Politics, wrote the economist Kenneth Galbraith, is about choosing between the unpalatable and the disastrous, writes Europe Editor Tony Connelly.

RTÉ's Tony Connelly

Those who opposed Britain’s exit from the EU, including the Irish Government, now believe Theresa May is plumping for the disastrous by choosing a "hard Brexit".

In Europe attitudes have been hardening since the referendum. 

The resignation in early January of Sir Ivan Rogers, Britain’s ambassador to the EU, gave the impression of a government torn between hard and soft Brexiters, with the eurosceptics refusing the counsel of a civil servant blessed with a profound knowledge of (and respect for) what the rest of the EU was thinking.

It’s understood Sir Ivan was aware that Ms May was due to make a speech on her negotiating priorities in early January and that he wanted to resign ahead of the event, so as not to appear to be resigning as a result of her speech.

As such Ms May then delayed her speech to allow some time to separate the two events.

In any case, it appears the phoney war since the referendum is coming to an end. 

"The pace has quickened, there’s no doubt about it," says one official. 

Over the weekend, Ms May sent out the 'Mr Nice' from her cabinet - Chancellor Philip Hammond - to threaten the EU with a Singapore-on-Thames if Britain didn't get preferential access to the Single Market.

London’s relentlessly ingratiating attitude to Donald Trump is also adding a toxic adrenaline to the mix ahead of Article 50 being triggered.

Waving Trump’s commitment to a quick free trade deal with the UK may give Britain a certain swagger going into the negotiations, but Trump’s open hostility to the EU will certainly put backs up on the other side.

Shortly after the June referendum, one well placed diplomat told RTÉ News that Britain’s negotiating strategy would be to ask for everything, and then to paint the EU27 as the villains if they refuse.

Cabinet ministers like Boris Johnson have airily boasted that Britain will still be able to enjoy the fruits of the single market and end the free movement of people, despite repeated warnings from the EU that defending the four freedoms is a red line the 27 governments won’t cross.

It’s hard to tell whether this is a pre-negotiation psycho-drama, or simply a delusional belief in how the EU works.

As the negotiations draw closer, it will be increasingly difficult to separate bold gambits and sleights-of-hand from the actual concessions the EU27 might legally and technically be able to make.

London's calculus has been that the German car makers and French champagne growers won’t, when push comes to shove, want to abandon the UK market on a point of principle.

Volkswagen plant at Wolfsburg, Germany

In other words, it will be in the EU27’s interest to grant Britain preferential access to the single market in order to avoid a trade war in which continential exporters will lose out.

Brexiters in that camp were given a boost with a report in the Guardian that Michel Barnier, the EU’s chief negotiator, told MEPs privately that a special deal could be done with the City of London to ensure that the economies of the EU27 would not be cut off from the funding that comes from Europe’s main financial services hub.

A senior source told RTÉ that Mr Barnier’s remarks to MEPs were "completely distorted" and that the indivisibility of the single market – i.e., no carve outs for special interests in the British economy – would be sacrosanct.

Whatever the case, it is useful to look at the financial services sector as an example of the kind of crunch points Britain will face in the negotiations.

Single Market

The development of the single market in the 1980s and early 1990s, largely due to Britain’s insistence, foresaw a scenario where basic rules were harmonised and mutual recognition allowed firms to sell goods and services across the EU with a single licence.

In Britain’s case the sector that would benefit the most was the City of London.  By specialising in financial services, the City would attract big firms providing wholesale operations which could then service the whole of the EU through the use of a so-called Single Passport.

The passport is based on the "home" country of a financial institution (where the firm is registered), which supervises that firm and applies the EU’s "single rulebook".

Over time, those rules became more complex, and more far reaching. After the financial crisis of 2008 a raft of new regulations came in, and they covered things like ratings agencies, hedge funds and derivatives, which weren’t covered before.

The advent of the EU’s banking union, a major pillar of legislation designed to prevent a repeat of the banking crisis, has brought in even more harmonised rules.

All this was to ensure financial stability, and to prevent risks being transmitted across borders, and also to meet the EU’s commitments under G20 reforms. 

Whatever the rationale, the single rulebook itself became a dense thicket of rules and obligations, but one which allowed for the smooth operation of a single financial services market.

As Karel Lanoo writes in a paper for the Centre for European Policy Studies (CEPS), the City of London has had a huge incentive in remaining part of the single rulebook. 

City of London has huge incentive to remain part of single rulebook

"London has developed over the last quarter century into the wholesale financial centre for the EU, in the same way that Wall Street functions for the US or Hong Kong for China.

"London hosts some 358 banks, many insurance companies and institutional investors, hedge funds, and specialised finance providers. It is now also spearheading the growth of fintech companies. It is home to the largest stock exchange in the EU, the most developed derivatives market, and related clearing and settlement infrastructures. It also hosts important services for the financial sector."

But it has been vital, too, for the UK economy as a whole.  Financial services represent almost 8% of Britain’s GDP.

If Britain leaves the single market, then the hundreds of financial services operators in the City of London will automatically lose their passporting rights to sell their produces across the EU.

Brexiters have been quick to point to the concept of "equivalence" as the method by which Britain can leave the single market, yet still allow the City to keep its access.

Equivalence is a legal concept, which evolved during a period of more ambitious trade agreements between the EU and so-called third countries.

Effectively it means that the EU recognises the regulatory regime in a third country as being "equivalent" to standards which apply in the EU, so that commerce can flow between the two sides.

Brexiters argue that since the City has already adopted a wealth of rules and regulations thanks to EU membership, then "equivalence" will apply, and exiting the single market will not be a problem.

But there is a major drawback.

UK-licensed companies may avail of EU equivalence rules on the first day of Brexit, generally regarded as 1 April 2019.

But from 2 April a gap will open up.

Financial regulation at EU level is highly dynamic. It is changing all the time. And the moment those changes take effect, the City will only enjoy equivalence if it keeps up with the new changes.

Those changes will evolve with Britain having no input into the new rules.  

Equivalence can also be revoked by the commission without any grounds for appeal, while there may also be stricter rules on governance and supervision meaning Britain may find itself bound by the scrutiny of the ECB or the European Court of Justice.

Also, given the highly competitive nature of financial services, with Ireland, France, Luxembourg and Germany all fighting to boost their own sectors, equivalence rules will get political.

"The problem for the UK and equivalence," says one senior EU source, "s that the negotiations are about managing divergence, not about managing convergence."

None of this is to prejudge the negotiations, and Britain will argue that the City is a special case which should enjoy a special relationship with the single market.

Financial Regulation

While the withdrawal of the City from the financial life of the EU27 may be damaging and disruptive, there is a clear danger that if one sector enjoys a carve out, then there will be a clamour for other sectors in the British economy as well.

This will be very hard for the EU27 to accept, and Ireland, indeed, will have its own self-interest in poaching as many financial services firms as possible from London.

Professor Niamh Moloney, from the London School of Economics, has written extensively about the growth of financial regulation and how it will put the City at a major disadvantage if Britain leaves the single market.

In a paper for the German Law Quarterly, she writes: "The nature of the UK’s relationship with the EU following its exit from the EU has yet to be determined. But the consequences of the extraction of the UK from EU financial governance are likely to be disruptive in nature and long term in duration."

Minimising disruption will be key to how Britain manages a "hard Brexit". 

The most optimistic Brexiters talk of wrapping up the divorce proceedings and Britain’s new trading relationship with the EU within two years, but that is highly unlikely.

The two year timetable for negotiations once Article 50 is triggered is, strictly speaking, restricted to the divorce, i.e., the unscrambling of 40 years of EU rules, rights and obligations. 

Trade

Britain cannot get into formal talks on its future relationship with the EU during the two year negotiation period.  The EU can only conduct trade talks with third countries, and until 1 April 2019, the UK will still technically be an EU member.

If Britain opts to stay out of the single market, then from day one of Brexit it will be forced to trade with the EU under WTO rules, meaning it will be subject to the EU’s external tariffs.

But even that is complicated. At present Britain is a member of the WTO only through its membership of the EU. Once it exits, then its membership will be, in the words of Jean-Claude Piris, the former head of the EU’s legal service, "hollow".

In order for it to become a full member of the WTO, Britain will have to set out its own tariff schedules, in other words, a list of the full tariffs it will apply to goods across the board entering the UK.

Britain could simply cut and past the EU’s tariff schedule, but again, that will be politically hard for Brexiters to swallow.  So, setting out its own tariff lists could take two or three years, and they will have to be accepted by both the EU as a bloc, and the other 140 members of the WTO.

In this context, most observers believe the UK will look for a transitional arrangement that would allow exporters to avoid the cliff-edge of the WTO option (this will, of course, be of vital interest to anyone who trades between the North and the Republic, and between the Republic and the rest of the UK).

The drama will lie in what kind of transitional arrangement is agreed and how long it can apply. The simplest solution would be for Britain to assume, temporarily, the status of countries like Norway, Iceland and Lichtenstein, who form the European Economic Area (EEA).

The drawback for Brexiters is that that option requires paying in to the EU budget, accepting freedom of movement, abiding by all EU rules and regulations (except agriculture, police and judicial cooperation, foreign and defence policy) and being subject, still, to the European Court of Justice.

But Britain cannot remain in such a twilight world indefinitely, and it may still face a day where transitional arrangements lapse and there’s still no free trade agreement with the EU.

All this will be problematic for the Irish Government. At the moment Ireland is managing to keep its concerns to the forefront, and, according to close observers of the process, has managed to keep the key players in Brussels keenly – some would say obsessively – aware of Ireland’s vulnerability both in terms of trade and the peace process.

Officials have been in close contact with the European Commission, drilling into the commission's expertise in order to probe solutions or problem areas as they relate to Ireland and Britain’s withdrawal.

The Government is aware that this work has to be done ahead of time, because once the negotiations start, there will be hugely competing demands on the time and resources of the Commission’s Brexit task force.

Scottish Referendum?

Ireland is also having to manage a delicate posture towards Scotland.

SNP leader Nicola Sturgeon is struggling to maintain a clear position on whether or not she will launch a second independence bid for Scotland.

 Nicola Sturgeon is struggling to maintain a clear position on a second referendum

Any strategic solutions devised during the Brexit negotiations that relate to managing an Irish land border which straddles a single market and non-single market territory would be eagerly seized upon by Scottish nationalists.

This is because in the event of Scotland somehow remaining in the single market it would have the same kind of land border with England to the south.

But Dublin is extremely eager to avoid being “bundled” with Scotland in the eyes of the EU27 for the simple reason that Spain will block any attempt at granting an EU region special access to the single market because of the Catalonia powder keg.

Beyond Ireland’s own concerns, the overriding imperative among the other 26 member states is that the integrity of the EU cannot be undermined by whatever Britain achieves in the negotiations.

That means that Britain cannot be seen as better off outside, and that the EU’s single market cannot be undercut by a UK that may become a low tax, low-regulatory, low-standards free-market hub on Europe’s western shores.

That in turn will mean a tough attitude to Ireland’s land border, which will be one line of defence that protects the EU’s internal market, whose goods are heavily regulated, from being undermined by UK products.

This week the phoney war ends, but a long, bitter and divisive campaign awaits.