BREXIT PHASE 2

Most member states will want continued free trade in goods – as long as the UK maintains a level playing field.

Trade with the UK matters to all of the EU27 member states, with a significant proportion of their GDP generated by exports to the UK. The UK is one of the biggest 10 export markets for every member state apart from Slovenia. For some, trade with the UK represents a very high proportion of their GDP: Luxembourg tops the list at over 25%, but Malta, Ireland, Cyprus, the Netherlands and Belgium are all very exposed, with around 10% or more of their GDP generated by exports to the UK.

Twenty of the EU27 member states have a surplus in goods trade with the UK. For  some member states, particularly those close to the UK such as Belgium and the Netherlands, as well as some of the Central and Eastern member states including the Czech Republic and Slovakia, this surplus represents a substantial proportion of their GDP. Even for larger countries such as Germany and Poland, the goods surplus they run with the UK still makes a significant contribution to their economies.

Looking at a specific sector, vehicles are a key export industry for many of the EU27. Germany exported approximately €27 billion worth of vehicles to the UK in 2016; Spain exported around €6 billion worth of vehicles; and the Czech Republic exported around €2 billion worth of vehicles. These member states should want to maintain free trade in goods to protect their trade surplus. At the same time, all member states import goods from the UK. Producers in member states are keen to ensure that they are not undercut by UK competitors. Indeed, a recurring concern is that the UK would seek to gain competitive advantage by maintaining free trade while rowing back from EU rules.

Member states will also want the UK to continue to meet EU goods standards so that they can continue to use UK-made components in their manufacturing processes. Many companies operating in the UK and the EU27 have integrated supply chains that cross EU borders several times. On the other hand, some member states may hope to benefit from additional investment if trade with the UK becomes too onerous for just-in-time supply chains and production relocates inside the Single Market. Producer power may influence the outcome on agriculture and fisheries – against the UK’s interests

While the UK runs a deficit with most of the EU27 across all categories of goods, this is particularly significant for agricultural produce. In 2016, the Netherlands ran a surplus in agricultural and fisheries goods with the UK of more than €6 billion; Germany’s surplus with the UK was more than €3 billion; and Italy, France, Spain and Belgium each had a surplus of over €2 billion. Member states will want to preserve their trade surpluses. The draft European Council guidelines for the future relationship between the EU and the UK suggested tariff-free trade in all goods, including agriculture.

Agriculture

There is a concern in some EU countries that the UK will seek to undercut EU competitors by reducing agricultural standards or that the UK will cut trade deals with other countries and flood their markets with cheaper lamb and beef. The powerful Danish pork producer lobby are concerned about being undercut by UK competitors, while President Macron has flatly rejected any reduction of French agricultural standards.

Fishing

Fishing is likely to be another flashpoint. The UK has made it clear that it wants to leave the Common Fisheries Policy (CFP). But many EU fishing fleets prize their current access to UK waters. The draft European Council guidelines state that they want tariff-free trade in agricultural goods and fish to be accompanied by full access to UK waters. The University of the Highlands and Islands examined the proportion of fish caught by member states’ fishing fleets in UK waters between 2012 and 2014. Belgium was the most dependent on UK waters, with 45% of the fish caught by Belgian boats caught in the UK exclusive economic zone. The Netherlands was second, with 39%; then Ireland, with 35%; Denmark, with 34%; Germany, with 31%; France, with 17%; and Sweden, with 15%. Fishing was one of the most controversial issues in the UK referendum campaign and it is a similarly sensitive issue in other member states. Relevant governments will want to ensure that the UK remains close to EU fisheries policy.

Services

Services will be a more contentious area The UK has a clear interest in maintaining services trade with the EU. According to Eurostat data, 18 member states, including France and Poland, ran a deficit with the UK in insurance and pension services in 2016; 11 member states, including Luxembourg and the Netherlands, ran a deficit in other financial services; and 14 member states, including Ireland and Italy, ran a deficit in other business services, which includes accountancy, legal services and consulting. Some member states see an opportunity to take business away from the UK. Some member states are keen to use Brexit to attract some of these businesses away from the UK. The Paris regional government launched the ‘Choose Paris Region’ campaign shortly after the UK’s referendum, making no secret of the fact that it hopes to attract financial services firms away from London. Less conspicuously perhaps, Amsterdam, Dublin, Frankfurt and Madrid, among others, have been making the case to host financial and other professional services firms. The German Coalition Agreement makes only two substantive references to Brexit – one on fishing and one about the opportunity to attract financial services business from the UK.

But the EU relies on UK firms and expertise. The UK’s relative advantage in financial and other business services has been built up over many years and the EU will struggle to replicate it quickly. The City of London is the most sophisticated financial centre in the EU. The UK’s financial services sector provides 78% of foreign exchange trading for the EU and 74% of European interest rate derivatives trading takes place in the UK. German companies could face restrictions on access to potentially important financial services’ as a result of Brexit. However, this may only become relevant in highly specialized areas. According to Eurostat data, in 2016 Luxembourg had the highest demand for UK financial services (not including insurance and pensions), importing more than €7.7 billion worth, Germany was second, with €2.3 billion, and France and the Netherlands next, with €1.3 billion and €1 billion respectively. If key market infrastructure, such as clearing houses, were to be split up across Europe, ‘the costs for all financial market participants will soar’. On top of the importance of the UK’s capital markets, the UK’s financial regulators are some of the most experienced in Europe. Few other member states’ regulators have the same expertise in supervising large, complex institutions like those that operate out of the City of London. If international financial firms did relocate from the UK to other member states, building their regulatory and supervisory capacity would be a key challenge.

Integrity of the Single Market

Member state governments and business lobbies are united in their view that the integrity of the Single Market is the priority

The UK Government has argued that business organizations in the EU will put pressure on their governments to prioritize the economy and to do a deal that allows trade with the UK to flow as freely as now. So far there is little sign of that assumption crystallizing. The President of MEDEF, the French equivalent of the Confederation of British Industry, has said that ‘the idea is not to be particularly hard on our British partners… [but] when you pull out of the game, you cannot continue to enjoy its benefits’. MEDEF’s German counterpart, the BDI, which has established 10 project groups looking at different issues affected by Brexit, has called for ‘a deep and comprehensive partnership, investment and trade agreement’ between the EU and the UK. The BDI has been clear that its priority for the negotiations is to strengthen ‘the cohesion of the remaining 27 EU member states’. The Single Market matters more than the UK market to EU27 governments and businesses. While in theory it is in the interests of all of the EU27 and the UK to maintain free flowing trade in goods and services, many member states are concerned that the UK will seek to undermine EU standards to gain a competitive advantage. For both businesses and politicians, ensuring that the UK’s access to the Single Market is tied to its continued adherence to the rules of the market is key. A recent assessment by the Swedish Board of Trade recommended ‘that Sweden push for a far-reaching horizontal agreement, binding the UK as close as possible to EU law’ in order to maintain free-flowing trade in goods and services between the two countries. Member state governments are concerned that a deal that allows preferential UK access to the Single Market without ongoing compliance with the rules will threaten the integrity of that market, which is much more important to them than trade with the UK. For example, the UK was Germany’s third biggest export market in 2016, the destination for just under 8% of German exports. However, six of Germany’s top 10 export markets – the destination for approximately 31% of its exports – are other EU member states. This is true even for those member states with whom the UK has extremely close economic and historic relationships. In 2016, the UK was Malta’s biggest export market, the destination for over 18% of its exports, but there are another six EU member states in its top 10 export markets, which together are the destination for over 34% of its exports. The draft European Council guidelines for the future framework stressed the importance of avoiding ‘cherry-picking’ on the part of the UK, which ‘would undermine the integrity and proper functioning of the Single Market’. The guidelines also set out that the new relationship between the EU and the UK will require ‘checks and controls to uphold the integrity of the EU Single Market’. They recognized that these ‘will have negative economic consequences’ but that the integrity of the Single Market takes priority.

There are more genuine differences of interest between the EU27 member states in the approach to phase two of the Brexit negotiations than in phase one. This offers opportunities for the UK to secure what it wants from the future relationship it has with the EU, but it needs to avoid the impression that it is seeking to ‘divide and conquer’. Having spent months on internal wrangling, it needs to refocus and speak directly to audiences in Europe. Different groups of member states have different priorities. Member states have always formed coalitions and groupings within the EU to advance their priorities. The approach they take to Brexit will be no different. Their attitude to the UK, to the other issues that the EU is facing and to their domestic politics will affect who they work with.

Pro-integration Core

The pro-integration core group led by France and Germany, but also including Belgium and Luxembourg supports greater EU integration and is the closest to the European Commission. This group will prioritize the integrity and stability of the EU27, meaning that they will push for the UK to maintain compliance with EU rules if it wants significant access to the Single Market. The German government in particular is prepared to take an economic hit in terms of loss of trade with the UK to ensure that other member states do not seek to follow the Brexit example. France will want to maintain close security co-operation with the UK, but does not see Brexit as a threat to this. Luxembourg wants a close relationship with the UK on financial services, but will also be focused on the integrity of the Single Market.

France and Germany are still able to set the overall EU agenda, and bring other member states along with them.

Northern member states – the UK’s traditional allies

This group includes some of the Baltic member states, Ireland, the Netherlands and the Scandinavian member states. As liberal, open, trading economies, they are traditionally the UK’s closest allies in the EU, and they will miss the UK’s presence in the decision making process. Many, but not all, of these countries are also net contributors to the EU These member states are reluctant to see the UK ‘punished’ for Brexit and will want a close future relationship given the extensive economic, cultural and security links between them and the UK. However, they are also concerned about the integrity of the EU27 and many face Eurosceptic challenges at home. As a result, they are unlikely to deviate from the line pushed by France and Germany, at least in public. Ireland occupies a particularly important place in the debate and the European Council, Parliament and several member states have made it evident that solidarity with Ireland is a priority for them. While the Irish have been clear that they want a very close relationship with the UK, they have also been clear that they are taking a common position with the other 26 member states. So far, this solidarity shows no signs of weakening.

The Visegrád Four

The East, particularly the Visegrád Four (the Czech Republic, Hungary, Poland and Slovakia) have grown in influence in recent years. They all support a close trading relationship with the UK, particularly in goods where they all have an important surplus. Alongside some of the other Eastern member states, the group will want to maintain the rights of their citizens to work in the UK. The group tend to share a scepticism of the integrationist impulses of France, Germany and the European Commission. At the same time, as net recipients of EU funds, Eastern member states will want to keep France and Germany on side . This will be particularly tricky for Hungary and Poland, both of which have been criticised in Brussels for their approach to the rule of law. They are unlikely to want to diverge too far from a common EU position on Brexit, to avoid irritating the net budget contributor

These differing views do not mean that the EU27 will split. There are many reasons why the EU27 will want a close future relationship with the UK, and they will all have their own priorities. That does not mean that the consensus that has prevailed so far will crumble. All member states share an interest in a deal that protects the integrity of the Single Market and the stability of the EU, despite their differing visions for the future of the bloc. To achieve the relationship it wants, the UK needs to show that it understands those common interests and put forward a detailed proposal for the future relationship that takes them into account

Ranking of the United Kingdom among the top 10 Destinations of Exports (Goods & Services)

• Cyprus,  Malta: Ranking 1
• Greece, Ireland, Luxembourg, Netherlands, Poland: Ranking 2
• France, Germany, Spain: Ranking 3
• Belgium, Czech Republic, Denmark, Italy, Portugal, Romania: Ranking 4
• Hungary: Ranking 5
• Croatia, Latvia,  Slovakia, Sweden: Ranking 6
• Austria, Bulgaria, Finland: Ranking 7
• Lithuania: Ranking 8
• Estonia: Ranking 9