Theresa May's Folly

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Summary

  • Prime Minister Theresa May's Sunday speech at the Conservative Party's annual conference in Birmingham staked out an early position on how the UK will approach its Brexit goals.
  • The speech spoke of a "third way" that will recapture UK lost sovereignty while at the same time assuring the business community continuity in their access to the single market.
  • The approach would be sector by sector, garnered by minimal EU oversight.
  • The negotiating priorities will be foremost a political endeavor with ancillary economic considerations, not vice-versa - an approach that will hold jobs and economic growth hostage.

In Sunday's (2 October) speech at the Conservative Party's annual fall conference in Birmingham, Prime Minister Theresa May stated that while she wanted to "…offer British companies the maximum freedom to trade with and operate in the single market, the UK was not leaving the EU only to give up control over immigration again." The remark drew sustained applause from the party faithful. Never mind the stand violates the four defining features of the single market, namely the free movement of labor, capital, goods and services enshrined in the Treaty of Rome. A curious list of presumed government priorities fell swiftly into place:

  • The government would trigger Article 50 of the Lisbon Treaty by no later than March of 2017, just ahead of the French presidential elections in April and the German federal elections in the fall.
  • Parliament will not have a vote on the triggering of Article 50 and Jeremy Wright, the UK attorney general, would be representing the government's position in the courts.
  • The UK would not accept the right of EU law to supersede UK law, rejecting the jurisdiction of the European Court of Justice.
  • The UK would begin the process of negotiating free trade agreements with other countries, signaling the UK would be leaving the EU Customs Union which prevents member states from forging such independent trade deals with non-EU countries.
  • Scotland would also leave the EU and had no opt-out provision from the UK exit from the EU, with no word on the equally precarious status of Northern Ireland or Gibraltar.
  • The UK would also initiate legislation in Parliament to repeal the 1972 European Communities Act which allowed Britain to join the European Commission - the forerunner of the EU.

In Monday's trading (3 October) the pound carved out its own interpretation of events and fell to its lowest level against the euro since 2013 at €1.1434, signaling strong reservations over the emerging terms of the UK withdrawal from the EU single market. The pound fell more than 1% against the dollar to $1.2798 against the dollar, a fraction above the post-Brexit low of $1.2798 set in July.

The government's aim here is to carve out a so-called "third way," a bespoke deal that meets UK political goals of capturing lost sovereignty and control over its borders while at the same time meeting UK economic goals by assuring businesses continuity in their current unfettered access to the single market. The approach appears to be sector by sector. Durable goods such as cars, pharmaceuticals and agricultural goods, services such as financial securities, products, investment banking and insurance financial services with all the necessary passporting-garnered with minimal concessions to the EU over rules, regulatory or judicial oversight.

The negotiating process will be a political endeavor on both sides of the Channel and Ms. May has taken the first shot at defining the overall scope. It's a losing proposition for the UK from the opening gun.

Ms. May has fired a political broadside with the goal to restore parliamentary sovereignty over the economy devoid of EU interference - long a sore point among conservative decision makers in the UK. The UK never gave up the pound/sterling for the euro for much the same reason. Stripping the European Court of Justice of jurisdiction over British laws also fits nicely into the argument of restoring UK lost sovereignty.

For the EU's part, the critical political mass in the upcoming negotiations with the UK is to prevent at all costs the unraveling of the European project. The UK's opening salvo is an unabashed exercise of cherry-picking the benefits of the single market in which the remaining 27 countries of the EU would be more than happy to participate. The political premium here is preventing such a land grab by holding up the UK as an example by making the country pay a clear economic price for a much reduced level of future access to the single market. In setting this example, the EU is willing to risk short-term economic damage to drive home a much more fundamental political point to the remaining 27 member states in the grandstands.

It goes without saying the EU has the stronger hand from almost every imaginable angle. The EU is the UK's biggest market by far, absorbing 44% of all UK exports, which translates to £222 billion through the end of 2015. The EU is the source of 53% of all UK imports, which translates into £291 billion over the same period. Conversely, the UK absorbs about 17% of total EU exports with the lion's share coming from Germany, Spain, Belgium and The Netherlands with which the UK has the greatest running trade deficits. The EU clearly has the luxury of time. The UK will be precariously perched in legal limbo for the duration of the negotiation period as the scope of both the divorce and the future relationship with the EU is hammered out. The longer the process drags on the more uncertainty builds for UK businesses which will stifle long-term planning and investment. Job and overall economic growth in the UK will be clear casualties the longer the bureaucratic haggling continues.

While Mrs. May was forthright in her presentation of her opening political position in the Brexit process before a friendly party gathering, perhaps a better positioning statement might have included an equally forthright presentation of economic life after the two-year Article 50 negotiations run their course. Rather than signaling an exit to the EU Customs Union, an attempt at securing a position in the single market but outside the EU until the future deal was struck would have made more economic sense for the country as a whole. Of course, the Brexit exercise is not about economics - it's about politics. As a result, the UK negotiating position has been reduced even further.

Ms. May's opening salvo largely rules out the European Economic Area (EEA) path to single market access. While EEA countries are outside both the EU and the customs union, they adhere to EU rules and regulators, incorporate EU laws into their domestic legislation, accept the four freedoms and contribute to the EU budget. Services are largely excluded.

The Switzerland option also appears out of reach. Switzerland largely maintains its sovereign autonomy and arguably enjoys the most access to the single market of any non-EU country. The arrangement is based on a litany of bilateral agreements and deal almost exclusively with the commerce of goods. Services, particularly financial services and passporting rights, are largely excluded. While equivalency agreements provide Switzerland with access to the single market, these agreements are fragile and subject to rule changes which places something of a shroud over long-term investment planning. A recent referendum in 2014 rejected the free movement of labor continues to simmer as the deadline for its implementation in the spring of 2017 is fast approaching.

Even a straight-up free trade agreement along the lines of the Canadian package appears difficult to achieve given Ms. May's opening position. The Canadian deal is more of an agreement on regulatory convergence - both in the current environment and ongoing, which likely presents the UK with unacceptable political consequences. The agreement does give Canada access to the single market for an array of goods (not services) while allowing Canada to avoid contributing to EU budgets or accepting the four freedoms. The pact has been in negotiations since 2007 and was recently concluded. Enactment still awaits the unanimous approval of the remaining 27 parliaments of the EU. The deal is now in trouble in a largely unfriendly populist environment that is testing the viability of whether a trade agreement of whatever scope can be done given the deep popular suspicion over the benefits of unrestricted trade.

With no agreement at the conclusion of the two-year Article 50 negotiations and available option choices running thin, an interim FTA that carves out a middle ground between a World Trade Organization (WTO) and the EU comes to the fore. FTA agreements rarely include services and the scope of the option boils down to the ability of both sides to find common ground in spite of the stark political divide that appears to be defining the process from the opening bell. The UK's access to the single market will likely come down to concessions around the very political minefields defining the Brexit process. The greater the willingness of the UK to accept the basic fundamentals of the European project will likely determine the extent of the country's access to the single market for its goods. Access to the single market for services will likely be much reduced - or not exist at all.

Ms. May clearly lends a good deal of credence in the ability of her Brexit negotiators to impress upon their EU counterparts the commercial enormity of a favorable and timely solution to the upcoming EU-UK trade talks. Through the end of 2015, Germany maintained a £25 billion trade surplus with the UK. France, Italy, Spain and The Netherlands, which along with Germany make up the top five economies of the eurozone, and all maintain a trade surplus with the UK as well, adding additional financial pressure to get a trade deal done. Both the EU and the UK are starting from a common regulatory and legal staging area. Yet herein lies the difficulty - the commonality of a starting point delineates the line for future regulatory and legal departure. This departure will define the scope of the UK's access to the single market - and financial services on the scale of the present will simply not be a part of the final equation. Brexit will define Ms. May and her government from here on out.

This article was written by

Douglas Adams profile picture
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Douglas Adams specializes in macro-economic research and turning theory into practical portfolio applications for clients over the past seventeen years. Mr. Adams recently formed Charybdis Investments International based in High Falls, New York where he is the managing director of a fee-only investment advisory practice with clients throughout the United States. As an author, Mr. Adams has commented widely on a diverse array of topics from Brexit to monetary policy to forex to labor productivity and wage growth. He holds an undergraduate degree from the University of California, a master’s degree from the University of Washington and an MBA in finance from Syracuse University.
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