Prime Minister Theresa May this week kicked up the Brexit dust by promising to invoke Article 50 by the end of March next year and thereby formally starting the UK’s exit from the European Union.
Despite endless media coverage of the political wrangling and financial speculation, the average Briton can be forgiven for remaining confused about what ‘soft’ and ‘hard’ Brexit really mean.
They may know little more about the difference between the ‘Norway model’ for the UK’s post-Brexit relationship with the UK and the ‘Swiss solution’. But a clever table put together by HSBC in a report called ‘Is Brexit Getting Harder?’ cleaves some clarity from the murk.
Options explains: HSBC’s economics team set out what the varying degrees of separation from the EU will entail for trade, EU budget contributions, regulation and immigration.
The UK has exactly two years to negotiate a new deal with the EU, after Article 50 is invoked, in which the country must complete the terms of its divorce and a new trade deal with the bloc.
So far the ‘Brexit team’ led by May, Boris Johnson, David Davis and Liam Fox has made it clear the UK is heading for a ‘hard’ exit, with taking back control over immigration prioritised over the UK’s trading relationship with the EU.
In the table above, the ‘hardest’ of Brexits would be represented by the right-most column – the same relationship that the typical non-European nation has with the EU.
The ‘softest’ Brexit would be represented on the left by the Norway example, or membership of the EEA, the European Economic Area.
With the help of HSBC’s report, we have a go at explaining those extremes and the options in between.
Norway’s membership of the European Economic Area means that Oslo has full access to the Single Market and free trade in services.
Broadly, says HSBC, ‘a soft exit refers to a solution where the UK maintains a high degree of tariff-free access to the single market and minimises the imposition of non-tariff barriers (albeit losing some influence)’.
Norway: Single market access via EEA but no customs union
Norway’s membership of the European Economic Area means that it has full access to the Single Market and free trade in services. But as it is not part of the customs union, its tariffs for trade outside the EU are not set by the EU.
But, says HSBC, ‘that presents a bureaucratic barrier to goods trade with the EU since, despite being in the Single Market, Norwegian exports to the EU have to go through rigorous "proof of origin" checks’.
Although Norway is free to negotiate free trade deals in theory, the report adds, ‘in practice, it has done so only as a member of the EFTA’.
Switzerland: EFTA and bilateral agreements
Switzerland has has 120 separate accords with the EU which make it a quasi-member of the single market. But it has no say in regulations and its single market access covers goods and some – but not all – services.
As a member of EFTA, Switzerland’s third-party trade agreements are typically made via that organisation. But, says HSBC ‘like Norway, it is technically free to negotiate its own bilateral agreements and it does have some of its own, for example with China (as does Iceland, another EFTA member)’.
Switzerland has has 120 separate accords with the EU which make it a quasi-member of the single market.
Are either of these realistic?
No because neither of these two countries restricts immigration from the EU – one of May’s pledges.
Norway is subject to the ‘four freedoms’ as a member of the EEA. ‘The current government line that "Brexit means Brexit" and that the UK must control immigration suggests that EEA membership is currently not on the cards,’ suggests the HSBC report.
Switzerland had, in theory, accepted free movement of EU citizens across its border. But a referendum in 2014 rejected free movement and the Swiss government has a February 2017 deadline to implement the result.
‘The EU has threatened to restrict market access if Switzerland imposes immigration controls and, so far, no solution has been found,’ adds HSBC.
Customs union: Turkey option
Turkey is in a customs union with the EU but not part of EFTA. This means it applies the same tariffs as the EU to non-EU trade, in return for largely tariff-free goods trade across the EU.
For the UK, this would mean that goods could continue to move more or less freely across the bloc, without the checks and controls that are undergone by non-members.
Istanbul is in a customs union with the EU but not part of EFTA.
Crucially, it would also have control over inward migration. The UK would also be bound by the customs union’s commercial policy, and have no seat at the table for law-making and regulations.
But such a deal would probably not cover trade in services. And the government would not be able to negotiate new external deals with third parties, because of the requirement to maintain a common external tariff.
The HSBC report points out that back in February 2015, this model was considered a relatively ‘hard’ Brexit option: ‘It is telling of how the debate has moved on that it now seems a relatively gentle break in comparison to some being touted’.
These imply a loss of access to the single market, which would involve the imposition of tariff and non-tariff barriers (including customs checks and ‘proof of origin’ certification) on British goods and services.
The UK would be free to deregulate its industry and impose any restrictions it wanted to on immigration – but to sell into the EU, the UK would still have to abide by its regulations and standards (in which it would have no say).
Canada has a free trade deal with the EU and Brexiteers argue the UK would get something similar.
Canada-style free trade agreement with EU
The Brexiteers have argued that it is in the EU’s interests to do a good deal with the UK on goods trade, since it is such a big consumer of, for example, German cars and Italian sparkling wine.
HSBC does not disagree with this and notes that tariff rates have fallen markedly over the last two decades.
No deal – WTO membership
Many goods are tariff-free already for WTO members – so the cost could be manageable even if no deal was done.
HSBC notes that ‘generating strong bilateral relationships with countries like China and the US could reduce the UK’s dependency on the EU’.
In the long term it adds ‘this could stand it in good stead, as the bloc continues to wrestle with structural weakness and heavy debt levels’.
‘However, this will take time, and the delay could be harmful to the UK’s exporters.’
More risks attached to hard Brexit
HSBC thinks that non-tariff barriers are a threat. If negotiations do not go the UK’s way, HSBC economist Doug Lippoldt estimates that these could be equivalent to a tariff of 10-15 per cent on UK trade.
Leaving the customs union could mean UK exporters face rigorous ‘proof of origin’ checks for any goods they are selling into the EU. Customs checks would be imposed on the 56 per cent of UK imports which come from the EU customs union – entailing additional administrative burden and lengthened journey time.
There are concerns over services trade, where the UK has more to lose, as it runs a sizeable surplus with the EU. But Mr Lippoldt points out that the second-biggest consumer of UK service exports, after the EU, is the US (24 per cent of the total in 2013).
‘That this is achieved with zero preferential access is a hopeful sign for the UK service sector in the post-Brexit world,’ the report adds.
Many in the City fear loss of EU access with financial services firms particularly worried whether the the UK will retain the ‘passport’ that allows them to offer services across the EU.
An EEA financial institution, licensed by its home regulator, can use a ‘passport’ to access markets in other EEA countries. So if the UK leaves the EEA passporting rights will be lost unless a new and similar agreement is struck.
For many parts of investment banking, UK financial regulations would be very similar to EU rules, meaning ‘equivalence’ could be granted. But this would be awarded on a case-by-case basis and mean the UK would have to ‘keep up’ with changes to EU regulation or risk losing equivalence, adding to uncertainty.
Meaning the UK might not be able to deregulate the financial sector significantly or stray far from the EU standard.
There are no equivalence provisions for retail banking and asset management, meaning that UK banks would require a banking licence in the EU, via a branch or subsidiary, to continue operating within the EU.