What Is Brexit?
Brexit is an abbreviation for "British exit," referring to the U.K.'s decision in a June 23, 2016 referendum to leave the European Union (EU). The vote's result defied expectations and roiled global markets, causing the British pound to fall to its lowest level against the dollar in 30 years. Former Prime Minister David Cameron, who called the referendum and campaigned for Britain to remain in the EU, announced his resignation the following day. Theresa May, who replaced Cameron as leader of the Conservative Party and prime minister, stepped down as party leader voluntarily on June 7, 2019 after facing severe pressure to resign and failing three times to get the deal she negotiated with the EU approved by the House of Commons. The following month, Boris Johnson, a former Mayor of London, foreign minister, and editor of The Spectator newspaper, was elected prime minister.
Johnson, a hardline Brexit supporter, campaigned on a platform to leave the EU by the October deadline "do or die" and said he is prepared to leave the EU without a deal. British and EU negotiators agreed on a new divorce deal on October 17. The main difference from May's deal is the Irish backstop clause has been replaced with a new arrangement. The revised protocol on Ireland and Northern Ireland is available to read here.
Britain is slated to leave the EU by October 31, 2019, but the U.K. Parliament voted to force the government to seek an extension to the deadline and also delayed a vote on the new deal. The government has so far extended the negotiating period three times to avoid leaving without ratifying a deal with the EU or a "hard Brexit."
European Union (EU)
What Happens Next
Since Parliament put off a decision on Johnson's deal on October 19, triggering what is known as the Benn Act, the Prime Minister was forced to ask the EU for another extension of the negotiating period until January 31, 2020. It's unclear if all 27 EU members will agree to an extension, but Johnson will push for a general election if it is granted "until January or possibly longer." He had previously proposed a snap election, but the Conservative Party leader was unable to get two thirds of all MPs to support him as required. If he is successful this time, it would be Britain's third general election in five years.
The Brexit bill, or legislation that needs to be passed before his deal can be approved or implemented, was backed by MPs, but the timetable of pushing it through Parliament in three days was rejected. MPs hoping for a soft Brexit that allows Britain to stay in the bloc's customs union are expected to introduce amendments to the deal Johnson negotiated with the EU.
The government has to ratify a Withdrawal Agreement with the EU before leaving if it wants to avoid a chaotic no-deal exit. If Britain leaves the EU without the ratification of a deal, there will be no 14-month transition period. The U.K and the EU are meant to negotiate a new, long-term trade agreement during the transition period which would last until the end of 2020. In the absence of a deal, WTO rules will come into effect.
"Leave" won the June 2016 referendum with 51.9% of the ballot, or 17.4 million votes; "Remain" received 48.1%, or 16.1 million. Turnout was 72.2%. The results were tallied on a U.K.-wide basis, but the overall figures conceal stark regional differences: 53.4% of English voters supported Brexit, compared to just 38.0% of Scottish voters. Because England accounts for the vast majority of the U.K.'s population, support there swayed the result in Brexit's favor. If the vote had been conducted only in Wales (where "Leave" also won), Scotland and Northern Ireland, Brexit would have received less than 45% of the vote.
The Article 50 Negotiating Period
The process of leaving the EU formally began on March 29, 2017, when May triggered Article 50 of the Lisbon Treaty. The U.K. initially had two years from that date to negotiate a new relationship with the EU. Following a snap election on June 8, 2017, May remained the country's leader. However, the Conservatives lost their outright majority in Parliament and agreed on a deal with the Euroskeptic Democratic Unionist Party (DUP). This later caused May some difficulty getting her Withdrawal Agreement passed in Parliament.
Talks began on June 19, 2017. Questions have swirled around the process, in part because Britain's constitution is unwritten and in part because no country has left the EU using Article 50 before (Algeria left the EU's predecessor through its independence from France in 1962, and Greenland – a self-governing Danish territory – left through a special treaty in 1985).
On November 25, 2018, Britain and the EU agreed on a 585-page Withdrawal Agreement, a Brexit deal, touching upon issues like citizen's rights, the divorce bill and the Irish border.
Parliament first voted on this agreement on Tuesday, January 15, 2019. Members of Parliament voted 432-202 to reject the agreement, the biggest defeat for a government in the House of Commons in recent history.
Theresa May survived a no-confidence vote held on January 16 and she unveiled her Plan B on January 21. The plan was criticized for being very similar to the original deal she presented.
On January 29, MPs voted for May to return to Brussels to remove the controversial Irish backstop portion of her plan and replace it with alternative arrangements, but the EU had said the deal is not open for re-negotiation. The backstop is a plan to avoid a hard Irish border if the U.K. and EU don't sign a free trade deal during the transition period post-Brexit.
May was seeking changes to the controversial Irish backstop provision to win Parliament's backing. The backstop is intended to be temporary, but Euroskeptic MPs worry it will last indefinitely and compromise Britain's autonomy. She was also accused by the Labor Party of "recklessly running down the clock" to force MPs to choose between her deal and a no deal outcome.
MPs voted against her deal by 391-242 votes on March 12 despite May's claim of "legally binding" changes to the agreement, setting Britain on the path to a no-deal Brexit. Parliament stepped in to delay it and the EU gave its permission.
On March 27, none of the eight Brexit alternatives voted on by Members of Parliament received a majority. May's deal was rejected again on March 29 by a margin of 58 votes, despite her vow to resign before the next stage of negotiations if it was passed.
On August 28, 2019, Prime Minister Boris Johnson requested the Queen to suspend Parliament from mid-September until October 14 and she approved. This was seen as a ploy to stop Members of Parliament (MPs) from blocking a chaotic exit from the EU and some even called it a coup of sorts. The Supreme Court's 11 judges unanimously deemed the move unlawful on September 24 and reversed it.
The Labour Party faces its own crisis after almost a dozen lawmakers decided to leave and form the Independent Group in the House of Commons. They blamed Corbyn's failure to address anti-Semitism in the party and his poor Brexit policy. Three MPs belonging to May's Conservative party have also quit to join the Independent Group. They complained that the policies and priorities of the Tories are being defined by the hardline Euroskeptics in the party.
Britain's lead negotiator in the talks with Brussels was David Davis, a Yorkshire MP, until July 9, 2018, when he resigned. He was replaced by housing minister Dominic Raab as Brexit secretary. Raab resigned in protest over May's deal on November 15, 2018. He was replaced by health and social care minister Stephen Barclay the following day.
The EU's chief negotiator is Michel Barnier, a French politician.
Preparatory talks about talks exposed divisions in the two sides' approaches to the process. The U.K. wanted to negotiate the terms of its withdrawal alongside the terms of its post-Brexit relationship with Europe, while Brussels wanted to make sufficient progress on divorce terms by October 2017, only then moving on to a trade deal. In a concession that both pro- and anti-Brexit commentators took as a sign of weakness, British negotiators accepted the EU's sequenced approach.
One of the most politically thorny issues facing Brexit negotiators has been the rights of EU citizens living in the U.K. and U.K. citizens living in the EU.
The Withdrawal Agreement allows for the free movement of EU and U.K. citizens until the end of the transition period. Following the transition period, they would keep their residency rights if they continue to work, have sufficient resources, or are related to someone who does. To upgrade their residence status to permanent, they would have to apply to the host nation. The rights of these citizens can be abruptly taken away if Britain crashes out without ratifying a deal.
EU citizens have been increasingly leaving the U.K. since the referendum. "EU net migration, while still adding to the population as a whole, has fallen to a level last seen in 2009. We are also now seeing more EU8 citizens – those from Central and Eastern European countries, for example, Poland – leaving the U.K. than arriving,” said Jay Lindop, Director of the Centre for International Migration, in a government quarterly report released in February 2019.
Britain's Parliament fought over the rights of EU citizens to remain in the U.K. after Brexit, publicly airing domestic divisions over migration. Following the referendum and Cameron's resignation, May's government concluded that it had the right under the "royal prerogative" to trigger Article 50 and begin the formal withdrawal process on its own. The British Supreme Court intervened, ruling that Parliament had to authorize the measure, and the House of Lords amended the resulting bill to guarantee the rights of EU-born residents. The House of Commons – which had a Tory majority at the time – struck the amendment down and the unamended bill became law on March 16, 2017.
Conservative opponents of the amendment argued that unilateral guarantees eroded Britain's negotiating position, while those in favor of it said EU citizens should not be used as "bargaining chips." Economic arguments also featured: while a third of British expats in Europe are pensioners, EU migrants are more likely to be in work than native-born Brits. That fact suggests EU migrants are greater contributors to the economy than their British counterparts; then again, "Leave" supporters read these data as pointing to foreign competition for scarce jobs in Britain.
Brexit Financial Settlement
The "Brexit bill" is the financial settlement the U.K. owes Brussels following its withdrawal.
The Withdrawal Agreement doesn't mention a specific figure, but it is estimated to be up to £39 billion, according to Downing Street. The total sum includes the financial contribution the U.K. will make during the transition period since it will be acting as a member state of the EU and its contribution toward the EU’s outstanding 2020 budget commitments.
The U.K. will also receive funding from EU programs during the transition period and a share of its assets at the end of it, which includes the capital it paid into the European Investment Bank (EIB).
A Dec. 2017 agreement resolved this long-standing sticking point that threatened to derail negotiations entirely. Barnier's team launched the first volley in May 2017 with the released of a document listing the 70-odd entities it would take into account when tabulating the bill. The Financial Times estimated that the gross amount requested would be €100 billion; net of certain U.K. assets, the final bill would be "in the region of €55bn to €75bn."
Davis' team, meanwhile, refused EU demands to submit the U.K.'s preferred methodology for tallying the bill. In August, he told the BBC he would not commit to a figure by October, the deadline for assessing "sufficient progress" on issues such as the bill. The following month he told the House of Commons that Brexit bill negotiations could go on "for the full duration of the negotiation."
Davis presented this refusal to the House of Lords as a negotiating tactic, but domestic politics probably explain his reticence. Boris Johnson, who campaigned for Brexit, called EU estimates "extortionate" on July 11, 2017, and agreed with a Tory MP that Brussels could "go whistle" if they wanted "a penny."
In her September 2017 speech in Florence, however, May's spokesperson said the U.K. would "honor commitments we have made during the period of our membership." Michel Barnier confirmed to reporters in October 2019 that Britain would pay what was owed.
The Northern Irish Border
The new Withdrawal Agreement replaces the controversial Irish backstop provision with a protocol. The revised deal says the entire U.K. will leave the EU customs union upon Brexit, but Northern Ireland will follow EU regulations and VAT laws when it comes to goods and the British government will collect the VAT on behalf of the EU. This means there will be limited customs border in the Irish Sea with checks at major ports. Four years after the end of the transition period, the Northern Ireland assembly will be able to vote on this arrangement.
The backstop emerged as the main reason for the Brexit impasse. It was a guarantee that there would be no "hard border" between Northern Ireland and Ireland. It was an insurance policy that kept Britain in the EU customs union with Northern Ireland following EU single market rules. The backstop, which was meant to temporary and superseded by a subsequent agreement, could only be removed if both Britain and the EU gave their consent. May was unable to garner enough support for her deal due to it. Euroskeptic MPs wanted her to add legally binding changes as they feared it would compromise the country's autonomy and could last indefinitely. EU leaders have so far refused to remove it and have also ruled out a time limit or granting Britain the power to remove it. On March 11, 2019, the two sides signed a pact in Strasbourg that did not change the Withdrawal Agreement but added "meaningful legal assurances." It wasn't enough to convince hardline Brexiteers.
For decades during the second half of the 20th century, violence between Protestants and Catholics marred Northern Ireland, and the border between the British countryside and the Republic of Ireland to the south was militarized. The 1998 Good Friday Agreement turned the border almost invisible, except for speed limit signs, which switch from miles per hour in the north to kilometers per hour in the south.
Both British and EU negotiators worry about the consequences of reinstating border controls, as Britain may have to do in order to end freedom of movement from the EU. Yet leaving the customs union without imposing customs checks at the Northern Irish border or between Northern Ireland and the rest of Britain leaves the door wide open for smuggling. This significant and unique challenge is one of the reasons that "soft Brexit" advocates most cite in favor of staying in the EU's customs union and perhaps its single market. In other words, the Northern Ireland conundrum may have created a back door for a soft Brexit.
The issue is further complicated by the Tories' choice of the Northern Irish Democratic Unionist Party as a coalition partner: the DUP opposed the Good Friday Agreement and – unlike the Conservatives' leader at the time – campaigned for Brexit. Under the Good Friday Agreement, the British government is required to oversee Northern Ireland with "rigorous impartiality"; that may prove difficult for a government that depends on the cooperation of a party with an overwhelmingly Protestant support base and historical connections to Protestant paramilitary groups.
Arguments For and Against Brexit
"Leave" voters based their support for Brexit on a variety of factors, including the European debt crisis, immigration, terrorism and the perceived drag of Brussels' bureaucracy on the British economy. Britain has long been wary of the European Union's projects, which Leavers feel threatens the U.K.'s sovereignty: the country never opted into the European Union's monetary union, meaning that it uses the pound instead of the euro. It also remained outside the Schengen Area, meaning that it does not share open borders with a number of other European nations.
Opponents of Brexit also cite a number of rationales for their position. One is the risk involved in pulling out of the EU's decision-making process, given that it is by far the largest destination for British exports. Another is the economic and societal benefits of the EU's "four freedoms": the free movement of goods, services, capital and people across borders. A common thread in both arguments is that leaving the EU would destabilize the British economy in the short term and make the country poorer in the long term. In July of 2018, May's cabinet suffered another shake-up when Boris Johnson resigned as the U.K.'s Foreign Minister and David Davis resigned as Brexit Minister over May's plans to keep close ties to the EU. Johnson was replaced by Jeremy Hunt, who favors a soft Brexit.
Some state institutions backed the Remainers' economic arguments: Bank of England governor Mark Carney called Brexit "the biggest domestic risk to financial stability" in March 2016 and the following month the Treasury projected lasting damage to the economy under any of three possible post-Brexit scenarios: European Economic Area (EEA) membership such as Norway has; a negotiated trade deal such as the one signed between the EU and Canada in October 2016; and World Trade Organization (WTO) membership.
|The annual impact of leaving the EU on the UK after 15 years (difference from being in the EU)|
|EEA||Negotiated bilateral agreement||WTO|
|GDP level – central||-3.8%||-6.2%||-7.5%|
|GDP level||-3.4% to -4.3%||-4.6% to -7.8%||-5.4% to -9.5%|
|GDP per capita – central*||-£1,100||-£1,800||-£2,100|
|GDP per capita*||-£1,000 to -£1,200||-£1,300 to -£2,200||-£1,500 to -£2,700|
|GPD per household – central*||-£2,600||-£4,300||-£5,200|
|GDP per household*||-£2,400 to -£2,900||-£3,200 to -£5,400||-£3,700 to -£6,600|
|Net impact on receipts||-£20 billion||-£36 billion||-£45 billion|
Adapted from HM Treasury analysis: the long-term economic impact of EU membership and the alternatives, April 2016; *expressed in terms of 2015 GDP in 2015 prices, rounded to the nearest £100.
Leave supporters tended to discount such economic projections under the label "Project Fear." A pro-Brexit outfit associated with the U.K. Independence Party (UKIP), which was founded to oppose EU membership, responded by saying that the Treasury's "worst-case scenario of £4,300 per household is a bargain basement price for the restoration of national independence and safe, secure borders."
Although Leavers have tended to stress issues of national pride, safety, and sovereignty, they also muster economic arguments. For example, Boris Johnson, who was mayor of London until May 2016 and became Foreign Secretary when May took office, said on the eve of the vote, "EU politicians would be banging down the door for a trade deal" the day after the vote, in light of their "commercial interests." Labor Leave, the pro-Brexit Labour group, co-authored a report with a group of economists in September 2017 that forecasted a 7% boost to annual GDP, with the largest gains going to the lowest earners.
Vote Leave, the official pro-Brexit campaign, topped the "Why Vote Leave" page on its website with the claim that the U.K. could save £350 million per week: "we can spend our money on our priorities like the NHS [National Health Service], schools, and housing." In May 2016, the U.K. Statistics Authority, an independent public body, said the figure is gross rather than net, "is misleading and undermines trust in official statistics." A mid-June poll by Ipsos MORI, however, found that 47% of the country believed the claim. The day after the referendum, Nigel Farage, who co-founded UKIP and led it until that November, disavowed the figure and said that he was not closely associated with Vote Leave. May has also declined to confirm Vote Leave's NHS promises since taking office.
Brexit Economic Response
Until an exit deal is finalized or the deadline for negotiations set by Article 50 expires, Britain remains in the EU, both benefiting from its trade links and subject to its laws and regulations.
Even so, the decision to leave the EU has had an effect on Britain's economy.
The country's GDP growth slowed down to around 1.5% in 2018 from 1.8% in 2017 and 1.9% in 2016 as business investment slumped. The IMF predicts that the country's economy will grow at 1.5% in 2019 and 2020. The Bank of England cut its growth forecast for 2019 to 1.2%, the lowest since the financial crisis.
The U.K. unemployment rate hit a 44-year low at 3.9% in the three months to January 2019. Experts attribute this to employers preferring to retain workers instead of investing in new major projects.
In 2018, the pound managed to claw back the losses it suffered after the Brexit vote but reacted negatively as the likelihood of a no-deal Brexit increased. The currency could rally if a "soft Brexit" deal is passed or Brexit is delayed.
While the fall in the value of the pound has helped exporters, the higher price of imports passed onto consumers and has had a significant impact on the annual inflation rate. CPI inflation hit 3.1% in the 12 months leading up to November 2017, a near six-year high that well exceeded the Bank of England's 2% target. Inflation eventually began to fall in 2018 with the decline in oil and gas prices and was at 1.8% in January 2019.
A July 2017 report by the House of Lords cited evidence that British businesses would have to raise wages to attract native-born workers following Brexit, which is "likely to lead to higher prices for consumers."
International trade is expected to fall due to Brexit, even if Britain negotiates a raft of free trade deals. Dr. Monique Ebell, former associate research director at the National Institute of Economic and Social Research, forecasts a -22% reduction in total British goods and services trade if EU membership is replaced by a free trade agreement. Other free trade agreements could probably not take up the slack: Ebell sees a pact with the BRIICS (Brazil, Russia, India, Indonesia, China, and South Africa) boosting total trade by 2.2%; a pact with the U.S., Canada, Australia and New Zealand would do slightly better, at 2.6%.
"The single market is a very deep and comprehensive trade agreement aimed at reducing non-tariff barriers," Ebell wrote in January 2017, "while most non-EU [free trade agreements] seem to be quite ineffective at reducing the non-tariff barriers that are important for services trade."
June 2017 General Election
On April 18, May called for a snap election to be held on June 8, despite previous promises not to hold one until 2020. Polling at the time suggested May would expand on her slim Parliamentary majority of 330 seats (there are 650 seats in the Commons). Labor gained rapidly in the polls, however, aided by an embarrassing Tory flip-flop on a proposal for estates to fund end-of-life care.
The Conservatives lost their majority, winning 318 seats to Labor's 262. The Scottish National Party won 35, with other parties taking 35. The resulting hung Parliament cast doubts on May's mandate to negotiate Brexit and led the leaders of Labor and the Liberal Democrats to call on May to resign.
Speaking in front of the Prime Minister's residence at 10 Downing Street, May batted away calls for her to leave her post, saying, "It is clear that only the Conservative and Unionist Party" – the Tories' official name – "has the legitimacy and ability to provide that certainty by commanding a majority in the House of Commons." The Conservatives struck a deal with the Democratic Unionist Party of Northern Ireland, which won 10 seats, to form a coalition. The party is little known outside of Northern Ireland, judging by a wave of curious Google searches that caused the DUP's site to crash.
May presented the election as a chance for the Conservatives to solidify their mandate and strengthen their negotiating position with Brussels. But this backfired.
"The election served to diffuse, not concentrate political power, especially with regards to Brexit," wrote Sky News political correspondent Lewis Goodall. "Ever since election night, Brussels hasn't just been dealing with Number 10 but in effect, the House of Commons too."
In the wake of the election, many expected the government's Brexit position to soften, and they were right. May released a Brexit white paper in July 2018 that mentioned an "association agreement" and a free-trade area for goods with the EU. David Davis resigned as Brexit secretary and Boris Johnson resigned as Foreign Secretary in protest.
But the election also increased the possibility of a no deal Brexit. As the Financial Times predicted, the result made May more vulnerable to pressure from Euroskeptics and her coalition partners. We saw this play out with the Irish backstop tussle.
With her position weakened, May struggled to unite her party behind her deal and keep control of Brexit.
Scotland's Independence Referendum
Politicians in Scotland pushed for a second independence referendum in the wake of the Brexit vote, but the results of the June 8, 2017 election cast a pall over their efforts. The Scottish National Party (SNP) lost 21 seats in the Westminster Parliament, and on June 27, 2017, Scottish First Minister Nicola Sturgeon said her government at Holyrood would "reset" its timetable on independence to focus on delivering a "soft Brexit."
Not one Scottish local area voted to leave the EU, according to the U.K.'s Electoral Commission, though Moray came close at 49.9%. The country as a whole rejected the referendum by 62.0% to 38.0%. Because Scotland only contains 8.4% of the U.K.'s population, however, its vote to Remain – along with that of Northern Ireland, which accounts for just 2.9% of the U.K.'s population – was vastly outweighed by support for Brexit in England and Wales.
Scotland joined England and Wales to form Great Britain in 1707, and the relationship has been tumultuous at times. The SNP, which was founded in the 1930s, had just six of 650 seats in Westminster in 2010. The following year, however, it formed a majority government in the devolved Scottish Parliament at Holyrood, partly owing to its the promise to hold a referendum on Scottish independence.
2014 Scottish Independence Referendum
That referendum, held in 2014, saw the pro-independence side lose with 44.7% of the vote; turnout was 84.6%. Far from putting the independence issue to rest, though, the vote fired up support for the nationalists. The SNP won 56 of 59 Scottish seats at Westminster the following year, overtaking the Lib Dems to become the third-largest party in the U.K. overall. Britain's electoral map suddenly showed a glaring divide between England and Wales – dominated by Tory blue with the occasional patch of Labour red – and all-yellow Scotland.
When Britain voted to leave the EU, Scotland fulminated. A combination of rising nationalism and strong support for Europe led almost immediately to calls for a new independence referendum. When the Supreme Court ruled on November 3, 2017, that devolved national assemblies such as Scotland's parliament cannot veto Brexit, the demands grew louder. On March 13 that year, Sturgeon called for a second referendum, to be held in the autumn of 2018 or spring of 2019. Holyrood backed her by a vote of 69 to 59 on March 28, the day before May's government triggered Article 50.
Sturgeon's preferred timing is significant since the two-year countdown initiated by Article 50 will end in the spring of 2019 when the politics surrounding Brexit could be particularly volatile.
What Would Independence Look Like?
Scotland's economic situation also raises questions about its hypothetical future as an independent country. The crash in the oil price has dealt a blow to government finances. In May 2014 it forecast 2015-2016 tax receipts from North Sea drilling of £3.4 billion to £9 billion but collected £60 million, less than 1.0% of the forecasts' midpoint. In reality, these figures are hypothetical, since Scotland's finances are not fully devolved, but the estimates are based on the country's geographical share of North Sea drilling, so they illustrate what it might expect as an independent nation.
The debate over what currency an independent Scotland would use has been revived. Former SNP leader Alex Salmond, who was Scotland's First Minister until November 2014, told the Financial Times that the country could abandon the pound and introduce its own currency, allowing it to float freely or pegging it to sterling. He ruled out joining the euro, but others contend that it would be required for Scotland to join the EU. Another possibility would be to use the pound, which would mean forfeiting control over monetary policy.
Upsides for Some
On the other hand, a weak currency that floats on global markets can be a boon to U.K. producers who export goods. Industries that rely heavily on exports could actually see some benefit. In 2015, the top 10 exports from the U.K. were (in USD):
- Machines, engines, pumps: US$63.9 billion (13.9% of total exports)
- Gems, precious metals: $53 billion (11.5%)
- Vehicles: $50.7 billion (11%)
- Pharmaceuticals: $36 billion (7.8%)
- Oil: $33.2 billion (7.2%)
- Electronic equipment: $29 billion (6.3%)
- Aircraft, spacecraft: $18.9 billion (4.1%)
- Medical, technical equipment: $18.4 billion (4%)
- Organic chemicals: $14 billion (3%)
- Plastics: $11.8 billion (2.6%)
Some sectors are prepared to benefit from an exit. Multinationals listed on the FTSE 100 are likely to see earnings rise as a result of a soft pound. A weak currency may also benefit tourism, energy and the service industry.
In May 2016, the State Bank of India (SBIN.NS), India's largest commercial bank, suggested that the Brexit will benefit India economically. While leaving the Eurozone will mean that the U.K. will no longer have unfettered access to Europe's single market, it will allow for more focus on trade with India. India will also have more room for maneuvering if the U.K. is no longer abiding by European trade rules and regulations.
UK-EU Trade After Brexit
May advocated a "hard" Brexit, meaning that Britain would leave the EU's single market and customs union, then negotiate a trade deal to govern their future relationship. These negotiations would have been conducted during a transition period that will begin when a divorce deal is ratified. The Conservatives' poor showing in the June 2017 snap election called popular support for a hard Brexit into question, and many in the press speculated that the government could take a softer line. The Brexit White Paper released in July 2018 revealed plans for a softer Brexit. It was too soft for many MPs belonging to her party and too audacious for the EU.
The White Paper says the government plans to leave EU single market and customs union. However, it proposes the creation of a free trade area for goods which would "avoid the need for customs and regulatory checks at the border and mean that businesses would not need to complete costly customs declarations. And it would enable products to only undergo one set of approvals and authorizations in either market, before being sold in both." This means the U.K. will follow EU single market rules when it comes to goods.
The White Paper acknowledged that a borderless customs arrangement with the EU – one that allowed the U.K. to negotiate free trade agreements with third countries – is "broader in scope than any other that exists between the EU and a third country."
The government is right that there is no example of this kind of relationship in Europe today. The four broad precedents that do exist are the EU's relationship with Norway, Switzerland, Canada, and World Trade Organization members.
The Norway Model: Join the EEA
The first option would be for the U.K. to join Norway, Iceland, and Lichtenstein in the European Economic Area (EEA), which provides access to the EU's single market for most goods and services (agriculture and fisheries are excluded). At the same time, the EEA is outside the customs union, so Britain could enter into trade deals with non-EU countries. The arrangement is hardly a win-win, however: the U.K. would be bound by some EU laws while losing its ability to influence those laws through the country's European Council and European Parliament voting rights. In September 2017, May called this arrangement an unacceptable "loss of democratic control."
David Davis expressed interest in the Norway model in response to a question he received at the U.S. Chamber of Commerce in Washington. "It's something we've thought about but it's not at the top of our list." He was referring specifically to the European Free Trade Association (EFTA), which like the EEA offers access to the single market, but not the customs union. EFTA was once a large organization, but most of its members have left to join the EU. Today it comprises Norway, Iceland, Lichtenstein, and Switzerland; all but Switzerland are also members of the EEA.
The Switzerland Model
Switzerland's relationship to the EU, which is governed by around 20 major bilateral pacts with the bloc, is broadly similar to the EEA arrangement. Along with these three, Switzerland is a member of the European Free Trade Association (EFTA). Switzerland helped set up the EEA, but its people rejected membership in a 1992 referendum.
The country allows free movement of people and is a member of the passport-free Schengen Area. It is subject to many single market rules, without having much say in making them. It is outside the customs union, allowing it to negotiate free trade agreements with third countries; usually, but not always, it has negotiated alongside the EEA countries. Switzerland has access to the single market for goods (with the exception of agriculture), but not services (with the exception of insurance). It pays a modest amount into the EU's budget.
Brexit supporters who want to "take back control" would be unlikely to embrace the concessions the Swiss have made on immigration, budget payments, and single market rules. The EU would probably not want a relationship modeled on the Swiss example, either: Switzerland's membership in EFTA but not the EEA, Schengen but not the EU, is a messy product of the complex history of European integration and – what else – a referendum.
The Canada Model: A Free Trade Agreement
A third option is to negotiate a free trade agreement with the EU along the lines of the Comprehensive Economic and Trade Agreement (CETA), a pact the EU has finalized with Canada but not ratified. The most obvious problem with this approach is that the U.K. has only two years from the triggering of Article 50 to negotiate such a deal. The EU has refused to discuss a future trading relationship until December at the earliest.
To give a sense of how tight that timetable is, CETA negotiations began in 2009 and were concluded in 2014. Three years later, a small minority of the EU's 28 national parliaments have ratified the deal. Persuading the rest could take years. Even subnational legislatures can stand in the way of a deal: the Walloon regional parliament, which represents fewer than 4 million mainly French-speaking Belgians, single-handedly blocked CETA for a few days in 2016. In order to extend the two-year deadline for leaving the EU, Britain would need unanimous approval from the EU 27. Several British politicians, including Chancellor of the Exchequer Philip Hammond, have stressed the need for a transitional deal of a few years so that – among other reasons – Britain can negotiate EU and third country trade deals; the notion has met with resistance from hard-line Brexiteers, however.
In some ways, comparing Britain's situation to Canada's is misleading. Canada already enjoys free trade with the United States through NAFTA, meaning that a trade deal with the EU is not as crucial as it is for the U.K. Canada's and Britain's economies are also very different: CETA does not include financial services, one of Britain's biggest exports to the EU.
Speaking in Florence in September 2017, May said the U.K. and EU "can do much better" than a CETA-style trade agreement, since they're beginning from the "unprecedented position" of sharing a body of rules and regulations. She did not elaborate on what "much better" would look like, besides calling on both parties to be "creative as well as practical."
Monique Ebell, formerly of the National Institute of Economic and Social Research stresses that even with an agreement in place, non-tariff barriers are likely to be a significant drag Britain's trade with the EU: she expects total British foreign trade – not just flows to and from the EU – under an EU-U.K. trade pact. She reasons that free-trade deals do not generally handle services trade well. Services are a major component of Britain's international trade; the country enjoys a trade surplus in that segment, which is not the case for goods. Free trade deals also struggle to rein in non-tariff barriers. Admittedly Britain and the EU are starting from a unified regulatory scheme, but divergences will only multiply post-Brexit.
WTO: Go It Alone
You want out? You're out. If Britain and the EU cannot come to an agreement regarding a future relationship, they will revert to the World Trade Organization (WTO) terms. Even this default would not be entirely straightforward, however. Since Britain is currently a WTO member through the EU, it will have to split tariff schedules with the bloc and divvy out liabilities arising from ongoing trade disputes. This work has already begun.
Trading with the EU on WTO terms is the "no-deal" scenario the Conservative government has presented as an acceptable fallback – though most observers see this as a negotiating tactic. British Secretary of State for International Trade Liam Fox said in July 2017, "People talk about the WTO as if it would be the end of the world. But they forget that is how they currently trade with the United States, with China, with Japan, with India, with the Gulf, and our trading relationship is strong and healthy."
For certain industries, however, the EU's external tariff would hit hard: Britain exports 77% of the cars it manufactures, and 58% of these go to Europe. The EU levies 10% tariffs on imported cars. Monique Ebell of the NIESR estimated that leaving the EU single market would reduce overall British goods and services trade – not just that with the EU – by 22-30%.
Nor will the U.K. only be giving up its trade arrangements with the EU: under any of the scenarios above, it will probably lose the trade agreements the bloc has struck 63 third countries, as well as progress in negotiating other deals. Replacing these and adding new ones is an uncertain prospect. In a September 2017 interview with Politico, Trade Secretary Liam Fox said his office – formed in July 2016 – has turned away some third countries looking to negotiate free trade deals because it lacks the capacity to negotiate.
Fox wants to roll the terms of existing EU trade deals over into new agreements, but some countries may be unwilling to give Britain (66 million people, $2.6 trillion GDP) the same terms as the EU (excluding Britain, around 440 million people, $13.9 trillion GDP).
Negotiations with third countries are technically not allowed while Britain remains an EU member, but even so informal talks have begun, particularly with the U.S.
Impact on the U.S.
Companies in the U.S. across a wide variety of sectors have made large investments in the U.K. over many years. American corporations have derived 9% of global foreign affiliate profit from the United Kingdom since 2000. In 2014 alone, U.S. companies invested a total of $588 billion into Britain. The U.S. also hires a lot of Brits. In fact, U.S. companies are one of the U.K.'s largest job markets. The output of U.S. affiliates in the United Kingdom was $153 billion in 2013. The United Kingdom plays a vital role in corporate America's global infrastructure from assets under management, international sales, and research and development (R&D) advancements. American companies have viewed Britain as a strategic gateway to other countries in the European Union. Brexit will jeopardize the affiliate earnings and stock prices of many companies strategically aligned with the United Kingdom, which may see them reconsider their operations with British and European Union members.
American companies and investors that have exposure to European banks and credit markets may be affected by credit risk. European banks may have to replace $123 billion in securities depending on how the exit unfolds. Furthermore, U.K. debt may not be included in European banks' emergency cash reserves, creating liquidity problems. European asset-backed securities have been in decline since 2007. This decline is likely to intensify now that Britain has chosen to leave.
Who's Next to Leave the EU?
Political wrangling over Europe is not limited to Britain. Most EU members have strong euroskeptic movements that, while they have so far struggled to win power at the national level, heavily influence the tenor of national politics. In a few countries, there is a chance that such movements could secure referendums on EU membership.
In May 2016, global research firm IPSOS released a report showing that a majority of respondents in Italy and France believe their country should hold a referendum on EU membership.
The fragile Italian banking sector has driven a wedge between the EU and the Italian government, which has provided bailout funds in order to save mom-and-pop bondholders from being "bailed-in," as EU rules stipulate. The government had to abandon its 2019 budget when the EU threatened it with sanctions. It lowered its planned budget deficit from 2.4% of GDP to 2.04%.
Matteo Salvini, the far-right head of Italy's Northern League and the country's deputy prime minister, called for a referendum on EU membership hours after the Brexit vote, saying, "This vote was a slap in the face for all those who say that Europe is their own business and Italians don't have to meddle with that." The Northern League has an ally in the populist Five Star Movement (M5S), whose founder, former comedian Beppe Grillo, has called for a referendum on Italy's membership in the euro – though not the EU. The two parties formed a coalition government in 2018 and made Giuseppe Conte prime minister. Conte ruled out the possibility of "Italexit" in 2018 during the budget standoff.
Marine Le Pen, the leader of France's euroskeptic National Front (FN), hailed the Brexit vote as a win for nationalism and sovereignty across Europe: "Like a lot of French people, I'm very happy that the British people held on and made the right choice. What we thought was impossible yesterday has now become possible." She lost the French presidential election to Emmanuel Macron in May 2017, gaining just 33.9% of votes.
Macron has warned that the demand for "Frexit" will grow if the EU does not see reforms. According to a Feb. 2019 IFOP poll, 40% of French citizens want the country to leave the EU. Frexit is also one of the demands of the yellow vest protesters.