Norway or Canada? Britain weighs post-trade ties

Brexit talks are set to enter their second phase, and Britain faces historic choices on its future relations with Europe, including a possible trade deal.

With the EU demanding "clarity" from Britain on what it wants before embarking on full negotiations, here are the options floated by both sides so far:

The Norway option

Energy-rich Norway opted against EU membership in 1994 and instead chose to join the European Economic Area (EEA), enjoying all the benefits of the EU's single market without having a say in the rules that shape it.

As a member of the EEA, which includes all EU countries as well as Iceland and Liechtenstein, Norway must allow the free movement of goods, capital, services and persons with its fellow members.

These are the EU's four fundamental freedoms as set out in the Treaty of Rome, the cherished accomplishment of Europe's drive towards peace and unity after World War II.

EEA members must accept EU rules in many important sectors, including competition, consumer protection and the environment, with rules updated automatically in line with EU legislation.

The big advantage for Britain in the Norway model is that its financial hub in London would remain undisturbed.

By remaining in the single market, the City of London would keep its unfettered access to Europe and remain the launching point for US and Asian banks into the EU.

But Norway, with just 5.2 million people, is a far smaller player than Britain, and its model of ties with the EU is a no-go for Brexiteers.

Fuelled by anti-immigration sentiment, Britain's vote to ditch the EU was a clear rejection in particular of freedom of movement, making the Norway option untenable as long as Theresa May's conservative, pro-Brexit government remains in power.

The pro-Brexit camp also rejects any involvement of the EU's European Court of Justice, which holds the ultimate authority over the EEA.

But staying in the single market would be challenging for a pro-EU government in Britain given the colossal loss of sovereignty involved.

Canada 'plus plus plus'

Barring the close alignment of the single market, Britain is keen to strike a trade deal even more ambitious than the EU's recent accord with Canada, known as the Comprehensive Economic and Trade Agreement (CETA).

That treaty is considered a blueprint for the EU's trade deals going forward and was a model for the most recent talks with Japan.

UK Brexit negotiator David Davis has called for a "Canada plus plus plus" while Belgian Prime Minister Charles Michel advocated the same, albeit with only two pluses.

Unlike classic trade deals of old, the CETA pact touches on all aspects of the economy, including health and safety norms, and not just the usual cuts to tariffs and import quotas.

Both parties negotiate, sector by sector, an agreed level of regulatory cooperation, with London especially keen for closely aligned norms for finance, aviation and autos.

While they are ambitious for far-off Canada or Japan, an EU-UK trade deal would in fact mean a signficant distancing between the UK and Europe, which are now perfectly aligned with zero tariffs.

In a Brexit twist, the trade talks would decide where to impose barriers and division -- known in trade parlance as divergence -- instead of the usual practice of trying to remove them -- known as convergence.

These future trade barriers, which may require customs checks, pose a daunting problem with regards to EU-member Ireland, which insists on maintaining a frictionless border with the UK's Northern Ireland -- and has the backing of Brussels to defend this point.

But some have seen a back door to a possible "soft Brexit" through a provision in last week's Brexit divorce deal which says that if London fails to come up with a better idea, there should be "alignment" between Britain and Ireland.

WTO rules

If neither of the above options prevails, Britain will inevitably revert to "third country" status in the eyes of the EU, with trade relations administered according to the rules of the World Trade Organisation.

The EU's default position at the WTO involves tariffs and increased barriers that could cripple the seamless supply chains that connect Britain and the EU.

While the EU's average tariff rate for third countries is low – around 1.5 percent -- they are bigger in certain strategic sectors: for cars, the rate is 10 percent.

Moreover, under WTO rules, also known as "hard Brexit", it is unlikely that British products could enter the EU without further checks at the border.

The situation would grow worse as regulatory differences widened over time -- a prospect Ireland would surely refuse.

Researchers at the London School of Economics predict that the "WTO rules" scenario is underestimated by hard Brexit proponents and would slash Britain's trade with the EU by a catastrophic 40 percent over ten years.