The likely post Brexit, UK-EU trading relationship, is a very complex subject. The objective of this article is to examine the range of possible models of UK-EU trade in depth, in order to better understand the likely outcome.
It is helpful to begin by looking at the publicly announced negotiating objectives for both the UK and the EU governments, during the 2-year Brexit negotiation period – dictated by the Article 50 Brexit process.
Brexit – The UK’s negotiating objectives
The UK government has now publicly set out their aims for the Brexit negotiations and for the UK’s future relations with the EU after it has left. At a high level, the UK aims to be global in all its endeavours, cooperate with it’s EU neighbours, and would like as frictionless a departure and transition as possible.
The UK Prime Minister and Secretary of State, put forward a number of specific negotiating objectives in speeches in January, a White Paper in February 2017, and the Article 50 letter of notice.
The key areas that will determine which models of UK-EU trade will be possible, are:
- Take control of our own laws – Ending the jurisdiction of the European Court of Justice in the UK (while honouring international commitments and following international law)
- Control immigration – The Free Movement Directive will not apply and migration of EU nationals will be subject to UK law. New system will allow UK entry to brightest and best, students, academics; may be phased implementation so businesses can prepare for new arrangements
- A new customs arrangement – Prioritising trade in goods and services, including financial services, between UK and the EU
- Being able to secure new trade agreements with other countries (outside of the EU)
- No more UK contributions to the EU Budget (though the UK will make appropriate contribution to any EU programmes in which UK participates)
- No deal for the UK is better than a bad deal
Many of these desired outcomes from the UK government, are based on the key elements of the leave campaign prior to the Brexit referendum in 2016, and therefore what the marginal majority of the UK population voted for.
Brexit – The EU’s negotiating objectives
The European Parliament and European Council have also published draft negotiating guidelines, setting out what they want the negotiations to be about, and put forward their views on the UK’s future relationship with the EU – which must not be more beneficial outside the EU than in it.
The key areas that will determine the UK-EU trading models post Brexit, are:
- The four freedoms: People, Goods, Capital, Services – There are indivisible and there can be no cherry picking… The UK must continue to accept the four freedoms, the jurisdiction of EU Court of Justice, budgetary contributions and adherence to EU’s common trade policy
- The EU has also indicated that a non-EU Member without the obligations of a Member State, cannot have the same rights and benefits as a Member State… any agreement with UK will be based on balance of rights and obligations, and ensure level-playing field…
- Overall, the European Council is prepared to work towards an ambitious free trade agreement with UK, to be concluded after Brexit
Possible UK-EU trading models going forward
Referring back to our previous blog article [A Guide to Brexit – Key International Entities], and keeping the above desired negotiating outcomes in mind, it is clear that many of the possible alternatives to the UK’s current full EU membership status are not possible.
|Trading Model||Probability||Main Issue|
|1. Single Market||Low||Four freedoms|
|2. E.E.A||Low||Four freedoms|
|3. E.U.C.U||Low||Restrictions on other F.T.A.'s|
|4. Swiss (bi-lateral) Model||Low||EU wants to reform|
|5. E.F.T.A||Possible / Low||UK government prefers a bespoke FTA|
|6. Bespoke FTA||Possible||Lengthy negotiation|
|7. W.T.O Rules||Likely||No deal - Fall back position|
1 & 2. Single Market & EEA
Being a member of either single market, or the E.E.A. (European Economic Area) would not be possible, since these require acceptance of the ‘four freedoms’, acceptance of EU laws, and EU budget contributions, which the UK government does not want.
Remaining in the EUCU , would also not work, since this would mean the UK would have to apply the common (EU) external tariff on all imports from any countries outside the EU, into the UK. The UK government have instead made it clear that they wish to negotiate preferential FTA’s (Free Trade Agreements) with many countries outside the EU, which would help to off-set any potential loss in trade from no longer being inside the EU.
Some have suggested the UK could adopt a similar model to the Swiss bi-lateral arrangements with the EU. However, the Swiss also have free movement of people, EU budget contributions, and Schegen membership as pre-conditions for this bi-lateral arrangement, plus other elements the UK does not want. In addition, the EU has recently made it clear they wish to reform the Swiss-EU bi-lateral arrangement, and have little appetite to allow other countries to follow this model going forward.
The UK could re-join the EFTA, which would enable the UK to have trade deals (outside the EU) themselves, as well as the existing trade deals the EFTA has already negotiated.
However, there would still be some restrictions as an EFTA member. The UK would have to contribute to the EU budget, albeit to a lower extent than currently. Under standard EFTA terms, the UK would also have to accept free movement of people, although there is debate as to whether this could be negotiated as Switzerland (an EFTA member) did historically. Due to these and other downsides of the EFTA, the UK government has said that they prefer not to seek EFTA membership.
6. Bespoke FTA (Free Trade Agreement)
A possible outcome, and the option government has indicated it would like, is to negotiate a new bespoke FTA between the UK and the EU. The government is currently examining FTA models used by other countries, such as Canada (CETA), Switzerland, and others, to work out what elements they wish to aim towards in the next phase of negotiations with the EU.
Should a FTA be successfully negotiated, it would likely mean reduced access to the single market (especially in services), compared with EU membership. However, it would mean no need to accept free movement of people, or make financial contributions to the EU budget. A FTA would also allow the UK to make its own trade agreements with non-EU countries.
If none of the above options succeeded, then the next best option would be that the UK defaults back to trading under WTO rules, as a ‘third country’ trading with the EU. Under this option, there would be no preferential trade agreement between the UK and the EU. Trade would be based on WTO rules.
What sort of areas would a UK-EU FTA cover?
What is an FTA?
A FTA (Free Trade Agreement) is an agreement between countries to reduce barriers to trade between them, particularly customs duties faced by certain goods when imported. This might also be accompanied by deals on quotas, for example setting out the quantities of goods to which certain tariffs applied.
A free trade agreement would mean the UK would be outside the customs union, meaning UK exports to the EU would be subject to customs checks and rules of origin. The UK would, however, be free to negotiate its own trade agreements with third countries.
What other (trade) areas would an FTA cover?
Trade agreements also commonly contain agreements on customs arrangements and mechanisms for the resolution of disputes. While tariffs also remain a common part of trade agreements, and are important for certain countries and sectors (such as agriculture), they are becoming less of a focus overall, partly because the average tariffs faced by goods have been falling.
Trade agreements that mostly deal with border measures, such as tariffs and customs arrangements, are often called “shallow” agreements. In contrast, agreements that include rules on other domestic policies are referred to as “deep” agreements – this type of agreement has become more common. Modern deep trade agreements often cover areas such as technical barriers to trade, services and trade-related investment measures. Other common topics include competition policy, intellectual property rights, investment and movement of capital. Some agreements also cover issues such as environmental laws, labour market regulations and measures on visa and asylum.
Despite the move towards deeper trade agreements, these agreements generally do not go as far in removing barriers to trade as the EU single market.
Will the UK Government secure an FTA in the 2-year Brexit negotiating schedule?
A trade agreement might take a long time to negotiate. The EU’s trade agreement with Canada took seven years to negotiate and has yet to be ratified. A trade agreement with the EU would need to be approved by the European Parliament and possibly by each Member State. The UK has also not negotiated a trade agreement while it has been in the EU. Therefore, the UK’s experience and capacity to negotiate trade deals is likely to be limited at the moment.
What would the ‘WTO option’ look like?
Under the current arrangements (while the UK is a member of the EU), there are no tariffs on UK-EU trade. Under the WTO option, there would be no such preferential trade agreement, instead, trade would be based on WTO rules. This is the “default” option – i.e. the one which would apply in the absence of a preferential trade agreement between the UK and EU post Brexit.
WTO rules would mean the imposition of tariffs on trade in goods between the UK and the EU. There are WTO rules on tariffs which work on the principle of non-discrimination, which require WTO members not to treat any member less advantageously than any other. This means, the tariff that applies to the ‘most-favoured nation’ (MFN), must similarly apply to all. This MFN principle would prevent discriminatory or punitive tariffs being levied by either the EU on the UK (i.e. to the level of the MFN tariff). This MFN principle also extends to non-tarrif barriers (e.g. different product standards) also.
Post Brexit, the UK would also need to decide the level of tariffs on imports into the UK, and must also adhere to the MFN principle except where there was a free trade agreement. Setting UK tariff levels would involve a trade-off between lower domestic prices, and bargaining power in future trade negotiations with other countries. Setting relatively high tariffs would increase domestic prices, but give a bargaining chip in future negotiations. Eliminating or setting low tariffs would tend to reduce domestic prices, but give trading partners little incentive to reduce their tariffs in any future negotiations. For now, the Government has announced that it intends to replicate the EU’s tariff structure as far as possible.
Regarding services, without further negotiation, the UK’s trade with the EU would be governed by the WTO General Agreement on Trade in Services (GATS). The same MFN principle would apply.
The WTO option would impose the fewest obligations on the UK, since there is no requirement to implement EU legislation. Although UK businesses would still have to comply with EU rules to in order to export to the single market. There would also be no obligation to accept free movement of people, or make a financial contribution to the EU budget.
Regarding trade barriers, overall, trading on WTO terms would mean many UK exporters would become less price competitive than their competitors operating within the remaining EU. This is particularly true for certain heavily protected industries with very high tariffs such as agriculture and motor vehicles.
Interestingly however, the EU’s tariffs have generally fallen over time, meaning the advantage of EU membership has actually declined over time. Therefore any loss of competiveness might actually be offset in many cases by the depreciation of the pound which has occurred since the referendum. Despite this, various published studies have generally find the WTO option to be the most costly, in economic terms, to the UK.
What about trade with other Non-EU countries
Overall, the UK currently does slightly more trade with non-EU countries than with the rest of the EU. The share of UK exports accounted for by non-EU countries is rising: from approximately 45% in 1999 to around 55% in 2015.
Existing EU agreements with non-EU countries
As an EU member state, the UK is not allowed to operate its own independent trade policy, under EU rules. As noted above, the UK is a member of the EU customs union, which means all EU Member States have the same tariffs on goods imported into the EU from non-EU countries.
However, the UK does benefit from the trade agreements the EU has active with over 60 countries outside the EU. These agreements range from large economies, such as South Korea, to very small economies such as Dominica (Notably, EU does not currently have trade agreements in force with a number of the world’s largest economies, such as the US, Japan, China and India).
It seems unlikely that the UK will continue automatically to benefit from the existing EU’s trade agreements after Brexit, although the situation is not entirely clear. The Government has stated, that it is not possible for the UK to negotiate or conclude new free trade agreements with non-EU countries while it remains an EU Member State. Despite this, preparation for future trade deals is already underway, since the government is allowed to have exploratory talks with non-EU countries in the meantime. The ideal outcome would be for the UK to continue with the EU’s preferential trade agreements with non-EU countries for a transitional period, until new agreements can be settled.
New trade agreements with Non-EU countries
In addition to these EU agreements, the UK benefits from trade with other non-EU countries via the WTO rules. Leaving the EU will allow the UK to forge its own new free trade agreements. Since the UK will no longer be part of the large EU trade bloc, the UK can pursue its own interests rather than have to negotiate a common position with other EU member states. The Government has said the UK “will be champions of free trade driving forward liberalisation bilaterally, as well as in wider groupings”.
Nine working groups have already been announced, to work on developing these new trading relationships with the following countries:
- New Zealand
- South Korea
- Gulf Co-operation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates)
The future outlook
Looking ahead, it is unlikely the exact trading model chosen will become clear, until after the current UK general election is concluded on 8th June. Once the result is clear, will we know whether the current Conservative party, their associated mandate, and the Brexit negotiating objectives they have laid out, will be the basis the UK-EU negotiations.
After this is settled, the UK government will move into the next phase of negotiations with the EU, and the nature of any bespoke FTA, or WTO trading option, will become more clear.
Stay posted for more analysis on this, and Brexit related topics to the financial industry.
For more detail on the above, feel free to download the following Government briefing papers:
Brexit: Red lines and starting Principles, 31/03/17
Brexit: Trade aspects, 21/03/17
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