The UK-EU Withdrawal Agreement and Political Declaration on Future Arrangements: Five Key Points for UK Trade Policy.

In perhaps the most significant development since the UK voted to leave the European Union in June 2016, negotiators representing the UK and the EU member states have struck an agreement on the terms of the UK’s withdrawal from EU membership. Accompanying that draft Withdrawal Agreement is a draft Political Declaration that provides a framework for the negotiations between the UK and the EU on a future arrangement. The ambition is for such a future agreement to be concluded in time for it to take effect by 31 December 2020. That is the date at which the transition period stipulated in the Withdrawal Agreement -under which current arrangements continue to apply, minus UK involvement in decision-making -is due to lapse. (The transition period itself can be extended once by common agreement to an as-yet unspecified date, sometime this century).

The text of the Withdrawal Agreement is yet to be approved by parliaments in the UK and the member states, an outcome which appears far from guaranteed. The agreement has already caused splits within the UK government: the Secretary of State for leaving the EU announced his resignation early the day after the agreement was signed, and others resignations have followed or are expected.

The main recent sticking point to the Withdrawal Agreement had been proposals to address the Irish border question. Or more precisely, how to accommodate the desire to avoid a “hardening” of the Irish border and the UK government’s stated “red-lines” of: exiting single market principles on free movement, reasserting control of over rule-making, leaving the EU’s customs union, and not having a separate regime for Northern Ireland relative to the rest of the UK.

The finalised draft states that the overall solution to the Irish border question will be addressed through the future EU-UK arrangement negotiated under  the Political Declaration. But it also sets out a “backstop solution” which would apply if the EU and UK fail to agree a solution that satisfies the requirements of the Good Friday agreement, by the time the transition period expires. The proposed solution to the Irish border question is thus directly linked to the shape of the future agreement. Indeed this is explicitly recognised in Protocol 2 the Withdrawal Agreement, which states the common objective of the UK and the EU to establish ambitious customs arrangements that “build on the single customs territory” – the single customs territory being the key concept in the “backstop” solution.

Many aspects of the Withdrawal Agreement and the accompanying Political Declaration merit attention. In the remainder of this article we focus on the implications for the UK’s trade policy.

Backstop to the future?

The backstop is set out in Protocol 2 to the Withdrawal Agreement, which along with its 10 Annexes accounts for 173 of the 585 pages of the Withdrawal Agreement. Ostensibly, Protocol 2 stipulates a single customs territory between the UK and the EU. But an examination reveals that it aims at much more than ensuring the flow of goods on a duty and quota free basis with low levels of administrative burdens at the border. The Protocol aims at retaining a deep level of integration between the UK and the EU.

Article 6 of Protocol stipulates that EU law as set out in Annex 5 shall apply to the single customs territory. Annex 5, which runs to close to 70 pages, then sets out the EU regulatory corpus on general matters (such as trade and customs, or the marketing of products) and specific matters, from animal health, to food safety, to motor vehicles to chemicals and pesticides. This entire corpus goes into the single customs territory. Other annexes specify the UK’s external trade policy regime vis a vis non-EU members, commitments on state aid,  commitments on environmental protection, commitments on labour standards, and commitments on fair taxation.

Many of these points are echoed in the Political Declaration on the future arrangement between the UK and the EU. Moreover given the Withdrawal Agreement’s statement that both parties share a common objective “of a close future relationship, which will establish ambitious customs arrangements that build on the single customs territory provided for in [Protocol 2]” it is hard not to see the provisions of Protocol 2 as setting out, if not the template, then the basis for future arrangements. If alternatives are to be found to the backstop, it is likely that one or more of the political red lines set out by the UK will need to shift.

The impact of the backstop on the UK’s trade policy

The Withdrawal Agreement and the backstop provisions under Protocol 2 carry deep implications for the UK’s trade policy vis a vis non-EU countries. Under the terms of the Withdrawal Agreement, the UK is permitted to negotiate free trade agreements with non-EU countries, provided these do not enter into effect before the transition period ends. The difficulty for the UK is that this permission is undermined by uncertainty surrounding the Irish question.

If difficulties in addressing the Irish question through a new EU-UK agreement delay the latter, and make it likely that an extension in the transition period will be triggered, potential trade partners will be wary of seriously negotiating with the UK, given uncertainties regarding when the transition would end. If the transition period is not triggered and the Irish question looks difficult to resolve, then agreements with non-EU trade partners would be constrained by the very limiting terms of Protocol 2, and especially its Annex 2.

The effects of Annex 2 on trade policy are far-reaching. Under the terms of Article 3 of the Annex, the UK is required to implement the EU’s Common Customs Tariff. It is specifically forbidden from applying duties that are lower than those applied by the EU to non-members. This means that the UK cannot negotiate on goods with the likes of say, Brazil, China, India or the US. It would need to focus – as far as good are concerned – on rolling over existing EU free trade agreements (with say, Japan, Korea or Canada).

But even on this score, the process could be complicated. The requirement to implement the EU’s Common Customs Tariff, and the free circulation provisions of the single customs territory,  mean that the UK must grant duty free or preferential access to exports from the EU’s external free trade area partners. In essence the UK would be committed to granting access to these partners before getting a commitment for reciprocal access for UK exporters. [1]

Whether these partners are willing to grant such reciprocal access if they know they can pocket access to UK markets “for free “ is open to question. Perhaps they might out of goodwill. Or they might ask for other concessions from the UK. At any rate they have incentives to hold off negotiating with the UK until it becomes clear whether the backstop applies or not.

Setting aside this issue, commitments to implement EU regulation may also constrain the UK’s negotiating position. For example, a requirement under Annex 4 to the protocol to implement the precautionary principle will constrain how far the UK could negotiate with countries, like the US, that do not recognise these principles.

The provisions of Annex 2 also extend to a slew of other areas of trade policy over which the UK could have expected to exert its control. This includes trade remedies (anti-dumping, countervailing measures, and safeguards), and trade preferences that granted to developing countries. On all these counts the UK would implement the EU’s approach. Trade preferences in particular had been a subject on which the UK had wanted to put into place significant innovations on leaving the EU, as part of its overall approach to aid and trade.

Services not included

The trade provisions under the backstop relate to goods. As such, they leave open the door for the UK to conclude services-only free trade agreements with the rest of the world. Even setting aside the backstop issue, the UK might be led to focus more on services than goods, especially if a desire to reduce administrative burdens at the border lead it to follow the EU’s customs arrangements vis a vis the rest of the world. This idea indeed seemed implicit in UK’s White Paper of July 2018, and the position papers it prepared in 2017 on trade.

Whether services only FTAs are a viable proposition remains to be seen. None have been negotiated on an international basis. Indeed, services coverage in free trade agreements outside the EU’s single market is notoriously weak. Commitments have focused mainly on reducing or removing the gap between commitments made at the WTO and actual regulations and policy, rather than pushing further liberalisation. Services are also increasingly embedded in manufacturing operations organised in global value chains: leaving manufacturing out of a trade deal may not be helpful to suppliers of services.  Setting all that aside, given the UK’s particularly strong position in services and generally liberal regulatory environment in services, it is not clear how enthusiastic trade partners would be for services only negotiations.

From “Canada plus” to “Turkey plus”, or Norway-for-now?

As already observed, the language of the Withdrawal Agreement proposes that a future ambitious customs arrangement that builds on the provisions of the single customs territory. That represents a change of tone on the part of the EU towards a position closer to that set out in the UK’s White Paper, and away from previous statements that the best the UK could expect outside the single market was an enhanced version of the agreement the EU struck with Canada (the “Canada plus” option).

The attraction of an ambitious customs arrangement (call it “Turkey plus”) that involves deep levels of integration on regulation, compared to the a Canada option is that it could mitigate the losses to the UK on its trade with the EU on goods. Those losses, compared to the status quo, could come to around 16% per year under a Canada arrangement purely on goods trade. The drawback to the “Turkey plus” approach is that it would probably infringe several red lines drawn by those most in favour of Brexit. These include the extent to which the UK aligns itself to EU regulation, and the extent to which the UK conduct its own external trade policy (for reasons already set out in point 2 above).

Ultimately, the issue regarding the UK’s ability to pursue its external trade policy depends on how far the political desire to do so is weighed against the economics of the UK’s trade position. As already explained elsewhere, the losses from moving from current arrangements with the EU to shallower (“Canada”-type) agreements will be very difficult to offset by signing free trade agreements with the rest of the world, unless truly heroic assumptions are made about the willingness of other parties to enter into agreements that essentially replicate, in their agreements with the UK, the elements of the EU’s single market. One of the reasons the UK Government (or at least the Prime Minister and her allies) are more open to a deeper agreement on goods trade even if it ties the UK hands on external trade negotiations is that they have internalised this point.

What other options are available? In the weeks leading up to the Withdrawal Agreement, there had been calls to consider a Norway-EEA type solution as a possibility, if only as a temporary solution (“Norway for now”).  That possibility seems less in evidence in the Political Declaration. That is partly because of the UK’s red line on the movement of people (and its willingness to leave the single market for services if it can leave single market provisions on free movement), and partly because of the focus on customs administration as part of the solution to the Irish border issue.

However, if the idea of a single customs territory proves too much to stomach, the Norway solution could be considered afresh. A commitment to free movement, besides having beneficial trade and economic effects, would obviously facilitate the process of keeping a soft border between both Irelands. A Norway solution would not involve common customs arrangements, but with regulatory alignment, customs controls could be done away from the border  – as the EU had previously suggested might be possible.  A Norway option would also present the UK with more flexibility in pursuing an external free trade agenda.

Still up for grabs: finance, fisheries, mobility, and a lot more

The Political Declaration calls for ambitious arrangements on services that go beyond the UK and the EU’s WTO commitments on services. That statement in itself is not particularly ambitious, since the WTO commitments are substantially weaker than the actual level of liberalisation implemented by both the UK and the EU. As already observed, the agreement between the EU and Canada improves on their respective WTO commitments, but does not change much when it comes to actual practice.  Moving from current single market arrangements to Canada- type arrangements could reduce UK services exports to the EU  by up to 30% per year, only a little less than if there were to be no services agreement at all.

The UK therefore has an interest in securing as deep a set of commitments in services as it can get. Financial services are clearly an important area to the UK. Indeed, access to the EU is not only important for UK-EU trade and investment in financial services, but also US-UK trade and investment since part of the attraction of London to US institutions is that it provides a base from which to supply the EU. The current proposal is for an equivalence regime. This could provide some security of access, but no more so than for third countries. Equivalence can be lost too, and not always for economic reasons[2].

Greater security would be provided by negotiating a specific chapter on financial services. One possibility, floated by the Irish Taoseach Leo Varadkar, is that the UK could trade off access to its territorial waters in fishing in return for better financial market access. Whether the political trade- offs of a “fish for finance” deal would work remains to be seen.

The issue of movement of people is partially addressed by the Withdrawal Agreement, which provides for rights of residence (or pathways to it) for UK citizens residing in the EU and vice versa. The Political Declaration contains a few summary statements on mutual recognition of qualifications, on arrangements for temporary entry and stay for business purposes, and “other aspects”.  The issue of mobility is one which, from a trade perspective, the UK should track closely. As explained elsewhere, losing the principle of free movement acts as a tax on the UK’s exports globally (both to the UK and the EU), and this is especially true in services sectors in which the UK has a strong position. Pursuing a more liberal track on mobility for a deeper set of arrangements on services would make eminent sense.

Conclusion

Coverage of the Withdrawal Agreement has been dominated by the provisions of the Irish backstop provisions. This is understandable given that it had been the primary sticking point, and given that the mooted solution has far reaching implications for UK trade policy. The backstop agreement is the primary driver of political angst in the UK, in both the “leave” and “remain” camps, and thus whether the Withdrawal Agreement will get parliamentary assent is unclear. At the time of writing, polling suggested that UK voters opposed the deal by a margin of 2:1. Polling also suggests that the deal would finish last in a three way referendum that presented staying within the EU and “no deal” as options (with the former commanding more support than the latter).

While the Withdrawal Agreement is unpopular, it reflects the efforts by negotiators to simultaneously avoid a disorderly Brexit process – and notably  significant disruption to businesses and citizens – while attempting to accommodate the UK’s red lines and the EU’s concerns to safeguard the integrity of its single market project. The difficulty in doing this explains the complicated nature of the backstop agreement. Both the UK Prime Minister and the EU are emphasising that the backstop need only be implemented as a last resort. But, in order to get to an outcome in which the backstop is not needed, a political shift would be required, primarily in the UK but also in the EU. The calculus made by the drafters of the texts may well be that, presented with the alternatives of a hard exit and an unpalatable backstop arrangement, such a shift may happen. But engineering political shifts through technocratic means is a hazardous process, and time will tell if that calculus leads to an improvement, or to an implosion

[1] This is sometimes known as the “Turkey problem”, reflecting the fact that Turkey implements the EU’s customs tariff and needs to grant duty free or preferential access to exports from the EU’s partners that enter Turkey via the Customs Union..

[2] The case of Switzerland’s stock exchanges being granted only short term equivalence is usually cited. The decision is widely attributable to Switzerland’s reticence to meet EU demands on a framework agreement covering the series of bilateral agreements between the two parties.