London is right to prepare for no deal on Brexit

By Wolfgang Münchau

Theresa May's warm words in Florence were welcomed by EU leaders, but the main effect of the prime minister's speech was to soften public opinion back in Britain for the compromises that lie ahead. They mattered little for the negotiations themselves. Both the UK and the EU will have to move until a deal is possible.

They are very close to agreement on EU nationals living in Britain. But Mrs May will now have to make a financial offer that goes beyond a statement of principles. The EU will need to give up its insistence on a strict separation between the talks on the exit deal, on the transition and on the trade deal. The talks are not proceeding because we have reached a point where progress on finance and Northern Ireland is only possible if both sides have a clearer idea of the scope of the future trade agreement and the financial settlement. For example, it will make a huge difference to Northern Ireland whether the UK has an association agreement with the EU customs union after the transition.

EU leaders meet this week, and then again in mid-December. The latter is not a formal deadline either, but we will be closer to the point where failure to agree might trigger panic decisions by business. My expectation is a deal at that stage, but the probability of a no-deal Brexit is clearly not zero. Talks can still fail for the following three principal reasons, in declining order of importance.

First, the continued support for an outright Brexit reversal before 2019 among a subsection of Remain supporters (and lawyers in particular) makes it rational for hard Brexiters to toughen their stance, and opt for a version of Brexit that will be impossible to undo even if there is a future change in public opinion. If they can blame a breakdown in negotiations on the other side, which should not be too difficult, it would be hard to imagine a political process that would result in a second referendum before March 2019, the formal date for departure from the EU, let alone a convincing majority for revoking Brexit.

The EU could always offer a zero-tariff on goods because of its large trade surpluses. But it could insist that the free flow of services, including for airlines, would require an open immigration regime.

Second, the EU might overplay its hand, for example, by failing to open trade negotiations before the end of this year. As Philip Hammond, UK chancellor, explained to the Treasury select committee last week, the time value of a transitional agreement will decline rapidly in 2018, as companies will start to make preparations for a hard Brexit. Once you have fallen over a cliff, your focus shifts away from cliffs.

Third, the UK continues to misjudge the EU’s uncompromising position on immigration. If trade negotiations were to begin in the new year, it is possible that we get to a point where Britain realises that even the mildest form of restrictions on immigration could preclude any agreement on trade in services. The EU could always offer a zero-tariff on goods because of its large trade surpluses. But it could insist that the free flow of services, including for airlines, would require an open immigration regime. The UK may at that point realise that it will not get the trade deal it wants, and this again would reduce the value of a transitional arrangement.

These are, of course, not the only reasons why a no-deal Brexit might happen. It is theoretically possible that an agreed deal may not receive the necessary support in the House of Commons, the European Parliament and the European Council. I think this is unlikely, but political votes can never be taken 100 per cent for granted.

As a long-time observer of the EU, I also know that failure is often a precondition to subsequent agreement. Think about the French and Dutch referendums on Europe's constitution treaty in 2005, or the near-ejection of Greece from the eurozone 10 years later. Disappointment more often than not precedes success. This does not mean that gridlock in the Brexit negotiations is irrelevant. But the contours of the final deal often do not become visible until late in the process.

The reason why I expect a deal to be struck is that interests are aligned. The EU needs Britain's money. Neither Germany nor France are politically in a position to provide additional finance to cover the UK's liabilities. Nor is there any legal certainty that the EU could win a case against the UK under international law. The net beneficiaries want a deal because they do not want to receive less. Mrs May wants a deal because her entire premiership would lose its meaning. None of this invalidates the reasons why a deal might not happen, but it puts them in to perspective.

My conclusion is that the UK is right to prepare for a no-deal Brexit. It is right to allocate funding for this. The pitiful "no deal is better than a bad deal" episode is mercifully over. London is also right to state its strong preference for a deal, but it would be irresponsible not to prepare for an event with a small, but clearly not zero, probability.

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