The Brexit Endgame: Will the U.K. Avoid Chaos?

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University of Pennsylvania's Brendan O'Leary and Michelle Egan of American University detail the endgame for Brexit.

Brexit, or the U.K.’s process of exiting the European Union, may get an extension beyond the current start date of March 29, and possibly some guarantees from the EU to help British Prime Minister Theresa May push her proposals through Parliament in a vote on March 12. Those possibilities started to emerge when British Secretary Stephen Barclay and Attorney General Geoffrey Cox met Tuesday in Brussels with the EU’s chief Brexit negotiator Michel Barnier. Though no agreements came of that meeting, more is on tap: May is set to travel to Brussels before for additional talks before the vote.

Barnier had said on Saturday that the EU was ready to give the U.K. further guarantees to help Brexit through the British Parliament, AFP reported. He had also suggested that EU leaders would be amenable to a short “technical” delay beyond March 29, when the U.K. is scheduled to begin the process of leaving the EU, the report added.

Amid the “jostling” that is underway among U.K. parliamentarians ahead of the March 12 vote, the uncertainty over Brexit is unsettling for businesses, said Michelle Egan, a professor at American University’s School of International Service and a global fellow at The Wilson Center. She highlighted the uncertainty businesses face as they wait for clarity on the Brexit process. She noted that businesses are complaining that if the Brexit deadline is extended beyond March 29, they would have “to make accommodations again,” and cope with problems in terms of negotiating trade agreements, foreign direct investments and other impacts on the economy.

According to Brendan O’Leary, professor of political science at the University of Pennsylvania, even as the U.K. economy appears to be “relatively stable” and with low unemployment, economic growth is stagnating. “We can see an ‘investment strike,’” he said. “That investment strike is entirely rational — why invest when you don’t know what your future horizon looks like?”

O’Leary recently joined Egan on the Knowledge@Wharton show on Sirius XM to discuss the implications of the uncertainty over Brexit. (Listen to the podcast at the top of this page.)

The Business and Economic Fallout

Egan said the impact on businesses varies by their size and the markets they operate in. “If you are a local market, and you are a small manufacturing company, the impact may be much less catastrophic than if you are, say, the automotive sector or the health care sector, or one that relies on these integrated supply chains moving products and services back and forth across countries,” she said. “Many businesses are finding that in bidding for contracts or setting things in place, people are hesitant. People are hesitant to say to Britain, or British manufacturers, ‘Yes, we will strike this deal with you, we’ll buy from you, we’ll purchase.’”

Another big factor for businesses is getting in place policies to allow for trade across borders, such as customs clearance and customs documentation requirements, Egan said. For example, they would have to prepare for rules that would stop, test or examine products, particularly in the agriculture and livestock sector, she added.

Egan said that if the Brexit can is kicked down the road, the implications could be disheartening for businesses and investors. Already, some businesses in the U.K. have decided to increase their supplies or shut down for a period until the key issues are worked out, she added. “They were doing this for March, and now they might have to do it down the road.”

More broadly, the uncertainty is hurting the U.K.’s trade relationships with countries outside the EU. Other countries are adopting a wait-and-watch approach until such time that the U.K. actually leaves the EU, Egan said. “People want to see what deal they get with the U.K. This is a chance for countries like Japan, Korea and Canada to say, ‘We don’t want the exact same terms that we have with the EU — we would like to reopen those deals.’”

O’Leary pointed out that the U.K. has had a year of “no net investment.” The Bank of England is preparing for the possibility of that leading to a recession some time down the road, he said. “Most of the warnings that have now been issued by the U.K. civil servants look very bleak if there were to be a hard exit,” he added. “A hard exit without a deal is incredibly improbable, just because [the U.K. is] completely unprepared for it.”

A delay beyond March 29 could also mean that the U.K. could have a vote in the elections to the European Parliament in May, Egan noted. The EU could extract a “financial penalty” from the U.K. for an extension, she said. It could argue that it would allow an extension beyond March 29 so long as the U.K. contributes to the EU’s next budget cycle, she explained.

“Many businesses are finding that in bidding for contracts or setting things in place, people are hesitant.”–Michelle Egan

The ‘Backstop’ Hump

The U.K. and the EU have been struggling to find an acceptable “backstop” solution that would avoid a hard border between the Republic of Ireland and Northern Ireland on the island they share. Brexiteers want that to be a temporary arrangement, and for it to be replaced with alternative arrangements. Under the proposed backstop plan, the U.K. will stay aligned with EU customs rules until they agree on their future relationship or alternative arrangements are worked out.

The U.K. and the EU had agreed last November that in order to avoid a “hard border” between the Republic of Ireland and Northern Ireland after Brexit, Northern Ireland would continue to be aligned with some rules of the EU single market, if another solution is not found before the end of the transition period, a BBC report explained. That would require checks on goods entering Northern Ireland to ensure they met EU standards. It would also mean that the U.K. would stay temporarily in the EU customs union until such time both sides agree to end that arrangement. Brexiteers do not want the U.K. to be subject to EU rules indefinitely, and they want a firm end date to the backstop arrangement.

As uncertainty loomed last week over how best to handle Brexit, May’s latest tack was to angle for an extension of the deadline through a vote in Parliament on March 12. That vote would decide, from the British standpoint, whether the U.K. exits the European Union in a disorderly way without a deal or works to gain a “limited” extension.

Across the Channel, however, the idea of an extension got a chilly reception from French President Emmanuel Macron, who in a recent joint news conference with German Chancellor Angela Merkel, said Britain would have to have good reason for such a delay, presumably an election or a new referendum. Yet another wrinkle came when the U.K.’s  opposition Labour Party announced it would now support a new referendum on the Brexit question.

In any event, the EU considers the May deal as the only possible deal, Wharton Dean Geoffrey Garrett noted in a recent opinion piece. “Any attempt by Britain to strike a fundamentally different deal from May’s will be a) very hard, and b) take a long time,” he wrote.

A Time of Reckoning

“We are at the end of the beginning,” said O’Leary. He noted that May is “gambling on the supposition” that she will successfully persuade the EU that Cox will revise his earlier advice that, even as the Irish customs backstop is not intended to be a permanent arrangement, “there is a legal risk that the U.K. might become subject to protracted and repeating rounds of negotiations.” Those would continue until “a superseding agreement took its place,” such as a trade deal between the U.K. and the EU by the end of 2022. However, that plan faces hurdles — the EU and Ireland have to agree to Cox’s revised advice.

Against that backdrop, the presence of Cox at the Brussels meeting on Tuesday had been viewed as crucial. After all, it was Cox’s advice that the Irish backstop might continue indefinitely that cost May her Brexit vote in January. British MPs at the time had rejected her Brexit deal in an 432-302 vote. As O’Leary saw it, “the probability … is remarkably low” of May being able to use Cox’s revised advice to persuade those MPs who voted against her in January.

“We can see an ‘investment strike.’ Why invest when you don’t know what your future horizon looks like?”–Brendan O’Leary

Meanwhile the Financial Times reported on Wednesday that Cox “admitted there had been no breakthrough in the search for a revised Brexit deal, as he returned to Britain after ‘robust’ talks in Brussels.” He also noted that May would visit Brussels this weekend or Monday in search of breakthroughs before the key vote on March 12, which is just 17 days before the U.K. is scheduled to leave the EU.

The opposition Labour Party’s stated position is that it wants a “new comprehensive UK-EU customs union to ensure that there are no tariffs with Europe, and help avoid any need for a hard border in Northern Ireland.” It remains committed to implementing the 2016 referendum where the Brexit proposal was narrowly voted in, but wants to protect “jobs, rights and living standards” in that process. O’Leary said that as the Labour Party’s “soft Brexit” proposal is likely to be defeated, it would call for a fresh referendum on the subject.

In what is seen as an ill-advised overreach to win over Labour MPs to her Brexit plan, May on Monday announced a £1.6 billion funding boost for deprived British towns. “What Mrs. May has done is to promise to send lots of pork to Labour constituents that voted ‘Leave’ to see if she can buy off 25 or so Labour MPs,” said O’Leary. “It is an overt bung or bribe, on top of the bung and bribe already paid to the Democratic Unionist Party [in Northern Ireland, which supports May’s minority government]. Clearly she is in some desperation and trying to build that coalition.”

Preparing for Delays

Along with businesses, EU member states are also “adjusting” and figuring out what they need to do to mitigate the effects on their economies as the U.K. begins to leave the EU. O’Leary added that Ireland is preparing for Brexit with a bill called the United Kingdom Withdrawal from the European Union Consequential Provisions Act. The Benelux countries (Belgium, the Netherlands and Luxembourg) are taking similar measures, he added.

Egan noted that the EU has published some contingency plans. “They want to make sure that, for example, euro transactions and transactions that are done from the City of London will not destabilize financial markets, and they will continue to allow that for a short period,” she said. The EU would also continue to allow some form of airline cooperation to avoid problems with flights, she added.

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