Penn's Brendan O’Leary and American University's Michelle Egan discuss the challenges facing the Brexit negotiations.

British Prime Minister Theresa May last week set the precise moment that the U.K. would leave the European Union — March 29, 2019 at 11:00 p.m. — the two-year cutoff date after March of this year, when the British government officially conveyed its Brexit decision to the EU.

But as the U.K. becomes increasingly mired in the difficult issues surrounding its exit from the European economic and monetary union, to many, May’s 16-month timeline is starting to look overly optimistic. (Indeed, May faced pressure from her own party to scrap the exit date shortly after proposing it.)

Three critical questions remain to be resolved before the next stage of the negotiations, according to Brendan O’Leary, professor of political science at the University of Pennsylvania. One has to do with protecting the rights of British citizens living in the E.U. and E.U. citizens who reside in the U.K. The second is to adhere to the Good Friday Agreement between Northern Ireland and the Republic of Ireland, and prevent a hard border dividing from them after Brexit. Leadership in Northern Ireland want to find a way to remain in the E.U. single market and the Customs Union; the majority of voters there cast ballots in favor of staying in the E.U. during the June 2016 Brexit referendum. The U.K. has resisted the authority of the European Union’s Court of Justice in resolving disputes, and said that it will subject itself only to British law after it leaves the E.U.

“Thirdly, there’s the price of the divorce, and we were talking roughly of a gap between 20 billion and 60 billion [euros],” or between $24 and $70 billion, said O’Leary. The EU wants the U.K. to pay that yet-to-be-finalized settlement amount to honor obligations it has signed to finance five-year projects within the union. The U.K. has made a case that it would no longer benefit from those projects after Brexit, and disputed that bill. Some thawing on that emerged on Wednesday, and “May is close to offering a deal on money that would unlock the Brexit negotiations,” The Guardian newspaper reported.

“The greatest obstacles are the U.K.’s goodbye payment, given its previous commitments, and the future trade deal,” said Mauro Guillen, Wharton professor of management and director of The Lauder Institute.

May is clearly responding to mounting pressure. Last week, the E.U.’s chief negotiator, Michel Barnier, gave 10 Downing Street a two-week deadline to provide clarity on withdrawal issues, including its financial settlement as it leaves the E.U. Barnier also said that contingency plans exist should the Brexit talks with the E.U. collapse.

“We’re dealing with a world in which Conservative fantasies about their bargaining power have yet to be fully confronted with reality.”–Brendan O’Leary

Barnier’s comments reflect growing concern over the slow progress the May government has achieved thus far in finding solutions to the issues dogging Brexit. “I think we’re in the latest episode of Groundhog Day,” an American movie in which a weatherman inexplicably lives the same day over and over again, said O’Leary. “Things are moving incredibly slowly; for those of you who don’t know that movie, it’s about constant repetition.” According to Wharton finance professor Joao Gomes, “virtually all the work is still ahead.”

“The lack of progress is perhaps what is pushing the E.U. negotiators, who are now concerned about the collapse of the talks,” added Michelle Egan, professor at American University’s School of International Service. “They’re looking at what effectively from outside the British government looks confused, floundering and ineffective.”

O’Leary and Egan discussed the likely directions the Brexit talks could take on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

Weakness All Around?

Egan noted that while Europe is witnessing an economic recovery, Britain is grappling with rising inflation and falling real wages, even though unemployment rates are low. “We’re really in a slowdown and possibly a recession,” she said of the U.K. “And we have business uncertainty, particularly for the City of London about what any deal will mean for financial services.”

On Wednesday, U.K. government data for the July-September quarter seemed to confirm fears that the days of an employment boom are over. The government’s Office for National Statistics said 14,000 fewer people were at work, bringing down the total number of employed people to about 32 million as of the end of September. The latest unemployment rate at 4.3% was unchanged from the previous quarter, but lower than the 4.8% of a year ago. U.K. retail sales fell 0.3% in October, year-on-year, marking the first such drop since 2013, although they grew 0.3% from September, according to government data.

“The terms of the negotiations are bound to be more favorable to the party whose economy seems less vulnerable to Brexit.”–Joao Gomes

The E.U.’s relatively stronger economy could give it an upper hand over the U.K. “It seems clear to me that in the end, the terms of the negotiations are bound to be more favorable to the party whose economy seems less vulnerable to Brexit,” said Gomes. He noted that the U.K. is losing out in other areas as its economic fortunes lag those of the E.U. “It has strengthened the Union’s resolve to stick with its demands and made it more difficult for the U.K. negotiators to risk a hard Brexit.”

O’Leary expected major companies, including those in the financial services sector, to decide on relocating from the U.K. after Christmas. Businesses were hoping to have had some clarity by now about the likely final shape of the Brexit agreement, and cannot afford to put off their decisions, he said. “The loss of foreign direct investment on top of a falling pound and on top of inflation might concentrate the mind.” In the past year and a half, the pound has lost more than 22% against the euro.

Politically Shaky

To be sure, nobody expected the going to be smooth, given the thorny issues involved. “Brexit negotiations are difficult because there is no precedent and because neither party is really convinced that Brexit should happen,” said Guillen. Added Egan: “We always expected this process to be difficult. This is a negotiation.” All the same, Europe is running out of patience, she suggested. “Europe is also moving on; they’ve got other issues that they want to deal with beyond Brexit.”

It does not help that May’s government is on “very weak” ground, as Guillen noted. “The Conservative Party is divided, and a resurgent Labour Party under [Jeremy] Corbyn is using the Brexit crisis as a way to boost its electoral chances. Moreover, May has agreed to have a vote in Parliament about any deal.” In the snap elections May had called in June, the Conservative Party fell short of a majority, while the Labour Party significantly improved its tally.

The May government has been shaky also because it recently lost two ministers and may lose more because of unrelated scandals. Damian Green, the first secretary of state, faces a probe after police allegedly found pornography on his work computer during a raid in 2008. Green has denied the allegations and termed them “unscrupulous character assassination,” but it has shaken the government. “Theresa May does not look like she’s in control of the process and so the crisis of governance is part of the problem,” said Egan. Added O’Leary: “She’s a dead woman walking. The only question is when she falls. She’s very lucky. Her conspirators are totally incompetent.”

Questions over Credibility

O’Leary felt the Conservative Party is overconfident as well. “We’re dealing with a world in which Conservative fantasies about their bargaining power have yet to be fully confronted with reality,” he said. He expected a turning point at the next round of talks with the E.U. in December. He said the E.U. could insist on a settlement hammered out by the fall of next year, in good time before the European parliamentary elections in May 2019. “Time is very much running out for the Conservatives.”

Alongside battling those domestic troubles, May’s government does not seem to have a winning strategy for the Brexit negotiations. “Are the negotiations going to lead to the U.K. fully leaving the Customs Union and the single market, and refusing to accept jurisdiction [of] the Court of Justice of the European Union?” O’Leary asked. “If that’s the case, then there isn’t going to be any successful settlement of any kind.”

O’Leary said the U.K. has difficulty striking a credible treaty with the E.U.-27 (the remaining members in the E.U.) because its own credentials are questionable. “The U.K. … has the ability to repudiate treaties,” he said. “If a treaty is made with the E.U.-27, what is the credible commitment that the U.K. can make that it will abide by that treaty?” In the light of that, he said it is “absolutely vital” that the U.K. agrees to adjudication by the Court of Justice of the European Union, because that ensures the U.K. would suffer “a significant penalty, were it to break its treaty obligations.”

“Any outcome is possible: from a reasonable deal for Brexit all the way to the U.K. cancelling Brexit and remaining in the E.U.”–Mauro Guillen

Likely Outcomes

O’Leary saw two possible outcomes. “One is the U.K. simply leaves the E.U. on the appointed hour without any agreement at all, and without paying its bills,” he said. That outcome could create “serious difficulties for the U.K. and Ireland, but less so for the E.U.-27 who could absorb the shock quite easily,” he added.

The second likelihood, O’Leary said, is of a “last minute transitional deal which keeps the U.K. inside the single market and the Customs Union, while they agree to continue negotiating.” That outcome could prove to be “a sticky position” for the Conservative government to be in, “because they wouldn’t really be out — they’d be pretending to be out,” he added. In that scenario, the U.K. would have no say over the regulatory structure in the period ahead and it will not be able to negotiate trade deals with other countries, he pointed out.

“The fantasy of the U.K. is also that they going to get what we call a bespoke deal — like pick-and-mix sweets,” said Egan. However, the European side wants it to be a clear-cut deal — “It’s either you’re in it or you’re out,” she noted. Europe’s concerns are also that Britain’s exit might trigger “a real regulatory race to the bottom,” where the U.K. might strike more favorable trade deals with countries outside the E.U.

With so much uncertainty, “it is nearly impossible to predict what might happen,” said Guillen. “Any outcome is possible: from a reasonable deal for Brexit all the way to the U.K. cancelling Brexit and remaining in the E.U.”