Brexit and trade: the view over the hill

In a recent TV debate, a member of the audience complained to Michael Gove, one of the leaders of the Leave campaign, that Leave were like a WW I general shouting “over the top” to his troops, without anyone knowing what awaits them there. Gove called it an arresting image, and I agree. Here is an attempt to make some sense of what may await the UK “over the top”, with respect to international trade.

If the UK leaves the EU, it will have to set up its own external trade regime. The only exception to that requirement is if the UK were to keep its current customs union with the EU, and therefore also keep the EU’s external trade regime. A customs union means free trade between the parties, and a common trade regime – the EU is a customs union. That is an unlikely scenario, though, as it would effectively also mean keeping the UK inside the internal market. Indeed it would make little sense for the UK to give up its opportunities for determining its own trade regime, and for concluding trade agreements with other countries, without also maintaining full access to the internal market. At any rate, the customs union/internal market option involves the kind of transfer of sovereignty which Brexiters find so objectionable. Note also that both the Norway and Switzerland models are not customs unions. Both Norway and Switzerland maintain their own external trade regime.

The UK has not had a trade regime of its own since its accession to the EEC. What does setting up a trade regime involve?

First of all, the determination of customs tariffs for all physical products (goods) which could be imported into the UK. As a member state, the UK applies the EU tariffs. Of course the government might attempt to find shortcuts, such as keeping the equivalent of a number of EU tariffs. Still, the exercise is a big one, and a wholesale adoption of the EU tariffs seems to me unlikely. Tariffs are a way both to protect domestic producers and to raise revenue. There are surely economic sectors for which the UK would want a different tariff regime from the EU one.

Second, the UK needs to adopt trade legislation of its own. For example, the EU operates a detailed and extensive Customs Code, which will need to be substituted with UK legislation. Also on other trade matters, such as anti-dumping, safeguard, and anti-subsidy measures, etc etc, new legislation will be needed.

Third, the UK will have to look into trade in services, to see whether it wants to change any rules on access to its services markets.

If the UK does not keep the customs union with the EU, there will need to be a WTO negotiation on the UK’s new external trade regime. The WTO Director General has already warned the UK about this. Why is this required, and what does it involve? The reasons are very simple. Tariffs are “bound” in the WTO. Where the UK makes changes to the pre-existing tariffs (in this case the EU ones), particularly changes involving an increase, it needs to negotiate these “bindings” with any other WTO member (basically any other country around the world) with an export interest in the products concerned. Effectively, this looks very similar to a WTO accession. Of course, the UK is already a member, but it does not have a trade regime of its own. So in substance the withdrawal from the EU is comparable to a full WTO accession, and accession negotiations can easily take years. These negotiations would need to be completed before the UK starts negotiations with other countries on free trade. This is the logical sequence: you determine your external trade regime, which applies to all your trade, and you can then conclude free-trade agreements with preferred partners.

Some might say that this WTO negotiation will be straightforward, because the UK will adopt more of a free-trade position: not raising tariffs, but cutting them. One of the Brexit economists, Patrick Minford, even suggests completely free market access – meaning no tariffs. Of course other WTO members would like that, yet there are quite a few comments to be made on that course of action.

First, if the UK opted for total free trade (no tariffs), it would be giving up revenue – and it would be interesting to see how that would affect the alleged financial gains resulting from non-membership of the EU. Currently the income from customs tariffs is part of the UK’s financial contribution to the EU. The UK would also lose most bargaining chips in any future trade negotiations. Why would countries around the world still be interested in negotiating free-trade agreements with the UK, if they already have full access to the UK’s market because of the UK’s free-trade regime? The free-trade model is wholly inconsistent with the idea that the UK will be able to strike better trade deals than the EU. Trade negotiations are about reciprocity, and if you have nothing to offer, others will simply not be interested. Complete, unilateral free trade is of course also an ultra-liberal policy, giving up on any protection of domestic industries.

Second, even with a cut in tariffs, or with complete free trade, other WTO members are likely to call for a negotiation, in which the EU will also need to be involved. The reason? Well, there will be EU tariffs on imports from the UK into the EU. Even if the UK concludes a free-trade agreement with the EU (the ‘Canada’ option), such an agreement covers only products originating in the respective parties. This means that products which are imported into the UK from outside the EU, will no longer benefit from free circulation in the EU. So other WTO members lose the advantage of having the UK as one of the gateways into the EU internal market. For example, it is not inconceivable that an EU-UK free-trade agreement might mean that cars assembled in the UK by Japanese car manufacturers, do not benefit from free access to the EU market: the agreement’s rules of origin may determine that these are not UK products, because of the use of imported components. Also, the EU market effectively becomes smaller. So WTO negotiations there will need to be. And the potential effects on companies’ investment in the UK are obvious: if such investment does not guarantee free access to the EU internal market, there will inevitably be cases were certain companies decide to invest inside the EU, to have guaranteed market access, and not in the UK.

In other words, the first enemy encounters over the top are not so nice, and it may take a long time to get past them.

But then the UK will be able to start a golden age of concluding its own free-trade agreements (FTAs)! The conception among Brexiters appears to be that the UK will not be the last in the queue, and that, with its dynamic and flexible economy, it will in fact find it easier to conclude FTAs than does the EU. Again there are quite a few hurdles, though.

First, the UK will need to catch up, compared to its current position as a member of the EU benefiting from a whole series of EU-concluded FTAs. The view that the UK will be able to maintain its contracting-party status to those agreements seems to me politically and legally untenable. It is true that most of these EU FTAs are so-called mixed agreements, with the UK as a contracting party in its own right. But UK exit will change the terms of trade, and for the same reasons as those requiring a WTO negotiation, the terms of free trade between the UK and existing EU-FTA partners will need to be renegotiated. As was pointed out by Thomas Sebastian at a recent seminar, the rules of origin do not allow the UK to be an autonomous party to such FTAs.

Second, the UK’s market is but a fraction of the EU internal market. It is hardly realistic to think that no major economy will take that into account in determining its trade policy priorities. Access to the EU internal market is a much bigger prize.

Third, modern trade negotiations are as much, if not more, about regulatory issues than about pure trade measures, such as customs tariffs. The EU is a regulatory giant – on that much there is agreement between Leave and Remain. I have argued, before, that Brexit is not an escape from EU regulation. The UK may aim to replace EU regulations with its own, but to the extent that it keeps trading with the EU – currently accounting for a little less than half its trade – it will be a regulation-taker, and it will of course lose its ability to influence those regulations. This is a further reason why major economies will be less interested in negotiating with the UK.

So what could be the gain, really? What does the conquest of the last bulwark, deep down in the valley which lies beyond the hill, actually offer? What a long and uncertain battle to reach a position where the UK is most unlikely to be an important player in international trade policy, and where it is most unlikely that its terms of trade will be any better than the ones resulting from current EU membership. And that is leaving to one side the loss of full access to and participation in the internal market, which accounts for more than 40% of the UK’s external trade.

 

 

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