University of Pennsylvania's Brendan O'Leary and Erik Jones from Johns Hopkins University discuss the U.K.'s options following Theresa May's Brexit defeat.

British Prime Minister Theresa May’s government narrowly survived a no-confidence motion on Wednesday (325 votes against the motion, 306 for it), a day after the House of Commons voted 432-202 to reject her revised Brexit plan. May has begun talks with political parties ahead of another Brexit vote coming up Jan. 29 and continues to reject the idea of a second referendum. She also does not want the U.K. to remain in the EU Customs Union because that would preclude it from pursuing independent trade deals with other countries.

The uncertainty has rattled investors, and the British pound lost ground after Tuesday’s vote. Investors in the U.S. and elsewhere are worried about a no-deal Brexit, which means the U.K. would crash out of the EU after March 29, the date May has set for the beginning of the exit process. Many firms have moved out of London, or are planning to, and have relocated to Ireland, Germany and the Netherlands.

“If there’s a hard exit on March 29 without a withdrawal agreement, the U.K. will be in legal and economic chaos,” said Brendan O’Leary, political science professor at the University of Pennsylvania, during a recent segment on the Knowledge at Wharton radio show. (Listen to the podcast at the top of this page.) “Supply chains will be massively disrupted, and the U.K. will be dependent centrally on the cooperation of the French, the Dutch, the Belgians and the Irish authorities where a great deal of their goods and imports come back and forth. There will, of course, be some contingent bilateral emergency cooperation on all sides, but one would imagine another very serious fall in the pound and another fourth quarter of net fall in investment. Now, given that potential economic horror scenario as well as practical chaos for lots of people, [the U.K.] parliament knows that it must make a decision in the period ahead.”

“There are no longer any good solutions for the U.K.,” said Wharton finance professor Joao Gomes. “The benefit of an early Brexit is clarity. That removal of any uncertainty would be a great help to the U.K. and the EU’s economies. Theresa May’s deal offers this as its main advantage.”

However, it now seems that a timely Brexit would also be a bad Brexit, Gomes pointed out. “[May’s] agreement clearly does not appeal to those who idealized Brexit two years ago as a restoration of British sovereignty that would allow the U.K. to rejuvenate its commonwealth ties to again become a great power on its own. It has also failed to gain the support of an absent Labour Party that is clearly more interested in short-term political gains than in playing a role in carving the future of the U.K.”

A Guardian report explained the likely scenarios with a chart. After the defeat of the no-confidence motion on Wednesday, May would hold talks with political parties on her Plan B deal. Then, the revised deal would be presented to the House of Commons, where MPs may want amendments. It would then go to a vote, and if the U.K. parliament approves it, the U.K. leaves the EU on the revised terms on March 29. But if the revised deal is rejected, one of the following scenarios could play out: The Labour Party could call for a second vote of no-confidence in the May government; it could push for another referendum; May could be forced out or resign; or the U.K. could ask the EU for an extension on Article 50 of the Treaty of Lisbon, which gives any EU member state the right to quit unilaterally, with two years to negotiate an exit deal.

May faces another defeat in the Jan. 29 vote on her new plan, according to Erik Jones, professor of European studies and international political economy at Johns Hopkins University School of Advanced International Studies, who joined O’Leary on the radio show. “It seems to be a repetitive cycle of small gains and large losses,” he said.

“If there’s a hard exit on March 29 without a withdrawal agreement, the U.K. will be in legal and economic chaos.” –Brendan O’Leary

O’Leary explored the options for the U.K. to resolve the Brexit issue and likely scenarios. One option is “to settle things through a general election,” he said. He noted that the Labour Party is pushing for a general election. He expected it to argue for a second referendum on the Brexit issue. If the Brexit withdrawal date is pushed beyond March 29, the U.K. would have to seek an extension under Article 50. The U.K. also has to get involved in the processes to elect a new European Parliament in May or appoint a new European Commission, he added.

“There are three possible equilibria,” said O’Leary. “One is a resort [for the U.K.] to remain [in the EU] either through a rapid referendum or an independent parliamentary decision. [The second option] is some version of Norway, which is a very soft exit and a compromise position, and therefore has those merits attached, but is a very unstable equilibrium. The third option is a hard exit without an agreement [that would result in] legal, political and economic chaos.”

Why Investors Abhor a No-deal Brexit

Jones pointed to a statement from investment management company BlackRock that “a second referendum may be required to break the deadlock,” and he said that reflects the sentiments of investors. “The U.S. and global investment community is looking at the possibility of a no-deal Brexit. They would like to see any political procedure in place to avoid that outcome, because the damage that would be wrought by a no-deal Brexit is considerable.”

“U.S. capital is voting with its feet, and it’s also exercising voice,” said O’Leary. “They’re relocating to Ireland, an English-speaking location, for foreign direct investment. They’re relocating to Amsterdam and to Frankfurt. The Japanese are considering very seriously whether to remove their capital as well.”

It doesn’t help that the position of the U.S. government on Brexit is unclear, according to O’Leary. “We have to get into the mind of our president, and that’s a floating roulette wheel,” he said. “Initially, the president welcomed the possibility of a U.K. exit, but also made it manifestly clear that it would be no easy matter to negotiate a trade deal with the U.S. This has overturned decades of settled U.S. bipartisan foreign policy consensus. America was an agent in the project of European integration, welcoming it as a way of avoiding war on the continent and organizing its European allies in opposition to Soviet and subsequent Russian interests. It is bizarre that the U.S. is not a formal actor in encouraging its allegedly special partner – the U.K. – to remain in its historic alliances and allegiances.”

The Irish Border Issue

A key obstacle in the Brexit process has been disagreements over the type of border Ireland and Northern Ireland could have between them after the U.K. leaves the EU. That issue focuses on how the EU would ensure customs checks on that border. The EU’s concern is that with Ireland as a member country, border checks are needed to ensure that substandard goods do not enter the union from Northern Ireland. Both the U.K. and the EU have said they do not want a “hard border,” meaning physical checks, and prefer a “soft border” that relies on technology-enabled solutions such as blockchain and artificial intelligence to scan goods at factories and in trucks.

“There are no longer any good solutions for the U.K.” –Joao Gomes

On Nov. 25, EU leaders approved an agreement between U.K. and EU negotiators that included a so-called “backstop” arrangement. The backstop is a safety net – an arrangement that will apply to the Irish border after Brexit if a wider deal or technological solution cannot keep it as frictionless as it is today, as a BBC report explained. Disagreement over May’s backstop proposal was one of the chief reasons she lost the Brexit vote on Tuesday. Incidentally, Irish Prime Minister Leo Varadkar has said the deal was the “next best outcome” to the U.K. staying in the EU and that it allowed for an orderly withdrawal.

Under the plan, the EU and the U.K. had agreed that Northern Ireland would follow the rules of the EU single market if another solution cannot be found by the end of the transition period in December 2020. That means that goods coming into Northern Ireland would need to be checked to see if they meet EU standards. It would also involve a temporary single custom territory effectively keeping the whole of the U.K. in the EU Customs Union – unless and until both the EU and U.K. agree that it is no longer necessary, according to the BBC report.

But May faced opposition to her backstop proposal from her own party MPs and Brexiteers in other parties, who feared that the U.K. would continue to follow EU rules for an indefinite time without having any say over them. “If the backstop deal does not stick, then there is no withdrawal agreement and no transition period,” the BBC report noted. “That means a hard, possibly chaotic, Brexit.”

The Irish Position

According to O’Leary, Varadkar’s options are limited. “One has to remember that Leo Varadkar leads a minority government much more successfully than Mrs. May leads a minority government,” he said. “He has a supply-and-confidence agreement with the second-largest party in the Irish parliament – Fianna Fail. (The agreement enables the minority Varadkar government to operate.) If Varadkar appeared to succumb to a weak-kneed moment right now, he would lose the comprehensive solidarity he enjoys not only from Fianna Fail, but [also] from Sinn Fein (a left-wing political party active in both Ireland and Northern Ireland). He noted that the Northern Ireland public would prefer “the softest of all possible soft exits, which means the Norway option or something like Mrs. May’s deal.”

“The global investment community would like to see any political procedure in place to avoid that outcome, because the damage that would be wrought by a no-deal Brexit is considerable.” –Erik Jones

Jones felt the U.K. has mishandled the Northern Ireland issue. “It’s very difficult for the British governing class to understand that the U.K. would not be supported in coming to a deal against the interests of the Irish Republic, when they look at Ireland as a much smaller country and less important to the European Union as a whole,” he said. “They have failed to see the extent to which the European Union was going to unite around Ireland as a fellow member.” Even within the U.K., while the move to leave the EU enjoyed a popular majority, “there has never been a majority in the U.K. around what that leaving should look like.”

Added O’Leary: “Ireland was definitely going to take the position that it needed to defend the Good Friday agreement in all its parts. It was going to prevent a hard border and look after the rights of its citizens.” The Good Friday Agreement of 1998 agreed on a system of government for Northern Ireland and was signed by most of Northern Ireland’s political parties, and another was signed between the British and Irish governments, specifying the relationships between them.

The Norway Option

O’Leary said some quarters are still pushing for a Norway-like arrangement with the EU, with some amendments. Norway is a member of the European Economic Area and the European Free Trade Association, which gives it full access to the EU single market, guaranteeing very limited restrictions to trade with the EU, as a report in the Irish Times explained. In return, Norway makes substantial contributions to the EU budget and has to follow many EU rules and laws, but it has no say in how those rules are formed, it added.

If the U.K. were to adopt a Norway-style arrangement, it would remain in the single market and the Customs Union permanently. “That would solve – at least temporarily – the Irish question because there would be no need for a border across the island of Ireland,” said O’Leary.

He said a Norway-style arrangement would make the idea of Brexit “pointless” because it would allow the U.K. to continue in the EU single market and the Customs Union, and “in a secondary sense,” make it subject to the jurisdiction of the European Court of Justice. “So, the question [for the U.K.] would be: ‘Why would we exit to make ourselves completely impotent?’” The U.K. has consistently said it does not want to be subject to the Court of justice of the European Union, stressing its sovereignty.

“You can imagine that the next general election would be a competition between those who say, ‘Let’s remain,’ and those who say, ‘Let’s shift out of this position and break our treaty.’” –Brendan O’Leary

In the Norway-style arrangement, the U.K. also would not have voting power in the EU, and “that’s not a stable equilibrium,” said O’Leary. “You can imagine that the next general election would be a competition between those who say, ‘Let’s remain,’ and those who say, ‘Let’s shift out of this position and break our treaty.’ But if they do break any future treaty arrangements, then the Irish question re-emerges with a vengeance.”

The Road Ahead

Jones warned that if the U.K. parliament were to try to take up the next round of negotiations on Brexit, the March 29 deadline could be missed. “I don’t expect any negotiations,” said O’Leary. “I expect surrender. The surrender takes two forms – either it takes the form of saying ‘Let’s remain; let’s cut our losses and retreat for another day,’ or it means accepting the provisions that EU Michel Barnier (the European Commission’s chief negotiator on Brexit) put forward at an earlier stage that would allow them to exercise some kind of Norwegian option. So, their choice is surrender or face the possibility of a hard exit.

“The fact is, the U.K. is not prepared for a hard exit,” O’Leary noted. “That’s what encourages the possibility of a moderately sensible outcome at the end of the day.”

According to Gomes, “The best of the many bad options is to consult the British people with a three-question referendum: Do you prefer a no-deal Brexit, the current deal, or no Brexit?”

However, such a referendum “would be unique and tricky,” Gomes continued. “It will divide Labour and Conservatives and may tear the country up again in a divisive campaign. But the alternatives are all far worse. Whatever option parliament chooses at this stage will always be viewed as illegitimate by a very large fraction of the U.K. The answers should not be binding on Parliament, but they would allow the British people to have a voice in a process that will define the next decade.”

A referendum would delay Brexit until after the European elections, “which is a problem,” said Gomes. “It also adds another six months of uncertainty at a minimum. But all other options are far worse.”