Brexit: Limiting the Damage

It is one of the ironies of history that the EU as it is today, starting with the single market, was largely made in Britain, the achievement, above all, of former prime minister Margaret Thatcher and her right-hand man in Brussels, the then Commissioner (Lord) Arthur Cockfield. The single market has long been viewed by observers in countries with less of a free market tradition as a typically British liberal invention. And yet it is this market, as well as the EU itself, that another Conservative government is now seeking to leave.

Britain has also left its stamp on key EU initiatives from regional policy to development assistance and fisheries. The EU’s interest in a common foreign and security policy originally stemmed from Britain. The EU’s comparatively transparent and accountable administrative rules date from the reforms introduced by former British Labour Party leader Neil Kinnock when he was Vice-President of the European Commission from 1999 to 2004. Thus, representatives of Britain’s two major parties have helped to make the EU what it is today.

If British prime ministers had explained to public opinion earlier the extent of their country’s influence on the EU, something that other Europeans never doubted, the referendum of 23 June 2016 might never have occurred.

A “Smooth and Sensible” Brexit

Be that as it may, Europeans on both sides of the English Channel are now grappling with the consequences of that vote. If reason and economic interest prevail, a “smooth and sensible” Brexit, as evoked by the British prime minister in Florence in September, might yet emerge.

This would involve a broad agreement, in 2017, on the principal aspects of the divorce settlement. This concerns mainly Britain’s financial commitments to the EU, the residence, professional and health rights of citizens living on both sides of the Channel after Brexit, and the need to maintain the Common Travel Area between Britain and Ireland and to avoid a hard border across the island of Ireland after Brexit. While Brussels, London and Dublin have affirmed their intention of achieving these goals, there are many practical and political issues to resolve.

If sufficient confidence and trust between EU and UK negotiators is established, it should also be possible to agree to the general terms of a future political and economic agreement between London and Brussels by the end of the year and to broach the question of transitional arrangements to smooth the way for government and business. The British government wishes to ensure that business need adjust to Brexit only once, hence the need for a smooth transition to a well-defined future relationship.

If good progress is made next year, the separation agreement and transitional arrangements could be drawn up by October 2018, allowing enough time for approval by EU and British institutions ahead of Britain’s exit from the EU at midnight between 29 and 30 October 2019. Little, except Britain’s lost vote in EU institutions, would then change for the next two to three years, as the UK continued to make payments to the EU budget, respect judgements of the European Court of Justice and accept the free movement of labour.

The breathing space would be used to negotiate, sign and ratify a two-part long-term agreement. The first part would cover trade and economic issues; it could take effect provisionally relatively quickly after agreement had been reached. The second part, though, would be a wide-ranging political agreement, involving security and even aspects of defence. Both sides have an interest in cooperation on armaments production and unconventional forms of conflict, as well as police and judicial affairs. This would involve the member states’ legal responsibilities and require ratification by all twenty-eight countries concerned. It might not come into effect before the mid-late 2020s.

This relatively benign sequence of events assumes that the British government is unified behind its negotiator, David Davies, and that the political situation in Britain and the EU remains generally stable. It also assumes that the EU can move beyond its rigid two-stage sequencing of the negotiations.

However, there may well be political upsets, involving a leadership competition in the Conservative Party and, perhaps, an early general election. The opposition Labour Party may come to power bringing a change in priorities but also differences of opinion in its own ranks. The British economy will be damaged by Brexit, according to leading economists, and public opinion is likely to react when this is widely felt.[1]Until now, the main impact has been a decline in sterling and rising inflation, raising the prospect of higher interest rates.

The “Cliff Edge” Scenario

Such uncertainties, as well as the divergent political agendas of London and Brussels, may make the smooth and sensible Brexit impossible to achieve during the limited time available. This opens the way to a second scenario, widely described in Britain as the cliff edge. Under this hypothesis, the December 2017 goal for achieving a breakthrough in the separation talks is missed. This further postpones discussion of transitional arrangements and a future long-term agreement.

Negotiations continue fitfully during 2018 but the two sides are too far apart to reach agreement by October 2018, which the EU chief negotiator, Michel Barnier, has designated as the effective deadline. If October passes without an overall agreement, it will probably be too late to secure the agreement of the European Parliament before 29 March 2019, when the two-year negotiating period initiated by the British government’s notification of withdrawal expires. Nonetheless, negotiations might well go down to the wire.

Unless all twenty-eight countries “stop the clock” at midnight, an old Brussels ruse, the UK would then leave the EU without an agreement. Business leaders have warned of the chaos this will bring. There will be an unmanageable fivefold increase in work at British, Irish and mainland European ports checking consignments, the suspension of air travel between the UK and the EU, pending the conclusion of a new air transport agreement, and other major disruptions.

Health, safety, veterinary and phytosanitary inspections, as well as the assessment of customs duties, would lead to long queues of lorries at ports on both sides of the channel. Neither side can build the necessary infrastructure and linked IT systems or recruit sufficient qualified staff in time to cope with dramatically increased requirements after a hard Brexit. Supply chains would be disrupted and many foreign-owned companies, which had not already relocated to remaining EU countries, would seek to do so rapidly.

The political and economic damage of going over the cliff edge would last for years and embitter the UK’s relations with the EU and third countries. Many would question the value of Britain’s WTO commitments in the absence of appropriate trading arrangements between Britain and the EU.

This then is a sketch of the cliff edge. Those who admire Britain for its pragmatism, fairness and common sense find it hard to believe that such a scenario might become reality. Surely, they say, Britain and the EU are involved in preliminary skirmishing of the type that precedes any negotiation. They are sure to come to their senses as the decisive deadlines approach. Nothing is less than certain.

A Tale of “Downside” Risks

The outcome may well diverge from either the optimistic or the pessimistic scenarios delineated above. However, the risks are mainly “downside” as the economists put it. British negotiators have not yet grasped the fundamentally asymmetric nature of negotiations between twenty-seven countries backed by European institutions on the one side and a single country seeking to leave the club on the other. It would be better for government, business and the public, if this reality were more widely recognized, leading to realistic negotiating targets. Indeed, Brexit is not really a negotiation at all in the usual sense. It is rather an effort by the leaving country to secure some exceptions from the club’s rules at the time of its departure. This is much akin to the efforts of a candidate (joining) country to achieve some, temporary, transitional exceptions to the EU’s rules.

The Brexit talks are essentially an exercise in damage limitation, mainly through transitional arrangements. When the divorce and transitional arrangements have been agreed, Britain and the EU can concentrate on negotiating a long-term partnership which will be in their mutual interest.

This post was written by Michael Leigh of Covington & Burling LLP., © 2017
For more Global legal analysis, go to The National Law Review

Trump, Xi Kick Off Economic Relationship

china economic relationshipOn Friday, April 14, the U.S. Department of Treasury published a widely anticipated semi-annual report detailing the foreign exchange practices of America’s major trading partners. Although he regularly called for China to be labeled as a “currency manipulator” as a candidate, President Donald J. Trump and his administration declined to use the occasion of this report to do so. Mr. Trump previewed this decision days earlier in an interview with the Wall Street Journal, reflecting the consensus among economists that the Chinese “are not currency manipulators.” While, according to many economists, the Chinese government did keep the value of the Renminbi (“RMB”; also known as the “Chinese yuan”) at an artificially low level for many years, Chinese policymakers have been hard at work trying to prop up the currency since 2014 due, in part, to a strengthening U.S. dollar and surging capital outflows.

The decision not to label China as a currency manipulator comes on the heels of the first in-person meeting between Mr. Trump and Chinese President Xi Jinping. On April 6 and 7, Mr. Trump hosted Mr. Xi at his Mar-a-Lago estate in Florida for a two-day summit, an important weather vane for near-term relations between the United States and China. Despite concerns that strategic differences over thorny issues such as North Korea and the South China Sea or harsh rhetoric regarding U.S.-China trade relations from Mr. Trump in advance of the meeting might sour the mood, both sides came out of the meetings with a buoyant step. The two sides agreed to implement a new, comprehensive framework for bilateral negotiations that will shape U.S.-China engagement in the years to come. Further, U.S. and Chinese officials announced a plan to reach agreement, within 100 days, on steps that can be taken to address trade-related frictions between the two countries.

For much of the Obama presidency, bilateral negotiations between the U.S. and China were centered around two main events: the U.S.-China Strategic and Economic Dialogue (“S&ED”) and the Joint Commission on Commerce and Trade (“JCCT”). During this first face-to-face encounter, Mr. Trump and Mr. Xi agreed to a new framework for high-level negotiations called the “U.S.-China Comprehensive Dialogue,” which is to cover four main tracks: diplomacy and security, economics, law enforcement and cybersecurity, and society and culture. Few details have been released as to how the new dialogue will work in practice, and which of the components of the S&ED and JCCT might be preserved in this new framework.

The 100-day plan for trade negotiations is aimed at addressing trade frictions, particularly with regard to increasing U.S. exports and reducing the U.S. trade deficit with China. Few details about what the 100-day plan will entail have been released, and many details are yet to be negotiated. However, it appears that these negotiations will focus on securing Chinese commitments on a range of U.S. exports including beef (banned in China since 2003) and other agricultural products, steel, oil, and gas. Additionally, the Chinese might provide greater market access for U.S. investments in the financial sector—e.g., in securities and insurance. U.S. Treasury Secretary Steven Mnuchin explained during a press briefing that there was a “very wide range of products that we discussed.” According to some reports, at least some Chinese commitments proposed at this early stage may have originally been intended for offer in the context of the bilateral investment treaty negotiations between the U.S. and China, the prospects for which are now less certain.

The current dynamics present significant opportunities for individual businesses and industry groups. Businesses seeking access to the Chinese market for exports or investment should consider engaging with U.S. policymakers to leverage the situation and make a case for addressing their specific needs during the current round of negotiations. Even if the 100-day plan does not bring about the kind of comprehensive economic benefits potentially possible under a bilateral investment treaty, companies with interests in China should see this as an opportunity to seek relief in a Chinese business environment that, according to over 80% of member companies responding to an AmCham China survey, has become less friendly to foreign business than in the past.

© 2017 Covington & Burling LLP

Economic Impact of Homebuilding and Remodeling

Bilzin_logo300 dpi

Blocked streets, noisy construction and unwelcome trash can be just a few of the inconveniences that come along with a neighbor’s new home construction or home remodeling. However, a report released in early May by the National Association of Homebuilders (NAHB) confirms that for the overall good of the nation’s economy, some of these inconveniences may be worth the hassle.

Residential home building is back, and it’s helping the economy in a big way

The NAHB’s report calculated the approximate number of jobs that are created and how much tax revenue is generated relative to the different types of residential construction projects. It found that the construction of an average single-family home creates approximately 2.97 jobs and generates approximately $111,000 in taxes per home. Not having quite as significant of an impact, but still highly beneficial to the economy, are rental apartment construction projects, which create roughly 1.13 jobs per unit and generate approximately $42,000 in taxes per unit. In generating these statistics, the NAHB defined a “job” as work that can keep one worker employed for an entire year based on an average number of hours worked per week in the homebuilding industry.

homesA robust homebuilding market has wide-reaching benefits. In addition to the workers in a variety of construction and remodeling industries, including lumber, concrete and HVAC, other beneficiaries include workers that transport homebuilding materials and products, as well as those in the service sectors, such as architects, engineers, real estate agents, lawyers and accountants.

This latest report is the first update to the NAHB’s National Impact of Home Building estimates since 2008. Interestingly, the statistics related to tax revenue and jobs-per-housing-unit are roughly equal to what they were in the 2008 report, but the NAHB article indicates that that is likely due to inflation, changes in housing preferences and the use of somewhat revised metrics in determining these estimates.