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Unravelling the Brexit trilemma

Unravelling the Brexit trilemma

Room for adjustment after referendum

by Elliot Hentov

Tue 5 Jul 2016

Uncertainties about the UK’s political, legal and economic relations with the European Union will be resolved only gradually in the coming months. We can investigate the post-referendum outlook in the form of a trilemma – a triangular relationship where a combination of only two elements is permissible. The triangle consists of three corners: promises made to the electorate; rules governing the EU and European Economic Area; and UK single market participation. One of these will have to be broken.                                                  

                                      Hentov -050716-120 (1)

The 23 June ‘Brexit’ mandate centred heavily on controlling immigration, followed by desires to repatriate sovereign decision-making, strike trade deals and cancel (or greatly lower) the cost of EU membership. Under EU/EEA rules, fulfilling all these promises would require a complete exit from the economic architecture of today’s Europe. The UK would lose the core benefits of inclusion in the single market, important to sustain foreign investment across many sectors, as well as preserve its status as Europe’s financial centre.

The latter two are particularly acute in the context of the UK’s large current account deficit. Uncertainty will almost certainly slow or delay investments. This will remain a highly relevant factor, even though the current account deficit is likely to fall owing to a weaker sterling and lower imports.

In the long term, the UK could construct alternative legal arrangements that uphold its economic allure, but this would take years of protracted political and technical negotiations; it is not a medium-term option.

If economic realities demand that single market access cannot be forfeited, what would be permissible under EU/EEA rules? The widely floated option has been that the UK exits the EU, while retaining EEA membership, preserving the benefits of single market inclusion. However, the fundamental pillars of EEA enshrine the four freedoms of movement: goods, services, capital and people. The latter point expressly denotes persons, not only workers, enshrining a core European ideal, yet countering the UK desire for immigration controls.

Moreover, EEA members cannot strike conflicting trade deals with third nations and they are still required to contribute financially to the EU. Modifying the latter two aspects would presumably be easier than violating the four freedoms, which would require consent from all EU members.

What happens next depends on a subjective view of politics. The EU has perfected the art of political ‘fudge’: the compromising of conflicting principles. So there could be room for adjustments. The great benefit of EU membership is participation in the single market and influence over its rules. It is hard to see how the EU would grant the UK continued participation without a major contradiction to referendum promises.

Freedom of movement of people would need to be fulfilled in some manner, though there could be an introduction of ‘limits’ or ‘emergency brakes’ permissible for EEA members. Central and eastern European states would strongly resist this, but there are precedents. Technically, the EEA rules do allow for temporary suspension. One EEA member, Liechtenstein, has negotiated precisely that (though the argument is easier for a country of 37,000 citizens wishing to preserve its national character).

Most Leave voters were not endorsing fully closed borders but rather controlled borders, so there could be scope for a compromise that satisfies different political constituencies.

The most important point for the future is that the UK’s long-term status should reflect the democratic will of the majority. How this future will be shaped, and what it will be, is not clear. But, depending on UK politics and the reaction abroad, Britain’s eventual trajectory could look very different in the next few weeks and months compared with the first few days after the referendum. It would be advisable to keep an open mind on the outcome.

Elliot Hentov is Head of Policy & Research, Official Institutions Group, at State Street Global Advisors.


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