What MPs need to know about trade policy before voting on the EU Withdrawal Bill

What MPs need to know about trade policy before voting on the EU Withdrawal Bill

As Members of Parliament prepare to debate the EU Withdrawal Bill again, we thought it would be useful to revisit some of our previous work on the impact on our independent trade policy of various arrangements the UK might have with the EU. These are very relevant to the amendments which will be before the House of Commons next week. The point is that each of these options has a serious impact on the ability of the UK to execute an independent trade policy. Those who vote for arrangements that would seek to compel  the UK to negotiate a customs union or single market membership should know that they will take the UK’s independent trade policy off the table, and turn Brexit into a damage limitation exercise, at best.

The stated policy of the UK Government is to leave the customs union and single market on day one of Brexit, but proposals are being floated to remain in a customs union, or join EFTA, possibly acceding to the EEA Agreement (which are not the same: Switzerland is in EFTA but not the EEA, with its own set of agreements with the EU, and in fact membership of EFTA precludes membership of a customs union as EFTA has its own trade agreements).

Proposals also include a potential “backstop”, whereby the UK “aligns” with the customs union and the single market rules to purportedly avoid the need for border checks at the Irish border. Being outside a customs union and having regulatory autonomy are not some ideological choice, but are in fact the only way to be able to execute an independent trade policy.  Brexit leads to costs which need to be minimised, and opportunities which need to be maximised. If the opportunities are taken off the table, there is only cost. We are at a critical moment where the bold move is actually the safe one, and fear and timidity is in fact the dangerous one.

We analyse these potential scenarios as follows:

A Customs Union

Being in a customs union entails two central consequences:

  • The UK will not have control over tariff schedules, so would be unable to negotiate tariff reductions with other countries or take action to reduce import duties payable at home.
  • Not having control over tariff schedules also means the UK cannot act independently in the WTO to work proactively on the reforms in world trade that would most benefit us.

The very fact that we are still operating with a lack of clarity on fully and effectively leaving the EU customs union means that important negotiations in the WTO, on fundamental matters like tariff-rate quotas (TRQs)  are not proceeding effectively. This has serious and long term implications, as these discussions, if held constructively and bilaterally with affected partners could be a springboard to future liberalisation.

Customs union membership alone, meanwhile, is not sufficient for frictionless movement of goods.  Most border checks are not associated with import duties at all; they cover adherence to regulations such as in the safety of goods, for instance.  Only continued UK harmonisation with single market rules will deliver free circulation of goods between the UK and the EU, such that border inspections would not be necessary. So in practice, if the goal of complete free circulation is to be achieved within a customs union, this would require both customs union and single market membership (at least regarding all rules for goods).  In reality, border formalities for imports from outside the customs union and single market are very streamlined and operate at very low cost to traders (the CEO of the Port of Zeebrugge told the Treasury Committee on Tuesday that around 1% of freight value is the norm) so conceding sovereignty over tariffs and regulation to avoid them is unnecessary and disproportionate.

EFTA states with the EEA Agreement

Membership of the European Free Trade Association (EFTA) alone would not confer single market access. This is achieved through EFTA’s European Economic Area (EEA) Agreement with the EU. In EFTA, Norway, Iceland and Liechtenstein are signatories to this agreement, (whereas the Swiss arrangement, below, is somewhat different).  The EFTA EEA members are obliged to adopt all EU single market legislation. They have a theoretical right to opt out of these regulations, but this mechanism has never been used, because the consequences would be severe. When Norway attempted to diverge from a directive on postal services, for example, it was threatened with loss of market access in unrelated areas like fisheries.

One of the components of the EEA Agreement is the EFTA Court, which resolves disputes. The Agreement requires the Court to follow the rulings of the Court of Justice of the European Union “given prior to the date of the EEA Agreement as to the interpretation and application of EU laws incorporated into the EEA Agreement”, while it must also take due account of CJEU decisions thereafter. The European Commission also wants the Court “strengthened” to “function as a mirror to EU authorities”.

The EEA Agreement provides for consultation and communication with the EFTA countries at the early stages of formulating single market legislation, but they do not have a vote and in reality, as the European Parliament itself states, EFTA countries “have little influence on the final decision on the legislation on the EU side”.

EFTA membership outside the EEA Agreement

Membership of EFTA would provide for free trade with other EFTA members and, potentially, give access to the benefits of the existing FTAs that EFTA has with other countries. As noted above, it does not entail preferential access to the single market, and these limited benefits would come at the cost of material limitations to the UK’s independent trade and domestic regulatory policies. The EFTA Convention requires its members take on all EU technical barriers to trade and there is a complex mechanism of notifications wherever an EFTA member intends to regulate in ways that diverge from either European standards or international standards.

The gains of EFTA membership are the relationships the UK would then automatically have with EFTA members: thus a better approach would be to agree a full FTA with EFTA as soon as possible. Since the UK is a major trading partner with the EFTA countries, there is strong mutual incentive to achieve this, and it has been endorsed by the president of Switzerland.

Different states and different models – and why none work for the UK

The Swiss model

The EFTA membership that we have discussed would not in itself solve any of the market disruption issues related to leaving the customs union: these can only be solved by agreement with the EU. Although a member of EFTA, Switzerland is not a signatory to the EEA Agreement, but has its own bilateral agreements with the EU. The Swiss have single market access through a series of agreements where they agree to adopt elements of the EU rulebook. They have also committed to the four freedoms and Schengen membership.

As well as the free movement of people, this means Swiss financial contributions to ‘economic and social cohesion’ in the new EU member states. The model does not grant Swiss companies unrestricted access to the Single Market for services.

The Turkey model

The Turkish model is a customs union with the EU for industrial goods and processed food (agriculture is excluded, but covered by other preferential arrangements with respect to tariffs).

While this includes removal of tariffs between Turkey and the EU on the goods it covers, it also requires Turkey to apply the Common External Tariff (CET) on these goods. The arrangement includes increasing harmonisation, such as a Turkish commitment to adopt the acquis in sectors covered by the customs union. Turkey must also take on whatever the EU negotiates in terms of the CET, then negotiate its own benefits but without the leverage of being able to remove tariffs or change regulation in large areas. Turkey’s land border with the EU is a hard border that is subject to long delays for goods traffic, illustrating that customs union membership is not a route to a frictionless border.

The Ukrainian model

Called the Deep and Comprehensive Free Trade Agreement (DCFTA), this gives tariff-free access for goods and ‘passporting’ for services. It also includes alignment of large areas of regulation – in competition, state aid, public procurement and anti-dumping. The agreement also plans integration in foreign policy, defence and security, home affairs, and justice policy, stating that Ukraine is expected to ‘[achieve] convergence with the EU in political, economic and legal areas’.

Progress here – and whether Ukrainian regulations are sufficiently aligned to the acquis – will be judged by a joint Association Council, with no right of appeal. In disputes on interpretation of the provisions of EU law with which Ukraine is converging, the ECJ has the final verdict.

The Global Regulatory Opportunity

The global trading opportunity being presented to Britain through Brexit is not just about doing bilateral trade deals. Many of these opportunities relate to what the UK can do unilaterally (attracting investment and trade globally), such as reducing food prices by cutting tariffs, but also by introducing pro-competitive regulation to improve consumer welfare and the environment for innovation and SMEs.

In services in particular, where the UK is the world’s second-largest exporter, the EU is moving in a negative direction, with a number of anti-competitive interventions, such as the recent adoption of the General Data Protection Regulation.

Other opportunities relate to the UK’s potential influence multilaterally (improving the global system), Regulatory sovereignty also affects how the UK can connect to regional partnerships and plurilateral agreements: to join advanced trade agreements, the UK must have control over its own regulation.

The challenge is in how other countries look at the UK — and the likelihood that it is sufficiently in control of its regulatory choices to be a proper partner, capable of agreeing and implementing its own measures on technical barriers to trade and services regulation. Because the customs union and EEA Agreement restrict members’ regulatory freedom, many of the things that other countries would need from the UK to agree comprehensive and meaningful FTAs would be impossible.

A Cost/Opportunity Summary – and what independent UK trade policy requires

A broad cost-opportunity analysis is as follows:

  • Customs union (and partial customs unions like the Turkish model) – Delivers little or no advantage in terms of regulatory divergence; only meaningful opportunity gain is in the potential for reducing border control formalities and rules of origin costs.
  • EFTA with EEA – High cost in terms of being a rule-taker and having to mirror EU regulations, eliminating potential for domestic regulatory reform and deals with others; has little upside, as access to single market and border frictions can be addressed in other ways.  
  • EFTA without EEA – This would impose the cost of EU technical barriers to trade, limiting UK ability to execute independent trade or domestic regulatory policy. The gains of EFTA membership would be the UK relationships with EFTA members – but the better approach would be a full FTA with EFTA.
  • Swiss-style agreement – The Swiss have single market access, but through a series of agreements involving adopting elements of the EU rulebook and commitment to the four freedoms, including free movement of people, and Schengen membership. This has worked well for Switzerland which is heavily reliant on exports to the EU, at a cost of regulatory autonomy in affected sectors.

UK independent trade after the interim period – the FTA we need:

An FTA with the EU must mean no membership of a customs union, the EEA or EFTA, and freedom to negotiate all future tariff schedules with third countries.

In customs, the interim period must be followed by tariff-free trade. This FTA needs to include liberal Rules of Origin for goods and expedited customs arrangements.

In regulations, the UK needs regulatory autonomy, without which we will have only partial freedom to negotiate with other countries, and little or no capacity to create a pro-competitive economy and increase consumer welfare. Both the UK and EU will need maximum regulatory autonomy on day one of Brexit, then a system to manage differences as they arise that imposes disciplines on either party if they wish to withdraw this recognition unreasonably.