We must be prepared to walk away

The prime minister has called this general election to strengthen her hand in the Brexit negotiations. How will it do so?

The most crucial card in Theresa May’s hand is her statement that “no deal is better than a bad deal.” Any negotiator knows that you can only obtain a good outcome if you are willing to walk away from a bad one. However, so long as the Conservatives have a slender majority, the rest of the European Union may calculate that if it pitches the price for leaving so high that she does walk away, parliament will send her back to make concessions.

However, if she and her party are re-elected with a healthy majority on a manifesto backing her negotiating position, neither the Commons nor the Lords could undermine her. So, the EU27 will be less likely to overplay its hand.

That does not guarantee that they will agree to a deal. Undoubtedly the best outcome for both Britain and the EU27 would be a free trade deal continuing zero tariffs and the minimum of new non-tariff barriers. It’s in their interest—the rest of the EU member states sell about £60bn worth more goods and services to us than we sell to them.

Yet such a deal is far less likely than most people assume. This is not because it would be difficult to negotiate in time. Moving from zero tariffs to zero tariffs is infinitely easier than negotiating their removal. And we don’t have to negotiate convergence of rules and regulations as they will start off identical—we just need a procedure (required in similar agreements) for dealing with future divergences in rules.

But for the EU, politics trumps economics. It may be more important for them to make things difficult for the UK, to discourage their electorate from voting for Eurosceptic parties. So, it is important that we are genuinely prepared to walk away from the negotiations if the EU demand an impossibly high price in money or concessions.

In this case, we will trade with the EU on Most Favoured Nation (MFN) terms under World Trade Organisation rules. That is second best, not a disaster as some wish to portray it. We would be trading on the same terms as the United States, Japan, China or Russia, for example. Overall, Britain will be better off with this arrangement than if we had remained within the EU.

The MFN tariffs on our goods would average just 4 per cent. Compare this to our current net budgetary contribution to the EU, which is equivalent to a tariff of 7 per cent. At the same time, sterling’s movement against the Euro means our exporters are 15 per cent more competitive than a year ago.

We can compensate those experiencing the highest tariffs, such as our car manufacturers and farmers, in a number of ways, including increased research grants, marketing support and lower taxes. We can fund this using just some of the £12.3bn Britain would collect in tariffs on imports from the EU (tariffs on our exports to the EU will be only £6.5bn). Under WTO rules we can remit tariffs on imported components incorporated into exported goods, reducing the impact of tariffs on complex supply chains.

We can negotiate free trade agreements with the rest of the world, with whom we do the majority of our trade. The share of our exports going to the EU is falling fast—it was 55 per cent at the start of the century, it is now 44 per cent and was expected to fall to as low as 35 per cent by 2030 even if we remained in the EU.

We will be able to reduce the burden of EU regulation, particularly on the 89 per cent of companies who do not export to the EU. We can abolish the high EU tariffs on food, clothing and other items which we do not produce—helping “just about managing” households. Instead of UK consumers paying high prices to support uncompetitive EU producers, we would be importing these products from developing countries: ending the hypocrisy of giving aid to countries while excluding their products from our market.

We will save £200m per week when our net budgetary contribution ceases—that is how much each week’s delay costs the UK.

Services, particularly financial services, form a major part of Britain’s exports and do not incur tariffs. However, the City was initially worried about the likely loss of “passporting” rights, which permit companies to trade in other EU countries directly or via a branch without setting up a subsidiary.

But financial services trade did, does and will take place without passports. The City traded extensively with European customers before passports were introduced. Since their introduction, our services exports to the EU have grown less rapidly than to the rest of the world. Most UK financial services exports are outside Europe where passports do not exist. And passports are mainly needed for retail business whereas most City business is wholesale, delivered at source.

An alternative to passports is an agreement on equivalence. But City firms are increasingly worried that if it is tied too tightly to EU regulation then it would be at a disadvantage, as the US revises its regulations to become more competitive.

It will be more beneficial for the UK to regain the right to regulate itself (not to deregulate, as an unregulated regime would be as bad as an overregulated one). But we need to ensure our regime remains competitive, trusted and flexible—avoiding the rigid regulation which stifled the growth of financial centres on the continent. It is no coincidence that the four great financial centres—London, New York, Singapore and Hong Kong—all developed on the basis of Common Law and related British institutions, in most cases without being part of a captive continental market.