Brexit : Britain’s regulatory-divergence dilemma in leaving the European Union

— There will be costs to diverging from EU regulation. But there will be benefits, too

Britain –Jan 30th 2020 edition – The Economist Magazine

On January 31st Britain leaves the eu. It goes into a sort of limbo—a transition period—until the end of 2020, when in dozens of areas, from trade, migration, environmental rules and farming to financial services, data policy, regional subsidies and state aid, the country’s freedom to run its own affairs will be constrained only by its ambitions to do deals with other countries. The big question, says Sir Bernard, an enthusiastic Brexiter, is whether it can remember how to roam.     

The riposte from Brussels to Mr Javid’s remarks was swift. Ursula von der Leyen, president of the European Commission, repeated that greater regulatory divergence would necessarily mean a more distant trading partnership with the eu. The government’s own economic analysis of Brexit last year put the long-term loss in gdp per person of a close relationship (like Norway’s) at some 1.4%, against a loss of 4.9% for a more distant one. The difference is a proxy for the cost of regulatory divergence.

British manufacturers protested. The car and aerospace industries, chemicals and pharmaceuticals firms, the Confederation of British Industry (cbi) and Unite, the biggest trade union, all talked of the adverse consequences of divergence. Ministerial promises only to diverge when that is in Britain’s interests do not much reassure them. The only way to avoid customs, rules of origin and regulatory border checks is to make legally binding commitments to observe all current and future eu rules, which the government has rejected.

Some 80% of the auto industry’s output is exported, and over half those exports go to the eu. Regulatory divergence would mean cars (and car parts) being subject to compliance checks in both directions, increasing costs and delays. Some 60% of the chemicals industry’s output goes to the EU.

But there is bound to be divergence. Regulation is the expression of public attitudes to business and the state; since those are different all over the world, Britain’s rules will become increasingly British. And there could be benefits as well as costs.

Regulation in Britain tends to be based on principles, rather than prescription; the country’s common-law system builds on it over time. European regulation, by contrast, is more codified, which leads to a lot of prescriptive detail. The very word “directive” strikes fear into executives, says Helena Morrissey, a City financier. Financial firms get snarled up in detailed eu rules. The cost to the British asset-management industry of obeying the revised Markets in Financial Instruments Directive, which came into force in 2018, for example, is an estimated €2.5bn ($2.75bn). The burden of regulation falls especially heavily on small firms, discouraging enterprise.

Britain’s new freedom to regulate flexibly and nimbly will be invaluable, says Rishi Sunak, chief secretary to the Treasury and a rising star in government. A particular opportunity, says the boss of a London-based exchange, would be to adopt America’s regime for regulating derivatives, considered the best in the industry. The eu recognises it, so London could ask to be treated in the same way, he says.

Two of the buzziest areas of finance are fintech and sustainable finance. The City has a better chance of getting ahead in those areas if it has its hands on its own regulatory levers, says Jonathan Hill, a Conservative politician and former financial-services commissioner for the eu. One approach likely to be used more widely is the “regulatory sandbox”: rather than banning an innovation or approving it for use across the system, regulators allow it to be used on a limited scale and monitor its effects. If the risks seem low, the new practice is allowed wider application.

Of more economic significance is the divergence in attitudes to finance. The long campaign to introduce a financial transactions tax has more takers in the eu than in Britain. And hostility to wealth is probably more pronounced within the eu than in Britain, hence one of the most disliked pieces of eu regulation—a cap on bankers’ bonuses introduced in 2014, which forces banks to raise the proportion of their costs that are fixed, thus potentially making profits more volatile.

The eu’s instincts, meanwhile, are more protectionist than Britain’s. Britain is, for instance, already moving away from the eu requirement that only airlines 50% owned by local companies have unrestricted rights to fly within the eu. And the noises coming out of the commission about the need to foster local tech titans suggests that the gap on this front may widen.

In science, too, Britain is likely to diverge from Europe. Britain’s empirical approach to intellectual life makes it more permissive, while the “precautionary principle”, for which the continent has more time, tends to be inhibitive. In July 2018, for instance, the European Court of Justice (ecj) ruled that plants obtained by modern forms of mutagenesis, of which gene-editing is an example, fall under the eu’s gmo directive from 2001. The gmo legislation, because it is complicated and expensive to comply with, amounts to a de facto ban. Sir Mark Walport, chief executive of uk Research and Innovation, attributes this hostility to gmos in part to personal beliefs about the legitimacy or otherwise of fiddling with nature. “Now we can work in the context of uk society which in general thinks very positively about science.”

London’s tech industry is also excited about what a trade deal with America might bring in the field of digital services, says Nicole Sykes, head of eu negotiations for the cbi. “We could create a more stable environment for technology firms large and small,” says Stephen Booth, director of Open Europe, a Eurosceptic think-tank.

The globalist wing of the Brexit movement is keen to boost the country’s competitiveness by lightening social, economic and environmental rules. Business will have plenty of suggestions. Many dislike the requirement that obliges them to hire temporary workers after a short period of time. Smaller businesses in particular could be awarded more exemptions from labour regulations.

This worries the eu, which is particularly concerned that there should be a “level playing field”. On environmental protection, Brussels calculates that British industry could save €4.7bn a year if it departed from the eu’s rules on industrial emissions and pollution.

Focused as it is on boosting growth in England’s peripheries, the government seems more likely to diverge from eu state-aid rules than from social, environmental and labour protections. Mr Johnson has put the creation of ten “freeports”, that for customs purposes are legally outside Britain, high on the agenda. Freeports can offer zero tariffs, low taxes and loose regulation. America has 250 free-trade zones. The eu claims to have 85 customs-free zones but in reality there isn’t much to them. Mr Sunak says eu single-market regulations and state-aid law have stopped Britain from using such zones properly. “The eu makes it very hard to make them seamless and really exciting,” he says.

Going free range

The biggest arguments are going to be around fisheries (see article) and agriculture. Farmers and fishermen, who voted enthusiastically for Brexit, make up a tiny proportion of gdp—0.6% and less than 0.1% respectively—but their travails will loom large: Scarry’s Law, formulated over a decade ago by this newspaper and named after Richard Scarry, a children’s illustrator, states that politicians mess at their peril with groups that feature in children’s books—farmers, fishermen, train drivers and suchlike.

The eu’s approach to farming is unpopular among an impressively wide range of people. Some dislike the fact that the common agricultural policy (cap) has shovelled vast subsidies to a tiny sector, many of whose members are landed gentry; others that it depresses the price of agricultural products, thus impoverishing developing countries. Environmentalists regard automatic payments for agricultural land as an incentive to clear wildlife habitats and cut down trees. Farmers dislike the eu’s tight rules on the use of pesticides.

Sectoral worries aside, surveys suggest that business sentiment soared after the election result. A cbi survey of manufacturers published on January 22nd reported the biggest positive swing in confidence since the poll was first taken in 1958. Manufacturers’ absolute confidence level is now as high as it was in 2014 when the economy was emerging from recession.

This surge of animal spirits is down partly to the defeat of a left-wing Labour Party and partly to greater clarity about Britain’s future relationship with the eu. But it also springs from a hope that the government will not just throw off eu rules, but also improve the way it works with business. “We’ve got to park the past and make the best of what we’ve got,” says Sir Roger Carr, chairman of bae Systems, a defence firm. The hardest part of Brexit—negotiating a full trading relationship with the eu—is still to be achieved, but British business appears ready to be bolder than the pike. ■

This article appeared in the Britain section of the print edition under the headline “Britain’s regulatory-divergence dilemma”

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  • kamtanblog  On 02/02/2020 at 2:07 am

    Exactly !
    In time even the pike will “click” and enjoy
    it’s freedom as before ….
    It takes time !
    Laws will change to accommodate the new freedom …laws made in parliament by
    democratically elected British
    MP’s for British subjects citizens of UK.

    Hopefully free and fair trading without tax or
    tariffs on goods and/or services.
    UK a tax haven !
    Way forward.


  • brandli62  On 02/02/2020 at 9:42 am

    One thing is clear. As of February 1, 2020, the UK can no longer blame the EU for all its internal problems. The British public has been brain-washed for decades by politicians and tabloids that it’s the EU that is responsible for the loss of manufacturing jobs, the decline of the NHS, and bad state of education for people not being part of the upper class. I doubt that turning the UK into tax haven will benefit the unemployed in the Northeast of the country .This will benefit primarily the financial industry in the London. The disruption of cross-boarder manufacturing lines, once the UK has left the common market, can only be countered by moving manufacturing from the UK to the EU. There is sufficient manpower on the continent to staff these plants. Tesla announced late last year that they are building their first European electric car and battery plant in Germany. Why didn’t they choose the UK over Germany? Think and draw your conclusions.

    My prediction is that the financial industry might benefit most from Brexit, an industry known to be experts at avoiding taxes while enjoying the London infrastructure provided by the UK tax payers.

    All others with jobs in manufacturing, aeronautics, the pharmaceutics industry, agriculture, and fishing will suffer as these jobs will go sooner or later.

    Last point, look at Switzerland. After a decade of economic decline in the late nineties, the Swiss economy took off after it signed the bilateral agreements with the EU. This meant freedom of movement and full acceptance of EU regulations in exchange to access to the common market.

    • kamtanblog  On 02/02/2020 at 10:05 am

      Good points …however no one can compete
      with China or India in manufacturing.
      My guess is UK will look for similar deals as
      Swiss or others with EU. If not possible UK
      can also join BRICS trading block. Even USA
      another option.
      We can but speculate until Brexit dust has settled and deals are signed and sealed.
      Early days


  • brandli62  On 02/02/2020 at 10:57 am

    Manufacturing is moving out of China to the ASEAN countries, such as Vietnam, the Philippines, and Indonesia. The reasons are a combination of increasing labor costs, the Chinese surveillance state that undermines company secrecy and IP, and lack of rule of law in China. The UK has actually only two choices. Alignment with the US, which will destroy is agricultural industry and generate further pressure on the NHS. The UK has nothing really important to offer to the US, apart of services, which make up 80% of its exports. US will definitely not allow the British financial industry access to the US market without regulation. There is no need for British manufacturing in the US. The GDP of the BRICs countries are combined about the one of the UK (pre-Brexit). Hard to see how this should be a valuable replacement for the loss of friction-free access to a now 450 million common market, where you had the privilege to determine the rules as a member state. The Swiss have access but no right to determine the rules. That’s in my opinion the actually loss of sovereignty and control you have accept by leaving the EU and still having to trade with your biggest partner at your door step.

    • kamtanblog  On 02/02/2020 at 12:13 pm

      EU and USA now have protectionist
      policies in place/trade.
      Will BRICS follow ? Doubt it !
      Am no economist but am sure the
      British economic advisers will be involved/consulted
      in the trade negotiations.
      WTO rules will apply.
      As for manufacturing the north
      can become the hub for manufacturing.
      The south tourism finance.

      The political decisions will be discussed and
      decided by MP
      The economic ones will be much more
      important for UK future.

      We have until end of 2020 to sort it out.

  • Trevor  On 02/02/2020 at 11:51 am

    Brexit was born from xenophobia, racism and “anti-globalist” sentiment.

    Like my Canadian friend once told a fishery company in Canada, “if Poland doesn’t like immigrants or foreigners, then why are they exporting their sardine tins to the Caribbean and Africa?”


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