This article is taken from IEG Policy dated 26/05/20.

While the whole process of orchestrating Brexit was full of drama, the ongoing negotiations about future trade relations between the EU and the UK appear destined to exceed even the wildest anticipations of a super-dramatic escalation.

The time pressure imposed on the negotiations by UK Prime Minister Boris Johnson's decision to leave no more than 11 months for putting together a set of agreements that in other cases, even less complex ones, required several years of negotiations, would in any case have generated a sense of nearly desperate urgency.

The coronavirus pandemic, of course not foreseen when that timetable was set, turned everything on earth upside down and precluded face-to-face meetings, thus making it even harder to achieve a successful conclusion of the negotiations in an anyhow impossibly short time.

"If the two sides can't find agreement in time, their economic relations will essentially break entirely apart on 1 January 2021."

This might not be too much of a problem if what is being negotiated were something nice to have but not absolutely essential. In many other negotiations the absence of an agreement means that life continues as we knew it for ages, and the only problem is that a desirable improvement does not materialize.

Yet this is not what would happen to EU-UK trade relations. If the two sides can't find agreement in time, their economic relations will essentially break entirely apart on 1 January 2021.

The historically closest form of cross-border economic integration, as created by the EU among its member states, will come to an abrupt end literally over night. Trade relations between the EU and the UK would then be far less favourable than what the EU connects with the many non-EU nations with which it has negotiated free trade agreements (FTAs), for example Japan, Canada or Mexico, not to speak of Norway and Switzerland.

Open letters at cross purposes

The most recent indication of the dreadful state the EU-UK negotiations have meanwhile reached is the unprecedented exchange of open letters between the top negotiators on both sides.

On 19 May 2020, David Frost of the UK wrote to his EU counterpart Michel Barnier, who reciprocated the following day, both letters being immediately circulated to the media.

In his letter, Frost conveys the impression that the UK is seeking essentially no more than to negotiate an FTA of the type the EU has concluded with a host of other nations, preferably one of the 'modern' agreements such as the Comprehensive Economic and Trade Agreement (CETA) EU has a few years ago concluded with Canada.

The Frost letter even goes as far as suggesting that the UK might be willing to agree to not eliminating all tariffs in trade with the EU, just to make the point that the UK is not aiming at trade relations with the EU that are closer than what the EU has with so many other cases.

But then the Frost letter also says that the UK wants to be treated no less favourably than what is provided in other FTAs the EU has concluded, citing examples of selected individual cases of the EU's FTAs that have this and that provision that the UK would also like to achieve.

"Negotiating positions typically contain a fair dose of tactics, and alleged misunderstanding of the other side's objectives is one of them. Johnson's repeated refusal to allow the negotiations more time may also be a tactical manoeuvre."

The Barnier letter, on the other hand, appears to suggest that the UK aims for substantially more than a typical FTA. According to Barnier, the UK wants to combine the most favourable elements of a number of FTAs the EU has concluded with other countries in the past, plus selected features of the EU's holy grail, the Single Market. Yet, Barnier warns Frost that "there is no automatic entitlement to any benefits that the EU may have offered or granted in other contexts and circumstances to other, often very different, partners".

And, to make it crystal clear, Barnier repeats the EU's criticism and refusal of cherry picking by the UK: "Just as we do not accept selective benefits in the Single Market without the corresponding obligations, we also do not accept cherry picking from our past agreements."

The Frost open letter argues that the EU is misrepresenting the UK's objectives, and Barnier's open letter does the same thing vice versa. If both sides do not understand what the other partner is aiming at, how can negotiations then ever bear fruit?

Of course, negotiating positions typically contain a fair dose of tactics, and alleged misunderstanding of the other side's objectives is one of them. Johnson's repeated refusal to allow the negotiations more time may also be a tactical manoeuvre. However, tactical moves must not be allowed to obscure the actual objectives pursued in negotiations to the point where they become undecipherable.

What are the UK's objectives?

What is it that the UK really aims at? Of course, only a very few insiders may really know, and only they will be able to tell whether the UK actually prefers a negotiated outcome at all to a hard Brexit without, at the end of 2020, a bilateral trade agreement with the EU.

But a look at publicly available statements, and at the Draft UK Negotiating Text as shared with the EU negotiating team (and now made public along with Frost's open letter), suggests, in gross simplification, that the UK wants a far-reaching FTA combining many of the most favourable elements contained in past trade agreements the EU has struck with other countries, something that might be dubbed CETA plus.

"The UK is strongly interested in having as open as possible access to the EU's market for services, in particular financial services."

Moreover, the UK is strongly interested in having as open as possible access to the EU's market for services, in particular financial services. More specifically, it wants assurance of stability for equivalence agreements with the EU that allow each other's financial enterprises to do business on the other's market.

What the UK wants to avoid in this regard is a situation in which Switzerland found itself when the EU threatened to, and then actually did, withdraw the equivalence decision so as to impose pressure on the Swiss in negotiations about future economic relations.

What the UK does not want is to maintain unrestricted movement of persons vis-à-vis the EU, one of the four freedoms represented in the Single Market. In a nutshell, and with some degree of exaggeration, what the UK is aiming at in its trade negotiations with the EU is a half-way-house between a deep FTA and membership in the Single Market. Other elements of the negotiations such as those on fisheries will not be discussed here.

Aims of the EU

The EU also aims at a deep FTA with the UK, including tariff and quota free trade in goods. It also has an interest in mutual access to markets for financial services, though with less restrictions on the EU's equivalence decisions. The EU acknowledges that the UK no longer wants to allow the free movement of persons.

These and many other elements appear to suggest that the EU and the UK have rather similar objectives in the negotiations, and that it should therefore not be too difficult to reach agreement.

A big stumbling block, though, is the EU's insistence on maintaining a 'level playing field'. In the words of Barnier's open letter this means "upholding the common high standards applicable in the EU and in the United Kingdom at the end of the transition period in the areas of state aid, competition, social and employment standards, environment, climate change, and relevant tax matters". What is more, the EU wants cases of doubt to be adjudicated by the European Court of Justice.

"What the EU aims at can also be characterized as an arrangement somewhere between a deep FTA and the Single market."

In essence, this means that the EU expects the UK to align its national standards with those of the EU, though "the UK will remain entirely free to set its own higher standards". Frost's open letter argues "that this is simply not a provision any democratic country could sign, since it would mean that the British people could not decide our own rules to support our own industries in our own Parliament".

In other words, what the EU aims at can also be characterized as an arrangement somewhere between a deep FTA and the Single market, though combined with a number of Single Market type conditions regarding the level playing field.

Where is a landing zone?

Essentially there is not really a fundamental difference between the nature of trade relations the two sides are aiming at. The most important disagreement appears to relate to the side-conditions accompanying these economic relations.

The UK wants more favourable access to the EU market than so far provided by the EU to any single non-EU country, but largely without side-conditions regarding a level playing field. The EU says it is prepared to maintain closer economic ties with the UK than it has with any other third country, but only if a good part of the side-conditions underpinning the Single Market can be agreed.

There is a bit of a logical gap in both positions. The UK cannot deny that it has to accept somewhat more stringent conditions if it wants to maintain a privileged trade relationship with the EU. The EU, on the other hand, has always said that there cannot be Single Market benefits without the corresponding obligations, but must then also accept the reverse logic, i.e. that it cannot expect the UK to consent to obligations that do not correspond to the nature of benefits the UK is asking for.

"The dialogue between the EU and the UK needs to return to substance, discussed at the negotiating table. For decades to come, too much is at stake to allow these negotiations to collapse over tactical manoeuvres."

Regarding trade in goods, the special treatment of the UK that is considered in the negotiations is no more than zero tariffs for the one or two percent of tariff lines where other FTAs of the EU do not provide tariff-free treatment.

Most of the few goods where tariffs are maintained in other FTAs of the EU are agricultural products. Are demanding conditions regarding matters such as competition, social and employment standards or taxes really a necessary precondition for waiving tariffs on such a small share of all goods? When it comes to granting the UK privileged access to the EU's markets for financial services, which are the appropriate obligations to be honoured by the UK that really correspond, in a substantial sense, to this special treatment regarding financial services?

These are questions that are more easily asked than answered. Finding satisfactory answers in negotiations between the EU and the UK requires patience and time, not only for political, but more importantly also for reasons related to the complex subject matter. The UK government could send a welcome signal of its willingness to engage in fruitful negotiations on such matters if it were to suggest an extension of the transition period and hence the time available for friendly talks. The logistical difficulties generated by the coronavirus pandemic provide an excellent reason for suggesting that more time is now needed.

The dialogue between the EU and the UK needs to return to substance, discussed at the negotiating table. For decades to come, too much is at stake to allow these negotiations to collapse over tactical manoeuvres. Listening carefully to each other is a prerequisite of success in so important talks.

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This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.