4 August 2016

Summary

As the new UK government begins to formulate a Brexit plan, many businesses and some politicians have turned to the European Economic Area (EEA) model – or some variant of it – which would leave the UK in a relationship with the EU that is similar to that of Norway and keep it in the single market.

The EEA option comes with some notable benefits. It provides an ‘off-the-shelf’ model, thereby minimising short-term economic disruption and uncertainty, and could help smooth some of the regional differences thrown up by the Brexit vote, such as those raised by Scottish First Minister Nicola Sturgeon. EEA membership also means exiting some EU policies – such as agriculture and fisheries – and regaining the ability to negotiate stand-alone trade agreements with non-EU countries.

However, a Norway-style relationship is unlikely to be a viable long-term option for the UK. Firstly, it is a poor fit when set against the Leave side’s key arguments during the referendum campaign: restoring full control over UK immigration policy, restoring UK sovereignty over lawmaking including vis-à-vis the European Court of Justice, eliminating the UK’s financial contribution to the EU, and reducing the burden of EU legislation on business. Secondly, and perhaps just as importantly, it is unlikely that such an EU-satellite status would satisfy the national self-image of a major G7 economy with deeper trade and foreign policy links across the world, such as the UK.

So, what are the alternatives to the EEA? Assuming that falling back on the WTO option, i.e. no preferential trade agreement with the EU at all, is a last resort, the realistic choice is between the EEA or some form of stand-alone comprehensive free trade agreement (FTA). One option could be to seek reform of the EEA itself to account for the above concerns, but this would require the EU (and other EEA members) to agree to sweeping changes to a model that appears to have suited its parties relatively well to date.

The FTA route is probably better suited to addressing the main political drivers of the leave vote over the long-term, but it comes with its own set of problems, most notably the length of time it would take to negotiate – while the Article 50 exit mechanism currently only allows for two years. Moving straight to an FTA with the EU is also likely to cause more disruption to the UK’s trade with the EU than the EEA option at a time when the UK is still establishing new trade agreements and seeking to deepen relationships with non-EU countries, which are crucial to enabling it to rebalance.

This leaves the possibility of a transitional EEA-style relationship (it is unlikely that the UK would join the EEA formally, a more likely arrangement is one that mirrors the EEA in almost every aspect) pending a tailored, bilateral agreement being thrashed out. However, even this would still come with many challenges. These include controlling EU immigration, ensuring any EEA transition is truly transitional, managing the domestic politics, and making progress on the non-EU trade front. However, these challenges could be overcome if the UK and EU are able to establish the outline of a desired final settlement, even if the details will be subject to further negotiation. Indeed, a long-term vision for the UK outside the EU would be an essential component of any transitional phase.

Recap: what does the EEA/Norway model entail?

The EEA is an agreement between the EU and three of the four members of European Free Trade Association (EFTA) – Norway, Iceland and Liechtenstein – that grants these countries virtually full access to the EU’s single market (Switzerland, the fourth EFTA member, has a separate deal with the EU). This means that the ‘four freedoms’ of goods, services, capital and people apply within the EEA on the same basis as within the EU itself, with the exception of some agricultural and fisheries products. Continued EEA membership would therefore allow the UK to ‘remain within the single market’ post-Brexit as some on both sides of the Remain/Leave divide have called for (of course, in reality, the single market only truly has two full freedoms – of goods and people – with services and capital far from free despite efforts from the UK and others to push for this).

EEA members are also bound by EU legislation in a number of policy areas beyond those strictly related to the single market, such as social and employment policy and environmental legislation, although they are outside of the EU’s Common Agricultural and Fisheries policies, as well as the EU’s regional development policy. Unlike the EU itself, the EEA is not a joint customs area, meaning that EFTA members manage their own trade policies and that exports to the rest of the EU must comply with customs procedures. Finally, crime and policing laws and foreign policy are also outside of the scope of the EEA agreement.

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How would the UK join the EEA in practice?

This is uncharted territory from a legal perspective. Some, including EU legal expert Steve Peers, have suggested it might be possible for the UK to retain its EEA membership upon leaving the EU. However, our interpretation is that since the EEA is an agreement between the EU and EFTA and not a standalone entity, leaving the former means that the UK would have to apply to join the latter in order to retain its EEA membership. This would first require the consent of the other EFTA member states. Secondly, all EU member states – and potentially the European Parliament – would have to give their consent.

How does the EEA model fit with the referendum campaign?

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Free movement

EEA membership comes with free movement as it is one of the four freedoms that make up the single market. Free movement in the EEA applies on two levels – directly between EFTA members and between EFTA members and the EU. This includes provisions on non-discrimination when it comes to access to benefits. This means that Norway could not enact the kind of restrictions on EU migrants’ access to in-work benefits negotiated by David Cameron without EU agreement.

The EEA Agreement does grant member states the ability to enact ‘safeguard measures’ in the event of “serious economic, societal or environmental difficulties”, allowing them to suspend parts of the Agreement, including the free movement of people, albeit temporarily. These can be triggered by a country unilaterally, but the EU can take retaliatory “proportionate rebalancing measures”. The use of safeguard measures triggers a negotiation between the EEA/EFTA countries and the European Commission “with a view to finding a commonly acceptable solution.” This ‘emergency brake’ should therefore not be mistaken for an indefinite policy tool; it is a nuclear option which could be used to bring the EU to the negotiating table. The outcome of any such negotiations would ultimately be determined politically.

Norway has never used the safeguard measures for this purpose but, in the late 1990s, Liechtenstein applied safeguard measures to restrict free movement while it negotiated a more permanent arrangement concerning foreign EEA nationals’ residence and employment. In 1998, the EEA joint committee agreed that Liechtenstein should be allowed to issue residence permits to Norwegian, Icelandic and EU nationals owing to its “specific geographical situation”. The exact mechanism is set out in Annex VIII of the EEA Agreement. Liechtenstein is the only EEA member allowed to impose such restrictions on free movement.

The Liechtenstein system is quite specific; the number of residence permits issued annually – measured in terms of the net increase compared to the previous year – has to be at least 1.75% of the number of Icelandic, Norwegian and EU nationals resident in Liechtenstein on 1 January 1998. As such, it is a floor as opposed to a cap, one which Liechtenstein cannot amend unilaterally. There are also specific rules on facilitating family re-unification and allowing persons giving up their economic activity to remain in the country. It is worth noting also that the conditions concerning nationals of Iceland, Norway and the EU Member States cannot be more restrictive than those which apply to third country nationals.

There is therefore a precedent for an EEA member to benefit from a tailored immigration regime, although it is highly questionable whether other EEA member states would agree to a similar deal for the UK given Liechtenstein’s unique circumstances – a population of around 37,000 and a territory of around 160 square kilometres – clearly do not apply. That said, in 2014 the UK’s population density was 232.8/km2 (and 413/km2 in England), while Liechtenstein’s was 266.4/km2. For context, Belgium’s and the Netherlands’ were 370.3 km2 and 500.7/km2 respectively.

Sovereignty

Non-EU EEA members still have to adopt EU laws in all the areas covered by the EEA agreement, but because they lack formal representation in the EU institutions, they have minimal input into the EU’s legislative process and no voting rights. It is possible for non-EU EEA states to secure limited amendments to EU laws before they are incorporated into the EEA Agreement, although ultimately, this is down to the goodwill of the European Commission.

EEA members can theoretically refuse to transpose EU legislation into the EEA agreement. Whilst it is a legitimate tool, it has major drawbacks limiting its practical effectiveness. This ‘right of veto’ does not stop the EU enacting legislation and, if it relates to product standards or financial regulations, for example, EEA members cannot use the old ones to continue to export to the EU and can therefore find itself locked out of the Single Market in the areas affected. For this reason, Norway has never exercised this veto right. The closest it came to doing so was over the Third Postal Directive, where the incoming Conservative government reversed the previous Labour government’s decision to refuse implementation of the Directive into the EEA agreement.

The EEA Agreement is policed by the supranational EFTA Surveillance Authority and the EFTA Court. The former works closely with the European Commission while the latter follows ECJ case law closely in order to maintain legislative homogeneity within the EEA; an explicit objective referenced clearly within the Agreement. Prof. Dr. Carl Baudenbacher, President of the EFTA Court, has noted that the homogeneity rules within the EEA agreement “essentially bind the EFTA Court to follow relevant ECJ case law”. He also concluded that “On balance, the EEA Agreement is closer to supranational [European Community] law than to public international law.”

As noted above, the scope of the EEA Agreement is narrower than the EU Treaties giving non-EU EEA members control over policy areas including agriculture, fisheries and regional policy, as well as police and criminal co-operation. That said, given the extent to which EU law does apply in the EEA, and the fact that there are dedicated supranational institutions mandated to enforce this, the EEA cannot reasonably meet a purist’s definition of national sovereignty as set out during the referendum campaign.

From a practical perspective, it is also worth noting that, according to the ONS, as of 2013, agriculture only accounted for 0.7% of UK GVA compared to 8% for financial services – an area where under the EEA the UK would lose sovereignty by virtue of no longer having a say over single market rules. In addition, if the Eurozone does pursue deeper integration in future, there is a risk that single market regulation, particularly in the area of financial services, could become more ill-suited to the UK’s needs and interests.

Financial contribution to the EU

Although EEA members do not pay directly into the EU budget, they do contribute to and receive funding from specific EU programmes such as the Horizon 2020. They also offer direct financial assistance to less developed EU member states – for example, Norway is contributing €391m every year between 2014 and 2021. Although sometimes presented as a ‘voluntary’ contribution, the EEA agreement explicitly references the “need to reduce the economic and social disparities.” This means that EEA members’ contributions are not significantly lower in per capita terms than that of the UK. For example, according to our calculations, in 2015 Norway’s per capita net contribution was 88% that of the UK – £100.03 compared to £113.79.

Reducing burden of EU regulation on businesses

Although EEA membership means adopting fewer regulations than full EU members, EEA members must adhere to all relevant laws in areas ranging from product standards through to social and employment laws and energy and climate change regulations.

For example, of the 100 most burdensome pieces of EU legislation currently in force in the UK, 93 are also in force in the EEA. This includes laws like the Working Time Directive, the Agency Workers Directive and the Alternative Investment Fund Managers Directive which Leavers have singled out for repeal or amendment post Brexit. Crucially, unlike in the case of trade agreements which set out common standards for exports of goods and services, EEA membership means that these continue to apply throughout the whole economy. This means that EEA membership offers limited scope for deregulation other than in the areas of agriculture and fisheries.

Negotiating own free trade agreements

Unlike the EU itself, the EEA is not a customs union. EFTA members can either negotiate FTAs with third parties collectively – EFTA has 27 trade agreements with 38 countries ranging from Canada through to Ukraine or, where EFTA cannot agree a common position, individual members can negotiate unilateral agreements – Iceland has an agreement with China for example.  EEA exports into the EU customs union must comply with customs procedures.

Membership of the single market could act as a constraint on the UK’s flexibility in trade talks with non-EU states. Ulf Sverdrup, director of the Norwegian Institute of International Affairs, has noted that: “A lot of issues in free trade agreements are about non-tariff barriers like food security, and technical standards are already in the acquis [law] of the EU so we cannot negotiate on these things. So what we in reality can deal with in those free trade agreements is very much constrained.”

Nevertheless, EEA membership would enable the UK to do a first round of trade negotiations that could focus on reducing tariffs with high-tariff markets such as India, China and Brazil.

The UK is not Norway

It is also important to consider the broader picture. As obvious as it may seem, it is worth noting that the UK and Norway are in very different positions. The EEA arrangement works well for Norway, a country of 5.2 million and an economy of around $388bn which does 74% of its total trade with the EU. In contrast, the UK is a country of 64.8 million with a total economy of around $2,849bn which does only 49% of its total trade with the EU. As a member of the G7 with a permanent seat on the UN Security Council, the UK should be in a position to set its long-term sights higher than EU-satellite status.

Could the EEA work as a temporary/transitional solution?

In view of the imperfections inherent in the EEA model, some have argued it could serve as a temporary solution while a more tailored, long-term alternative is worked out. The EEA could act as a ‘safe haven’ with minimal uncertainty and economic disruption which would allow the UK the necessary time and breathing space to negotiate free trade agreements with other countries and to identify which EU laws to maintain, amend or scrap altogether.  Such a scenario could be feasible, although there are several issues which would need to be considered:

  • Need EU agreement to continue negotiations – the EU must agree beforehand to continue to negotiate with the UK on a separate final deal. Once the UK is in the EEA, there may be little incentive for EU members to continue negotiations as this minimises disruption to their economies and leaves them with a significant say over the rules of the UK economy. They might also not be keen on negotiating UK entrance to the EEA and then negotiating with the UK again, especially after having devoted time to the UK renegotiation before the referendum. Of course, the UK could force talks by triggering the process of leaving the EEA, but this only allows for a one year transition rather than the two years available when leaving the EU.
  • Need an idea of final destination – if the aim is to quell business concern then some idea or outline of where the UK would like to go in terms of its final relationship with the EU will be needed. Otherwise, the uncertainty will continue in the medium term and business will be concerned over every headline during the lengthy negotiations and transition. It would amount to at best a can-kicking exercise.
  • Domestic politics – it will be necessary to convince those who voted to leave that this will still eventually happen. There would also be a need to explain why it is best for the UK to use a transitional relationship which includes keeping free movement of people (to some degree) and oversight of the European Court of Justice (indirectly but still binding).
  • Free trade agreements and WTO tariffs – as soon as the UK enters the EEA, the FTAs which it has via the EU would cease to be in force. These would have to be grandfathered or renegotiated; it seems likely these could be agreed, but it would still take time since there are 60+ deals with 30+ countries. Additionally, the UK will have to decide and negotiate its WTO tariffs. This is largely technical but could be important, as it sets the terms on which Britain trades with much of the world and it is not completely guaranteed that we can simply step into the EU’s tariff schedule as this was negotiated on behalf of a market of 28 states. It is also hard to negotiate new FTAs until the WTO baseline tariffs have been set.

In reality, an EEA transition is unlikely to mean formally joining the EEA and then leaving again – this might be seen as overly disruptive for existing EEA members, for example. More likely, it would be a temporary agreement between the UK and the EU which mirrors the EEA in almost every aspect, but with a specific sunset clause to demonstrate that it is transitional. This might help to tackle some of the concerns laid out above. The UK could try and negotiate temporary controls on issues such as free movement, although the problems in getting the EU to agree to this would undoubtedly still apply.

The EEA is not the only model that could be employed during the UK’s transition from full membership; other options include staying within the EU for a specified period albeit with curtailed voting rights or a more bespoke, medium-term arrangement of the sort proposed by Professors Anand Menon and Damian Chalmers as part of a comprehensive, three-step Brexit plan.

The EEA and the future of the UK

 In the wake of the referendum in which Scotland, Northern Ireland and London all voted to Remain, there has been renewed speculation about the break-up of the UK. Politicians from all those areas, above all Scottish First Minister Nicola Sturgeon, have called for the UK to respect their voters by maintaining as close a relationship with the EU as possible, including continued membership of the single market. The EEA model is clearly the best way of achieving that, although it could also cause a backlash in other parts of the country. It could also be argued that even adopting the EEA model would not placate Scottish nationalists for long if independence from the UK is their ultimate goal.

What about an EEA-light or an EEA-minus?

Some have also suggested that the EEA could be amended in some way to allow the UK to respect voters’ concerns about immigration while still maintaining a high degree of market access – this has been dubbed the ‘EEA-light’ or the ‘EEA-minus’ option. Rupert Harrison, the former Chief of Staff to ex-Chancellor George Osborne, summed this option up as “a bit more immigration control and a bit less single market.”

This would be more politically viable than EEA membership as it stands now. However, it remains to be seen exactly what the extent of this trade off would be; the more extensive the restrictions on free movement, the more market access the UK could have to concede. For example, a beefed-up ‘emergency brake’ allowing the UK to temporarily limit migration if it exceeds a certain threshold may be politically viable, while a much tougher system, for example comprising caps or quotas, will be harder to negotiate and is likely to come at a much higher price.

It is unclear whether this would involve reforming the EEA as a whole – quite an arduous task – or negotiating a separate agreement that mirrors the EEA but for a few reforms, as suggested in the transitional section above. Of course, other EFTA states may question any such arrangement if it is seen as giving only the UK a more favourable deal.