U.S. Markets closed

Here's what the future of EU-UK trade will look like

Rayhanul Ibrahim
NEW YORK, NY - JUNE 24: A portrait of Queen Elizabeth hangs on a wall at the popular British restaurant and grocery Tea & Sympathy in Manhattan on June 24, 2016 in New York City. The world was shocked on Friday morning to learn the Britain had vote to leave the European Union. (Photo by Spencer Platt/Getty Images)

The UK voted to leave the European Union, but that doesn’t mean it will leave right away.

To start the official exit process, the UK must first activate what’s known as Article 50 of the Lisbon Treaty (an agreement governing EU membership). It will take the UK roughly two years to exit the EU — and lose its benefits and laws associated with its membership. This means the UK will no longer be part of the European market and must negotiate a new EU trade deal.

The details of this trade deal could influence the long-term effects of the Brexit.

The EU’s sheer size gives it the upper hand in shaping the trade agreement, as does the fact that nearly half of British exports go to the EU (according to a British fact-checking nonprofit, Full Fact).

The UK’s actual trade agreement with the EU could also take far longer than two years to implement, according to a number of recent analyst notes. That’s because of the massive number of details involved with trade in a post-Brexit world: tariffs, regulations and immigration are just the big three.

What’s more, the Brexit campaigners may not have had an adequate plan for post-Brexit trade.

“In our view, the Leave Campaign did not offer a detailed version for the UK outside the EU in the campaign period before the vote,” commented HSBC analysts in a note Friday.

The EU may also not be incentivized to give the UK a good deal, given the rise of euroscepticism in other EU countries. After all, people all across Europe will be looking to this trade agreement as a model for what they could get if they leave the EU.

The UK’s current trade details with the EU may gives us a better idea of what to expect in the final trade agreement.

Open Europe, a think tank that did not take an official position on the Brexit issue, published a report examining the potential effects of Brexit a year ago. In that report, the think tank included a sector by sector breakdown of where British trade with the EU had the greatest risk of disruption, which can be seen below:

From the Open Europe Think Tank.

Pay close attention to the sectors the UK has a trade surplus with versus the sectors where the UK has a trade deficit. The EU is likely to make life more difficult for the former sectors, given the UK benefits more from that type of trade. 

It’s clear that  financial services are likely to be have harsher trade conditions attached to it in the future. Other analyst reports back up the likelihood of this prospect.

“The EU would be unlikely to offer the UK migration restrictions without some quid pro quo,” the previous HSBC analysts commented in their note Friday. “Most likely it would seek to limit the freedom of movement of capital and services, since these are areas where it potentially would have most to gain and the UK a lot to lose.”

This is problematic, given that the UK's "external trade in financial services is a signifcant contributor to the economy," according to a 2015 report from a group called Economists of Britain. That suggests whatever trade deal comes out of the Brexit could have a negative long-term effect on Britain’s economy.

Two other countries also offer a glimpse into what an eventual trade agreement might look like; Norway and Switzerland. Both are outside the EU, but have worked out trade deals with it.

However, British economist Andrew Sentance pointed out in The Telegraph recently that a post-Brexit England may not be able to have trade deals that look like Norway or Switzerland.

Moreover, Norway may not have a model the the UK wants to follow anyway. Norway has no say in the EU political process but still has to pay into the EU budget and follow some of Europe’s regulations and directives to trade. A 2013 UK report found that Norway pays 106 pounds per person to the EU, while the UK pays 128 pounds per person — not too significant a difference. 

Switzerland on the other hand has managed to work out a fairly advantageous deal. It does not have to pay into the EU budget. But, as Sentance pointed out in The Telegraph, Switzerland’s deal took nine years of negotiation.

The UK might not want to wait that long. The markets hate uncertainty, and a mediocre deal negotiated quickly may do less damage than a superior deal negotiated over a decade.


SEE ALSO:

A single word explains why financial markets everywhere are nosediving

Currency expert warns the British pound faces a 'grave danger' in the weeks ahead

The UK may have commited 'an act of economic self-harm with global ramifications'

One chart captures the night of insanity as the Brexit vote counts trickled in

Credit Suisse: The US stock market won't be safe from a 'full Brexit'