3 February 2017

In the EU institutions in Brussels, an assumption made by many is that if the British get a “good deal” after Brexit, this would be bad for the EU. Even those genuinely concerned that negotiations shouldn’t go off the rails, like Joseph Muscat, the Prime Minister of Malta, whose country holds the rotating presidency of the Council of the EU, has stated that “we want a fair deal for the United Kingdom, but that fair deal needs to be inferior to membership….It cannot end up better than the current situation.”

This attitude reveals how many in the EU institutions and member states instinctively consider trade to be a zero-sum game: when one party wins, the other party must lose. Of course, it’s the other way around. If Britain gets a bad deal, for example because it faces tariffs to export to the Continent, the EU also loses. That’s the case not just because Britain could itself seek to impose tariffs on imports from mainland Europe, but because restrictions on investment from the City of London into the Continent would drive up the cost of investment in the EU27.

To be fair, this is appreciated in Brussels to a certain extent. Last month, the EU Commission’s Brexit Chief Negotiator Michel Barnier expressed concern that there would need to be “special vigilance on financial stability risk” as a result of possible EU restrictions imposed on UK-based financial service providers. One senior European official has even remarked that closing London as a euro clearing centre is likely to increase costs for EU banks and companies.  This echoes an estimate made by the CEO of the London Stock Exchange Group, who has warned that if the UK were to lose the ability to clear euro-denominated transactions as a result of Brexit, this would fragment markets and cost European banks an extra £63bn in additional collateral.

The EU of course would be sensible to avoid cutting itself off from the world’s biggest financial centre, but then all kind of grand strategies are being prepared on the Continent to lure finance jobs from London, for example by limiting UK banks’ ability to operate in the EU. UK banks then would need to set up a subsidiary, putting up new capital to do so, which would hamper their investment in mainland Europe. As Open Europe argued in our recent financial services report, UK firms are more than capable of surviving and thriving in such scenarios, but a pragmatic and mutually-beneficial regulatory solution would be a far more preferable. As so often, however, special interests may trump the general interest.

This is something that the British need to keep in mind. They must not assume that the EU institutions are acting purely rationally or shielded from the influence of special interests.

It is not merely flawed economic thinking that makes some EU policy makers in Brussels skeptical about giving Britain a ‘good deal.’ Some of them actually believe that the EU project would benefit from giving the UK a ‘bad deal.’ It was reported that Martin Selmayr, the “chef de cabinet” of Jean-Claude Juncker, thinks that “Britain’s departure will help Europe to finally forge a new identity.” But this view is not universally accepted: a senior EU commissioner commented that “Martin is mad — he is positively insane” as “no one else believes this idea that Brexit will unite Europe somehow. I don’t think Jean-Claude believes it either.” Still, although not everyone in Brussels is as radical as Selmayr, the thinking goes that if the British leave the club too easily, others may start thinking of taking this route as well.

While this reasoning may appear sensible at first glance, it doesn’t hold up. Any economic damage for Britain would go hand in hand with economic damage for the EU27, especially for the Benelux, Germany, Malta, Cyprus and Ireland. The EU Commission is often blamed for all the wrongs in the world, so how would it not be blamed for job losses related to this?

Assuming the UK triggers Article 50 this spring, a period of two years will then start, after which Britain will automatically leave the EU (unless this period is extended by unanimous agreement).  In Brussels, there is near-consensus that fixing a long-term free trade deal in such a short time span is completely unrealistic. Clearly, Theresa May wouldn’t fancy the prospect of tariffs kicking in one year before the scheduled general election in 2020, with potential job losses as a result. But equally she’s been clear that the government would prefer no deal over a bad deal.

Despite the talk of “setting an example” to others, many on the EU side would be genuinely unhappy with a cliff edge. Some in Britain may think that this prospect would drive the EU to agree some kind of a deal, perhaps temporarily. They may be right, but there’s little certainty.

There is willingness to conclude a transition deal, but both the Commission and  the Council presidency have (so far) stated that during that period the UK would be subject to EU rules and jurisprudence without having a say. A Belgian high-level business group advising the government on Brexit has stated that if the UK refuses this, Belgium should still “remain open minded” and prioritise avoiding tariffs. The question is if this view will prevail. One senior European official, commenting on a transition deal, told Reuters that “the technicians of course say it’s obvious. But frankly, politically it’s not at all. (…) Do the Brits really want it? On the kind of terms we can offer? There’s a real danger they will just fall off the cliff.”

Although Theresa May wants to avoid an ‘unlimited transitional status,’ she has acknowledged the case for a ‘phased process of implementation,’ for example on a sector-by-sector basis. But she doesn’t have long to agree this.

Will she be successful? Perhaps. As so often with things in Brussels it will come down to politics above all else. As we saw with the imposition of EU sanctions against Russia, politics can triumph over economics. If the politics is of punishment and setting an example then the consequences could be bad: a cliff-edge Brexit with tariffs and no winner on either side. But if the politics is more constructive, things could become much easier.

A version of this article was also published by BrexitCentral.