The BBC’s Adam Fleming reported today that the EU’s trade commissioner hasn’t yet started preparing for trade negotiations:
EU Trade Commissioner @MalmstromEU says “presumably” DG Trade will negotiate a post-Brexit Free Trade Agreement with the UK but her department has done no preparatory work because it hasn’t received a mandate from the European Council.
— Adam Fleming (@adamfleming) April 18, 2018
Katya Adler said something similar yesterday:
[T]his is another reason for the rather laid-back atmosphere in Brussels Brexit circles right now – EU insiders think much of the detail and substance governing EU-UK future relations will actually be worked out after the UK leaves the bloc in March next year.
Perhaps the clue to this is in the report by Institute for Government last month on the views of the EU 27:
The Single Market matters more than the UK market to EU27 governments and businesses.
[T]he other member states mean it when they say that maintaining the integrity of the EU and its Single Market is their priority.
[T]here are many reasons why the EU27 will want a close future relationship with the UK, and they will all have their own priorities. That does not mean that the consensus that has prevailed so far will crumble. All member states share an interest in a deal that protects the integrity of the Single Market and the stability of the EU.
The integrity of the Single Market is a phrase we hear often from the EU but one to which a lot of our politicians and commentators don’t seem to have paid a lot of attention. There are good reasons for wanting to preserve it though. When it works in sync with the EU’s Customs Union it enables trade to flow freely in a way it does nowhere else in the world.
Outside the EU, trade is a lot more complicated. Many people seem to think that leaving the EU will free us; that there is some state of nature where countries trade freely with each other. The truth is that, in international trade, the state of nature is nasty and brutish. Historically, countries have restricted trade. They have protected their home markets and imposed tariffs, quotas and regulations on others. Over time, through trade agreements and the World Trade Organisation, these barriers have started to come down.
The EU has taken this process further than most. Its Customs Union removes tariffs and its Single Market harmonises regulations on goods and some services. The combination of these two systems removes the need for border controls. Common tariffs are charged and common standards enforced at the EU border so once something is inside the EU, whether as a finished product or a component of another product, it can be moved freely. It is therefore possible to put goods on a truck in Manchester and drive them to Munich, then pick up another load and come back again, without being stopped. One way to think about the EU is as a system of immunity. It provides a space in which the usual constraints of international trade do not apply.
It therefore follows that once a country leaves the EU it loses that immunity. There is much talk of the EU threatening to put up barriers once the UK has left. That is back-to-front thinking. Once the UK leaves the EU, the barriers that exist in the normal course of international trade will reappear. By placing itself outside the system, the UK loses the benefits of that system’s removal of tariffs and regulatory barriers. The EU’s border will move and the restrictions that apply to other countries will then apply to the UK.
But couldn’t we just decide not to check goods that cross our borders with the EU? After all, we have the same regulations as the EU at the moment so what’s going to be different after 29 March? Wouldn’t that solve the problem in Ireland too?
Unfortunately it’s not that simple. WTO rules mean that countries can only offer preferential trading terms as part of a trade deal. As the Institute for Government explained last year:
[T]hough there is scope for flexibility to unilaterally apply a lighter-touch regime, the UK would be unable to liberalise its borders for EU imports completely.
First, under World Trade Organization (WTO) rules, unless the UK is prepared to drop tariffs for all imports, it will have to collect duties on EU imports.
Second, as a member of treaty organisations such as the WTO and as a signatory of the TBT (Technical Barriers to Trade) and SPS (Sanitary and Phytosanitary) agreements, the UK would be bound by the principle of non-discrimination when it comes to applying regulatory checks.
In other words, if you drop tariffs for one country you have to drop them for everyone. The same applies to regulatory checks. If the UK decided not to implement checks on the Irish border it would have to stop checking imports from anywhere or else, sooner or later, someone would bring a legal challenge to the WTO. As the FT’s Alan Beattie pointed out:
If the UK discriminates in this way, it will be vulnerable to widespread litigation in the WTO. This will come at a time when the UK is attempting to regularise its position in the organisation, in which it has hitherto been represented by the EU. The UK is dependent on the goodwill of other WTO members in the tricky question of splitting the EU’s existing commitments on food import quotas. It must also establish its position in the WTO’s government procurement agreement which gives its companies the right to bid for public tenders abroad. Arriving on the scene while creating one of the biggest breaches of WTO law in the organisation’s existence probably isn’t the way to get other countries on side.
The same applies in the opposite direction. The EU would be obliged to treat UK exports the same way as any other and therefore subject to customs and regulatory checks. It is not that the EU would ‘slap’ tariffs and checks on British goods. They would simply appear as a consequence of our withdrawal from the customs union and single market.
There is no free trade deal that can magic these borders away. A zero tariff agreement on its own would not remove the need for border checks. Regulatory and rules of origin checks would still need to be applied. Once the UK leaves the customs union and the single market there will have to be border checks.
Which is why the EU is very reluctant to allow the UK to ‘cherry pick’ which bits of the single market it wants to be in. Once the UK starts doing trade agreements with other countries it will mean that goods that don’t conform to EU standards will be circulating in the UK. That means there is a risk of those goods crossing borders and so there will need to be border checks. A country can’t be half in and half out of the Customs Union and Single Market because that contaminates the system. The whole point is that any goods inside can be moved anywhere and any goods outside are checked as they come in.
This ease of movement has enabled firms to set up EU-wide supply chains. This FT graphic, showing the journey of a fuel injector, is an example of how something manufactured in the UK can end up as part an EU product manufactured elsewhere.
The UK imports to make its exports and exports so that others may make their exports. As Mark Carney pointed out last year, over 30 percent of the total value of UK exports is components for goods that are finished elsewhere in the EU:
The proportion of UK exports that are intermediate components of EU value chains has increased from about 1/5th of exports in 1995 to about 1/3rd in 2014. Increasingly the UK doesn’t so much export to Europe as through Europe; it is a supplier of components to final goods that are exported beyond the continent.
Chart by Bank of England
Once the UK leaves the Single Market and Customs Union this trade will be subject to border checks. This will cost to processes that have been integrated for years, many of which are time sensitive. In some cases, the disruption will be enough to make it worth relocating these supply chains. For the most part, it will be a lot easier for EU firms to do that than for UK ones, simply because they will still have a number of other countries from which to choose while UK firms will have to source components from within the UK.
[T]he UK is a much less important source of inputs for the EU than vice versa. For example, manufacturing firms in the rest of the EU only obtain 1.5% of their inputs from the UK.
The disruption to supply chains will be a lot less of a problem for EU countries than for the UK.
From the perspective of other EU countries most of the problems associated with Brexit come from the UK’s withdrawal from the Customs Union and Single Market. A free trade agreement might mitigate that to an extent but it won’t restore the smooth flow of supply chains. As BMW’s sales and marketing director Ian Robertson said, a FTA isn’t that much better than WTO rules. Once the supply chains are disrupted the damage is done.
8/ ‘There is a feeling that a FTA is the answer to a lot of the problems (raising of tariffs, RoOs, regulations, NTBs). Actually its not much better than a WTO agreement.’ Ian Robertson (Sales and marketing director at BMW). pic.twitter.com/cy4t2D1gvO
— Martin Cooper (@mpc_1968) March 28, 2018
The British Ports Association agrees. The impact on ports, it says, would be the same under a FTA as under WTO rules. Its chief executive said:
A potential Brexit free trade deal will be welcomed by many in the sector but this is unlikely to cover border processes. In terms of border operations the impact of leaving the Customs Union and Single Market is now fast becoming a ‘no deal’ scenario for ports. Indeed this means that new border controls on UK–EU trade are likely to be unavoidable and that delays at certain ports and important trade gateways are a distinct possibility.
Maybe that is why the EU doesn’t appear to be in any great hurry to talk about trade deals. Its objective is to limit the damage to EU supply chains and re-set the Customs Union and Single Market to operate without the UK. That’s the priority. Set against that, a trade deal is simply a nice-to-have.
It reminds me of what happens when you disturb an ants’ nest. The ants rush to seal the breach as quickly as possible. That is what the EU will do when the UK ruptures its carefully designed system. It will re-seal it in a way that does not leave any holes. A two-year transition period, should it be agreed, will give it time to do this. EU firms will be able to relocate their supply chains so that when the final break with the UK comes it will not be as big a deal.
There is a possibility that the EU might agree to the UK staying in the Single Market for goods only and negotiating a new customs union. As Sam Lowe and John Springford argue, this is similar to the arrangement Jersey has now and it would enable the UK to regain control of its immigration policy. The “Jersey Option” would also remove the need for physical checks on goods thereby avoiding the disruption to supply chains and the need for a visible border in Ireland. So far, it is the only proposal I have seen which enables the UK to retain its red lines, honour its commitment on the Irish border and to which the EU might just agree.
Otherwise we may find that come 2021 the EU will happily let us leave without a trade deal. It will have relocated its supply chains, put its port infrastructure in place and secured the UK’s budget contributions until the end of the financial period. With its system of friction-free trade preserved, then the EU might get around to talking about a trade deal with its awkward neighbour.