Can Europe Make It?

Labour's Brexit trilemma: in search of the least bad outcome

The great irony of Brexit is that most outcomes will lead to a loss of sovereignty and democracy. But there is a route forward.

Laurie Macfarlane
11 December 2018


This week, MPs were due to vote on whether to endorse Theresa May’s Brexit withdrawal agreement. However, the vote was deferred in the face of fears that the deal would suffer a disastrous defeat and bring an end to Theresa May's tenure as Prime Minister. The decision may have bought Theresa May some time, but it has not quelled the mounting dissatisfaction over her deal and her leadership.

It is also a critical time for the Labour Party. Up until now Jeremy Corbyn’s team have played a careful balancing act – respecting the result of the referendum on the one hand, while making occasional gestures to those who want a second referendum on the other. But now it’s decision time: with the political calculus in parliament balanced on a knife-edge, the decisions taken by the Labour Party leadership over the coming weeks could have huge repercussions for the party, and for the country.

There is no easy route forward. The European Union has long been a source of division on the Left, and the Brexit vote has brought these divisions to the fore. One of the reasons Brexit is so difficult is that it bundles together various complex issues – trade, regulation, migration, democracy, etc – into a single, binary choice. Many of the issues at stake are mutually exclusive, therefore arriving at a Leave/Remain position involves making a series of difficult trade-offs. By attaching slightly different weightings to different priorities, it is possible for two people who otherwise agree on most political issues to arrive at opposing views on the EU.

A helpful framework for untangling these issues is Dani Rodrik’s impossibility trilemma. This states that democracy, national sovereignty and cross border economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full. In the context of Brexit, it means that we can do any two of the following:

a) Retain the benefits of economic integration that come via membership of the EU’s single market and customs union;

b) Reclaim national sovereignty by returning powers to the British parliament that currently lie with the European institutions;

c) Uphold democratic principles by ensuring that we have a say over all the laws we are subjected to.

Theresa May’s plan partially achieves a) and b), while sacrificing c). Her strategy has been to retain some of the benefits of economic integration to avoid the damage resulting from a cliff edge, while reclaiming national sovereignty over certain key areas (immigration, agriculture, fisheries etc). However, the price of this strategy is that EU institutions will still have considerable influence over our laws and regulations.

The Labour Party’s position has become clearer over time. In a speech delivered earlier this year, Jeremy Corbyn stated that Labour’s priorities were as follows:

– Negotiate a deal that gives full “tariff-free access” to the single market;

– Negotiate a new customs union with the EU, while ensuring that the UK has a say in future trade deals;

– Not accept any situation where the UK is subject to all EU rules and EU law, yet has no say in making those laws;

– Negotiate protections or exemptions from current rules and directives “where necessary” that push privatisation and public service competition or restrict the government’s ability to intervene to support domestic industry.

The first two of these seek to keep the benefits of economic integration that come via the single market and customs union. The third is about maintaining democracy, while the fourth is about reclaiming national sovereignty. Labour is trying to have all three ends served at once. This is an internally contradictory position that falls foul of the Brexit trilemma, meaning that trade-offs will likely have to be made.

Labour’s official line is that Theresa May should “step aside” and let a Labour government negotiate an improvement on her deal. While this might be a savvy political move, the chances of Labour being able to significantly improve on Theresa May’s deeply unsatisfactory deal are extremely slim – as the EU have already made clear.

The EU’s red lines have been clear from the beginning, and there is little reason to expect any more concessions from Michel Barnier – particularly if the general strategy adopted is similar to that of Theresa May’s (i.e. attempt to retain some of the benefits of economic integration, while reclaiming national sovereignty over certain areas such as immigration and agriculture). In order to strike a deal along these lines, Labour would inevitably have to compromise on a number of their priorities, which would most likely involve accepting a situation where the UK will be subject to some EU rules and EU laws while having no say in making those laws, and accepting EU State Aid and competition directives.

Importantly, it is not clear if such an approach would win the backing of parliament. Given the significant criticism that Theresa May’s deal has received, including from the Labour Party benches, it would be difficult for the Labour leadership to successfully sell anything that looks remotely like Theresa May’s deal.

Some MPs have backed a so-called ‘Norway plus’ option, which would see the UK remaining in the European Economic Area (EEA) and joining a customs union with the EU. However, with the exception of a car crash disorderly Brexit, this represents the worst of all worlds – sacrificing both democracy and national sovereignty in order to maintain the benefits of economic integration with the EU. It amounts to “all pay, no say” – accepting all EU laws and regulations while sacrificing any democratic say over them, while also contributing to EU budgets.

It is hard to imagine a world where our politicians and electorate – who voted for Brexit in order to “take back control” – would stomach such an outcome. In any case, Norwegian leaders have made it clear that they would oppose Britain’s application to join such an arrangement.

This leaves two possible options which, on the face of it at least, do not involve a significant loss of democracy and sovereignty. Firstly, Labour could favour a harder Brexit which seeks to reclaim national sovereignty and take back control of our rules and laws, while sacrificing economic integration with the EU – and incurring whatever economic cost that might carry (hereafter referred to as the ‘Lexit’ option). This effectively combines options b) and c) in the list above, while sacrificing a).

Secondly, Labour could favour a second referendum and campaign to remain in the EU, and seek to transform it from within – and incur whatever political cost this might carry (hereafter referred to as the ‘Remain’ option). This effectively combines options a) and c) in the list above, while sacrificing b).

These are not black and white options – there is some room for nuance between them. But they represent two important strands of debate that are currently jostling to influence the Labour Party. As the ‘Lexit’ option represents a radical break with the status quo, it is important to consider its implications carefully, and assess these against the case for remaining in the EU.

The case for Lexit

The case for Lexit relies heavily on four key assumptions. The first is that EU membership places significant constraints on key levers of domestic policy that would prevent a left-wing government from implementing its agenda. The second assumption is that these constraints can only be escaped by leaving the EU (i.e. reform within the EU is impossible). The third assumption is that once outside the EU, the UK will be able to exert sovereignty over these areas of policy as an independent country. The fourth assumption is that the benefits of this will more than offset the economic and political costs of leaving the EU. In the following sections, each of these will be examined in turn.

1. The constraints placed on domestic policy by EU membership

Few would dispute that membership of the EU places constraints on domestic policy, or that some areas of these constraints are problematic. The Common Agricultural Policy and Common Fisheries Policy, for example, are widely criticised across the political spectrum for being badly designed.

For the Left, two of the most contentious areas are State Aid and competition policy, which have been the subject of intense debate. While some argue that these rules would prevent a Labour government from being able to implement certain policies, such as taking industries into public ownership and intervening to support domestic industry, others argue that these claims are highly exaggerated. As is often the case, both positions contain elements of truth.

EU rules do not prohibit public ownership per se. Article 345 of the Treaty on the Functioning of the European Union (TFEU) states that “This Treaty shall in no way prejudice the rules in Member States governing the system of property ownership.” However, over time new liberalisation directives have required governments to open certain sectors to market competition, such as gas, electricity, postal services, telecommunications, and (more recently) railways. In these cases, public sector companies are allowed to exist, but must compete alongside private firms (or the public sector companies of other countries) in a market on a “level playing field”.

Similarly, while EU rules do not prevent states from providing support to domestic industry, they do prevent forms of support that are likely to ‘distort’ market competition. Where states wish to provide support to firms, they must do so on a commercial basis (i.e. on the same terms and with the same risks and rewards that a commercial private investor or lender would invest or lend at). Importantly, however, there are a number of exemptions to this which do allow states to provide support to industry on a sub-commercial, or ‘promotional’, basis.

The first of these is the ‘De Minimis Regulation’, which sets a threshold figure below which State Aid will not apply because it will be assumed that the aid will not distort competition. The current De Minimis threshold for aid granted to any one organisation is €200,000 – meaning that the European Commission does not need to be notified of any support that is below this limit.

State Aid support is also permitted in areas that fall within the scope of the General Block Exemption Regulation (GBER). These are activities that have been exempted from State Aid rules due to certain social, development or environmental objectives, and include things like regional aid, support for SMEs and start-ups, support for environmental protection and aid for research and development. There are also exemptions for social services such as education and healthcare.

For any interventions that do not fall within De Minimis limits or a block exemption regulation, states must provide the European Commission with an ex-ante analysis of the ‘market failure’ that is being addressed – which can be a difficult and laborious task.

Whether or not these rules are a barrier to Labour’s economic agenda depends on the scope of the Party’s aspirations. Labour’s 2017 manifesto was very much in the vein of moderate European social democracy. Nearly all of the flagship policies already exist in other northern European countries such as Germany and the Nordic countries, and it would be possible to implement most of these within the EU’s State Aid and competition regimes. The reason these policies have not been implemented in the UK so far is not because of any EU rules – it is because successive UK governments, including Labour governments, have been ideologically opposed to them. As the chart below shows, the UK has consistently spent significantly less on State Aid expenditure relative to other Northern European economies.

Total State Aid expenditure as a % of GDP in 2015

Screen Shot 2018-12-09 at 23.40.52_0.png

Source: European Commission

However, while the EU’s State Aid and competition regime is relatively accommodating of social democracy, it is less accommodating of democratic socialism. At a basic level, the EU’s State Aid and competition regime is fundamentally rooted in the idea that goods and services are most efficiently produced by private firms operating in a competitive market, and that the state should only intervene in markets to ‘level the playing field’ or to correct certain identifiable market failures.

If Labour plans to mount a serious challenge to this logic, and move beyond the moderate social democracy implied by its 2017 manifesto, then it is likely that this would place a Labour government on a collision course with the EU’s State Aid and competition authorities.

A final area of concern for many of the Left is around capital mobility. Some have argued – rightly in my view – that allowing capital to flow seamlessly across borders has imposed many costs on society while generating few benefits for ordinary people. As Grace Blakely explained in a recent article:

“Since the crisis, there has been a growing recognition amongst economists that capital inflows and outflows affect both the structure of the economy and the risk of financial crises. As such, capital controls are now recognised as an important macroprudential tool for promoting financial stability.”

However, because the free movement of capital is one of the “four freedoms” that is codified in the Treaty on the Functioning of the European Union (TFEU), introducing any controls on capital mobility would again probably place the government on a collision course with European authorities (although so far Labour has not expressed support for introducing capital controls).

For the most part, however, the key source of division on the Left is not whether there are areas of EU policy that are problematic. Instead, the division is over what the best strategy for overcoming these problems should be.

2. The impossibility of reform within the EU

For Remainers, the best way to overcome the problems with the EU is not to leave it, but to reform it from within. For Lexiteers, the problem with this strategy is that the EU lacks the democratic structures to achieve meaningful reform: the European Commission is unelected, while the European Parliament lacks teeth. According to many Lexiteers, the entire architecture of the EU has been set up in such a way as to make it impervious to democratic pressures. The tragic events in Greece are often held up as an example of why a ‘remain and reform’ strategy is destined to fail.

The lack of democracy across the EU institutions is certainly a legitimate cause for consternation, and the EU’s actions towards Greece deserve universal condemnation. But Greece is very different to the UK, in two key respects. The first is that Greece is a small peripheral state, whereas the UK is one of the most influential member states that is predicted to have the largest economy by the 2030s.

This is important, because the EU is not the rigid and uncompromising bureaucracy that it is often portrayed to be. In reality, it is a young and fluid institution that is constantly being remoulded and reformed around its internal power dynamics. EU laws and regulations are not permanent lines in the sand, but social constructions that are constantly being bent, broken, contested and revised over time ­– especially by the larger, more powerful states.

Recent statistics on enforcement actions against member states show that Germany is by far the biggest breaker of EU rules, and that the Germans have also been incredibly successful at shaping EU rules to suit its own interests. The UK has also been successful at influencing EU policy to suit its own interests, particularly in the areas of competition policy and financial services – two areas of EU policy now being cited by Lexiteers as evidence of why we need to leave. But we should not underestimate the UK's power to reshape EU policy in these areas once again.

The second reason why the UK is not like Greece is that the UK is not a member of the Eurozone. The importance of this cannot be emphasised enough. In the event of a confrontation between a country that uses the euro and the EU, the bargaining power will always be firmly in favour of the EU. This is because if push comes to shove, the European Central Bank can suffocate disobedient governments by letting bond vigilantes punish them on financial markets, and by failing to provide the banking sector with liquidity. This is why SYRIZA’s strategy failed in Greece, and it is also why the Italian government’s current confrontation with the European Commission will probably end in failure too.

But this is not the case with the UK. The UK is one of the few countries in the world that is in the privileged position of having its own currency, its own central bank, a freely floating exchange rate, and the ability to borrow fully in its own currency. This means that the worst that could happen in the event of a confrontation with the EU would be a fine and diplomatic row. Similarly, while Eurozone countries face legal sanctions if they breach the deficit and debt limits contained within the EU’s Stability and Growth Pact, the UK is exempt from such sanctions. It is perhaps ironic that among all member states, the UK is the best placed to weather the consequences of non-compliance with EU policies and spearhead a campaign of ‘remain and reform’ – and yet it is the one state that has unilaterally decided to leave. It is perhaps ironic that among all member states, the UK is the best placed to weather the consequences of non-compliance with EU policies and spearhead a campaign of ‘remain and reform’ – and yet it is the one state that has unilaterally decided to leave.

The story is similar with regard to capital controls: while it is true that the free movement of capital is a fundamental principle codified in the Treaty on the Functioning of the European Union (TFEU), again the picture is more nuanced. The TFEU states that non-euro countries can “take the necessary protective measures” including introducing capital controls, for example if a sudden balance of payments crisis occurs. Iceland, which is not a member of the EU but is a member of the European Economic Area, imposed capital controls in 2008 and kept them in place for nearly 10 years.

Eurozone countries do not have such legal leeway on capital controls. However, in practice two Eurozone countries ­– Greece and Cyprus – have imposed capital controls in contravention of European treaties, again highlighting how EU rules are often bent and broken.

This highlights a wider point, which is that many arguments for Lexit are often rooted in a critique of the Eurozone. Often these critiques, such as that offered by Costas Lapavitsas in his recent book ‘The Left Case Against the EU’, are clear and convincing. But many of these arguments do not apply to the UK, and therefore they do not amount to an argument for Brexit.

To make a convincing case for Brexit, it is also necessary to substantiate the third and fourth assumptions – that the UK will be able to exert sovereignty over new areas of policy as an independent country, and that the benefits of this will more than offset the economic costs of leaving. This is where we turn next.

3. The UK’s ability to exert sovereignty in key policy areas as an independent country

The EU has made it clear that alignment on issues such as State Aid is a red line for any free trade agreement with the UK after Brexit. Were the UK to enter into a free trade agreement with the EU, there would be very little wiggle room to bend or break these rules. As a third party, the European Commission would enforce strict compliance, and terminate the agreement if the UK tried to deviate from them. The UK’s bargaining power would be extremely weak.

Lexit therefore demands a hard form of Brexit, where post-Brexit arrangements with the EU are kept to a bare minimum. Any softer form of Brexit would mean that the UK government would not have control over the various policy levers that the case for Lexit relies on. Under such a scenario, the UK would have more flexibility over areas such as State Aid, although it would still be bound by WTO rules, which are narrower in scope compared with EU state aid rules. It would also be able to introduce capital controls if an elected government so wished.

However, a Labour government would also find that it has less sovereignty over some areas of policy than it had before. As others have pointed out, in a world where production takes place through global networks and intra-industry trade dominates, so-called ‘non-tariff barriers’ such as regulatory standards play an incredibly important role in everything from the medicines we take, the food we consume and the safety of the flights we board.

It is here where the EU’s key power lies. As Sir Ivan Rogers has pointed out:

“The correct way to think of the EU in economic terms is as a “regulatory union”, with the appetite and ability to extend its rules extraterritorially: the so-called Brussels effect. The EU is a superpower in no other respect. But in this critical one, it is. And the idea that, on its own, the UK, can compete with massive regional trading blocs – the EU, the US, China – as a standard setter, on industrial goods to data, is an illusion.”

As Anthony Barnett has noted, there is no way out of the EU’s regulated space for the UK. Even in a Lexit scenario, the UK would have to comply with European regulations and standards if it wants to maintain and expand its global production chains, but will have no say over these rules. For the same reasons, after Brexit the UK will be less able to hold multinational corporations to account compared with being inside the EU. An independent UK is simply not a large enough economic power to exert influence on large foreign-owned corporations. This is why Mark Zuckerberg agreed to appear before the European Parliament, but didn’t bother to respond to the invitation from the UK parliament.

An independent UK – socialist or not ­– cannot fully insulate itself from the forces of global capital. The left-wing belief that it can shares a common trait with the right-wing fantasy that Brexit will create the conditions for “Empire 2.0” – both are rooted in a failure to come to terms with the UK’s rapidly diminishing power in the world. When it comes to regulating these forces, the reality is that an independent UK will be reduced to a “rule taker” that has to abide by decisions taken by the EU, China and the USA. So while Lexit might enhance national sovereignty over some policy areas, it will also reduce the amount of influence that the UK has over other policy areas. The reality is that an independent UK will be reduced to a “rule taker” that has to abide by decisions taken by the EU, China and the USA.

4. The economic and political costs of leaving the EU

Even if all of the above assumptions are met, a Lexit can only be justified if the expected benefits exceed the economic and political costs of leaving the EU. Because by definition a Lexit must resemble a hard Brexit, these costs will be high. There are broadly four issues of importance here.

The first relates to jobs and trade. Leaving the single market and the customs union without any replacement trade agreement will cause severe disruption to trade and supply chains. In recent weeks, a plethora of analyses have been published which have attempted to estimate the economic impact of different Brexit scenarios. According to the Bank of England’s “disruptive scenario”, where tariffs and other barriers to trade between the UK and EU are introduced and no new trade deals are implemented within a five year period, GDP could fall by 8% relative to the path the economy was on prior to the EU referendum, unemployment could spike to 6% and inflation could rise to 4%.

According to the Government’s own analysis, a no deal scenario could see GDP fall by 9% compared to today’s arrangements ­– with the main hit coming from the impact of customs costs, tariffs and non-tariff barriers. Similar estimations were arrived at by the independent National Institute of Economic and Social Research (NIESR).

While it is right to treat the specific figures contained in these assessments with a degree of scepticism, it would be foolish to ignore their overall message. Moreover, while GDP is far from everything ­– particularly in a country where GDP growth has become decoupled from most people’s earnings – history shows that it is often the poorest who suffer the most from such severe economic shocks.

Of course, the ultimate impact of any Brexit deal will depend on how the government decides to respond. In the face of a hard Brexit, it is likely that the government would respond with a programme of fiscal stimulus to offset the loss of demand. But replacing loss of access to continental supply chains and demand from European consumers is not something that can be achieved overnight. Even with an active fiscal response from government, it is likely that a Lexit would involve a painful adjustment process that will hit some parts of the country particularly hard, in the short to medium term at least. Such an outcome would be difficult to reconcile with the “jobs first Brexit” that Labour has promised the country.

It is also worth considering the potential impact of this on Labour’s electoral fortunes. If Labour did manage to win a general election, there is a risk that the party would assume power during this painful adjustment process. Life was never going to be made easy for an incoming government led by Jeremy Corbyn, even if it were to happen under the most buoyant economic circumstances. But if this was to happen during the fallout of a hard Brexit, there is a significant risk that Labour’s plans for economic transformation would be derailed by short-term firefighting.

Regardless of the extent to which a Labour government could be held responsible for the economic turmoil brought about by a hard Brexit, the electorate are unlikely to thank them for it if they are the party in power when the going gets tough.

The second issue relates to immigration. While it would be wrong to suggest that everyone who voted to Leave the EU did so because of concerns around immigration, it is clear that anti-immigrant sentiment played a key role in fuelling the Brexit vote. Since the referendum took place, hate crimes have surged, and many migrant communities have been made to feel unwelcome. The risk that a hard Brexit may exacerbate these trends – and help fuel a resurgent far right – must be taken seriously. It is also likely that a hard Brexit will lead to lower levels of overall immigration, even in the unlikely event that a Labour government does not introduce new controls on inward migration. There is already evidence that the UK has become a less attractive destination for migrants. Since migrants are a significant net positive to the economy, this will also impose a significant economic cost. Since migrants are a significant net positive to the economy, this will also impose a significant economic cost.

Many on the Left are highly critical of the EU’s “fortress Europe” approach to its external borders. However, leaving the EU does nothing to address this, but will only guarantee that the UK has no power to influence the creation of a more humane European border regime in future.

The third area relates to domestic political forces. In order to get the type of hard Brexit required by Lexit through parliament, Labour would very likely need to ally with right-wing Brexiteers, who have their own plan for Brexit. This involves radical re-shaping of the UK economy along free-market lines by dismantling labour and environmental standards, opening up the NHS to global competition, and entering into a comprehensive trade deal with the USA – the conditions of which would make EU membership look like a socialist paradise. This would represent a colossal defeat for the Left, and the risk of this outcome materialising – however small it may be – should be taken very seriously indeed.

Finally, there are geopolitical factors. The most significant of these relates to the prospect of a hard border on the island of Ireland, which many experts believe would pose a significant risk to the peace process won through the Good Friday Agreement. It is therefore incumbent on Lexiteers to provide a convincing solution for how a hard border can be avoided under a hard Brexit scenario (I have yet to hear one), or acknowledge that a hard border would be erected – and explain why that would be a price worth paying. There are also other geopolitical considerations that ought to be considered, such as the possibility that a hard Brexit may increase support for Scottish independence and accelerate the break-up of the United Kingdom.

Conclusion: towards the least bad outcome

From the very beginning, Brexit has been a process of weighing up a set of deeply unsatisfactory outcomes. The case for Lexit was predicated on being able to regain control over economic levers such as State Aid, competition policy and capital controls. However, doing so would involve sacrificing control over other areas of policy, while generating significant costs and risks. Moreover, given that the UK is not a member of the Eurozone, these levers could be utilised by a Labour government while in the EU – provided that there is the political will to do so. While this would also generate costs and risks, they would not be as high as those associated with a hard Brexit.

As a democrat, the idea of a second referendum is deeply uncomfortable. It would certainly be preferable to have a general election first. But given how shambolically the Brexit process has been managed from the very beginning, giving the electorate another say is not as unreasonable as it might otherwise have been. In any case, it is difficult to see another way out of the political deadlock if a general election is not forthcoming, as seems likely.

While concerns are legitimate that a second referendum would undermine faith in democracy, they are somewhat alleviated by the fact that demographic trends are so firmly in favour of staying in the EU. It has been estimated that if nothing else changed from the 2016 referendum, Remain would have a majority by 2021, and this would increase steadily thereafter. So even if we leave the EU, we may well end up applying to get back in very soon, albeit on much worse terms than the current status quo.

Perhaps the biggest problem with a second referendum lies with the people who are campaigning for it on our airwaves. The likes of Alastair Campbell, Andrew Adonis and A.C. Grayling appear to have learnt nothing from the disastrous Remain campaign of 2016, and seem determined to simply rewind the clock back to 2016. In many ways, they epitomise what many people were voting against when they voted for Brexit. In this sense they are liabilities to the cause, rather than assets. If the campaign for a second referendum is to be successful, it must be made absolutely clear that the status quo is not an option. Critically, it must be led by figureheads who can clearly articulate the need for radical change – and who have the backing of the Labour leadership, as well as the SNP, Greens, Lib Dems and Plaid Cymru.

One silver lining from the Brexit debacle is that the Tories have been exposed as deeply divided and hopelessly incompetent. If Labour can successfully exploit these divisions, there is a very real opportunity to put the Tories out of power for a generation. Although it would need careful planning, such a strategy could involve painting the Brexit impasse as a crisis engineered by the Tories, highlighting that the only way out of the deadlock is to have another referendum, and then campaigning in the referendum on a radical platform of ‘remain and reform’. With the Tories weakened by internal division and political crises, and Labour’s grass roots membership firmly in favour of Remain, the party would be in a strong position to win the referendum – and ultimately the next general election. As Paul Mason has written:

“But the prize is not simply a general election. It is an election in which your opponent, the Tory party, has fallen apart. That would deliver a solid Labour majority and create the possibility of a landslide for the progressive parties in parliament, which could bury free market cruelty forever and bring institutional democratic change to the UK.”

Such a strategy is not without its risks. But for me at least, it’s the best route to arriving at the least bad outcome, in what is a deeply unsatisfactory state of affairs.

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