Prime Minister Theresa May delighted her Conservative Party followers by dancing her way onto the stage, with ABBA’s “Dancing Queen” in the background, at the recent party convention. In her address, she promised to honor the 2016 referendum on Britain’s exit (Brexit) from the European Union while seeking “a good trading and security relationship with our neighbors after we have left.” But it will be Europe that calls the tune for any dancing in the future. The Brexit negotiations are near an impasse, the remaining 27 EU members hold all the cards, and a (perhaps temporary) collapse of negotiations looks increasingly likely.
The latest EU-27 deadline for material progress on the Brexit Withdrawal Agreement is October 17, when European leaders plan to discuss Brexit among themselves at a dinner ahead of their EU Council and an Asia-Europe Meeting (ASEM) the next day. All the signals suggest that May will have to make a new offer to the EU-27 beforehand, if a special Brexit Summit is to be called for November and a breakdown avoided.
To unlock a deal in Westminster, significant shifts in the UK government position must occur. These changes could happen if party discipline is battered by increased financial market volatility and economic pressures arising from a perceived collapse of negotiations. The EU-27 might welcome such market turbulence, as it did with Greece in 2010, to pressure the United Kingdom. Expect Brussels (with Paris and Berlin in the background supporting) to apply soothing rhetoric while pursuing a hard line in the coming weeks.
At the party convention, May essentially doubled down on her earlier “Chequers Plan for Brexit,” which the EU-27 has summarily rejected as “unworkable.” May herself has rejected the two offers by the EU-27. The United Kingdom cannot accept the European Union’s rule-making authority, as Norway has—i.e., a “Brexit in Name Only” option. Nor can it accept a Canada-style free trade agreement (FTA), because doing so would involve carving off and leaving Northern Ireland inside the customs and regulatory sphere of the EU-27 to keep the border unchanged. Something’s gotta give.
The big sticking point remains the Northern Irish border, which all parties involved profess to want to remain unaltered. A plausible compromise might involve May accepting the idea of keeping all of the United Kingdom inside the EU customs union until other practical border arrangements become technically feasible. Such a compromise would eliminate the need for any customs checks between the United Kingdom and the EU-27. And the United Kingdom would have to accept internal market regulatory checks conducted between Northern Ireland and the rest of the United Kingdom.
But staying in the EU customs union would require the UK government to jettison its earlier “Facilitated Customs Arrangement” proposal and essentially abandon its plans to negotiate FTAs for goods with other countries for the foreseeable future. The technological fixes to replace a customs union that some have talked about are not forthcoming. The EU-27 will certainly demand that such an Irish backstop be made permanent in nature. But it remains doubtful if May can get the parliamentary backing of her own party and the Northern Irish Democratic Unionist Party (DUP) for such a plan. Hard Brexit proponents on the Conservative Party backbenches want the United Kingdom to have the ability to sign new trade deals outside the EU customs union. The DUP, on the other hand, has ruled out any new regulatory checks between Northern Ireland and the rest of the United Kingdom.
The EU-27 might not be willing to grant the United Kingdom such a de facto long-term trade arrangement, on the ground that it would not include other EU demands for a level playing field and other competitiveness considerations, as they will not want the United Kingdom to have the opportunity to undercut EU-27 standards while having access to its market. And the EU-27 are unlikely to accept the United Kingdom ending up inside the single market for goods only; EU leaders oppose what they see as granting the United Kingdom unacceptable economic benefits, allowing it to pick and choose parts of the EU single market in which to participate. Frictionless trade between the EU-27 and the United Kingdom is hence a fiction after Brexit, unless the United Kingdom ultimately chooses the Norway–European Economic Area (EEA) option that allows the free movement of goods, services, capital, and people.
A failure to break the impasse in mid-October, or subsequently to get parliamentary approval for a deal in Westminster, would unleash the “no deal scenario” with unpredictable political consequences. It seems clear, though, that even in this scenario of a mid-October breakdown, it remains highly unlikely for the United Kingdom to leave the European Union in March 2019 without a deal. Certainly, there would be a majority against such an outcome in the current British Parliament. Only if May were to call another general election and win it on an anti-EU platform explicitly endorsing a no deal scenario does it seem plausible that members of Parliament would take such an economically devastating step for the United Kingdom. The British electorate would have to essentially vote for a no deal Brexit in a general election before it could materialize.
The United Kingdom’s case is different from other troubled and obstinate euro area countries in several respects. In Greece, the bond markets did the heavy lifting to make the previously politically impossible suddenly possible during 2010–15. It is not clear, however, just how severe market pressures will be in early 2019 if the United Kingdom careens towards a no deal Brexit. How do you short the pound in such a scenario? And would the Bank of England attempt to stabilize the pound and inflation (i.e., by raising interest rates)? Or would it opt for stimulating economic output and unemployment (i.e., by cutting rates and buying assets)? A risk lies in financial markets underestimating the negative economic effects of a no deal Brexit, making British politicians complacent and EU-27 leaders overconfident.
The EU-27 leaders are not expected to be particularly helpful to the UK government if negotiations break down in mid-October. They advanced the negotiating deadline knowing that no amount of extra time would allow the UK government and parliament to agree over what kind of Brexit they want. And unless another referendum is called, the European Union will not likely extend the deadline. And it will not be lost on EU-27 leaders either that the closer the United Kingdom comes to a no deal Brexit, the more appealing simply “going for the economic status quo” in the form of the Norway-EEA option will become. At some point this is likely to be the only option left that will avoid the United Kingdom simply crashing out.