How do you work out a trade deal? If you are a party to one of the 280 or so other free trade agreements (FTAs) in the world, your starting point was the commitments you had made at the WTO. This is technically referred to trade on Most Favoured Nation (MFN) terms. You and other parties then decided how to expand on these commitments for goods and (usually) services, and various other matters (investment, competition policy, intellectual property and so forth).
But this is not the case for the UK and the EU-27. The starting point is that both parties are already part of a free trade arrangement, one that reflects 45 years of progressive integration. Indeed, the EU’s single market and customs union is the deepest free trade arrangement in existence, in terms of the extent of liberalisation it has generated (in services especially), and in the implementation of common rules.
Hence a key question: will negotiations over future arrangements start from the status quo and work on how far liberalisation is to be wound back? Or will negotiators follow a “tabula rasa” principle and start from the assumption that the baseline is MFN trade, and work upwards from there as in a standard FTA negotiation.
The political declaration on the framework for the future relationship between the UK and EU splits the answer between the two. On goods, it will be the first route. The idea is to preserve a deep level of integration, while recognising this will not be the status quo. The text recognises that the two parties will be separate markets with distinct “legal orders”. But it also calls for “comprehensive arrangements” that will facilitate the movement of goods; and “a free trade area with deep regulatory and customs cooperation”. Recall also that the provisions of the “Irish backstop” in the Withdrawal Agreement (a legally binding document, unlike the political declaration) sets out a single customs territory as essentially the default option on goods. Given that the political declaration also aspires to build on the single customs territory, then we can see that the approach is to start with current arrangements and work from there.
On services, it will be the second route. Indeed the text is explicit that the UK and EU will begin with their WTO commitments, and commitments made by the EU in its existing FTAs, and work from there. The text refers to Article V of the GATS, which sets out the basic requirements for two WTO members trading on MFN terms that seek to embark on FTA negotiations.
As noted elsewhere, this not a very ambitious starting point. There is a considerable gap between WTO commitments and the services trade regimes EU member states currently apply to non-EU parties, and EU FTAs essentially focus on closing that legal gap, rather than extending the level of liberalisation to anywhere near what is practised in the single market for services.
The position on services is largely explained by the UK’s decision to withdraw from the commitment to free movement of people (the declaration pointedly notes that it is the UK decision and not a joint one), and the EU’s insistence on the indivisibility of the four freedoms underpinning the single market. As explained elsewhere, the UK’s White Paper had proposed a bargain under which it would accept leaving the single market for services if it could leave single market requirements on free movement. The political declaration reflects that, and also reflects the White Paper’s proposal for specific negotiations in services sectors of particular interest – notably financial services and aviation.
Meeting May in November
The two-track route – i.e. EU-minus for goods, WTO plus for services – set out in the political declaration is more reflective of the UK Government’s White Paper proposals than it is of the EU’s guidelines of March this year, which essentially set out a WTO plus approach across the board. Of course there is a quid pro quo: in return for playing along with the White Paper’s general approach, the declaration departs from it on certain key points of detail: for example, references to a common rule book are replaced with references to the UK considering alignment with EU rules; the language on financial services is weaker. And beyond that, inserting into the Withdrawal Agreement the single customs territory as a default outcome, and to call for level playing field requirements (i.e. harmonisation of environmental, labour, tax and state aid provisions).
In doing so, the EU is undoubtedly signalling that it regards the Prime Minister as the only serious interlocutor in the UK, both within her party and more generally across UK politics, a perception undoubtedly reinforced by the political reaction in the UK to the draft Withdrawal Agreement. Observers within the EU have not missed that whereas in general, the negotiations the EU enters into are complicated by the need to secure agreement across its members states, in this case (aside from very specific matters like the status of Gibraltar or fisheries issues), internal wrangling across 27 EU member states, with a collective population of around 450 million people, has been much more limited and much less visible than squabbling between a subset of politicians in one party in the UK.
As with any statement at the outset of negotiations, the political declaration sets out objectives and aspirations and a framework for them. Those who dismiss the declaration on these grounds and talk about a “blindfold Brexit” largely betray their own inexperience in negotiations. Negotiators wisely refrained from negotiating the outcome at the start. That is a temptation all negotiations must avoid. But it is especially important in this context given that political uncertainty in the UK (in particular, but not exclusively) can cause the set of outcomes that can be plausibly delivered to shift. And also given that pre-empting outcomes at this stage could threaten the acceptance of the Withdrawal Agreement, an outcome both sides are very invested in avoiding.
Infact the text of the declaration incorporates flexibility precisely because it recognises that further time, and political decisions, will be needed to work out how various trade-offs play out. Take for example, paragraph 28, which deals with the question of checks and controls. The more intensive these are, the greater the economic costs in terms of burdens faced by cross-border supply chains, and political costs in terms of frictions on the border between the two Irelands. The costs could be reduced through greater UK commitments on customs and regulatory cooperation, but that will be governed by another set of trade-offs and the economic and political calculus that goes with these. Paragraph 28 therefore rightly envisions a spectrum of outcomes, which at this stage is all that can be done.
So what are the main trade-offs that need to be worked out on goods and services?
On goods, there remains an innate tension between the aspirations of the UK to run an independent trade policy (which the declaration elevates to the status of being one of the key things people voted for in voting to leave); the aspiration to have minimal checks on cross-border UK and EU trade, and the resolution of the Irish border question. (This issue is reviewed in greater detail here). The default trade arrangements set out in the backstop provisions of the Withdrawal Agreement would secure the second and third of these and dispense with the first. (But note that even without the Irish question, the first two objectives would be in tension.)
Therefore, the question becomes whether and how, in line with the objective of building and improving on the single customs territory, it would be possible to develop an independent trade policy. One option would be to pursue maximum regulatory alignment, which would remove some of the required checks on cross-border UK-EU trade. But that would require a political sacrifice: giving up large parts of the “take back control” agenda. It would also mean that the UK would need to pursue trade agreements with partners whose regulatory systems are not fundamentally at odds with the EUs and/ or do not seek commitments on regulation. That would rule out, or make very difficult, a FTA with the United States (which, for political, more than economic reasons, is seen as a prize by some politicians).
But even regulatory alignment would still require some border checks, notably to enforce rules of origin, in those cases in which the UK signs trade agreements with parties that have not entered into free trade agreements with the EU, and if the UK implements different MFN tariffs to the EU. Besides any economic costs associated with these, there remains the question as to whether the implementation of these checks leads to a hardening of the Irish border. It may not, if the checks can be held away from the border and/ or the as-yet unknown technological solution referred to in paragraph 27 of the declaration reveals itself.
Paragraph 23 of the Declaration, which sets out the objective of building on the single customs territory, would “obviate the need for checks on rules of origin”. This is true, but, as with the backstop provisions, it would remove the possibility of the UK pursuing its own trade policy. Unless the “independent” trade policy consisted in mirroring the EU’s i.e. striking the same agreements on goods with the same partners.
The discussion gives an idea of the parameters that determine where on the spectrum of outcomes referred to in paragraph 29 the parties will land. The prominence given to an independent trade policy is a recent development, since (as opposed to the issue of free movement), this matter did not feature prominently in pre-referendum campaigns. Economically, the costs of losing deep integration on goods with the EU will be difficult to compensate for by striking free trade agreements with other partners (certainly if they are of the Canada FTA type). In any event, with only fledgling capacity in trade negotiations, the UK will have its work cut out in simply rolling over those free trade agreements to which it is already party via EU membership.
If the objective of an independent trade policy is to be pursued, political capital will need to be spent on securing deeper regulatory alignment (acknowledging that this itself can constrain trade policy), and probably by seeking more liberal provisions on the mobility of people. Both would reduce needs for checks at the border; leaving origin checks as the main question to be tackled.
The section on services needs to be read in conjunction with the section of the declaration on mobility. There is a natural interface between the two: the movement of people is identified as a mode of services supply. And politically, the WTO plus approach for services is explained by the UK’s withdrawal from free movement provisions. The declaration’s pointed statement that this is the UK’s decision leaves open the possibility that if there were political shifts in the UK that led to this position being reversed, a flip from a WTO-plus to a EU-minus approach on services may be possible.
Because mobility is so closely intertwined with services, moving to MFN terms with the EU on the question of mobility will have significant impacts on the UK’s services exports. The mobility provisions in the declaration are designed to mitigate these, but how far they will depend on the content of what is agreed. Agreements on mutual recognition of qualifications (addressed separately in the declaration) is also a key issue, and on this the declaration confines itself to a broad statement of intent.
One of the complications of negotiating services on a WTO-plus basis with the EU is that many of the restrictions are defined at the level of EU member states. This is particularly true in professional services such as a law and accounting. EU free trade agreements (such as the one with Canada) typically set out country annexes stating limitations on the provision of services. For example in legal services, there may be EU or EEA nationality conditions that determine the ability and conditions under which legal services are provided, and the way in which these apply differ between, say, France, Germany and Italy.
More generally, restrictions on services are deeply emmeshed in the regulatory and legal architecture of member states, which is one reason why even the EU’s own single market on services is still a work in progress. Deepening commitments in the various areas in which there are national reservations will be a very strenuous undertaking. But it is very important one: the economic difference between commitments on services that are close to single market ones and those that are more along the lines of, say, a Canada type free trade agreement, could be worth upto 30% of the UK’s annual exports to the EU.
The crux of the issue is that working one’s way to close to current levels of integration in services from a WTO baseline is a very tough ask. It certainly hasn’t been attempted outside the EEA or the EU accessions process. It is one of the many curiosities of the political debate in the UK that so much time has been taken by the issue of trade in goods, when the economic impact of what happens in services will be much more significant given that services account for 80% of the UK’s GDP, and collectively are the fastest growing component of the UK’s trade.
A specific chapter on financial services is to be negotiated on the basis of equivalence. Both parties are supposed to complete equivalence assessments by June 2020. Because of the importance to the UK of financial services, there is a possibility of wrangling over equivalence as a way of extracting bargaining leverage on other matters. A similar possibility is raised by the timelines for equivalence in another area, that is critical to cross-border services flows, namely data. Here the approach is to finalise equivalence by the end of the transition period.
The economic impacts
Taken together, the backstop agreement together with the political declaration specify a deep level of integration on goods, and a shallower one on services, as the default position for the UK and the EU. This is what will apply unless the UK and EU can agree to other arrangements, by which we mean deeper arrangements on services (given the commitment to “build and improve” on the provisions of the backstop. The economic effect of the default is to put a floor on the losses that the UK would suffer on leaving the EU.
This is demonstrated by the chart below, which shows the export losses from various exit scenarios that involve the UK leaving the EU single market. The right hand bar shows the effects of a “hard exit”, the middle bar the effects of the UK and the EU entering into a conventional FTA (of the sort that exists between the EU and Canada). The left bar represents the effects of a deep agreement (EU-minus) on goods (and a shallow, WTO -plus agreement on services) of the sort envisioned in the default arrangements contained in the Withdrawal Agreement
The modelling results are consistent with those released by HM Treasury on 28 November that also projected that the package made up of the Withdrawal Agreement and the political declaration was the one most likely to limit losses of those scenarios involving an exit from the EU.
The Withdrawal Agreement and Political Declaration reflect painstaking negotiations on either side. They show a willingness by the EU to accommodate the UK government’s position expressed in the White Paper. The package represents a default option that puts a floor on the economic losses the UK would suffer on leaving the EU (and by the same token those losses the EU would face).
In order to improve on the default outcome, the UK would need to give close consideration as to how it manages the various tensions between its policy aspirations. This in turn could require revisiting some if its red-lines.
 In force, notified to the WTO and recorded in its database
 Colloquially and misleadingly referred to trade on WTO terms. Misleadingly because preferential trade under FTAs must also satisfy WTO rules governing FTAs.