commission is led by officials from the different member states, each with a different area of policy responsibility.
European Council Collective term for the heads of state and government of the member states (distinct from the Council of Europe, the organisation that oversees the European Convention on Human Rights (ECHR), which is also open to non-EU members).
European Court of Justice Court that settles questions over the implementation of EU law (not to be confused with the European Court of Human Rights, which rules on breaches of the ECHR).
World Trade Organisation Body which oversees international trade and records the tariffs that countries impose on imports.
Single market Area in which labour, capital, goods and services can move freely (or mostly freely – as with almost everything concerning the EU, opinions on this differ).
European Economic Area Countries have to be in this to be a member of the single market.
European Free Trade Association Loose trade bloc comprising Iceland, Liechtenstein, Norway and Switzerland, none of which are members of the EU (although they are part of the single market through separate agreements).
Customs union Effectively puts a wall around the EU, with goods subject to common external tariffs on entry, but able to move freely inside.
To read Allie Renison’s new report in full visit iod.com/Navigating-Brexit
Allie Renison is the IoD’s head of Europe and trade
Have your say by joining IoD’s Policy Voice via iod.com/policyvoice