Settling the Brexit Bill

This issue has dominated the Brexit news cycle, resonating strongly with the Pro-Leave UK press. Economically the sums are not that significant (~3% of GDP compared to UK’s debt of 88% of GDP – material but not catastrophic) especially when compared to the loss of membership of the Single Market, but it seems to evoke highly charged emotions on both sides.

From the EU side, it is simply settling the financial obligations that the UK had signed up to. They talk in terms of paying the bill in a restaurant after having eaten there. The Brexiteers in the UK, such as John Redwood and IDS, are adamant that the UK owes nothing. If an agreement is not reached, it could derail the entire negotiation and distract attention from far more important matters such as trade and Ireland.

Legal situation

My impression is that the argument that the UK does not owe money is legally plausible but completely misleading. For example, UK debt is issued under UK law therefore the UK has the legal right to not pay any of it. That does not make it a good idea.

A good rule of thumb for international treaties is that they cannot be enforced via the courts. There is no effective international court that has sufficient authority. The EU may well have grounds to take the case to the Hague; this is beyond my expertise but I think a highly unlikely place we end up.

In practice, international treaties are upheld via mutual consent and the desire to maintain international reputation and credibility. Enforcement for unreasonable behaviour is via repercussions in other areas.

Moral situation

How much of the Euro 60bn does the UK reasonably owe?

The argument that the UK morally owes nothing rests upon the argument given by Barney Reynolds, head of financial institutions at Shearman & Sterling
“It is essentially more analogous to a corporation, where the member states are akin to shareholders. The UK is departing and handing back its shares.”

Let’s run with this analogy. If the shares have a positive value then this is of course simple. You are giving back shares with a positive value for nothing, which is very generous. What if the shares have negative value? This is where the analogy becomes stretched as it is not possible for shares to have negative value. OK let’s say the shares have a very low value to start with, say £1, but it turns out after some time that they had a large negative value, because of say a large unfunded pension liability. Maybe this analogy is rather good after all!

It could be argued that Philip Green did nothing illegal in walking away from the BHS pension liabilities. However, MPs apoplectic with rage and a strong public reaction showed he had a clear moral obligation to pay with repercussions for non-payment in other areas (such as losing his knighthood). It reminds us of the outrage of Juncker which should not be assumed faked or bluster. When he says “the EU is not a golf club” he is expressing genuine horror.

The EU balance sheet

I think the above analogy is excellent but leads me to the conclusion we need to see the details of what the UK owes. Ignoring if the items are legally-binding for now and simply looking at the net value of the balance sheet so we can make a judgement call on what the UK could pay or receive. I will ignore contingent liabilities for now.

One material assumption is to include the rebate or not – is the UK’s share 12 or 15%?
I will assume the UK share is 12% (including rebate) – this makes the numbers smaller but seems reasonable to argue.

I found these excellent summaries for a full explanation of the line items if you really like the details.

Start with items that are clear cut and large (all figures in euro)

  1. Pensions – 7.7bn

John Redwood argues the UK should not pay because he does not like European civil servants. This argument seems ridiculous to me so I will include. Walking away from this seems identical to the BHS case.

  1. Commitments versus Payments – 29.2bn.
    This is the kind of item that causes confusion and emotional reaction and it shouldn’t.
    There are different ways of accounting for spending, which help visualise things in different ways. One is to only record items when you pay the cash. The other is to record items as you have “accrued” the benefit or cost.

The UK chooses to only account for its obligations to the EU after it has actually paid the cash. The EU keeps that version of the accounts but it also records the accrual method. This is known as the reste a liquide (RAL).

In the restaurant analogy, you can choose your accounting method to recognise your liability to the restaurant once you have ordered the meal, or you can choose to record it once you have paid the cash. There is no conflict between the methods. When you leave the restaurant however, you still need to pay the bill either way!

Politically given the popular confusion over accounting this item will be easy to misrepresent to the UK electorate but the EU will see any attempt to avoid payment as outrageous.

I think the next items are more debatable

  1. Future commitments to the EU – 22.7bn

These are items which are in the budget but since they are in the future they are not yet in the accounts. The EU is arguing that since the UK agreed to the budget, it should pay them. This seems genuinely debatable. It is politically difficult because if the UK refuses to pay, then to maintain the budget, either other large EU countries have to increase their contribution or the payments recipients countries such as those in Eastern Europe must fall. These same eastern European countries are being relied on by the UK as allies in the negotiations – refusing to pay money which they think you have promised to pay them is not a good start.

  1. Future payments from the EU to the UK – 17.7bn

Similar to Item 3 so similar logic applies.
If we add them up

  1. Theoretical Total – 41.9bn
    Simple answer would be that the UK pays all of its obligations (59.6bn) and receives all it is due (17.7 bn) for a net payment of 41.9bn. If the UK attempts to walk away from these commitments, then the EU will see this in the same way that Mexicans view Trump’s wall. We cannot stop you building a new hard border between our countries but would prefer you did not as it will cause mutual harm. But you must be joking expecting us to pay for it as well.

Negotiating stance

The progress of negotiations may be hard to assess from the outside. Sometimes parties seem a long way apart and then come to an agreement very quickly as they were just performing a ritual dance.

So far, this issue started informally as rumours of a 40bn bill from the EU. The UK Brexiteers made a lot of noise, taking the brinksmanship position of stating they owe nothing. Michel Barnier then responded with a bill of around 60bn. The UK has continued to argue strongly that it may refuse to pay anything with Merkel and Tusk further hardening their positions, adding more to their calculations.

If you are an optimist, you may think that this is normal deal making. Everyone asks for things they do not expect and eventually they meet in the middle and move on. I find this form of negotiation tiresome but very common. Given my career in liquid markets, I have always liked dealing at a clear price in a transparent market , distressed debt or property markets are very different.

Perhaps a compromise position will eventually be reached but I am concerned that we are heading in the wrong direction. The intervention by the arch-Brexiteers, such as John Redwood, looks to be similar to the approach of Varoufakis in the Greek debt negotiations. To insult and vilify the Germans, refuse to negotiate at all, claim the moral high ground and whip up your supporters into a self-righteous anger. This makes any subsequent compromise much harder to find.

PS – after writing this post I have just seen this headline.

This fits my model perfectly. The EU started at the number they believed should be quickly agreed to. The UK changes the nature of the negotiation into one where we start at extremes and move to the middle. The more extreme the UK gets the more the EU moves its starting point away. So now if the UK and the EU “meet in the middle” we can end up back where we started.

Brexit and Ireland

The EU has called for “imaginative and flexible solutions” for the question of dealing with Northern Ireland post-Brexit. This issue has had a surprisingly low-profile so far. I think it is more important than wrangling over pension obligations but also more intractable, whereas the implicit assumption seems to be that it will be quick and easy. It is also worth noting this is one of the stated three items the EU wants to resolve before any trade negotiations can begin (the Brexit Bill, EU-Citizens rights, and NI).

Framework assumptions

I want to lay out a simple framework in which to think of possible structures.
It is easier only to consider 2 of the principal pillars of the current structure which would change

  1. Goods
    Within the Customs Union, free movement of goods across borders without tariff or checks
  2. People
    People can move across the border if they are an EU citizen.

The current structure

uk current structure

  1. Goods
    Everyone is part of the EU and so goods can move freely.
  2. People
    More complicated as UK and Ireland are not part of the Schengen area but have had a Common Travel Area (CTA) between each other since 1922, such that different checks for different journeys are in place.
Journey Documentation Required
Between the Republic and Northern Ireland Nothing
Between EU and UK or Ireland (both) Passport
Between the Republic or N Ireland and GB Photo ID (not necessarily a passport)

If UK were to leave EU with no special agreement on Ireland, then the default situation would be.

Default – UK leaves EU

uk default

  1. Goods
    Free movement from Rest of EU to Republic of Ireland.
    Border checks between UK and the EU – so border checks between Republic and N Ireland
  1. People
    No right of travel or residence between EU and UK
    Hard border with checks for people between Republic and North.

An imposition of a hard border is likely to reignite old conflict, the Good Friday Agreement having removed military checkpoints along certain parts of the border.

Idea 1 – UK leaves EU but Common Travel Area remains

uk idea 1

“Special status for Irish citizens and a common travel area allowing free movement for Irish citizens pre-dates our membership of the EU by decades, and there’s no reason why it can’t continue in the same way after we leave the EU.”

Pre-referendum, Theresa Villiers Secretary of State for N Ireland suggested that there would be no future problem in case of Brexit as we would maintain the CTA and not have any border checks.
She was, in fact, a prominent Leave campaigner who signed a letter to Theresa May demanding a withdrawal from Single Market and Customs Union.

The justification seems to be that the CTA has existed for nearly a century and there has never been a material problem of trafficking of people or goods from the South to the North.
The problem here is the assumption that behaviour does not change when the incentives do.
Given we are all in the EU, goods and people do not move to Britain via the Republic and Northern Ireland – they move direct. If the direct route is closed, but the backdoor is open then I would suggest the route would become very popular. Note the argument applies for goods and people.

Note that this is a problem for the EU as well as the UK. if the UK allowed goods from China in with a lower tariff than the EU then there would be an incentive to bring them into NI to be rerouted to the EU.

Idea 2 – Open border between the Republic and Northern Ireland – Hard border around GB
uk idea 2

To me, this looks like a transitionary stage to a united Ireland. I struggle to see that an area with a hard border is part of the same country, in particular when it has no border at all with another country. The EU seems to be cognizant of this too, recently clarifying if the North joined the South then they would automatically join the EU. Perhaps too this is what the UK government has in mind with the term ”Brexit” i.e. a Britain Exit” – Britain exits but the UK does not.

To have democratic validity, this would require a referendum in favour in both the North and the South. Even so, quite a few Ulster Unionists would passionately object to this whatever any referendum said. Also, it seems an ironic policy choice for the Conservative and Unionist Party.

An aside on geography

For those of you who do not know the complicated naming structure of this area, this chart may help.
Northern Ireland is in the UK but not GB.
For UK citizens, the passport says “The United Kingdom of Great Britain and Northern Ireland”.
Also note that in the Republic of Ireland they do not use British Isles as they do not see themselves as living in the “British Isles”.

Idea 3 –Hard border between the Republic of Ireland and the Rest of the EU.

uk idea 3

To me, this looks like Ireland joining the UK in Brexit.
Nice solution for the UK perhaps but not very politically palatable for the Republic of Ireland. For the Irish Republicans, the de facto unification of Ireland would likely be far outweighed by the new relationship with Britain.

Idea 4 – UK does not leave the Customs Union and also retains the CTA.

This removes all the issues about goods and no hard border between North and South.
Would require passport checks and controls between N Ireland and the rest of the UK .
Small difference to situation today so the diagram would look very similar to the start.

The UK government has declared it wants to leave the Customs Union and this forms a core part of Brexit strategy and negotiating position. To the bulk of Brexit supporters, the Irish problems are far less important.

Idea 5 – UK does not leave the Customs Union and allows free movement of people.

Sounds very much like not leaving the EU at all. The diagram would be identical to the current position.

I am out of ideas.
I hope other people have more “imaginative” ideas than me.
If not a lot of people are going to have to be very “flexible” to choose one of the options above.
It seems unlikely to have a quick solution before we move onto discussing trade agreements.