How do you like your Brexit – hard or soft?

“Brexit means Brexit” has been Theresa May’s equivocal line since the referendum. It has become clear that this actually means that Britain will leave the EU – the manner of that departure, however, remains unclear.

The difference between a “hard” and a “soft” Brexit centres around the relationship with EU single market which allows goods to move around the EU unhindered. A soft Brexit would allow Britain to remain in the single market, whilst a hard Brexit would see it leave both the EU and the single market.

All UK politicians agree, at the very least, that Britain should aspire to “have access to the single market”. This is, however, a meaningless form of words since all countries in the world (with the exception of North Korea) are able to sell their goods to buyers in the EU if they wish – ie they have access to the single market. What is more important is to have “tariff-free access to the single market” – provided a nation is a member of the WTO (World Trade Organisation) then a maximum tariff (or a tax) of 10% can be applied to trade in goods between them. In general, this tariff will be applied to all goods imports unless there is a separate trade agreement between the importing country and the exporting country. There is also considerable bureaucracy involved in proving that the goods meet any national standards or regulations of the importing country.

Being “a member of the single market” means that there are no tariffs and no bureaucracy – if the product meets EU standards then it can be freely sold anywhere inside the EU, and in practice the slightly larger EEA which includes Norway and a few other small countries. The major disadvantage of not being inside the single market is the bureaucracy involved at border points when goods cross in to the EU, which means higher costs for business. This is a particular problem for the border between Northern Ireland and the Republic of Ireland, which is currently completely open.

Being inside the single market is a real prize for business, is the main reason that Mrs Thatcher wanted Britain to be a member of the EU, and has been the UK’s main focus of political activity while a member.

Given the referendum result, the best outcome for Britain is not to be a member of the EU, and thus able to control its own borders (by ending freedom of movement to EU citizens) and write its own laws, but to retain membership of the single market. In fact, this would probably be the best outcome for every EU member and is why the EU negotiators will not agree to it.

Since Article 50 has not yet been triggered and negotiations have not yet started, both sides are talking tough and making clear that they would not be unhappy if nothing is agreed and Britain leaves the EU with no new agreement about trading relations in place. This is assumed by both sides to be that Britain would leave the EU and become a member of the WTO in its own right, rather than as part of the EU. This would be the hardest Brexit – access to the EU but with 10% tariffs applying to all trade (though Britain could unilaterally set a zero tariff on imports if it so wished). In any negotiation, the side least able to accept the situation if the event of no agreement has the weaker hand, so both sides are saying publicly that this would not be a problem for them.

Many in the UK claim that the €90bn trade deficit in goods that Britain has with the rest of the EU, means that the EU would suffer more, in money terms, from no agreement, whilst those in the EU point out that with 47% of Britain’s goods exports going to the EU, while for the EU’s leading exporter, Germany, the UK represents just 7.5% of their exports, the effective impact of tariffs on the British economy would be much greater than on the rest of the EU.

In practice, the obvious solution for both sides is tariff-free access for goods – it is the closest solution to the current situation and any tariffs would be negative for both parties. Provide the negotiations are conducted on a friendly basis, this should be the outcome, and can be construed as a medium-hard Brexit.

In financial services, where the UK has a large trade surplus, the EU operates a “passport” system, if a firm is regulated by an EU country it can apply to have a passport to provide those services in the rest of the EU. British firms are very keen to keep these rights, but if outside the EU they are dependent on the EU agreeing to this. France and Germany are both keen to have the power and the jobs from these financial services in their own countries, and so the price for maintaining these passports will be high. It is likely that the UK would have to offer concessions on the freedom of movement of people to achieve this – this would be a difficult compromise for the British people and politicians to accept.

Britain does not hold too many cards in the negotiations and a hard Brexit looks the most likely outcome.  Provided there is rationality and goodwill on both sides, tariff-free access for trade in goods should result, but an agreement on services, which is of greater importance for Britain will be much tougher to achieve.

Three into two doesn’t go

By their nature, if referenda are to be used only for matters of the greatest import, a clear answer must be forthcoming and therefore only binary outcomes can be permitted. In fact, though the Brexit referendum voting slip had just Remain or Leave printed on them, the Leave campaign was a coalition of two different perspectives. Michael Gove and Boris Johnson wanted to leave the loss of sovereignty implied by being a member of the EU with its automatic imposition of any Brussels regulations, but did not wish to lose the ability to trade freely with the EU, particularly in financial services where the UK dominates Europe. Many in wealthy parts of the UK voted Leave for this reason. For Nigel Farage on the other hand, the key issue was control of immigration – the EU’s freedom of movement for people in the single market was not acceptable and many in the poorer parts of the UK voted Leave for this reason.

The UK thus finds itself in a situation of intransitive preferences, known as Condorcet’s paradox. This occurs when a society prefers A over B and B over C and C over A. For a single individual this is obviously inconsistent, but in a society of many different points of view, this state of affairs is quite possible.

The referendum shows that the UK prefers Leaving the EU to Remaining in it. However, leaving the EU requires that we have to choose between continuing to be part of the Single Market with its economic benefits and having constraints of the freedom of movement of EU citizens. EU leaders have made it quite clear that this is the price to be paid to be part of the single market.

Thus it is entirely possible that there is majority preference to Remain rather than no longer be part of the single market but have control of immigration, ie Remainers plus many of the richer Leave voters, and a different majority preference to Remain rather than not have control of immigration and continue to have full participation in the single market, ie Remainers plus many of the poorer Leave voters.

Theory shows that for society as a whole such intransitive preferences have no good solution and this is where the UK finds itself today – wanting to Leave but with no plan and the world laughing at it.

Boris Johnson, now in campaigning mode to be the next Prime Minister, proclaims that the UK can have both, but David Cameron has already admitted that the UK must choose. The next Prime Minister will thus have to choose between the interests of business and the City and the poor. As a Conservative the obvious course may be to save the interests of business, but such a course of action will further alienate the poorer sections of the country and boost the support for UKIP and its anti-immigration stance.

There is already speculation that France would be prepared to offer the new prime minister zero tariffs on goods (where the Eurozone has a large surplus with the UK) and controls on immigration from the EU but no passporting rights for UK banks in to the EU. This would be exactly what the Farage wing of Leave would accept, but do great damage to the City and Conservative supporters.

As ever in politics there will likely be a compromise with some damage to the UK’s access to the single market in services in exchange for some flexibility on EU freedom of movement.