For decades, Britain’s Conservative Party politicians decried the European Union for its supposed aversion to free markets.
Now trade negotiations that will define the future relationship between the U.K. and the EU from next year have stalled, in large part because Prime Minister Boris Johnson’s government wants the freedom to ignore EU rules limiting state subsidies of private companies.
With trade talks restarting Tuesday, and little sign of quick progress, this impasse is increasing fears among officials on both sides that a trade deal won’t be secured by the end of the year, resulting in tariffs and a host of other barriers to trade amounting to $800 billion annually. Mr. Johnson said his government would walk away from talks if a deal isn’t reached by Oct. 15.
“If we can’t agree by then, then I do not see that there will be a free-trade agreement between us,” Mr. Johnson said Monday. “And we should both accept that and move on.”
EU officials say the bloc remains intent on striking a deal but that Mr. Johnson’s government will need to make some major concessions. The bloc’s chief negotiator, Michel Barnier, has said the end of October is the effective deadline for an agreement. The pound has fallen against the dollar on fears that talks will collapse.
Across the world, big government spending is on the rise, spurred by state interventions to stave off the economic calamity caused by the Covid-19 pandemic and by rising barriers to trade. In Britain, this—combined with Brexit—is driving a political U-turn.
Britain left the EU in January but continues to follow its rules during this year’s transition period. The two sides are now hashing out how they will trade in the future. The British government wants freedom from the EU to set its own rules. The EU doesn’t want Britain subsidizing businesses that then get tariff-free access to its market.
This debate is colliding with Mr. Johnson’s vision for more state intervention to bolster post-Brexit Britain. His position is far removed from the free-market economics of his Conservative Party predecessor, Margaret Thatcher, who questioned the government’s ability to pick winners among private companies.
“Here we are 30 years out from when Thatcher left office and we have a government contemplating a no-deal final Brexit settlement so that it can subsidize companies and choose national champions,” said Tony Travers, a professor at the London School of Economics. Mr. Johnson’s position curiously aligns him with figures on the left of the opposition Labour Party, whose skepticism about the EU derived in part from the bloc’s constraints on state subsidies, said Mr. Travers.
British government officials say they don’t plan to pump funds into ailing heavy industry, but rather turn the U.K. into an attractive base for tech companies by easing regulation, taxation and investing in promising businesses. They also say the argument is about the principle of sovereignty—the freedom for elected British governments to act as they choose.
This worries the EU. Around the time that Britain’s divorce with the bloc was sealed last year, German Chancellor Angela Merkel said the U.K. would become a competitor to Europe, especially in the areas of innovation and digital markets. “Great Britain will no longer belong to the union and as a third country with a free-trade agreement it will become an economic rival,” Ms. Merkel said.
EU rules—strongly backed by Britain when it was an EU member—limit the ability of governments to shore up national companies as a way of assuring no country gains an unfair advantage inside the bloc’s single market. Those rules have been effectively suspended because of the Covid-19 pandemic, but officials say they will return when it is over.
The EU has demanded a rundown of the government’s plans for its state-aid regime, which the U.K. government hasn’t yet completed. Officials are hopeful that they will be given at least an outline of the U.K.’s plans in talks in coming weeks, but they aren’t confident of that.
“We have no issue with regulatory divergence. It is normal that the U.K. wants to set its own standards and rules,” Mr. Barnier said in a speech last week. “But if these serve to distort competition with us, then we have a problem,” he said, making it clear that the bloc’s concerns go well beyond digital markets.
London argues that countries such as Canada, South Korea and Japan have secured trade accords with the EU without agreeing to stringent restrictions on subsidies. Brussels says that, unlike the U.K., economies with free-trade accords are either small or geographically distant and don’t represent a competitive threat on the EU’s doorstep.
Diplomats say agreement is possible on state aid that doesn’t impose prescriptive rules on the U.K. But if that happens, they say, the agreement would need an arbitration system that can impose costs—such as tariffs on imports from Britain—for British divergence that undercuts competition.
Adding to the complexity is the divorce deal the U.K. made with the EU last year. To avoid a hard border on the island of Ireland, Britain agreed that its province of Northern Ireland would follow EU state-aid rules. British officials have started signaling they are looking to backtrack from this and other parts of the accord, which has the status of an international treaty.
Northern Ireland minister Brandon Lewis said Tuesday the government would introduce legislation to unilaterally amend the agreement in a way that would break international law “in a very specific and limited way.” The proposal prompted the resignation of the head of the government’s legal department, Jonathan Jones.
An outline of Mr. Johnson’s industrial vision is starting to emerge. Earlier this year, the U.K. government made an unusual investment: a £500 million ($658.4 million) stake in a struggling British-American company that makes satellites. Mr. Johnson’s chief of staff, Dominic Cummings, also talks of repealing the EU’s online privacy law which has weighed on smaller startups, for instance.
For decades after World War II, Britain propped up various industries, including car manufacturing. Many proved flops which took years and billions of pounds to wind down. As a result, the U.K. hasn’t been a big user of state subsidies of late. British state aid made up 0.38% of the country’s gross domestic product in 2018, compared with 0.79% in France and 1.4% in Germany, according to EU statistics.
“For free marketeers, it is extraordinary that Brexit will result in the frontiers of the state being rolled forward,” said David Gauke, a former Treasury minister and Conservative lawmaker. “It turns out membership of the EU was a bulwark against a more interventionist state.”
However, Mr. Johnson faces a conundrum that his Conservative predecessors didn’t: A chunk of those who voted him into power late last year are former Labour-voting blue-collar workers in postindustrial districts of Britain. Mr. Johnson has vowed to improve their lot. Private-sector initiatives have repeatedly fallen flat in these areas. Officials expect the government to now intervene.
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