Archive for the ‘Economics of Brexit’ Category

LSE Continental Breakfast 7: the business consequences of a breakdown in exit negotiations

The seventh Continental Breakfast seminar at the LSE, held under Chatham House rules, focused on the potential implications that a breakdown of the Brexit negotiations would have for UK businesses. The overall message was that the consequences of such a breakdown – a “no deal” outcome – would be severe. Angelos Angelou (LSE) reports on the discussion.

A “no deal” outcome would be an economic disaster for most UK businesses. This is primarily because almost 90% of total British exports would be affected by tariffs, costing a total of £40bn. The imposition of tariffs would also have spillover effects for other sectors, like the food and drink industry, which the CBI estimated would suffer 20% in extra costs. Meanwhile, UK businesses would be exposed to increased exchange rate risks (the effect of unexpected exchange rate variations on a firm’s value).

In the aftermath of the vote, the pound dropped more than 10% against the US dollar and continued to decline until it reached its lowest level against the dollar for 30 years, at $1.30 to £1. In the event of no deal, uncertainty over the economic relationship between the UK and the EU might lead the pound to a new low. This would entail losses for multinational firms based in the UK, since they are more exposed to exchange rate volatility, as well as risks for UK firms with international operations. While a further fall in the pound might offset some of the new tariffs they will be facing, their production costs might also rise given the higher import cost of raw materials and the falling value of British wages to foreign workers.

canary wharf

The site of the future Crossrail station at Canary Wharf, London. Photo: Nick Moulds via a CC-BY-NC-SA 2.0 licence

Moreover, in the event of no deal, British consumers would see their purchasing power eroded due to import tariffs. The imposition of non-tariff barriers (like “rules of origin” regulations), as well as tariff-related costs, would end up costing three times more than previously. Non-tariff barriers would make British businesses less competitive, since they would deprive them of the ability to conduct prompt and low-cost transactions with the rest of the EU. All in all, UK per capita income could fall by 6.3%-9.5%.

For businesses in the Republic of Ireland and Northern Ireland, the impact would be even more acute. They have hitherto operated on the assumption that cross-border transactions can be conducted promptly and with minimal cost inside the European Single Market, without a hard border. The dynamics of the peace agreement may change since the economic interdependence of the two sides would decline. This has led some to argue for the closest possible alignment between UK and EU standards.

The status of EU workers in British firms would also be uncertain. The rights of EU citizens employed in Britain are not guaranteed if the EU and the UK fail to reach a final deal. Skilled labour could leave as a result. EU migrants are generally younger and more educated compared to UK employees and tend to raise capital productivity via knowledge spillovers and higher human capital stock.

Financial services

Under ‘no deal’, all financial service providers will lose their passporting rights (the ability of a firm that has been licensed by one EU member state to provide cross-border services to other EU member-states without getting additional authorisation from the local regulators). Since they would not be in the Single Market, UK financial firms would not be allowed to conduct financial operations there. Passporting has allowed many of the world’s leading financial institutions to operate in the EU with low bureaucratic and economic costs. The UK has attracted the largest number of headquarter-based investments in the EU. Facing ‘third-country’ rules usually means partial access to the single market, while the type of access is almost unilaterally decided by the Commission and can be ended or changed at any time.

‘Third country’ status would put around 50% of the UK’s EU-related economic activity (with a total worth of £20bn), 35,000 jobs, and around £3-5bn in tax revenues under threat. The downgrade would probably leave the UK outside all EU decision-making centres, meaning it will lose any source of political or technical leverage over issues of financial governance and regulation. The EU, and especially the European Parliament, appears to be unreceptive to the idea of a bespoke deal vis-à-vis financial regulation: indeed, the relevant EU authorities (ESAs and ESMA) that are responsible for the regulation of the financial markets are powering up in order to cope with the challenges that will arise if the UK falls under the status of a third country. Moreover, a number of other European financial centres like Amsterdam, Dublin, Frankfurt, Paris and Madrid have positioned themselves as the next centres for passporting-based activities. The UK would have to follow EU preferences for financial regulation. Britain, along with other EU countries with substantial international presence and stronger capital markets (like the Netherlands) has been advocating for a style of EU governance that is supportive of enhanced market access, liberalisation and open market substitutes instead of intervention. France, Spain and Italy, on the other hand, usually favour a more interventionist approach and are supportive of further regulation.

Legal limbo

A number of international deals signed by the EU on behalf of the UK will stop covering British firms. Replacing these deals, especially in the field of finance, would require much time and effort, with a characteristic example being the EU-US international agreement on derivatives contracts. Given that the UK derivative market is the biggest one in Europe, no deal will have immediate and substantial economic implications.

Investment and growth

Investment uncertainty has adverse implications for an economy’s productivity. The uncertainty that followed the referendum result and the current uncertainty about the state of the negotiations are potentially delaying investment and therefore also the recovery in UK productivity. Current investment dynamics appear to support this hypothesis. While GDP has risen in the UK over the past few months, the positive state of the global economy would have justified an even bigger increase. At the second quarter of 2016 it was estimated that UK GDP rose faster than expected, amounting to 0.6, with services and production driving this trend. On the other hand, construction has contracted, while consumer confidence and, subsequently, consumer spending also fell by 0.3% in 2017. (Before the referendum, consumer spending was driving GDP growth.)

Given the uncertainty, most UK businesses have started making contingency plans. Around 60% of British companies already have such plans in place, of which 10% have already taken some practical steps (e.g. moving people who may be affected by no deal). Another 25% of these companies are expected to take similar steps in the near future.

The shape of a deal

For the UK business community, the ideal deal would grant barrier-free access to the Single Market. However, the most realistic aspiration is for the UK to be in a customs union with the EU. A customs union deal would not have to cover all economic sectors (in the EU-Turkey deal, agricultural products are excepted), it would not require the UK to pay any fees to the EU and, most importantly, it would not require the UK government to accept freedom of movement. On the other hand, Britain would have to align its trade policy with the EU’s, without any say in it.

The conditions to reach a positive deal are already in place, since the EU now has a more centralised system of financial regulation – a trend that will be intensified with Brexit. Hence it would be simpler for the UK to conclude a single comprehensive deal with all EU member-states. One mechanism to ensure the compatibility of the two industries is through the establishment of British subsidiary companies in continental Europe, which would allow for a system of managed divergence. This would entail extra costs, because British companies would still need to comply with the corporate and market governance regulations of the respective country and its capital requirements. Of course, such a development would also have negative implications for the European financial market, since it will lead to increased fragmentation and higher refinancing costs for local EU banks.

An alternative would be a system of equivalence, which the EU has granted to certain third countries. It offers the possibility for non-EU firms to access the EU market provided that the regulatory regime of their country of origin is equivalent to the EU regime. This would imply that the UK would still need to follow EU regulations while having no influence over them. Furthermore, the regime of equivalence would only partially cover the field of financial services – for example, it will not apply to the field of asset management, lending and deposit-taking. It is also important to note that the process of granting equivalence to a third country is highly politicised. The European Commission can decide and revoke the regime of equivalence unilaterally whenever it sees fit.

Another solution would be for Britain to remain in the European Economic Area (EEA) UK-based firms would still be able to use passporting, since they would still have unrestrained access to the Single Market. But it would be necessary for the EEA and the EU to agree on the powers of the European Supervisory Authorities. At the same time the UK would not be a member of the customs union – meaning that its businesses would be subject to burdensome rules of origins regulations – and would not have any voting rights in the EU institutions. Moreover, the UK would still need to follow EU rules. Such an option is politically less feasible since it would require the four freedoms – of movement of goods, services, labour and capital – to remain in place.

For some politicians, no deal or a breakdown of talks still looks like an appealing option. Some Leavers would prefer it to a failure to control freedom of movement. EU politicians would like to avoid giving the UK access to the single financial market, including passporting, without getting any substantial concessions. Determined to avoid this, the UK business and financial community has formulated a careful campaign of public advocacy for their desired deal. This strategy is in stark contrast to their pre-referendum tactic, where a number of enterprises and business corporations joined the Remain campaign and produced evidence-based justifications on why the UK should stay in the EU. Since that strategy was ineffective, the business and financial community chose a subtler approach in order to avoid alienating public opinion.

Any final deal should strike a fine balance between access to the European market and border control. In that sense it is bound to be an agreement unlike any other that we have seen. Drawing conclusions from the agreements between the EU and Norway and the EU and Canada therefore has limited analytical value. Businesses in the UK need a more secure environment, and guarantees that the transition phase will be managed properly and that a final deal will be reached.

This post represents an account of a discussion held at the LSE, and not the views of the Brexit blog, nor the London School of Economics.

Angelos Angelou is a PhD candidate in the European Institute, working on EU-IMF cooperation. He is drawing case studies from the Eurozone bailouts and examines the main drivers of cooperation and discord between the IMF, the European Commission and the ECB during times of crisis.

The Commonwealth advantage: trading with the bloc offers buoyant economic prospects

One of Brexit’s potential advantages is the UK’s freedom to negotiate its own trade deals instead of being dependent on the EU. Of course, trade will continue with the EU after Brexit, probably little changed, and there is little doubt that the EU will continue to be a major trading partner after Brexit. But it is widely expected that the share of UK exports going to the EU will continue to decline, reflecting the maturity of the EU markets and the continuing decline of the EU’s share of global output. New deals are likely to be with countries as diverse as the US and Japan – and, of course, individual Commonwealth countries. Australia and Canada, for example, have already expressed interest in a free trade agreement. In this post, Ruth Lea, CBE (Arbuthnot Banking Group), explains why trading with the Commonwealth offers buoyant economic prospects. 

Image by Kgbo, (Wiki), licenced under CC BY-SA 4.0.

The current biennial Commonwealth Heads of Government Meeting (CHOGM), being held in London on 16-20 April, seems a suitable time to analyse the economic importance of Commonwealth countries and consider their potential as future growth markets for UK exports.

Commonwealth countries are rarely considered together as an economic entity. Yet they account for over 17% of world GDP in Purchasing Power Parity (PPP) terms (chart 1a) and contain 2.4 billion of the world’s 7½ billion people. Moreover, many Commonwealth countries have favourable demographics compared with several major European countries, where working populations are expected to age and shrink. Today’s 53-member Commonwealth spans the five continents and contains developed, emerging and developing economies. It also comprises some of the world’s largest economies and many of the smallest. In its diversity, it captures the character of the 21stcentury globalised economy as no other economic grouping can. The Commonwealth’s membership includes two of the world’s largest ten economies (the UK and India), two members of the G7 (Canada and the UK) and five members of the G20 (the UK, India, Canada, Australia and South Africa).

The Commonwealth: buoyant economic prospects

Charts 1a and 1b show the IMF’s latest forecasts to 2022 for EU28, the US, China and the Commonwealth in Purchasing Power Parities (PPPs) and at Market Exchange Rates (MERs).1-2 Chart 1a (in PPPs) shows just how profoundly the world economy has changed since 1980 and is projected to continue changing up to 2022. EU28 countries accounted for 30% of world GDP in 1980, whilst the US contributed nearly 22% and the Commonwealth contributed 15%. China’s share was just over 2%. By 2017, China had increased its share to over 18%, reflecting China’s staggering growth over the past 30 years, which exceeded the Commonwealth (over 17%), the EU28 (down to 16.5%) and the US (still over 15%). Crucially these trends are expected to continue to 2022, with China and the Commonwealth (not least of all because of India’s buoyant growth) expecting to gain share over the EU28 and the US.

Chart 1b (in MERs) shows how currency effects can affect the GDP data. For example, the strong dollar in 2000 “boosted” the US’s share (in MERs) to over 30%. Inevitably, the forecasts are dependent on forecasts of currency movements, which make them even more than usually non-robust. The decline in the EU28 share in MERs over the forecast period less pronounced than in PPPs because GDP in MERs favours developed countries. But, nevertheless, the global share had dropped from 34% in 1980 to 21½% in 2017 and is projected to slide further by 2022. The rise in the Commonwealth’s share is considerably dampened in MER terms, not least of all because the significance of India, where GDP in MER terms is significantly lower than in PPP terms. But it is still expected to more than hold its share.

Chart 1a Shares of world GDP (PPP terms), %

 

Chart 1b Shares of world GDP (MER terms), %

Source: IMF, World Economic Outlook, database, October 2017.

UK-Commonwealth trade

Given the relatively buoyant growth prospects in Commonwealth countries, UK export growth prospects to these countries should be favourable, especially if free trade agreements are successfully negotiated. There are two other general points worth noting. The first is the observation that, because of shared history and commonalities of language, law and business practice, it has been estimated that Commonwealth countries trading with one another experience business costs 10-15% lower than similar dealings with non-Commonwealth countries of comparable size and GDP. This has been called the “Commonwealth advantage”.3

The second point notes that the potential in any export market does not, of course, just reflect the size of the economy. It is also a matter of the relative incomes per capita in various export markets. Especially when it comes to consumer goods, potential consumers need to have the kind of disposable incomes that will allow them to buy the cars, televisions and other goods that have been staples of “middle class” life in the West for decades. And, on this metric, developed countries still have a very appreciable lead over emerging and developing countries. According to the IMF, income per capita was 7 times as high in Germany as in India in PPP terms in 2017, and 24 times as a high in MER terms. The corresponding figures for China were still as high as 3 times and 5 times respectively.

But, looking forward, the potential growth of the middle classes in the emerging markets, not least of all in India and China, is expected to change matters radically. A report by Ernst & Young (EY) on this issue concluded:4

  • “…by 2030, so many people will have escaped poverty that the balance of geopolitical power will have completely changed – global trade patterns will be unrecognizable too. Meanwhile, companies accustomed to serving the middle-income brackets of the old Western democracies will need to decide how they can effectively supply the new bourgeois of Africa, Asia and beyond.”
  • Specifically concerning China and India, EY said “…large populations and rapid economic growth mean China and India will become the powerhouses of middle class consumerism over the next two decades.”

Turning to the UK’s current trade with our major Commonwealth partners the main conclusion is that it is still relatively modest compared with the EU. This is not, of course, surprising given the relative size and wealth of many of the EU’s members. UK-Commonwealth trade is also modest relative to the US (especially) and, arguably, China. Clearly, there is potential for expansion.

Chart 2a shows exports grew by just over 31% to the top eight Commonwealth countries over the decade 2006-2016 compared with total export growth of 40%.5 Trade with India, Pakistan and South Africa, in particular, was disappointing. As a consequence, the share of UK exports to these eight Commonwealth destinations actually fell from 7.5% in 2006 to 7.0% in 2016. Commonwealth trade, nevertheless, outstripped the rise of just over 11% to the EU28. Exports to the US (which took over 18% of UK exports in 2016) were up over 55% and exports to China more than tripled, though from a very low base. Other buoyant non-EU markets included Switzerland, Saudi Arabia, the Residual Gulf Arabian Countries and Hong Kong. Chart 2b notes that, even if exports growth to the top eight Commonwealth countries over the past decade has been relatively subdued, at least overall trade has been in small surplus, whereas trade with the EU28 and China is heavily in deficit.

Chart 2a UK exports in goods and services, growth between 2006 & 2016 (%)

 

Chart 2b Trade (goods and services) balances, 2016 (£bn)

 

Source: ONS, UK Balance of Payments, the Pink Book, 2017 edition.

In conclusion, Commonwealth countries seem to have a bright economic future and offer expanding domestic markets that could greatly benefit UK exporters. There is, therefore, considerable potential for them to be future growth markets for UK exports.

This article gives the views of the author, and not the position of LSE Brexit, nor of the London School of Economics.

Ruth Lea CBE is Economic Adviser at the Arbuthnot Banking Group.

References

  1. GDP (PPP) data allow for the relative prices of goods and services, particularly non-tradeables, within an economy. They are, therefore, a better overall measure of the comparative real value of output than data calculated using market exchange rates (MERs).
  2. GDP data at market exchange rates (MERs) provide a better measure of a country’s international purchasing power, so relevant for international trade. Exchange rates can fluctuate wildly and currencies can, for example, be “overvalued” or “undervalued” for considerable periods of time.
  3. Sarianna Lundan and Geoffrey Jones, “The ‘Commonwealth Effect’ and the process of internationalisation”, World Economy, January 2001.
  4. EY, “Hitting the sweet spot: the growth of the middle class in emerging markets”, 2013.
  5. Exports to the top eight Commonwealth countries: Australia, Canada, India, Malaysia, New Zealand, Pakistan, Singapore and South Africa.

EU students at UK universities: patterns and trends

ludovic highmanWhat Brexit will mean for UK universities varies from institution to institution. Much data on Brexit’s impact focuses on sector-wide aggregates, the forest that hides the trees. The UK provides excellent teaching and research, as illustrated by the number of its universities ranked in the top 10, 50 or 100 in the world. Yet despite its world-class reputation, the UK’s higher education sector is hierarchical, and various layers will be affected differently. Ludovic Highman (UCL) explores the sector’s diversity in this regard.

The diversity of the student fabric of UK universities, so crucial to the overall student experience, depends on a healthy number of non-UK based students interacting with domestic students.

Internationalisation starts at home, on UK campuses. The presence of EU students is essential, both quantitatively and qualitatively. EU students graduate from rigorous secondary school systems and their drive to study abroad, most often in a language that is not theirs, makes them attractive to UK universities.

senate house ucl

Senate House, University of London. Photo: Frank Steiner via a CC-BY-NC 2.0 licence

EU students are particularly vulnerable after Brexit, especially in England. Currently they are treated as home students, but in all likelihood EU students enrolling in the UK after its withdrawal in March 2019 will be treated as overseas students. They will no longer benefit from the protection of EU law and the principle of non-discrimination between home and other EU nationals, they will pay higher fees, and they will no longer be eligible for the pay later UK tuition loans that soften high fees. Their position might be more favourable in Scotland, where free tuition for non-UK EU students was extended by the Scottish government to the 2019-2020 academic year.

While the London Russell Group universities have the highest numbers of non-UK EU students (with UCL ahead, followed by King’s), and Oxbridge remains firmly cemented within the top 10, the data also demonstrate the attractiveness of Scottish universities, and the subsequent relative drop in the number of non-UK EU students in English universities that are not located in global cities such as Birmingham, London, or Manchester, or academic powerhouses such as Oxford and Cambridge. Rare exceptions include Coventry and Warwick, which are geographically close to Birmingham. Scottish universities are attractive to non-UK EU students in absolute numbers, with Edinburgh, Glasgow and Aberdeen attracting more than Oxbridge and competing with the top London universities. Strathclyde and Edinburgh Napier also attract significant numbers, an unprecedented characteristic in any city outside London, as both Edinburgh and Glasgow are already home to universities attracting higher numbers of EU students (see table 1).

Three Scottish universities have some of the highest percentages of enrolled non-UK EU students, with the University of Aberdeen topping the ranking (see table 2). This is partly explained by the lack of tuition fees for non-UK EU students in Scotland. It is possible that higher concentrations of EU students will further relocate to Scotland, though this depends on the level of fees charged beyond 2020. Under the current tuition fee system, Scottish universities will remain attractive to prospective EU students, while many of their English counterparts (outside London and Oxbridge) that already have lower proportions of EU students will be less attractive if non-UK EU students lose their current status, comparatively-speaking.

EU students tend to enrol in Russell Group universities. Their numbers are both higher in absolute terms and proportionally-speaking in the most research intensive Russell Group universities. This suggests the added value of a UK degree for EU students is reputational. The tuition fee regime seems to have an impact on the choice of destination, as suggested by the high numbers and ratios of EU students in Scottish universities, while London as a global city attracts the most EU students.

Table 1: Universities with >5,000 students with highest number of non-UK EU domiciled students FPE (full-person equivalent), 2016-2017 (data extracted from HESA, policy analysis CGHE)

UniversityNumber of non-UK EU domiciled studentsTotal number of studentsNational university membership (other than Universities UK & Universities Scotland)% of non-UK EU domiciled students
UCL4,47037,905Russell Group11.8%
King's College London3,72530,565Russell Group12.2%
University of Edinburgh3,63031,910Russell Group11.3%
University of Glasgow3,00528,615Russell Group10.5%
Imperial College2,86517,690Russell Group16.2%
Coventry University2,79531,690University Alliance8.8%
University of Aberdeen2,71014,150n/a19.2%
University of Oxford2,69524,650Russell Group10.9%
University of Manchester2,58540,490Russell Group6.4%
University of Cambridge2,55519.955Russell Group12.8%
University of the Arts London2,36018,290n/a12.9%
University of Warwick2,31025.045Russell Group9.2%
University of Westminster2,18519,650n/a11.1%
City University2,12519,405n/a11%
LSE1,97011,210Russell Group17.6%
Queen Mary1,83018,890Russell Group9.7%
University of Birmingham1,82034,835Russell Group5.2%
(equal) University of Essex1,81514,585n/a12.4%
(equal) University of Kent1,81520,220n/a9%
(equal) University of Southampton1,81525,180Russell Group7.2%
Middlesex University1,73519,505Million+11.8%
University of Bath1,69016,910n/a10%
University of Strathclyde1,67522,955n/a7.3%
University of Nottingham1,62532,515Russell Group5%
Edinburgh Napier1,52012,910Million+11.8%
Ulster University1,50524,640n/a6.1%
University of Exeter1,47523,175Russell Group6.4%
University of Leeds1,44033,300Russell Group4.3%
Cardiff University1,43031,595Russell Group4.5%
University of Sheffield1,40528,715Russell Group4.9%

Table 2: Universities with >5,000 students with highest percentages of non-UK EU domiciled students FPE (full-person equivalent), 2016-2017 (data extracted from HESA, policy analysis CGHE)

University% of non-UK EU domiciled students
University of Aberdeen19.2%
LSE17.6%
Imperial College16.2%
Queen Margaret University, Edinburgh14.9%
SOAS14%
University of the Arts, London12.9%
University of Cambridge12.8%
University of Essex12.4%
King's College London12.2%
(equal) Edinburgh Napier11.8%
(equal) UCL11.8%

This post represents the views of the author and not those of the Brexit blog, nor the LSE. It as originally published as a Centre for Global Higher Education policy briefing.

Dr Ludovic Highman is a Senior Research Associate at the ESRC/HEFCE-funded Centre for Global Higher Education, based at the UCL Institute of Education.

EFTA’s model of compliance would struggle to accommodate the UK

morten kinanderWould the Norway model mean the UK was subject to the rulings of a foreign court? Morten Kinander (Norwegian Business School) responds to Øyvind Bø’s recent post for LSE Brexit. Yes, EFTA states are subject to the decisions of their Surveillance Authorities, but they are not formally bound by them in the sense that the state is subject to sanctions. This is an important distinction because it shows why the EFTA system is able to accommodate the sovereignty of its members. Yet EFTA was not designed for an ever more powerful supervisory structure, and it would struggle to incorporate the UK. This presents a welcome opportunity to refurbish the whole EFTA-pillar.

Judge Øyvind Bø’s competent response to my piece about Brexit, financial markets, and the Norwegian model seems to express relative agreement with my main point: that the UK has little hope of bargaining its way into passporting rights and special deals. Gaining access to the EU financial markets is a question of fitting into a supervisory system that has evolved into a semi-constitutional structure, with necessary supranational elements. In such a system, special exceptions make little sense.

He has, however, two issues with my article, one concerning the EFTA Court and the other concerning the EFTA Surveillance Authority.

aalesund norway

Aalesund, Norway. Photo: Les Haines via a CC BY 2.0 licence

Concerning the EFTA Court’s and the binding effect on Norwegian law, Bø is right to point out that I may have underplayed the function of the EFTA Court’s decisions in Norwegian law. Decisions that are not merely advisory according to the Article 34 of the Surveillance and Court Agreement (SCA) (which make up the majority of the decisions), are binding in the sense that the EFTA States are required to take all “necessary measures” in complying with the judgments of the Court, cf SCA Art 33. However, the Court itself lacks sanctioning capacity, and compliance is more a question of political choice than a legal obligation. Yes, the EFTA Court has in one sense binding effect in Norway, but surely, from a sovereignty perspective, being subject to the EFTA Court is a far cry from being subjected to the CJEU, even though the EFTA Court is set up to imitate the CJEU.

Concerning the EFTA Surveillance Authority, Bø claims that the EU ESAs’ opinions are essentially binding. As he says:

“Annex IX to the EEA Agreement states that whenever the ESAs issue draft decisions to the EFTA Surveillance Authority, the latter ‘shall, without undue delay’ adopt the relevant decision. The wording clearly suggests that the EFTA Surveillance Authority is under a legal duty to adopt a decision whenever the ESAs issue a draft. Arguably, the role of the EFTA Surveillance Authority is to adapt the draft, which has been drafted within the framework of the EU, to the framework of the EEA Agreement, and not to reconsider the underlying substance of the decision.”

The crucial point here is the phrase “under a legal duty”, which reveals a disagreement between Bø and myself: The claim that the EFTA Surveillance Authority is legally obligated to make certain decisions overlooks the centrality of the formal aspect in making the whole structure work from a sovereignty perspective. As the Norwegian Ministry of Finance said when presenting the arrangement: “EFTA’s Surveillance Authority will, however, have no legal or in any way formal duty to make a decision with a certain specific content when a draft has been received” (Prop 100 S (2015-2016), p. 14, emphasis mine). Obviously, if the EFTA Surveillance Authority or any of the EFTA States do not make a corresponding decision, the whole structure will likely fall apart, and with it potentially the EEA Agreement. So yes, in a sense the EEA EFTA States are bound by decisions of the ESAs, but this binding is a political and not a legal one, although the distinction is formal to the point of absurdity.

My main point, however, is that this hyper-formality performs a central task: The EEA EFTA States are not formally bound by the EU ESAs (and at least not by the CJEU) and as they get to influence the rules to a far greater extent than is the case for non-EEA EFTA States. That formality achieves, in other words, the crucial “selling case” of the structure, and provides a model of less subjection, although not as little when viewed from a purely formal perspective.

In a broader sense this precarious structure simultaneously presents an opportunity to rebuild the system, since it is far from ready to include an independent-minded and sophisticated player such as the UK. For example, as was (part of) my point; non-compliance does not carry a legal stick, as compliance turns on political risk of disagreement in the Joint EEA Committee, where the EU has the heaviest hand. In other words, the decisions of the EFTA Court have such a high degree of compliance in the EEA EFTA States due to the politically asymmetric status of the current EEA EFTA States.

Underlying this is the fact that the whole system was not designed for its current modus operandi with a supranational and ever more powerful supervisory structure, making decisions directly applicable in the Member States. The EU pillar seems to manage this, as the much-needed powers and regulations drafted by the EU ESAs are formally enacted by the Commission – thus complying with the conditions of delegation according to the Meroni-doctrine, with the CJEU being a true court of justice at the apex. The EFTA pillar, on the other hand, and along with it, the EFTA Court, is not designed to carry this weight, especially with an ever more powerful supervisory system that depends upon direct effect in the national markets.

The fact that the system is unfit for the direct and unchanged inclusion of a player like the UK gives Britain an opportunity to focus on remodelling the two-pillar structure according to its own preferences.

This post represents the views of the author and not those of the Brexit blog, nor the LSE.

Morten Kinander is Professor, dr.juris at the Norwegian Business School, BI, and Director of the Center for Financial Regulation.

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