Theresa May’s evolving Brexit strategy

The transition agreement between the UK and EU means that although the UK will officially leave the EU in March 2019, it will still remain in the customs union and single market for another 21 months. The deal was struck after several concessions by the UK, indicating the government’s willingness to sacrifice regaining full sovereignty in order to reach a trade agreement at the end of the negotiating period.

The UK’s concessions are indicative of the government’s broader negotiating strategy with the EU. While Theresa May has often claimed that no deal would be better than a bad deal and that she is prepared to walk away from negotiations, in practice, she has been very keen to compromise in order to reach an agreement. The transition agreement was struck almost completely on the EU’s terms.

Negotiations over the transition demonstrate the UK’s desire for reaching a wider withdrawal agreement even if that may mean making concessions on their part. The transition agreement thus increases the likelihood of an orderly withdrawal which would entail at least a limited free-trade agreement. During the transition, EU migrants arriving into the UK will continue to be granted permanent residency and the EU will continue to set fishing quotas. These terms violate May’s red lines of taking back control of borders and laws immediately after Brexit, and reflect a realization that despite May’s rhetoric, the UK would bear the brunt of the economic costs that a no-deal Brexit would bring about.

Muted political backlash from Brexiteers
Given the concessions over EU citizenship rights and fishing, the backlash from the Brexiteers in the Conservative party has been subdued. Jacob Rees Mogg, the head of the pro-Brexit European Research Group (ERG) faction of the Conservative Party previously warned that a transition deal would make the UK a “vassal state,” but now argues that he could live with the transition arrangement as long as the final withdrawal arrangement is satisfactory. There has been no serious threat to rebel against the government or the Prime Minister even though she has violated most of her previous “red lines.”

There are two reasons why Conservative Eurosceptics are still overtly supporting the Prime Minister. First, any attempt to vote against the government in October on the EU Withdrawal Bill might lead to fresh elections. Polls are currently neck and neck, which means that the Labour party has a non-trivial probability of winning. Labour is committed to striking a customs arrangement with the EU, which is anathema to many Conservative Brexiteers. Therefore, this option is highly risky for them.

Second, while the ERG could try to trigger an internal Conservative Party leadership election by instigating a vote of confidence in the Prime Minister, party rules state that a majority of Tory MP’s have to vote against the incumbent leader. This is unlikely to happen because there is no credible alternative candidate who can unite the party’s Remain and Leave camps. Moreover, there is simply no appetite for a leadership election at such a critical stage in the negotiations.

Therefore, Tory Brexiteers are unable to turn their displeasure over the transition deal into concrete action. Their lukewarm opposition to the concessions to secure the transition agreement demonstrates that the Prime Minister is not as beholden to the group of hard-line Brexiteers as previously thought, which makes it more likely that a final agreement with the EU will be reached.

Updated probabilities of final outcomes
Given Theresa May’s greater latitude for action, it is worth reevaluating the likelihood and impact of three of the most probably Brexit scenarios. The most likely of these is the signing of a limited free trade agreement in goods. As the EU runs a trade deficit with the UK of around £95 billion, it would be in its interest to strike a tariff-free goods agreement. The UK, despite demanding the full restoration of its sovereignty while maintaining full access to the single market, has demonstrated an increasing willingness to compromise in these negotiations so far. The Government’s official policy that no deal is better than a bad deal does not have much credibility at the moment.

A comprehensive deal would involve facilitating trade in services, however, trade in services is usually more complex to negotiate. Negotiations are set to complete in October 2018, and there simply might not be enough time to negotiate such a comprehensive deal. Importantly, this means UK financial services will likely lose their “passporting” rights to sell their products across the EU. Given the centrality to financial services to UK’s economy, a limited free trade agreement would entail significant economic costs to the UK. However, it would be preferable to a no-deal scenario under which the UK would fall back on WTO rules.

An obstacle to this outcome is the problem of the border in Northern Ireland. Leaving the customs union would risk creating a hard border between Northern Ireland and the Republic of Ireland which would threaten the Good Friday Agreement. The UK government is committed to preventing a hard border, but has not yet laid out how it would achieve this objective if it leaves the customs union.

Alternatively, to solve the Irish border conundrum, the UK could try to strike a new customs arrangement with the rest of the EU. Although the government has ruled out a customs arrangement, there is a pro-customs union majority in Parliament at the moment. If the government does not come up with a solution of its own, it might have to soften its position and aim to strike a customs arrangement, meaning this scenario remains a real possibility.

Finally, if there is no withdrawal agreement, economic risk will be significantly heightened. Trade flows and air traffic will be significantly disrupted and the legal status of EU citizens in the UK and British citizens in the EU would be unclear, while a hard border in Ireland would be likely. However, the recent negotiations over the transition process makes this outcome highly improbable. The UK’s negotiating strategy has followed a clear trend – the further the negotiations go, the more willing the UK has become to compromise to strike an agreement. The domestic political response to the transition has exposed the limited ability of the hard-line backbench Brexiteers to force the government’s hand. Moreover, the transition agreement has also engendered a mood of cautious optimism that a deal can be reached decreasing the chances of this worst case, “no-deal” scenario.

This article first ran on Global Risk Insights, and was written by Aman Navani