United Kingdom: UK and EU reach final withdrawal agreement, but UK parliamentary backing is in doubt
November 15, 2018
On 14 November, the UK and EU finalized negotiations on the withdrawal agreement and presented an outline of the political declaration of the future UK-EU relationship. If the withdrawal agreement is ratified by the EU Council and approved by the UK and EU parliaments, this would hugely reduce economic uncertainty, likely boost fixed investment and UK GDP growth in the near-term, and see the pound strengthen. However, there are serious doubts over whether the UK parliament will approve the deal as it currently stands.
The withdrawal agreement covers the financial settlement between the two parties—thought to be in the region of GBP 40 billion—guarantees the rights of UK citizens residing in the EU and EU citizens residing in the UK, and establishes a transition period, lasting from the moment the UK leaves the EU at the end of March 2019 to the end of December 2020. Moreover, the agreement allows for the possibility of a single extension of the transition period by an unspecified amount of time. Such an extension could well be necessary, given the difficulty of finalizing a trade agreement by the end of 2020, and should reassure businesses.
The fourth key aspect is the Irish backstop, which would come into force at the end of the transition period if the UK and EU fail to find a way to keep trade flowing freely at the Irish border. The backstop would lead to the creation of a “single EU-UK customs territory”; however, it could also see Northern Ireland remaining more closely aligned to the EU than the rest of the UK, and obliged to follow EU rules in areas such as VAT, excise duties and goods legislation. The backstop can only be terminated if the UK and EU “decide jointly”, potentially forcing the UK to remain within such a trading relationship indefinitely.
The outline of the political declaration is narrower in scope than Prime Minister May’s Chequers plan, which was presented in July and had called for “frictionless” trade in goods, a common rulebook and the establishment of a “facilitated customs arrangement” to remove customs checks at the border. The outline speaks instead of a free trade area for goods with “deep regulatory and customs cooperation”, along with “zero tariffs, no fees, charges or quantitative restrictions across all goods sectors”. However, some customs checks would likely remain. The deal for services—particularly financial services, where the UK has a strong comparative advantage—is less comprehensive.
Were such a trade deal to come into force after the transition period, it would hamper the UK’s long-term growth prospects compared to the status quo of remaining in the EU. However, if the withdrawal agreement is signed off, this would likely boost growth in the short-term, by supporting business and consumer sentiment and leading to a recovery in private investment—which has been measly in recent quarters.
Irrespective, MPs are likely to initially reject the deal when presented in parliament, which should occur in December. For the opposition Labour Party the deal will likely overly constrain trade between the UK and EU. The Northern Irish DUP—which provides Theresa May with a parliamentary majority—will likely balk at the potential for regulations in Northern Ireland to diverge from those in the rest of the UK. Moreover, many pro-Brexit Conservative MPs will likely consider the deal leaves the UK too closely aligned to the EU—particularly given that there is the possibility of an indefinite Irish backstop.
In the event of rejection, the way forward would be unclear. The UK could try to rework parts of the deal, although any changes would likely be cosmetic. As analysts at ING argue: “the political pressure for Theresa May to return to the negotiating table is likely to be immense - but the EU is unlikely to be in the mood to shift position.” The government could then attempt to resubmit a deal to parliament. According to analysts at ING: “if a slightly-amended deal was put to Parliament on a date much closer to March, then with little (if not no) time to go back to the negotiating table, MPs may feel obliged to vote through the agreement, simply to avoid the economic risks presented by the ‘no deal’ scenario.”
A vote of no confidence against Theresa May as leader of the Conservative Party is also possible. However, according to Kallum Pickering, senior economist at Berenberg, “While […] the chance of such a vote is probably quite high at this stage, the likelihood that May is actually ousted is low. 48 Conservative MPs would need to support the motion to hold a vote of confidence in May. However, with no obvious challenger that can carry a majority among Conservative MPs, and probably, with no party majority to bring her down in a vote of no confidence, May is probably safe.”
A snap general election is another option, although this would require some Conservative/DUP MPs to vote with the opposition. It is also possible that the UK doesn’t leave the EU at all. This would likely require a second referendum which overturned the result of the first. However, this scenario isn’t currently contemplated by the leaders of either of the two main parties. On the flipside, the UK could leave the EU with no deal. This would likely cause serious short-term disruption, weaken the pound and hamper investment and trade.
Author: Oliver Reynolds, Economist