A UK-EU Free Trade Agreement Will Be the Most Unusual in History

October 21, 2016

Much of the debate about the trade implications for the UK of Brexit focus on the loss of access to the Single Market. Since the Single Market accounts for some 60 per cent of the UK’s exports it is often suggested that these are all at risk. This, of course, is not the case. Moreover, it ignores the shape of any future trading relationship with the EU other than that based on most favoured nation (MFN) and it does not consider the wide range of options the UK will now have to enter into other preferential trading arrangements. And seldom does such discussion consider the potential benefits to UK consumers from being able to source considerably cheaper imports from more efficient suppliers from outside the Single Market.

After Brexit, were no other trading arrangement put in place, the UK’s trade with the EU would be at World Trade Organisation (WTO) MFN tariff rates. For most manufactured goods, other than processed agricultural products, the EU’s existing MFN rates are generally low. If the big downward adjustment of the British pound is sustained, then many UK exporters would find that they will still be able to sell into the Single Market profitably. Where the cost disadvantage for UK firms selling into the EU post Brexit is relatively small, other factors specific to certain industries, such as technology and skill, would also be likely to continue to apply. Many UK manufacturing firms are for these reasons integrated into European global production chains. The UK’s position in these is often based on factors other than simply price.

All of that is based on the UK and the EU being unable to reach some sort of preferential trading arrangement. It is unlikely that the UK and EU will not negotiate a new arrangement for reciprocal market access for goods and services. The UK and EU economies are highly integrated and many important industries in the EU are heavily dependent on access to the UK and on the UK’s access to the EU.

The best outcome would be a UK-EU free-trade agreement. It is also the most likely. It would be the most bizarre trade negotiation ever conducted were the negotiators to sit down to discuss raising tariffs. In view of the high-level of existing integration and the fact that the UK has signed onto the EU acquis for standards, technical barriers to trade would be minimal. Achieving a high quality FTA is therefore quite feasible. It could also be negotiated quickly for the same reasons. But even a high-quality FTA would still see the UK outside the Single Market and its trade would, for example, be subject to FTA-specific rules of origin.

The question of labour mobility inevitably arises, but it may not be a deal breaker. The EU has negotiated many FTAs which have not included labour mobility chapters. Indeed, for many of these, such as with Turkey, the EU did not itself want to include labour mobility provisions. The essential difference between a future UK-EU FTA and any others the EU has negotiated is that it is beginning with both economies being highly-integrated and operating within the same regulatory rules and procedures. As with goods trade, the absence of an agreement on labour mobility will not mean there is no movement of people between the UK and the Continent. Some Europeans will continue to move to the UK to live and work, but they won’t do so on the basis of an automatic right.

In the case of services, similar arguments apply for why a UK-EU FTA is feasible and should be sought. The EU has not been as successful in removing internal barriers to trade in services as it has for goods, partly because international agreements must deal with domestic regulation and this often needs to be negotiated in a sector-specific manner. The UK and EU will likely be able to preserve much of their integration on services, though there have been suggestions that the UK’s financial services industry will suffer if it loses its “passporting” rights into the EU.

The UK also has the option of becoming a member of the WTO’s TISA (Trade in Services Agreement), now under negotiation in Geneva. While not offering the same level of access as exists today in the Single Market, for many services it would be a considerable advance on MFN.

An FTA is a much preferred option for the UK than a customs union as some in the UK have been advocating. With a customs union the UK’s access to the Single Market would be essentially unchanged. But the EU has made it clear that to continue as a full member of the Single Market existing immigration rules would need to apply. So in the current political setting a customs union is not feasible. And in any event, the UK post-Brexit would not want its trade policy being decided in Brussels.

More importantly, it is also not desirable. Were the UK to enter into a customs union its hands would be tied from negotiating free-trade agreements with the long line of the UK’s potential future trading partners. Australia and New Zealand have each said they are prepared to enter negotiations immediately. Others might include Canada (especially if Brussels does not sign of the recently concluded Canada-EU FTA). For geo-political as well as trade and investment reasons an FTA with the US should be at the top of everyone’s list. Unfortunately, the politics of protectionism are, for a time at least, in the ascendency. Recently, the Republic of Korea and also Japan have shown increasing appetite for FTAs, each having concluded FTAs with Australia last year. China is also pursuing its own busy FTA agenda.

Two objections have been raised about the UK pursuing an FTA agenda at this time. One is that it cannot do so until it actually leaves the EU. This is something of a bully-boy attitude from Brussels. There is nothing in the EU agreements that prevents members discussing all manner of issues with non-members as long as it does not seek to conclude formal treaty agreements. In reality, FTAs take a lot of time to prepare for actual negotiations, let alone to conclude them. Much valuable work can be done in this preparatory phase.

The more thorough the preparatory work, the more quickly will the negotiations proceed once started. So the UK should now be opening discussions and commencing preparatory work with likely partners. There is a risk, however, that Brussels’ unhappiness over the UK’s commencing FTA discussions with third countries before it actually leaves the EU may make the Article 50 negotiations even more fraught than they otherewise would have been.

The second is that the UK may not have its own tariff schedule in the WTO so there is not a level of MFN commitments from which to negotiate tariffs down and to make additional services commitments. The simplest approach would be for the UK to take the EU’s schedule as if it were its own. While uncertainty exists in the WTO whether the UK can simply “delete and replace” in this way, or whether it may need to negotiate a new schedule, WTO Members may be prepared to use “creative ambiguity” to allow the UK to continue operating on the basis of the EU schedule . Potential FTA partners could just take the EU’s schedule as the starting point for FTA negotiations. If something were to change later, adjustments could be made subsequently.

The biggest constraint on the UK’s moving forward with an ambitious FTA agenda would be the resources required to negotiate it. Ideally, the UK could conduct parallel negotiations with the EU and several other possible candidates. Technically, the EU provides few challenges as both sides know each other so well in terms of trade in goods and services and technical barriers to trade. Some of the other candidates, such as Australia and New Zealand, would also be reasonably straight forward because of the openness of their economies, an unwillingness to bring non-trade social and environmental issues into the discussions, and strong political support for the negotiations. Finding the skilled negotiators for such an ambitious agenda and putting in place thorough mechanisms for inter-agency, industry and community consultations, however, will challenge the UK Government.

Making an early and confident start on a broad-based FTA agenda would contribute to lifting business and international confidence in a post-Brexit UK. At a time when protectionist sentiments are rising around the world, it would also allow the UK to provide leadership in resisting protectionism globally and starting to roll it back. As the UK readies itself to undertakeArticle 50 negotiations, it should already be working on a strategy and building the capability to engage in an ambitious FTA agenda.

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