How Brexit should be done

In the early hours of this morning—when we discovered "Leave" had won 52 per cent of the votes in this referendum—the rules of British politics were torn to shreds. David Cameron won last year’s general election by a relentless emphasis on risk: risk to the fragile recovery by the election of Ed Miliband; and risk to the United Kingdom itself, because the Scottish Nationalists might demand more concessions by supporting a Labour government. British votes are supposed to be won by appearing to be safer and more competent than your opponents. Yesterday, English and Welsh voters chose immigration over the economy, and, perhaps inadvertently, switched allegiance from David Cameron and George Osborne to a group of largely untested right-wingers who have no plan for managing the political—and potentially, economic—chaos that will now ensue.

The pound fell 8.5 per cent against the dollar overnight. Stocks are down by eight per cent. The Bank of England will probably intervene, providing emergency sterling liquidity to banks to calm financial markets. But beyond the short-term gyrations of financial markets, the future is enveloped in fog. The UK has a current account deficit of seven percent of GDP, meaning that we are relying on foreigners to lend to us. If markets bet that, by leaving the EU, Britain will have lower rates of investment and slower productivity growth in the future, the outflow of capital may be prolonged. And if the pound drops too far, the monetary policy committee may have to raise interest rates, pushing Britain into recession.

The political ramifications are equally uncertain. David Cameron had to resign, but should be allowed to stay on until a new leader is elected. Candidates for the leadership will have to set out their plans for taking Britain out of the EU, and Boris Johnson is likely to defeat a more competent candidate, like Theresa May. Nicola Sturgeon and Alex Salmond will probably try to force another referendum, pointing to the thumping victory for "Remain" in Scotland. And, ominously, Northern Ireland's Deputy First Minister Martin McGuinness has called for a referendum on a united Ireland. No one knows when Article 50 of the Lisbon Treaty will be triggered, which, if followed to the letter, would set a two-year deadline for Britain to withdraw, unless the EU’s member-states agree to allow the deadline to be extended. The French and German elections take place next year, and Francois Hollande and Angela Merkel’s impulses will be to offer nothing to the British until they are out of the way.

The other 27 member-states will meet next week to agree a common negotiating position. The EU and the UK must move quickly to stem the political and economic fallout from the vote. The best way to manage the economic risks would be for the EU to make a quick offer for the UK to join the European Economic Area. But that would require MPs, many with UKIP at their heels, to ask their constituents to sign up to the very EU policy they had rejected in the referendum: free movement. And in the unlikely event that Britain did agree to join the EEA, it would not last long, since the arrangement would offer no end to the running sores of immigration, contributions to the EU budget and regulation by Brussels. The EU is unlikely to make an offer that would not be a lasting settlement.

Article 50 gives the EU the upper hand: any member-state can veto the extension of negotiations beyond the two year deadline. This is a recipe for brinkmanship—the EU may be tempted to refuse to negotiate with the UK until Article 50 is triggered, then drag its feet until the deadline is close, in an attempt to wring maximum concessions from the UK. Economic pressures would intensify as the threat mounted that Britain might fall out of the single market without a trade agreement. This would inflame nationalism both in Britain and elsewhere in Europe.

Both the EU and the UK must recognise that British voters have chosen immigration over the economy—and that all have an interest in political and economic stability. The only solution is a bespoke trade agreement that is as comprehensive as possible. The UK should ask that the EU quickly pre-commit to give enough time for that agreement to be negotiated—no two-year deadline, but a more sensible date like 2022. In return, Britain would agree to go down the Article 50 process quickly, rather than delay in the vain hope that the EU will offer the family silver.

The outline of the agreement is obvious, and could be settled quickly, with the negotiations focussed on the details. There are to be no tariffs on goods. The UK agrees to match the EU’s goods market regulations, with the Commission given the right to suspend market access if the UK fails to do so. The free movement of workers ends. But the EU’s price would be that the UK leave the services single market, which will mean that banks will have to set up subsidiaries in the EU and be supervised by EU authorities. This will mean a hit to British export—over 40 per cent of which are in services. But the electorate’s desire to curb immigration from the EU will have to be acted upon.