With the UK parliament showing little sign of resolving its differences of opinion with itself on the UK’s departure from the EU, the UK government has published a list of customs duties that would apply “temporarily” in the event of a “no-deal“ exit. The government says that under such arrangements 87% of imports to the UK will receive duty free access. The reason it has done this is because under a no-deal scenario, the UK and the EU would revert to trade with each other on most favoured nation (MFN) terms. These are there terms on which the EU, and UK by virtue of its EU membership, trade with countries with which no preferential trade agreement has been concluded. If the UK were to apply to the EU the MFN tariffs currently applied to non-EU members, the price effects on consumers and users of imports could be significant.
Overview of issues
The default position is for the UK to apply the MFN tariffs it would inherit from the EU. On average EU MFN duties are low: around 5% using a simple average. But the average masks the fact that some products or sectors attract much higher duties. This is particularly true for agriculture and food. According to WTO data, dairy products attract an average of 38.1%; other animal products like meat average over 16%, while duties on fish averaged 11.4%. The averages mask a high degree of variation across or even within specific products. Beef, for example, can attract specific duties of between around 180 and 300 Euros per 100 kilos. Looking beyond agriculture, clothing imports face tariffs of around 11.5%, while motor vehicle tariffs range between 10% and 22%.
In proposing its tariff revisions, the UK has tried to strike a balance between the interests of its producers and consumers. The interests of the latter would be served by setting all MFN tariffs to zero, as that would mitigate any impact of leaving. But that would have potentially severe effects on producers hithero sheltered by the EU’s MFN tariffs and who would be exposed to word-wide competition without any time to adjust. The political and social costs that could ensue are likely too high for the government to countenance. Hence the cuts proposed by the UK are partial, in both their coverage and depth
The government has also sought to balance its short terms objectives of mitigating impacts from a no-deal exit with its long term objective of negotiating free trade agreements with non-EU countries, as well as obviously with the EU, in the event of a no-deal departure. It fears that if it eliminates all MFN tariffs, it would lose bargaining power. Hence the reason why the cuts are temporal. The idea is to raise applied tariff back to the maximum permissible rates (those that the UK has bound in the WTO, and which are rates it inherited from the EU) within a year, presumably on the assumption that the UK and the EU could have struck a free trade agreement by then even in the event of a no-deal exit. Indeed, the imposition of MFN duties on EU exporters – albeit at a reduced level – is likely seen as an incentive to bring the EU to the table, and (as we will see below) appears to have played an important role in the UK government’s thinking.
The issue of bargaining with non-EU countries also highlights another point. While the changes were made with UK-EU trade in mind, they will have considerable effects on the UK’s non-EU partners. Whether these effects are positive or negative depend on who these partners are and what they export. Countries like Japan, Canada, Korea, Singapore and Turkey, currently enjoy duty free access to the UK via free trade agreements negotiated by the EU. They would lose this access under no-deal scenario in which they face MFN tariffs.
Moreover, they would face competition in UK markets from the likes of China, the US , Brazil or Australia. These all export to the UK on MFN terms, but receive a tariff cut by virtue of the fact that the new UK MFN tariffs are lower than these countries faced when the UK was part of the EU’s commercial policy. Moreover, the tariffs these countries face would now be the same as those faced by competitors who had enjoyed preferential access to the UK. And finally, there are countries that benefit from preferential market access either through unilateral preferences (such as Sri Lanka or Uganda) or free trade arrangements (Switzerland) that could see the value of their preferential access fall (because the baseline MFN rate is lower).
We consider these issues in greater detail.
The EU’s applied MFN tariff schedule contains around 9414 tariff lines, around a quarter of which are duty-free. A little over 10% of these tariff lines consist of non ad-valorem rates (such as specific duties per weight of imports), mainly in agriculture, the effects of which are less transparent, and disproportionately fall on lower cost imports. WTO data suggest that around 80% EU tariffs are 10% or lower.
The key question is therefore where the UK chooses to cut . The benefits to consumers of the UK’s revisions will be greater if the cuts are broad-based, and particularly if they tackle the areas referred to above where EU tariffs are particularly high. But as already observed, this will affect producers in these sectors.
According to data published by the UK Government, there are around 470 products for which the UK proposes to impose MFN tariffs. Products not specified in this schedule are assumed to be duty-free. Over half of the products specified in the UK’s temporary schedule concern agriculture, where MFN duties inherited for the UK are particularly high. For these products, the UK has mainly followed a policy of reducing , but not eliminating the rates it would inherit from the EU. For example, with Beef tariff rate quotas, both the in-quota tariff and the out-of-quota specific duty are cut by around 46%. There are also very significant cuts to duties on pork products, of around 75 to 87%, and chicken of between around 30% to 80%.
But while a number of these cuts are significant in relation to MFN rates, they represent positive duties on EU imports, which is where imported food products in the UK overwhelmingly come from (around 75%). This in turn shows that the proposed revisions will mean an increase in duties on a large proportion of food imports, but that the impact would be less significant than if the UK had reverted to the EU’s existing applied MFN rates. Moreover, the UK is probably counting on an expansion of imports from non-EU sources to mitigate price effects for consumers.
Notwithstanding this, the proposals suggest that in key areas, the government has been more minded to consider some of its other objectives: protecting local producers, and creating incentives for EU exporters to lobby for a free trade agreement, by exposing them simultaneously to higher duties and by exposing them to more competition from non-EU sources who would face a more level playing field. French producers of Roquefort, for instance, may be chagrined not only by the 18 Euros per 100kg duty they face, but also by the fact that this duty represents a cut of over 85% in duties faced by non-EU supplies of blue-veined cheeses entering the UK on a MFN basis.
A similar logic of preserving domestic producer interests and also creating pressure for EU (and non-EU) partners to come to the table seems to have driven decisions on motor vehicles, on which EU MFN tariffs have largely been rolled over. It remains to be seen what effects this approach will have on the competitiveness of UK-EU automotive supply chains.
Not just about EU
As reported elsewhere, one of the challenges the UK faces is to roll over FTAs with non-EU members to which it is currently a party by virtue of EU membership. That roll-over has been hard to do, for a variety of reasons. One of these is that these other parties – Canada, Korea, Japan, Turkey, Singapore – might find the UK less valuable outside the EU than inside, and would wish to extract better terms. The MFN tariff proposals seem in part designed with these partners in mind. Korea and Japan, for example, would lose hard-won duty free access for cars in the UK. Moreover, they would be placed on the same footing in the UK market as other exporters, such as the USA . For Turkey, clothing is a strategic export sector, and the UK’s retention of many of the EU’s MFN duties will adversely affect its market access prospects. This will be exacerbated by the fact that Turkey will be placed on the same footing as producers from China, and on a less favourable footing than garments exporters from south and south east Asia that enter access the UK on duty-free terms under unilateral preferences.
In some instances, the desire to mitigate consumer impacts seems to have clearly dominated strategic concerns. This is notably the case for cereals. For example, liberalised access to wheat imports would give Canada better access than it had under its free trade agreement with the EU. Australia, with whom the UK is interested in negotiating a FTA, would also “pocket” a significant gain.
Beneficiaries of unilateral preferences (developing countries under GSP arrangements, and least developed countries) stand to benefit in areas such as textiles and clothing (for the reasons set out above). Least developed countries, especially, can gain from proposals in the food sector For example, the UK is one of the world’s five largest markets for shrimp, and preferential or zero-duty rates of access for frozen shrimp will give these countries a boost against large exporters such as Canada who will revert to MFN rates. By contrasts, the reduction or elimination of MFN rates on many fruit and vegetables, and cut flowers, will erode the benefits of preferences on these products to developing and least developed countries .
An overarching lesson that can be drawn from all of this is that Brexit has significant international spillovers. While larger countries have the clout to make the interests known and to defend them, smaller ones lack that in need largely to rely on the goodwill of the UK.
Backdoor over backstop ?
In order to avoid “friction” at the border between the Republic of Ireland and Northern Ireland, the UK has proposed that there be no border checks under the new arrangements. The government undoubtedly recognises the risk that this could make the Irish border a backdoor point of entry for importers looking to avoid duties, but has calculated that this risk is price worth paying to avoid a “hardening” of the border (concerns that prompted the government and the EU to negotiate the backstop arrangement).
There may also be a question surrounding the WTO-compatibility of this arrangement. WTO rules require that customs administration and processes be undertaken on a most-favoured nation basis. Special arrangements at the UK’s only land border with the EU seem to run counter to this principle. The government may be banking on the temporary nature of the proposed arrangements to protect it from challenge. Or perhaps it believes it can invoke exemptions to WTO rules on the rounds of national security.
Determined government, under-determined policy
The government’s proposals have received a mixed response, with many commentators pointing to the lack of consultation and analysis surrounding one of the UK’s first forays into international trade policy. The proposals reflect the Government’s determination to try and mitigate adverse effects on consumers while balancing narrower producer interests, as well as to try and exert negotiating pressure on the EU and other partners while also keeping sight of the concerns of poorer countries.
It is understood that factions within the government, notably the treasury, favoured a more ambitious strategy of unilateral liberalisation. Most economist would be in agreement that unilateral liberalisation is a sound strategy, and that in particular it should not be postponed on the grounds of bargaining power with other partners. The main challenge to the UK is that while liberalisation generates more gains than losses, the latter are concentrated while the former are more diffuse. This creates challenges of a political economy nature. Particularly at a time when the UK looks like it could take a hit in the markets of its largest export partners, and thinks it should persuade these partners to maintain continued access.
That such political economy concerns are driving policy are not a surprise and not unique to the UK. It is more that in the UK’s special case, the objectives are too numerous for one particular policy instrument like tariffs. The UK’s policy thus suffers from a serious problem of under-determination (too many variables, not enough equations). This under-determination explains why the government’s overall proposals are modest, even if the ambitions underlying them is not