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posted on 23 August 2016

How To Leave The European Union

from STRATFOR

-- this post authored by Adriano Bosoni

After the results of the Brexit referendum, many EU governments and officials went out of their way to emphasize that the vote did not herald the end of the European Union and could even make it stronger. For these officials, presenting the vote as an oddity is essential to preserving the bloc. After all, if the Brexit is not an exception, then it could become an example for other countries to follow. The specter of the British precedent will shape relations between the bloc and the United Kingdom for years to come, throughout the negotiations process and afterward.

By now, it is clear that London is trying to delay its formal discussions to leave the European Union for as long as possible. Two months after the vote, the British government still faces conflicting pressure from the country's "leave" and "remain" camps as it tries to develop a strategy for exit negotiations, tentatively scheduled to begin in early 2017. The European Union, meanwhile, has dilemmas of its own with which to contend. The bloc's political heavyweights, Germany and France, will each hold general elections in 2017, and Italy may well join them if a referendum on constitutional reforms fails before the end of the year, precipitating the fall of the government.

Dealing with domestic opposition parties that want their own versions of the Brexit referendum, Berlin, Paris and Rome want to send their voters the message that the costs of leaving the European Union outweigh the benefits. At the same time, Europe's main political players understand that prolonged uncertainty will hurt the Continent's fragile economic recovery. An agreement, therefore, is inevitable, even if negotiations could continue well into the next decade.

Breaking the Mold

For economic and political reasons, the United Kingdom and the European Union want to keep close ties post-Brexit. In or out of the Continental bloc, the United Kingdom is and will be a major European power. Moreover, the European Union is a significant trading partner for the United Kingdom, accounting for roughly 44 percent of its exports and about 53 percent of its imports. But without concrete guidelines for a member country's withdrawal from the European Union, the process will come down to politics. None of the three existing frameworks for relations between the European Union and countries outside it - the "Norwegian" or "Swiss" models or a free trade agreement - satisfies the parties involved.

Under the Norwegian model, Britain could preserve its membership in the European Economic Area, which allows the free movement of goods, services, people and capital within the EU internal market. To do this, London would have to join Norway, Iceland, Switzerland and Liechtenstein in the European Free Trade Association (EFTA). Such an arrangement would offer many of the advantages of EU membership without requiring the United Kingdom to participate in the EU Common Agriculture and Fisheries policies or prohibiting it from signing free trade agreements with outside countries. Adopting the Norwegian model would avoid new tariffs between the United Kingdom and the EU internal market, thereby reducing short-term economic disruption. It would probably also enable the United Kingdom to maintain the passporting rights that allow financial institutions operating there to sell their services to other countries in the internal market without having to request individual authorizations. Furthermore, it would ease concerns in Scotland and Northern Ireland - where a majority of people voted to stay in the European Union - by mitigating the economic and political consequences of the Brexit and avoiding the reintroduction of a hard border between Northern Ireland and the Republic of Ireland.

The solution is not perfect, though. Membership in the internal market would entail accepting EU workers, a sticking point for those "leave" supporters who hoped that a Brexit would reduce immigration. The Norwegian model would not resolve Britain's desire to regain its sovereignty, either. Despite not having a say on EU policy, EFTA members are nonetheless required to contribute to certain parts of the EU budget. As an EFTA member, London would once again be forced to accept rules that it cannot influence while chipping in to a budget that it cannot reform. Though this may be an acceptable compromise for a country with a small economy such as Norway, it probably would not work for a global power like the United Kingdom.

Then there is the Swiss alternative. The Alpine nation is not a member of the European Economic Area, but it has access to some parts of the internal market through multiple bilateral agreements. The problem is that Switzerland's relationship with the European Union took decades to build, and the country still must accept EU workers and keep up with EU regulations it does not influence. Swiss banks also do not have passporting rights, and most of them keep large operations in London to do business with the internal market.

The third option would perhaps be the most functional for the United Kingdom. A free trade agreement with the European Union would address many of the Brexit campaign's most important issues, giving the United Kingdom full control of its immigration policy and greater control of its foreign policy, eliminating its financial contributions to EU structures, and restoring full parliamentary sovereignty. But negotiating free trade agreements tends to be a lengthy undertaking. The European Union's free trade agreement with South Korea, for example, took a decade to hash out. In the meantime, trade between the European Union and United Kingdom could suffer, since both parties would have to reintroduce tariffs only to lift them again once an agreement is reached. To avoid this complication, some have proposed that the United Kingdom should temporarily join the EFTA to keep up the status quo during free trade agreement discussions. But joining the EFTA could relieve the pressure on the United Kingdom and the European Union alike to go through with negotiating a free trade agreement, an irksome prospect for the Brexiteers.

In addition, free trade agreements are easier to negotiate for goods than they are for services. When the European Union and Canada reached a free trade agreement, for instance, they agreed to lift all tariffs on industrial and fisheries products. But they did not liberalize many services, including financial services, and the agreement, which has not yet been ratified, did not involve passporting rights. For a services economy such as the United Kingdom's, this is no small drawback.

Migration Versus Market

Meanwhile, the European Union has its own concerns in the Brexit discussions. The free movement of people within the European Union has become a hot-button issue for Euroskeptic parties across the Continent, many of which are lobbying for Brexit-type referendums in their own countries. Consequently, the European Union is wary of granting the United Kingdom full membership in the internal market while also allowing it to reject EU workers, lest it set a precedent. Finding a balance between market access and migration will be a priority for the European Union in negotiating the Brexit.

Though the European Union has negotiated over similar issues with other countries in the past, each case differs significantly from that of the United Kingdom. When Liechtenstein joined the European Economic Area in 1995, it was authorized to introduce an immigration quota system, reviewed every five years, to prevent massive migration from overwhelming its tiny population (36,000) and territory (160 square kilometers, about 60 square miles). By comparison, the United Kingdom is a high-profile case that everyone on the Continent will watch closely, and EU members will be less inclined to make the same kinds of concessions to London.

Switzerland offers a more likely model. In 2014, the Swiss voted to introduce a quota on EU migrants. Since then, Brussels has threatened to end cooperation with Switzerland in multiple areas, including research projects with Swiss universities (trade agreements on electricity and financial services have already been frozen). If Switzerland were to reach a compromise with the European Union on the free movement of workers and access to the EU market, it could provide an example for the United Kingdom to follow in discussing the same issue. But here, too, the United Kingdom diverges from the established pattern. Some Swiss politicians are suggesting a second referendum to overturn the 2014 quota vote, an unlikely turn of events for the United Kingdom's Brexit.

A Tailor-Made Agreement

The final settlement between the European Union and the United Kingdom will probably not be a rehashing of existing models. Germany's European affairs minister recently admitted that, given its size and relevance, Britain could achieve a "special status" in its relationship with the European Union. In this respect, time may even be on London's side. Negotiations will probably far exceed the two-year period established by EU rules, and as Euroskepticism continues to grow in Europe, limiting the free movement of EU workers will gradually become less of a taboo topic in the Continental bloc.

Eventually, the United Kingdom and European Union will reach an ad hoc agreement, shaped by national economic interests on each side of the negotiating table. Because France and Germany hope to attract financial companies relocating some of their operations from London, they may be less inclined to preserve the United Kingdom's passporting rights. The Swedish government also recently warned that the United Kingdom's suggestion to entice investors by reducing corporate taxes could complicate its negotiations with the European Union. On the other hand, countries with strong economic links to the United Kingdom, such as Ireland, will advocate for the broadest possible deal with London. British officials, in turn, will try to resist subordination to EU decisions as much as possible.

Throughout the negotiations, the question of whether the United Kingdom is indeed an exception or the symptom of a broader trend will remain unresolved. The European Union is unlikely to lose any other members in the immediate future; opinion polls show that though support for the bloc has decreased over the past decade, most citizens in most EU member states want to stay in it. But once the Brexit has been settled, the Continental bloc will have a framework to handle future withdrawals. What's more, the final agreement may show EU members that bespoke arrangements are possible, even for rebellious countries.

In the face of this new reality, some countries may threaten to hold their own referendums to exact concessions from the European Union. Nations with larger economies may be more assured of getting a good deal upon withdrawing than are smaller members that depend on EU subsidies and investment. The issues on the table will also be different, with some countries focusing on migration and others making demands related to the eurozone, EU rules on deficit and debt, or the repatriation of powers to national parliaments. Regardless, the main danger for the European Union is that the Brexit - from the demands that preceded the referendum to the settlement that will follow it - will no longer be an aberration but a precedent that others can use to their advantage.

"How to Leave the European Union" is republished with permission of Stratfor.

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