Three reports on Brexit came out last week. Two of them were risible. The one by Economists for Free Trade (the re-branded Economists for Brexit), advocating what trade expert Samuel Lowe called “unilateral tariff disarmament“, has been well and truly ripped to pieces, even by Leave supporters.
In a similar vein, a report by the Institute of Economic Affairs assured us that we will still be able to trade tariff-free with the EU after Brexit, even without a free trade agreement. This, as Samuel Lowe said, is simply wrong;
Wrong. Absent a FTA WTO rules requires EU to levy same import tariff on UK goods as it does all other countries w/o preferential agreements. pic.twitter.com/9GfwwyfdzD
— Samuel Lowe (@SamuelMarcLowe) August 18, 2017
Once the UK leaves the EU, the EU is obliged by WTO rules to apply the same tariffs as it does to any other country without a free trade agreement. It can’t do anything else. Even I, merely an enthusiastic amateur, understand this.
Neither report is worth dwelling on but, sadly, that’s just what a lot of the media did. As a result, a report with proper evidence, by people who know what they are talking about, was blown out of the headlines. In case you missed it, which you might have done with all the fuss about the other reports, the Institute for Government’s Frictionless Trade? explains why all the UK’s post-Brexit options will make trade more difficult than it is now and why, even so, some options are better than others.
Essentially, there are three reasons why EU countries operate customs checks on imported goods:
- To impose tariffs and quotas;
- To confirm the imports’ country of origin;
- To ensure compliance with EU regulations.
A free trade agreement (FTA) would get us over 1 but not 2 and 3. Therefore, even with a FTA with the European Union, goods coming from the UK would still be stopped at EU customs posts.
The EU needs to check on the origin of goods to stop people using countries with FTAs as a back door to the EU. Let’s say the UK negotiates a FTA with the EU and one with the USA but there is still no FTA between the EU and USA. Without customs controls for UK goods, it would be easy to export goods from the USA to the UK and from there to the EU without paying tariffs.
A customs union would get us over point 2. By levying a common external tariff, the EU could be sure that any goods imported into the UK have already paid tariffs, so there is no need to check for their origin.
But that still leaves point 3. The EU has strict rules (those famous EU regulations) especially on the import of food. Without inspections to confirm compliance, again assuming the above scenario, what would stop US companies exporting GM foods, hormone injected beef and chlorine washed chicken into the EU, via the UK?
To satisfy point 3, the UK would have to shadow EU regulations, effectively remaining part of the single market, with all the obligations that entails, such as free movement and payments to the EU. Once we do that, there is really no point in leaving the EU at all.
There is a 2.5 option, a customs union with a series of Mutual Recognition Agreements on standards, which could significantly reduce the amount of border checks but it would not eliminate them completely. This is what Michael Barnier meant when he said that there could not be frictionless trade once the UK had left the EU. Much of the discussion about the UK’s post Brexit relationship with the EU has focused on free trade agreements and tariffs but that is, at best, one third of the picture.
Whatever option we end up with, there will be significant disruption to supply chains. As the Institute for Government report says, the UK is not an island factory. It has been in the single market for 24 years and the EU for 44. This has enabled companies to specialise and so many have become part of European-wide supply chains. As a result, many of the UK’s exports are dependent on imports.
It is increasingly the case that, to export, the UK imports. In 2011, almost a quarter of the value of UK exports came from imports (up from 18% in 1995; see Figure 3). In those sectors where the UK is more closely integrated into a global value chain, the figure is significantly higher; 44% of the value of UK car exports comes from imported products.
Of the UK car industry’s car industry’s £64 billion output, £12 billion is spent importing goods from the EU. A third of its exports to the EU are in the form of parts to go into other EU made vehicles.
So although we might talk about making cars in Sunderland, for example, it is just one part of an international factory floor. Parts enter and leave multiple times on their journey towards coming together as a finished vehicle.
In most UK manufacturing sectors, trade is deeply integrated with the EU. Brexit therefore brings considerable risks:
This integration – and the economic activity arising from it – is what is at stake when we describe the risk of introducing costs into UK–EU supply chains.
The UK’s integration into global supply chains ows in two directions:
- downstream integration – parts or inputs imported by the UK from other countries to be used for further production
- upstream integration – parts or inputs exported by the UK to other countries to be used for further production.
In some sectors, this level of integration is extremely high, some two-thirds to three-quarters of their supply chain.
Any disruption to this value chain will increase costs. Many companies now operate on a just-in-time basis and don’t have much slack to allow for delays. Companies within the EU can mitigate this risk by sourcing more of their parts from other EU countries, where there is very little chance of a truck being stopped. They have plenty of other countries to choose from. UK companies, on the other hand will have to swallow the increased costs at the same time as losing markets in the EU.
As the IFG points out:
[E]ven minimal increases in the cost of moving individual parts back and forth across the EU–UK border could accumulate into significant overall increases in the cost of finished products. A study by Oxera in June 2016 found that around 8% of the cost of importing goods by sea arose from customs clearance.
Nissan and Jaguar, two of the UK’s largest car makers, hold only two hours’ of stock of some items at their sites, in order to minimise inventories and save on costs. Even the threat of delays would mean the companies would have to invest in holding more inventory or localising suppliers. UK suppliers of parts face the risk of missing out on ‘just-in-time’ contracts if they cannot guarantee delivery on time.
And finding markets elsewhere won’t make up for the loss.
There have been suggestions that any decrease in trade with the EU as a result of Brexit could be offset by an increase in UK trade with other partners. There are many problems with this approach, not least that the sheer size of the EU market for UK exports means that a small percentage decrease in EU trade has to be offset by very large percentage increases in trade elsewhere.
But that pivoting strategy will be even more di cult for UK exports of intermediate products. A nished car can be sold to an Australian or to a German. But a car part can only be sold to countries that have car factories – which Australia doesn’t. As we have seen, cross-border supply chains often mean that countries specialise in particular parts of industries and the industry of another country may not be adapted or may have no need for specialised UK products.
You can’t sell parts to people who don’t make stuff.
A free trade agreement, even one like the EU has negotiated with Canada, would remove the need for customs checks because the EU would want to confirm rules of origin and regulatory compliance. The report gives an example from the chemical industry.
Steve Elliott, Chief Executive of the Chemical Industries Association, has stated that ‘the cost of providing the technical proof that a chemical or any other manufactured product originates from the EU or the UK, bearing in mind that in our case there could be several stages of synthesis involved … would clearly outweigh the benefit of duty-free sales.
And the result of this:
A range of estimates collected in the Trade and Investment Balance of Competence Review shows that ‘British firms would be exposed to a combination of administrative and compliance costs linked to rules of origin, ranging (based on existing estimates) from 4 percent to perhaps 15 percent of the cost of goods sold.
Enough to make customers in the EU look elsewhere.
As Frances says, there is something very nineteenth century about a focus on tariffs and free trade agreements. The UK economy in 2017 doesn’t work like that any more. It is no longer the workshop of the world. It is a section within a vast production line that stretches across Europe. Disrupting that will do severe damage to all its parts but it will be easier for the rest of the EU to repair its parts than it will be for us to repair ours. The more obstacles we put in the way of trade, the worse it will be. Whatever happens, this is going to cost us dearly.