Japanese companies can be forgiven for hoping that Brexit -- the U.K.'s painful separation from the EU -- will go as smoothly as possible. However, if the recent failure to make much progress in the exit negotiations is any guide, they should prepare for a possible disappointment -- and plan accordingly.
The first phase of Brexit negotiations was supposed to be the easy part. The fact that it has proven to be anything but does not bode well for the next phase of talks on the future relationship between the U.K. and the European Union, the outcome of which will affect partners around the world, including Japan.
Given the limited time available to finalize these talks, the EU and the U.K. need to agree on a transition period to avoid a very costly "no-deal" scenario. To mitigate the impact of this costly scenario for Japanese businesses investing in Europe, Japanese Prime Minister Shinzo Abe should use his recent election success to strengthen ties with the EU by finalizing the Economic Partnership Agreement by the end of the year.
The U.K. and the EU missed their self-imposed deadline last week to make "sufficient progress" on just three items (the rights of their respective citizens residing on each other's territory; the status of the U.K.-Irish border; and the so-called "divorce bill"). The biggest obstacle to advance to the next phase of negotiations is the "divorce bill," with a difference in positions estimated at approximately 40 billion euros. Behind this lies the greatest impediment of all -- the perceived lack of unity and fragile political leadership in the U.K.
Clock is ticking fast
The European Council on Oct. 19-20 eased the way to finalize the first phase of negotiations to December. While it still insists that the two sides should make "sufficient progress" in exit talks before negotiations with the U.K. on the future arrangement begin, the EU has agreed to begin internal consultations on the future arrangement among the 27 remaining member states. Assuming the two sides start phase two in December and remain committed to the March 2019 departure date, they will have only about 10 months' negotiating space, with the remaining time needed for formalities and ratifications. This is a highly ambitious schedule, seeing how most EU trade agreements can take up to 10 years to negotiate.
It is increasingly evident the first item on the agenda should be a transition period during which the same rules as now would apply, to reassure businesses and investors, and give the two sides sufficient negotiating time. British Prime Minister Theresa May rightly noted in her Florence speech last month that U.K.-EU negotiations would begin from a more advanced stage than with other third parties because the two sides already share the same standards. Shortly after the European Council, however, she also suggested there will no transition period unless the two sides can agree on a post-Brexit trade deal. German Chancellor Angela Merkel expressed cautious optimism at the European Council last week. Even though the EU will continue to negotiate as a united team in the second phase, individual Member States will become more active in promoting their own interests, potentially causing more disruptions and delays. Even some of the most pro-U.K. EU member states like Denmark may push for a less accommodating EU stance on fishing rights, for example.
The fact that the two sides missed their first major deadline in what was supposed to be the "easy" phase does not inspire much confidence in third parties like Japan. Officials in Tokyo are starting to privately express doubts about the ability of the British leadership to deliver on the reassurances they have made, both publicly and privately, to their Japanese partners.
The Japanese side, through both political and business channels, has always been uncharacteristically outspoken about its preferences: no Brexit, or the "softest" Brexit possible. More than 1,000 Japanese companies have concentrated their European investments in the U.K. to access the EU single market of more than 400 million consumers, so a "no deal" scenario would bear significant costs. The U.K. would be immediately cut off from the EU single market and incur trade barriers and tariffs in line with World Trade Organizations rules. For example, Japanese companies like Nissan Motor and Toyota Motor, which have production models that currently rely on frequent customs-free border crossings of car parts, will need to substantially reconsider their business models.
The U.K. has already started to make plans for a no-deal scenario, as have some U.S. companies -- and, reportedly, the EU as well. Tokyo should do the same. Its contingency plans should include a reevaluation of relocation costs from the U.K., and the exploration of new areas of collaboration with both sides. The reelection of Prime Minister Abe gives him the additional political capital to push closing the EPA deal by the end of the year. He must make sure that Japan stays close to the EU, even if the EU's links with the U.K. are disrupted. Especially in the light of the U.S. withdrawal from the Trans-Pacific Trade Partnership, the EU-Japan EPA may become the gold standard of mega-trade agreements in the twenty-first century -- and could ease some of the pain of a difficult Brexit.
Irina Angelescu is a Council on Foreign Relations Hitachi fellow at the Japan Institute of International Affairs in Tokyo. The views expressed in this piece are her own.