Ryan Bourne // 13 April 2017

The starting gun has been fired and the two year Article 50 process for exiting the European Union has begun.

Last week, both Theresa May and EU leaders were remarkably clear about their ambitions, at the same time as indicating their priorities for the talks. For the EU, the primary concerns are its own finances and the political sustainability of “the project”. For the UK, it’s securing a bilateral trade deal.

These are both understandable. In 2015, Britain was the third largest gross contributor to the EU budget, accounting for over 15 per cent of its funds. As a major net contributor, Britain’s exit will leave a significant hole in the EU’s finances – one that will have to be made up for by larger contributions from elsewhere or substantial cuts to EU programmes. Other countries such as Denmark and Sweden have already expressed their unwillingness to increase demands on their taxpayers.

This, combined with the fact that the EU does not want to make leaving seem an attractive proposition, explains why its leaders are seeking to divide the so-called “divorce settlement” from talks about any future trading relationship.

For EU leaders, the importance of this separation is that it changes the power dynamic: it wants to pressure Britain into agreeing to make substantial payments for covering long-term liabilities and the short-term budget shortfall. Knowing that Britain prioritises a trade deal, and that the two-year window presents a tight constraint on there being such a smooth transition, the hope is that Britain will quickly cede to EU demands on the budget to get onto those issues perceived to matter more.

Counter logic explains why the UK wants parallel talks about exit and the future relationship. For the British government, avoiding any short-to-medium-term economic disruption is paramount. Britain wants to use the implicit threat of a cliff-edge on budget payments and removal of security cooperation as a reason to bring the EU to the subject of a trade deal quickly. Recognising that, for many EU leaders, holding together the remainder of the EU appears more important than the continuation of a liberal trading relationship, Britain wants to make clear that there will be costs should a deal not be agreed.

If both parties only considered the interests of their citizens, the mutually beneficial nature of trade and security cooperation should mean that both were willing to continue liberal arrangements as far as possible. But the EU has always been more about politics than economics, and the balance of competing national interests at that, reasons why Britain was right to vote to leave in the first place.

That’s why I’ve always thought it best to assume that Britain should plan for no exit deal, and hence that British exporters will face tariffs selling into the EU post-Brexit. In such a scenario, Britain could maximise its dynamism by unilaterally removing its own tariff and non-tariff barriers and reviewing repatriated regulations. Such a framework would no doubt cause short-term disruption as the economy shifted production patterns, but in the longer term productivity gains would come from trading globally at world prices.

Expressing this clearly to the EU would have been a more credible threat than suggesting that security cooperation would suffer if no deal is reached, because the economic case for doing so would be coherent (whereas the security case is not).

Instead the May government has taken a more risky path. Whether it works or not is another matter. What her government should be absolutely clear on, though, is that Britain will not be willing to countenance any payments into the EU budget (outside of those programmes which we wish to remain in) after leaving, unless talks on the future economic partnership proceed immediately.

The EU’s own treaties allow for a member state to leave the union, and therefore Britain has no obligation whatsoever to pay a membership fee to a club that it has left under the club’s own rules. Any willingness to do so would be a display of goodwill, for which Britain should obtain goodwill in return.

Just as with David Cameron’s renegotiation, it’s tempting to presume mutual rationality will prevail and that both parties can form and maintain beneficial relations. This is clearly more a hope than expectation. Previous attempts to negotiate suggest behind the scenes Britain should be preparing for these talks to fail, remembering that economically its long-term fortunes will primarily be tied to decisions it makes domestically on tax, trade and regulation.

This article was first published in City AM.