A ‘hard Brexit’ means changing Britain’s trading relationships not only with the EU, but with the rest of the world. Brexit ministers have presented this as a relatively straightforward process. It isn’t.
We are currently within the EU customs union, where there are no internal customs checks, tariffs or quotas. Goods imported from outside are checked only at the point of entry, where all member countries charge a common external tariff at the same rate. EU countries negotiate tariffs and trade agreements with third countries collectively, and use the clout of being the world’s largest market to secure better terms than could be delivered by any individual member state.
Leaving the EU Customs Union implies not only needing a new trade deal with the EU, but also with countries across the world to replace the agreements we have via the EU. This is vital: only 15% of UK trade is with countries that are not in the EU or covered by an EU trade agreement that is either in force or under negotiation.
Through the EU we are currently party to:
- More than 50 Free Trade Agreements (FTAs) across the world, with negotiations underway for a further 67. They give reciprocal preferential access, waiving all or most of the duties normally required.
- Mutual Recognition Agreements (MRAs) with third countries, which allow goods to be inspected by approved bodies and declared in conformity with destination market rules before being exported. This saves time and expense, as shipments do not need to be impounded and checked at borders. MRAs are in place with many countries which do not have a full FTA with the EU, including China, the US and Australia.
- Sector-specific deals (e.g. on airlines’ rights to fly between the EU and third countries).
- Economic Partnership Agreements (EPAs) with a number of developing economies.
- And where no FTAs, MRAs or other deals are applicable, then WTO rules apply, and we have arrangements and commitments via the EU in that context too.
Leaving the EU customs union means all these cease to apply to us and we will have to negotiate our own deals to replace all of them. This page describes some of the complications involved in doing so.
We will not be able to conclude any FTA with a third country before leaving the customs union. We may be able to start discussions, but our counterparts will want to know what our future relationship with the EU is going to be before they can negotiate meaningfully.
In particular, they will want to know whether Britain hopes to retain its membership of the single market (either generally through membership of the European Economic Area, or through a bespoke agreement for specific sectors), and will likely want to see the terms of any deal, including arrangements for onward re-export of goods to the EU, before they can develop their own position.
If we leave the single market entirely and negotiate an FTA with the EU, then the nature of this FTA will materially change the calculations that any third country makes about signing a bilateral deal with the UK. Potential trading partners are therefore likely to wait and see what emerges from these talks before committing to negotiations. And even then, trade negotiations take time.
This question is also vital for foreign investors because onward access to the rest of the European market is one of the central attractions for any business looking to invest in the UK. If we are going to be outside the single market, the value of preferential access to the UK’s market to a prospective investor will be diminished.
It is also worth mentioning that leaving the EU customs union would require the introduction of new customs controls (a ‘hard border’) between Northern Ireland and the Republic, in order to prevent goods from crossing the border in contravention of customs checks.
At World Trade Organisation (WTO) level, Britain will have to establish “schedules of commitments”. These set out the default duties that will apply to imports into the UK of goods and services, notifying the rest of the world of our maximum import tariffs for merchandise, and other commitments for services, for every category of goods and services, replacing the common EU commitments we currently have.
We might attempt to speed up this process by simply replicating the existing EU schedule of commitments, rather than starting with a blank sheet of paper. However, this is unlikely to be plain sailing. The UK’s schedule of commitments has to be adopted by consensus among the 164 members of the WTO. Some WTO members may not want to give, just to Britain alone, the same concessions they gave to the EU as a whole for access to the world’s largest market. Or they may raise wholly unrelated matters to take advantage of the opportunity to exert pressure on the UK on other matters (think Falklands), or demand visa-free access to Britain for their citizens. Any single country can hold up the whole deal.
There may also be UK interest groups who do not want our offer to be based on the status quo. Sectors where the EU currently charges a zero tariff on imports may see protectionist interests in the UK wanting to increase the tariff. Or sectors where the EU currently applies relatively high tariffs where businesses and consumer groups in the UK may want to make imports cheaper. For example, Tate & Lyle want lower import duties on cane sugar.
The whole question of tariffs on agricultural imports can in any case only be settled once there is agreement on a UK agricultural policy which the government will have to thrash out in partnership with the Scottish, Northern Irish and Welsh administrations. Tariffs on beef, for example, which are currently high, will both be contentious domestically and of significant interest to many EU and third countries who will want to see them lowered. Aid levels to farms generally will be analysed by third countries to see whether they confer competitive advantages.
And besides tariffs, some agreement will have to be found on quotas. This will sometimes entail not only an agreement with the country concerned, but also with the EU. To take just one example, how will the quota of New Zealand lamb allowed onto the European market (a quota in place historically at Britain’s request) be shared out in a way acceptable to all EU countries and to NZ (irrespective of whether the UK takes an additional amount)? What knock-on demands will it trigger on other producers?
Perhaps most importantly is the loss of leverage. Negotiating as part of a market of 500 million consumers gave us far greater clout than we will ever have as a market of 65 million. This is simply matter of arithmetic: third countries will find our market less important and will not find it so worthwhile to make concessions in negotiations.
The EU challenge
As the above makes clear, much hinges on what deal we do with the EU upon leaving it. If the UK leaves the customs union and does not attempt to join the EEA, then a UK-EU FTA would be the next logical step if we are to ensure anything like the level of access to the EU market that we need. An FTA would seek to minimise tariff barriers and non-tariff barriers to some fields of the single market, but probably not all.
Any agreement on the UK’s future relationship with the EU will take time to negotiate. It is separate from the Article 50 “divorce” process. Strictly speaking, we will have to wait for the end of the Article 50 process and actually leave the EU before there can be a formal FTA negotiation, though in practice, and with EU goodwill, these discussions may be able to run in parallel to some degree. Another possibility might be for our Article 50 divorce deal to set a medium-term date for actual Brexit (say, 2024) and contain an appropriate enabling clause to allow trade and other negotiations to continue in the meantime.
A simple FTA just on tariffs and quotas needs the approval of a qualified majority of EU member countries and the approval of the European Parliament. A more comprehensive agreement would have to be approved by all 27 member states, and it’s extremely unlikely that every single country will give the UK an easy ride in the negotiations.
While Leave campaigners have claimed that the UK is in a commanding position due to its overall trade deficit with the EU (“they need us more than we need them”), in reality much of this trade deficit is accounted for by Germany. Many other member states buy more from the UK than they sell to us. The balance of negotiating leverage would be dictated by the fact that we represent only some 17% of total EU trade, while they represent about 44% of ours. There will be plenty of protectionist pressures from sectors keen to exploit any opportunity to reduce competition from British producers (think, Italian car manufacturers, French beef farmers). Again, non-economic issues may play a role (think Gibraltar). And, internally, domestic UK stakeholders are also likely to have diverse and often conflicting views and needs.
In the meantime, unless there is some interim arrangement for tariff-free access, the UK will need to impose tariffs on imports from the EU, for the WTO reasons set out above. This will raise the cost of imports from the EU, which will be borne by British consumers. Some studies estimate the impact on UK food prices alone could be as much as 8%, additional to that already created by the devaluation of the pound following the referendum.
Is there a way around these problems by putting in place a simple, ‘quick and dirty’ FTA covering essential sectors and leaving others for future negotiations?
No — WTO rules require any FTA to be comprehensive, covering “substantially all” the trade between the transacting parties. It the deal failed to meet this threshold, it would be ruled illegal and both the EU and the UK would revert to their Most Favoured Nation tariffs.
Is there scope for a quick deal based on an off-the-peg model?
It’s sometimes suggested that the EU’s Comprehensive Economic and Trade Agreement with Canada (CETA) offers such a model. But CETA is not yet in force, after seven years of talks. And it has hundreds of pages devoted to Canadian and EU ‘carve-outs’ from general liberalisation commitments, grants only limited access for services (vital for the UK, heavily dependent on service exports), and leaves Canada facing tariffs and other restrictions on scores of food and farm products. For Britain, it would introduce all sorts of new red tape on British businesses, from ‘rules of origin’ requirements to intrusive customs checks.
Could we avoid the need to sign an FTA by simply dropping our own tariffs on imports from the EU to zero, and challenge the EU to reciprocate?
Some MPs who favour a quick, unilateral Brexit have suggested this. But it would not work, for three reasons:
- In the absence of a comprehensive FTA, the EU is legally obliged under WTO rules to apply the Common External Tariff to the UK, resulting in immediate tariffs on goods ranging from 10% in the case of cars, to 12% for clothes, 21% for beer and spirits, and 29% for chocolate and other confectionery.
- WTO Most Favoured Nation rules dictate that if we unilaterally drop tariffs on EU imports to zero we will be obliged to do the same for every other country in the world. That would, at a stroke, undermine any prospect of securing favourable FTAs with third countries, as we would already have removed our own tariffs, squandering our negotiating capital.
- Also, such a move would do nothing to address the non-tariff barriers which are harmonised for countries inside the single market, nor the right to provide services, which will become a far more significant concern for British businesses once we leave the EU.
- Whatever deal we do get, if we leave the customs union, all goods exported to and imported from the EU will need to be declared to the customs authorities. British exporters will also have to comply with complex ‘rules of origin’, requiring exporters to obtain proof of origin certificates from their national customs authorities to guarantee that the product (or an agreed percentage of the product) originates in the UK. Under an FTA, goods have to be shown to come from the country in question in order to benefit from the preferential tariffs agreed under the FTA, and to prevent third country imports from being passed off as domestic products. This will introduce delays, extra paperwork and costs for British businesses, including customs checks, value declarations, inspection certification, and advance cargo declarations. It will also make continental businesses less willing to include UK-produced goods in their supply chains.
None of this applies now, while we are inside the EU customs union, so the impact of this change would be considerable. Just the rules of origin requirements have been estimated to increase trade costs by between 4% and 15%. The impact would be particularly pronounced on companies with highly integrated cross-border supply chains like the British aerospace and automobile industries. It would also be significant for agriculture: it is, for example, hard to see how any significant animal and animal product exports to the continent could continue given that imports to the EU have to pass through designated Border Inspection Posts, of which there are precisely none on the other side of the Channel. This is a £1.5bn export trade which would disappear overnight.
Securing an FTA with the EU is, as we have seen above, is essential but not straightforward. Securing it by parallel negotiations during the two years allowed for negotiating the Article 50 ‘divorce’ deal would be impossible in that time frame.
We could seek an arrangement whereby the Article 50 ‘divorce’ deal sets a later date for departure and includes a permissive clause allowing for negotiating an FTA (and trade deals with third countries) in the meantime. Alternatively, an interim agreement could provide for a transition period which prolongs our membership of at least the single market and/or customs union, could be sought, for the same purpose. It is not clear whether such a deal would be politically achievable or legally possible under Article 50. Even if it were, there is still the danger that talks would collapse, or that the terms of any agreement would fail to be agreed by the other 27 EU countries. Any of these problems would see the UK leave the EU without any form of agreement in place — the absolute worst-case scenario for trade barriers and legal certainty of all kinds.
And, besides trade, there are perhaps 600 other issues to be addressed — such as membership of (or relations with) various EU agencies, research programmes, Investment Bank, Europol, air travel agreements, fishing rights, residual budgetary contributions and much else.
If it can be secured, an interim deal based on the EEA / Norway approach would be the least bad option. It would preserve most of our membership of the single market while allowing us to strike our own trade deals outside the EU customs union. But even the ‘Norway option’ carries serious downsides: a major loss of sovereignty as we are cut out of the setting of single market rules, coupled with the introduction of new bureaucratic burdens for British exporters who will have to comply with complex ‘rules of origin’ to show where every element of their products was manufactured.
So the EU deal will be problematic enough. The time it will take puts a damper on any other deals we want to make. And, given the inevitable loss of trade with the rest of Europe, we will have to do better with the rest of the world to compensate — which seems highly unlikely.
And if we fail to secure an agreement with the EU, or don’t even try, matters will be worse: we would face immediate tariffs on our exports to the EU, loss of passporting rights for services, and substantial non-tariff barriers on goods and services, including the prospect of trying to certify our exports as being in conformity with EU rules without any recognised approved UK certification authority. For these reasons, the Treasury has estimated the cost to the UK economy of this option as 7.5% of GDP after 15 years.
However, there are no obviously better choices on offer – except a rethink of the whole scenario. As the realities of Brexit begin to sink in, this may yet regain support.