Trade facts the UK Government has to face

A central plank of the UK Government’s Brexit policy is to re-establish an “independent” UK international trade policy following more than forty years of integration into the Common Commercial Policy (CCP) of the European Union.  This would have been hard enough technically, even without the ill-tempered stand-off into which the Brexit negotiations have now declined.  Regardless of how Brexit happens – whether via a “no deal” scenario or on a negotiated basis – trade remains high up the UK national and international negotiating agenda.  This article reflects on some key political and legal facts which the UK Government must inevitably confront.

1. Brexit means tariffs

If the UK does leave the EU on October 31 (or any other date) on a “no deal basis” “it  will automatically find itself outside the EU’s Common Customs Tariff (CCT), and there will be no agreed basis for negotiating a future agreement.  From Brexit day +1 all UK exports to the EU of items which are subject to duties under the CCT will be subject to the full weight of those tariffs. This, it is now widely recognised, would be seriously damaging to many if not most of the UK producers and exporters concerned including UK-based car manufacturers and many agricultural sectors.  There would be no transition period for phasing in the impact of the tariffs which Customs authorities in the EU member states are already geared up to impose, since imports from the UK would immediately be treated as imports from any other country with which the EU has no preferential trading arrangements are treated. Moreover, from the date of Brexit (whether under a deal or on a no deal basis) the UK would lose preferential access to partners with which the EU has negotiated Free Trade Agreements, unless that partner has explicitly agreed a replacement arrangement.

Trade in the opposite direction is a different matter.  How, following Brexit, the UK side may choose to treat imports from the EU for tariff purposes is a decision for the UK Government alone.  As an individual member of the World Trade Organisation (WTO) the UK is obliged to deposit with the WTO for scrutiny draft Schedules of tariffs and other import charges.  It did this some time ago, and in order to minimize the risks of disruption the proposed Schedules reproduce as far as possible the tariff rates specified in the EU’s CCT, which the UK currently applies.

2. Tariff concessions are double-edged

However, in order to mitigate the price shock of sudden imposition of tariffs on imports from EU sources that are currently duty-free, the UK has also put forward proposals for a temporary suspension of tariffs on more than 80% of items dutiable under the draft Schedules.  Under the non-discrimination rules of the WTO the UK will be obliged to grant exactly the same tariff treatment (including rates of charge and tariff administration) to imports from all countries with which it has no preferential agreements  (the so-called “most-favoured nation” rule).  The temporary suspension for imports from the EU would therefore have to apply also to UK imports from the United States, Canada, Australia, New Zealand, Japan, China and dozens of other trading partners.  If activated in practice, it would in the longer run cause severe problems:

• There is no indication of how long the “temporary” suspension would last. It’s a basic fact of political life that once an important concession has been granted, in trade as in any other sphere of activity, it is much harder to take it away again.  And even if the “temporary” suspension got extended, it would still not provide UK importers and domestic producers with a stable basis for future investment.

• The suspension would open much of the UK’s agricultural production, particularly in the beef, lamb and dairy sectors, to tariff-free competition from powerful and efficient exporters in North America, Australia and New Zealand. Coupled with the grave impact on UK agricultural producers of new tariffs on their exports to the EU, this would be a destructive double whammy for much of UK agriculture.

• The UK would at one stroke have given away much of its bargaining power in international trade negotiations which, as far as trade in goods is concerned, still centre to an important extent on tariffs. For example, Canada has declined to “roll over” for the post-Brexit UK the terms of its recent comprehensive trade liberalisation agreement with the EU. This may be because it perceives, at least in the short run, that unilateral tariff suspension by the UK would be worth more to Canadian exporters than a roll-over for the UK alone of the full terms of the EU-Canada agreement.  Why should Canada or any other trading partner engage in laborious negotiations for a complex trade agreement with the UK when at least for a while it could get the central concession for free?

3. Compensating for the impact of tariffs on UK traders won’t work

Various suggestions have been put forward from Government and pro-Brexit sources for special financial measures to mitigate the impact of EU tariffs on UK exports.  For example, it has been suggested that the UK Government might reimburse to UK exporters an amount equivalent to the duty their exports would bear on entering the EU, so as to enable them to avoid increasing their sale prices in the Union.  Apart from the open-ended and potentially huge expenditure commitment entailed in such a proposal, export subsidies of all forms, including such direct payments, are banned outright by the WTO[1] and alleged abuses are subject to the detailed procedures of the WTO disputes system.

Faced with the alarming potential impact on UK farmers of effective destruction of much of their trade into the EU through the imposition of tariffs, and of the removal of tariffs on imports to the UK from other competing sources, the Government has recently suggested the creation of a form of intervention scheme which would involve buying up otherwise unsaleable stocks at predetermined prices.  This could probably avoid international challenge (because it would not involve direct subsidy to exports) but it would be politically unviable in any but the very short-term because it would involve spending a lot of money effectively on rearing livestock to be killed and burned or buried.

4. Trade agreements are about a lot more than tariffs

If the issues with tariffs are sobering enough, consider also that tariffs now really only represent the tip of the iceberg when it comes to trade. The main issues now lie behind the border in regulation. Regulation can increase the cost of producing goods and services, and/ or create barriers to entry and competition. But because regulation is usually enacted to correct some sort of market failure (negative environmental impacts, health hazards, lack of information to consumers) it also delivers public benefits. The key is to ensure that the benefits exceed the costs. This is often a tricky calculus, and one that also depends a lot on social preferences regarding risk. Good regulation is thus heavily context dependent. This makes negotiating over regulation technically tricky, and politically contentious. This is most obvious in sensitive sectors such as health care services, or food security.  Any deep free trade negotiation with partners like the United States that have fundamentally different approaches to regulation would therefore require deep seated changes to domestic regulation (particularly if the UK is obviously the lesser partner in the negotiation).

     5. Trade negotiations are hard and take time

There is no such thing as an easy trade negotiation.  Each participant carries a heavy baggage of national aspirations and specific sectoral and civil society interests. This the case even if the basic aim is to “roll over” or adapt the content of an agreement made on a different basis or with different participants.

The UK Government embarked on Brexit with repeated public assertions that it would be easy to secure continuation for the UK alone of the substance of more than 40 EU preferential trade agreements with other countries, so as to avoid any disruption of UK trade with those markets.  This was always a vain hope, because each individual trading partner or organisation involved would be bound to consider carefully what particular interests to pursue in negotiating bilaterally with the UK, and on the other hand what domestic interests it might wish to protect from specifically UK competition; so that effectively a rollover negotiation must become a negotiation of substance.  It is therefore vital to understand the objectives and priorities of the other side as well as, or even better than, your own.  These issues are discussed in detail in our articles respectively on An ABC of trade liberalisation negotiations, and What do we mean by free trade?

In practice, several months on from the original Brexit date of March 2019, the UK has still secured rollover of only 12 of the EU’s existing preferential agreements, mainly less important ones, plus an agreement in principle (not yet signed) with Korea.  Canada, as noted above, has poured cold water on the process by refusing to roll over the terms of its major agreement with the EU on the basis that, in the immediate term at least, it has more to gain from the UK’s proposals for temporary suspension of import tariffs.

       6.Transatlantic tension

Beware of assertions by the United States that an easy UK/US trade deal is there for the taking!  Even if that were true, it would be on American terms, with the post-Brexit UK very much the weaker partner.  US politicians, including President Trump himself, may hold out the prospects of a quick deal; but the detailed negotiating process would be in the hands of the men and women of the United States Trade Representative’s Office (USTR), who are the most hard-nosed negotiators in the business.  In February 2019 USTR issued a 15-page summary of “specific objectives” for negotiations with the United Kingdom.  A similar list has been issued for renewed US trade negotiations with the EU.  In both cases the demands listed amount effectively to a complete, and politically and legally impossible, rejigging of the EU and UK economies and regulatory systems on the basis of US standards and procedures.  The Obama Administration’s constructive attempt to negotiate a Transatlantic Trade and Investment Partnership (TTIP) a few years ago foundered inter alia on European objections to opening the EU market to genetically modified produce and US meat products produced by processes that are banned in the EU and, in the specific UK case, to US demands to open up National Health Service procurement to full US competition.  These issues have not gone away and will dominate any specific UK-US negotiation which may take place post-Brexit.  And at the time of writing President Trump himself has said that a US/UK trade deal will be conditional on the UK’s removing the “digital tax” imposed to ensure that major international IT corporations pay their fair share of tax in the UK.  The UK could not possibly agree to this.  The auguries for a comprehensive US/UK trade agreement do not look good.

      7. Trade isn’t just about agreements

Reduced or zero tariffs, streamlined electronic filing of customs and other required declarations, and “single window” checking procedures greatly facilitate the flow of trade, as the ease of doing business among the EU member states demonstrates.  But updated procedures can only smooth trade, not create it.  Export success depends upon the quality and reliability of products and services, on competitive prices, prompt delivery, efficient help with installation, and good after-sales care.

For the UK, the loss of a probably substantial part of its current trade in established EU markets may be partially offset by growth in new or expanded markets in non-EU countries, whether or not the UK manages to secure preferential bilateral deals with those markets.    But agreements between governments can only lay a foundation for trade.  What delivers enhanced sales is the long-term hard graft of market research, product development, honest salesmanship and care for the client.  That has long been understood by the UK Government’s export promotion services, and it will be even more true following Brexit than it is now. Moreover, as we have documented elsewhere, access to skills and services inputs is a particularly important driver of competitive strength for businesses. The estimated adverse impacts on British businesses of losing access to the EU single services market and to the EU work force are likely to be significant.

         8. Don’t misquote the WTO (1)

Too often, Brexit-supporting UK politicians and journalists tend to refer to “WTO terms” as though these constituted a comprehensive structure for the conduct of international trade.  They don’t.  The WTO, which has grown steadily since the first signature of the General Agreement on Tariffs and Trade (GATT) in 1947, has two main functions:

• It lays down, in a set of highly-developed technical Agreements, agreed basic rules which discipline the many ways in which national governments seek to intervene in and influence international trade, for example by tariffs or quantitative restrictions, the discriminatory award of subsidies and manipulation of standards to discourage imports. It has developed an elaborate mechanism for settlement of disputes in the event of alleged abuse.

• It provides a forum for the progressive reduction, aiming at elimination, of tariffs and physical restrictions on international trade in goods, and of regulations which unfairly limit market access for international services suppliers.

These days, with the WTO now counting 164 member countries and territories, what is really important for the development of trade is the measures of trade liberalisation and development which countries undertake over and above the basic WTO rules – for example in 301 regional preferential trade agreements that are currently in force[2] covering pairs or groups of countries.  Some of these – and the preeminent example is the EU – go far beyond WTO rules in order to lay down a positive environment for trade development benefiting their members, including tariff-free trade.  The UK recognises that following Brexit, the basic disciplines and protections of the WTO, though an essential safety-net, will not be nearly enough to create the positive and dynamic new environment for UK trade which Brexit-supporters want to create.  That is why Britain wants to recreate for its own account the structure of international trade liberalisation measures which it already benefits from as a WTO member, and indeed to develop that structure further. Meanwhile the WTO’s functioning has been seriously weakened by rising protectionism and breaches of the rules particularly by the US, and at a crucial time for the UK that does not serve the UK’s interest.

       9. Don’t misquote the WTO (2)

Senior British politicians including the current Prime Minister have widely claimed that something called “GATT 24” would permit the UK and the EU to suspend the introduction of customs tariffs against each other’s trade while the two sides negotiated a long-term free trade agreement at their leisure.

This is untrue.  What is referred to is Article XXIV of the GATT, which lays down the criteria for negotiated customs unions or free trade areas in goods to be acceptable in the light of the WTO rules.  The key criterion is that the parties should remove all tariffs and trade restrictions on “substantially all” the trade between them in goods which they produce.[3]  Participants in a free trade area should not increase the aggregate of the protection which together they previously had in place against the trade of non-members.  The key point is that these criteria apply only after an interim or final agreement has been settled between the parties and when all its terms are known.  Only at that point do whatever provisions have been agreed for reduction or removal of tariffs and other trade barriers between the parties kick in.  During the period of negotiations all the previously existing trade measures applied by the parties, including tariffs, remain in place.

So not only could the UK and the EU not apply zero-rate tariffs to each other during renegotiation of long-term trade relations; if they did so, the basic GATT/WTO non-discrimination rules would require them to apply zero tariffs to their imports from all other WTO members as well.  While the UK Government seems prepared to do something like this unilaterally, EU member states assuredly would not be so willing.

This particular misstatement of GATT provisions has been publicly corrected by many international trade experts plus the Governor of the Bank of England and the former Secretary of State for International Trade, Liam Fox; but it still gets trotted out by enthusiastic Brexiters.

Envoi

These are just some of the hard economic and political facts which UK ministers face in trying to dismantle and rebuild the UK’s international trade relations.  Others will emerge, including no doubt some that have not yet been thought about.

[1] Agreement on Subsidies and Countervailing Measures: Article 1, Article 3 and  Annex I

[2] Source: WTO website

[3] The term “substantially all” has never been satisfactorily defined, but as a rule of thumb it could be held to mean about 90% of trade under the agreement concerned.