Significant progress is needed on three “divorce” issues – the future rights of EU citizens in the UK and UK citizens in the EU, the UK’s financial obligations to the EU, and the future border between Northern Ireland and the Republic of Ireland – before the Brexit negotiations can move to the important stage of future trade relations and a transition period. While difficult discussions still are required on the first two issues, agreement on them appears to be achievable. The Irish border issue, however, has suddenly emerged as a serious obstacle to the negotiations.
The Republic of Ireland has moved to bring the border issue to a head now, strongly asserting that it agrees with the European Commission in seeking, before negotiations can proceed, an explicit guarantee from the UK that no ”hard border” requiring border checks will divide the island of Ireland. Dublin is also calling for a five-year transition. The UK also does not want to see a hard border across Ireland but has yet to put forward a realistic proposal on how to avoid this implication of its intention to exit the EU single market and customs union. The Republic of Ireland will remain a member of the EU and continue in the single market and customs union, whereas Northern Ireland is part of the United Kingdom.
Dublin has called for Northern Ireland to continue to apply the rules of the EU customs union and the single market. Brussels is similarly arguing that Northern Ireland may have to remain within the customs union and single market if the border is to remain without barriers. The UK has rejected these ideas, which would pose a threat to Britain’s “constitutional and economic integrity,” presumably because the result would be a hard border within the UK between Northern Ireland and the rest of the UK. Yet the UK has repeated that the 1998 Good Friday peace agreement must not be undermined and a return of a hard border to Ireland must be avoided.
This border issue is of great importance to both the UK and the Republic of Ireland. During the 20 years that the border has been open, free of barriers, trade between the UK and Ireland has grown to 65 billion euros annually, benefitting both Northern Ireland and the Republic of Ireland. The two economies have become increasingly integrated with supply chains crossing the border. The necessity of maintaining the Good Friday Agreement is obvious, and the open border has great political significance for this agreement. Dublin’s demands are understandable. As member of the EU, they are a party to the negotiations, which gives them a role in determining the outcome. It is in their interest that a deal between the EU and the UK be reached in the end, for a “no deal” outcome would be very damaging to Ireland.
In the next several weeks the UK’s government under Prime Minister Theresa May has to produce sufficient progress on the border issue as well as on the other two “divorce” issues noted above to convince the EU at its December summit to begin discussions on future trade relations and a transition arrangement. Meeting this challenge is made more difficult by the necessity of the UK government to depend on the support of the Democratic Unionist party of Northern Ireland. May’s tiny majority is also threatened by internal strife within the Conservative Party, which appears to be at war with itself. Her cabinet includes both pro-Europe “remainers,” ministers who would like the UK to remain in the single market, and “leavers”, ministers who are pushing for a hard exit, leaving the EU without reaching a deal. May’s leadership is being openly challenged by her foreign secretary, Boris Johnson. He is said to be the leader of some forty eurosceptic Conservative Party MPs ready to sign a letter of no confidence in the prime minister. They certainly will not be pleased by Mrs. May’s commitment this week, in a move towards meeting demands from the remainers in her party and in the Labor Party, that Parliament will eventually have the opportunity to vote on the final Brexit deal, a withdrawal agreement and implementation bill. And should a general election become necessary, the Labor Party, with its unclear positions on Brexit issues, could well win.
There are increasing concerns about the timetable and the possibility that, in the end, no deal will be reached. The political disarray in the UK gives good reason for doubts in Europe that the UK government will be able in the near term to make the necessary credible commitments for negotiations in order to move to the next phase. The EU’s chief negotiator, Michel Barnier, has warned that “everyone should get prepared” for the possibility of a collapse of Brexit negotiations and a hard exit. UK and European business leaders have warned of the damage that no deal would be to trade for both the UK and Europe. They have pressed for a transition deal that preserves the status quo. A group of major financial institutions with operations in London have warned that “a point of no return” is fast approaching for decisions on moving jobs, capital, and infrastructure if no acceptable transition arrangement is agreed within the next three months. There are estimates that foreign banks in London have developed contingency plans for moving as many as 10,000 jobs. The stakes are indeed high for the City of London.
Thus far the UK economy has held up better than might have been expected. GDP growth for both this year and 2018 looks likely to be at an annual rate of 1.5%. But in a period of strengthening global growth, the UK’s economy’s performance has been relatively sluggish compared with other advanced economies. Consumers’ spending power has been squeezed by a significant uptick in inflation while nominal wage growth has remained subdued. Brexit-related uncertainty has kept business investment flat, and this headwind looks likely to increase.
UK equities have also done fairly well considering the high uncertainty over Brexit and the domestic political situation. The iShares MSCI United Kingdom ETF, EWU, has gained 16.8% year-to-date, November 13th. This performance is significantly below the average for advanced-economy markets outside of North America. The iShares MSCI EAFE ETF, EFA, which covers these markets, has a year-to-date return of 22.58%.
Sources: Financial Times, The Economist, Oxford Economics, ETF.com, Yahoo Finance
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