Brexit, In-depth briefings

Monthly Trade Briefing: Brexit – a new beginning for UK trade policy (Part 1)

Brexit

Overview

The United Kingdom is planning to leave the EU. As a result of this decision, its trade policy will require a fresh start and a healthy dose of realism as to what it can achieve in the short term. The country will need to act in several stages on several fronts. First and foremost it needs to determine its priorities for its relationship with the EU (FTA or Norway model most plausible outcome), and its choice of trade policy, in particular in agriculture. Then it needs to clarify its current status in the WTO (as it is now in the WTO as EU member), and build trade negotiation capacity. Any FTA with third countries such as the US, China or India are not likely to materialise in the near future.

By Iana Dreyer

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The United Kingdom’s electorate expressed the wish to leave the European Union in a referendum on 23 June 2016 by a majority of 52 to 48. In the coming months, London is expected to formally notify its intention to leave the EU according to the Article 50 procedure laid down in the Lisbon Treaty. It is impossible at the time of writing of this note to determine whether, when, and under what conditions “Brexit” will actually happen. At the time of writing, the UK is expected to file its Article 50 notification in late 2016.

 

Article 50 of the Lisbon Treaty foresees a two-year period of negotiations over the future relationship between the leaving member state and the EU. After two years, membership may be extended, by unanimous decision among member states, taking into account what future relationship is taking shape (See full Article 50 in Annex).

 

The implications of Brexit for future British trade policy are momentous. Trade policy has been at the heart of the debate over Britain’s membership in the EU. Trade policy is one of the exclusive competences of the EU. Non-membership in the EU means not being involved in the EU’s trade policy.  As a result of leaving the EU, the UK will need to fully re-think its trading relationship with the rest of the world. This process has not yet begun as the country is undergoing a constitutional and acute political and leadership crisis whose end and outcome is highly uncertain.

 

The depth of the trade policy upheaval for Britain will depend on the country’s economic and political priorities, and also on the partnership negotiated with the EU. The most-discussed scenarios for a post-Brexit Britain-EU relationship are the following:

 

  • a plain most-favoured-nation (MFN)-based relationship without further agreement, anchored in the World Trade Organization (WTO)
  • a bilateral free trade agreement with the EU;
  • a customs union with the EU;
  • an arrangement akin to that enjoyed by Norway and Iceland in the European Economic Area (EEA), or, in a less comprehensive manner, Switzerland (EFTA), both involving full or almost full access to the EU’s single market

 

The single market’s core principles are the so-called four freedoms: the freedom of movement of goods, services, capital, and labour. Economic integration in the single market is buttressed by common regulations: technical standards, services market regulations, public procurement regulations, competition rules and enforcement, state aid disciplines, increasingly financial and capital markets integration and regulation, to name the most important.

 

The key gripes proponents of the UK’s departure from the EU have are first and foremost with the freedom of movement of labour. Another common criticism of the British eurosceptic camp is the (real or perceived) costliness of EU law and ‘bureaucracy’. A third and fundamental grudge Eurosceptics have with the EU is the loss of ‘sovereignty’ entailed by its supra-national decision-making and the power of the Court of Justice to shape the laws of national governments.

 

Possible scenarios for a future arrangement with the EU

 

None of the possible trade policy solutions for a Britain outside the EU will be comfortable. Below are the most plausible scenarios.

 

  • WTO only

 

The first scenario aired by ‘Leave’ campaigners ahead of the June referendum is ‘plain’ MFN-based trading relationship with the EU.

 

In fact this relationship would entail significant economic costs for Britain. The arrangement would subject British exports to standard EU import tariffs and secure sub-optimal access of the country’s thriving services sector (banking and finance, professional services) to the EU’s single market.

 

For example, the EU’s current 10 percent import duty on cars would apply to UK produced cars: this would significantly harm the currently thriving UK automobile industry, which exports first and foremost to the EU.

 

The ‘WTO only’ scenario would however ensure the greatest possible policy space for Britain (as long as its trade policy complies with WTO rules) and thus pleases many free-traders in the eurosceptic camp.

 

But ‘WTO only’ is not a very likely scenario. Both the UK and the EU would certainly seek to achieve the best possible outcome for their currently deeply intertwined commercial activities and industrial supply chains during their divorce negotiations.

 

The key issue will not be tariffs, but regulations. Both sides would need to explore ways to avoid that Britain’s goods would will not need to be tested twice for their compliance with health, safety, and environmental requirements before being released in the EU market. This is the case for all trading partners outside the EU’s single market.

 

Going down that route would choke off the seamless just-in-time supply chains in the top exporting industries of the UK and raise costs to consumers. Key industries negatively affected by such an arrangement include the UK’s mechanical appliances, automobiles, pharmaceutical and electronic appliances industries.

 

  • Classic or Swiss-style bilateral FTA

 

A bilateral EU-UK FTA would probably secure duty-free treatment of most if not all goods both ways. But it would most likely fall short of full access for British firms to the EU’s single market. This has costs, the UK’s financial services sector could well lose one of the single market’s most cherished prizes: the “single passport”, the system which allows financial services operators legally established in one EU member state to provide their services in other member states without further authorisation.

 

It is possible to enjoy significant privileges as non-EU services provider in the EU: this is the case of Switzerland. But achieving such privileges involves lengthy and complex negotiations.

 

But the EU’s treaties with its wealthy neighbours are consistent: any access to the EU’s single market involves respect of the four freedoms, i.e. also the movement of labour. Under the country’s bilateral arrangement with the EU, Switzerland is obliged to apply EU or ‘equivalent’ regulations to be able to benefit from access to the single market. Swiss regulatory sovereignty is, de facto, curtailed. Though economically beneficial, a Swiss-style solution would not satisfy British eurosceptic demands for curbs on movement of labour or legislative sovereignty.

 

An FTA with selective access to the EU’s single market increases red tape for goods exporters. These need to comply with rules of origin to be able to benefit from duty-free treatment. The rules of origin the UK would most likely need to comply with are those under the already existing Pan-Euro-Mediterranean rules. Adopting these rules would at least ensure that the UK is in a level playing field with other EU neighbours such as Norway or Switzerland.

 

On the upside, the FTA or ‘Swiss’ option leaves the partner freedom to define their trade policy with the rest of the world independently.

 

  • Customs union

 

The problem of rules of origin would disappear if the UK stayed in the EU’s customs union. But under such a scenario, Britain would lose control over its trade policy.

 

There is a precedent with Turkey’s 1995 customs union with the EU. Turkey has no decision powers over EU customs law, and it has no decision powers over the EU’s free trade agreements (be it the choice of partners or the content of the agreement). Turkey is obliged to apply the trade liberalisation measures negotiated by the EU in bilateral trade agreements without enjoying the better market access negotiated by the EU on behalf of EU businesses. What is more, customs union membership does not mean automatic access to the EU’s single market. The Turkish case, again, speaks for itself: there is no single market between the EU and Turkey? Notoriously absent if the freedom of movement of labour between the EU and Turkey, as well, of course, as the financial services passport.

 

The Turkish-style scenario appears rather unlikely for an arrangement between the EU and the UK.

 

  • EEA

 

The best economic solution for the UK, and for EU businesses operating in the UK, is for the UK to remain in the EU single market and retaining Britain’s freedom of manoeuvre in trade policy. This the Norway solution can offer.

 

Most economists and trade experts reckon the best model (outside being inside the EU) is joining the EEA (it includes Norway and Iceland). But this would mean the UK would be obliged to absorb EU law and accept the freedom of movement. But EEA membership goes without a seat at the decision-making table – which is the main definition and benefit of EU membership.

 

Contrary to EU treaties, the EEA agreement foresees an emergency safeguard for movement of labour: this could be a means to placage the the ‘Leave camp’ in Britain should the government in London opt for an EEA solution.

 

A question that law scholars are debating is whether the UK would need to apply to the European Free Trade Area of which EEA members as well as Switzerland and Liechtenstein are part. This adds another layer of complexity.

 

The EEA solution is the least satisfactory in terms of sovereignty and policy space for Britain. However, it would have the advantage of potentially being able to happen quickly: the EEA text exists already, and it doesn’t involve a process of disentangling UK from EU law, which any other arrangement: WTO only, FTA or Turkish-style customs union, would entail.

 

Nonetheless, the UK would be free to shape its trade policy with third countries.

 

This outcome would be highly ironic as Britain left EFTA in 1973 to become a full member of the EU. It would definitely see the UK “lose control” fully over sovereign policy-making.

 

Read Part 2 of the briefing.

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