This week has seen a series of interesting news related to Brexit. Four key elements start to emerge has important factors potentially determining the direction of travel of the UK post-Brexit. Firstly, the UK Government’s preferences regarding the market access versus sovereignty trade-off; Secondly, and not unrelated, the strategic decision for the UK on whether to engage in a regulatory ‘race to the bottom’ with the EU or a geographic ‘race to the East;’ Thirdly, the role of the state in the economy post-Brexit; and fourthly, the coinciding of Brexit with the Covid19 pandemic.

Sovereignty v. market access

Two news items this week suggest that the current UK government will maintain its ‘hard Brexit’ stance even in its approach to establishing a new relationship with the EU.

In the area of energy, UK energy producers have waited for some time for the UK government to announce its new carbon trading scheme. The FT reported that energy producers were increasingly worried about the prospect of the UK carbon emissions trading scheme not being linked to the EU’s scheme. Indeed, the government is yet to determine key aspects of the new scheme, most importantly the price at which carbon emissions will be traded. So far, the government has not committed to linking its scheme to the EU scheme. Significantly, a policy White Paper published in December 2020 acknowledges the possibility of international linkages of the new UK scheme, but does not mention the EU as a particularly likely partner. The uncertainty created by the absence of clarity on carbon trading prices, increasingly worries energy companies, but the government does not seem keen on alignment with the EU in this area.

In the area of financial market regulation, the media reported this week on a first draft of the Memorandum of Understanding (MoU) that the UK and EU are currently negotiating and which it is hoped will be signed by the end of March. According to the FT, the MoU explicitly contains a statement that “[t]he regulatory dialogue should not restrict the ability of either jurisdiction to implement regulatory or other legal measures that it considers appropriate.” This suggests, once again, that market access does not seem to be a key priority in these discussions. The impression that the current UK government strongly values sovereignty over market access is reinforced by statements made by the Governor of the Bank of England in relation to the EU’s purported attempts to force clearing of EUR denominated trade to take place within the EU from next year, suggest that in this area too, the British side is currently minded to accept a loss of market access in exchange for the ability to diverge significantly from EU rules.

Race to the bottom – or race to the East?

The ‘sovereignty approach’ to the post-Brexit relationships with the EU implies necessarily that UK companies will lose access to the EU’s single market. It therefore raises important questions about alternative markets UK companies may be able to access. Two basic – not mutually exclusive – strategies are emerging here: firstly, seeking increased competitiveness through regulatory competition with the EU by deregulating and attracting investors to Britain; or seeking to create closer ties with other geographic regions – in particular rapidly growing Asian markets – through bilateral or multilateral trade agreements.

Speaking at the National Farmers Union (NFU) annual conference, Trade Secretary Liz Truss announced this week a new governmental programme called ‘Open Doors campaign,’ which suggests that the geographic orientation towards East is an important part of the UK governments strategy in making up for the reduced access to the UK market. The programme seeks to support UK food and beverage businesses in reorienting their exports towards the increasing large middle-class consumers in Asian countries. Pre-Brexit, 60% of a total of £23bn in UK food and beverage exports went to the EU (2019 figures). This figure is bound to decline given numerous non-tariff trade barriers that are hampering food exports to the continent. Whether or not exports to Asian countries will compensate for the decline in exports to Europe will also depend on future trade agreements with countries in that region. Already in January, the UK has applied to join the Asia-Pacific free trade area CPTPP. Joining this regional agreement would help the governments geographic reorientation strategy. Whether membership of the CPTPP would make a material difference in the short run and allow exporters to compensate the expected losses from reduced trade with the EU is not certain. Currently, UK exports to the 11 CPTPP member states corresponded with 8.4% of GDP in 2019, approximately the same as the UK exports to Germany – and that in spite of the fact that the UK already has free trade agreements with 7 of the 11 member countries.

There was also some news this week, that indicate that the UK government will be pushed to play the regulatory competition card as well. The Association of British Insurers (ABI) urged the government to reduce the capital requirements for UK Insurers – that were set by the EU’s Solvency II regulation – and to simplify reporting requirements. This would constitute a considerable divergence from EU financial market regulation and almost certainly kill any hopes that the EU may still grant the UK equivalence status. However, the ABI clearly sees an opportunity to benefit from Brexit that would compensate for the loss of access to the single market. Whether or not that calculation is correct remains to be seen; what this push does suggest though is that certain industries may put considerable pressure on the government to go down the route of diverging from EU regulations rather than remaining closely aligned. This will add further incentives – besides more ideological ones – for politicians to choose sovereignty over market access. It may also create tensions between different sectors in the financial industry, with UK banks publishing a report this week that urges to government to work towards regulatory convergence not just with the EU, but globally.

State intervention

Another set of news that reach us this week was that the government is likely to take a very active role in reshaping the UK economy after Brexit.

Thus, already in November, the Chancellor had announced the establishment of a new public Infrastructure Bank, which will make up for the loss of access to the European Investment Bank (EIB). This week, ahead of the 2021 budget, the Chancellor specified that £12bn in capital investment and £10bn in loan guarantees would be committed to this new public bank. It remains unclear, however, what exactly the remit of the bank will be and therefore whether it will be able to live up to its potential.

The government also announced a new Standard Buyer Loan Guarantee (SBLG), under which the UK government guarantees loans of up to £30m by UK lenders to overseas buyers of UK products and services. This scheme is meant to boost exports by small and medium-sized enterprises (SME).

Together with another – Brexit-unrelated – announcement of state investment in high-growth firms through a new ‘Future Fund’ of £375m, it seems increasingly clear that the UK government does not shy away from a very hands-on role in the economy to shape the UK economy’s post-Brexit future.

 Covid a blessing for Brexiteers?

Finally, another aspect of Brexit that becomes increasingly clear is that contrary to what some may have expected, Brexit is not over but a process that has just begun. As such, politically too, Brexit is not settled – as many had hoped – with the departure of the UK from the EU, but it will remain a politically important issue for decades to come. In this respect, for the advocates of Brexit the coincidence of the end of the transition period with the Covid19 pandemic – and hence one of the most severe economic crises in living memory – may turn out to be a blessing in disguise. Indeed, while carefully designed academic studies may one day be able to disentangle the economic impact of Brexit from the economic impact of the pandemic, in the political arena it is unlikely that the two will ever be kept completely separated. A striking example was this week’s announcement of Italy’s trade figures. Italy is the first major EU economy to publish its trade figures for January 2021. They show a stunning 70% drop in imports from the UK. To be sure, much of this decline can be attributed to the pandemic. Yet, comparing this decline to that other countries exports to Italy have suffered, suggests that Brexit-related disruptions played a very major role. For instance, Italian imports from China, Russia, and Switzerland declined by less than 10%. Yet, in the political arena such subtleties can easily be forgotten and ultimately in public discourse the impact of Brexit may remain confounded with the impact of the pandemic. This may turn out to become an important element in future political discussions about the UK’s relationship with the EU.