Customs Union: A soft option with a dead end

June 19, 2017

Phillip Hammond is said to be the Cabinet’s pre-eminent exponent of a “soft Brexit” – by remaining in the Customs Union. On the Andrew Marr show yesterday he surprised some by stating that the UK should leave the Single Market and the Customs Union; but he hinted that there should be a period of transition before exiting.

For any change in trade and tariff policy a transitional period seems at first glance to be  sensible. However, the legal character of any such transition is very important. There is a real danger that the UK could remain in the Customs Union subject to its rules and obligations and in effect never execute its intention of leaving. Any transitional arrangements should be expeditious, time limited, under UK domestic law and outwith the jurisdiction of the European Court of Justice.

Unless these conditions are met, the objections to a transitional period in the Customs Union remain the same as staying permanently within such a regime. Remaining within the Customs Union would vitiate the principal economic benefit of leaving the EU which is the opportunity of constructing a more liberal trade policy with low or no tariffs and free trade agreements with countries around the world such as China, Japan and the US.

Remaining in the Customs Union is the “Turkey Option”.   Turkey was unable to join the Single Market because of EU members’ unwillingness to open its borders to unrestricted movements of people between the EU and Turkey –but it could join the Customs Union.

The halfway house of the Turkey Option, however, would be the worst of both worlds for the UK.  The UK would still bear many of the costs of leaving the Single Market (such as the potential loss of passporting) — while not having any of the benefits that would come from taking back responsibility for its own trade policy from Brussels.

Were the UK to remain in the Customs Union, its trade would be at the EU’s common external tariff.  Its tariffs would be set by Brussels and so it would be unable to enter into FTA’s with third parties.  It would also not be able to benefit from access to the most competitively priced imports, especially food and other agricultural products.

To some extent, the costs of leaving the Single Market would be offset by the gains in consumer welfare from cheaper imports sourced from outside Europe. These gains in economic welfare would only be possible if the UK could lower its tariffs.  The opportunity to improve economic welfare by lowering tariffs would be lost by joining a customs union with the EU.

A customs union, moreover, only deals with trade in goods.  Trade in services is a much more important area for the UK these days and one in which the UK enjoys considerable competitive strength.

Joining a customs union with the EU while remaining outside the Single Market would mean that the costs that will be borne by the services sector will remain.    It makes little sense for the UK to opt for a customs union to try to protect its existing goods trade with the EU, which is in any event declining as a share of UK’s exports, while doing nothing for its services sector and at the same time surrendering the benefits of leaving the customs union.

The only sensible choice for the UK then is between remaining in the Single Market or leaving it and the Customs Union.  Remaining in the Single Market has been described as the “Norway Option”.  This could allow the UK to retain full access to the Single Market.

The Norway Option is, however, a vague diplomatic fudge.  It is described as “access to the Single Market” as distinct from being a Member of the Single Market.  Trade between Norway and the EU is not completely free.  Many agricultural and food products have been classified as “sensitive” and so are excluded.

In any event, the Norway Option would require continuing free movement of people.  Full membership of the Single Market would be better than the half-way house of the Norway Option, with its concessions on people movements but limits on goods movements.  Norway also pays contributions to the EU budget, accepts the EU acquis and is under the jurisdiction of the European Court of Justice.

EU political leaders have made it clear that remaining in the Single Market would require reaching some sort of an agreement with the EU over freedom of movement of people, submitting to the jurisdiction of the EU Court of Justice, and budget contributions.

In view of the politics of Brexit, reaching such an agreement would seem implausible from either the perspective of the UK or that of the EU.   Although the hope to find a political compromise runs deep, and the search for some sort of compromise is seductive, the UK’s interests are now best served by being outside the Single Market and rejecting the false hope of a customs union.

It is not the time now for the UK, when about to enter negotiations with the EU on terms of its exit to begin to seek to find compromise, especially when the options that are being proposed are so deeply flawed and damaging to the UK’s national interests.  To blink now in the face of EU leaders’ intransigence will only result in the UK negotiating against itself.  The Prime Minister is correct not to reveal the UK’s negotiating position at this time.

EU apparent inflexibility is a standard ploy used by Brussels at the outset of every negotiation.  But the EU has shown itself to be flexible when it needs to be to conclude a deal.  In addition to its arrangements with Turkey, Norway and Switzerland – each of which has its own specific characteristics – the EU has signed some 60 bilateral trade agreements, of varying quality and of different levels of liberalisation.  All, however, have given the partners access to the Single Market to some extent.

In view of the substantial interest the EU has in the UK market, where the UK accounts for a bigger share of EU exports than the reverse, there is a deal to be done on an FTA.  It is often said that an FTA negotiation would take many years, but this neglects the fact that the two economies today have been deeply integrated for over four decades.

The hardest part of any FTA is the rules, especially behind the border regulatory measures, but the UK is already signed on to the EU acquis.  The UK is unlikely to want to renegotiate any of this, so an FTA should be achievable quickly.  After all, no two countries sitting down to negotiate an FTA have ever been so deeply integrated as the UK and EU.

And were the EU negotiators to seek to set a negative example for others who may be contemplating their own exit, then the world will not fall in on the UK if it were to have to trade and invest in a world of WTO-only rules.  Most of the EU’s common external tariffs are low under WTO rules.  Where they are high, such as in autos and agricultural products, the UK imports much greater quantities from the EU than it exports.  Reverting to WTO-only trade would hurt the EU more than the UK.

So rather than flinching at this time, the UK’s political leaders should be strengthening their resolve to reject a customs union, leave the Single Market, prepare for an FTA negotiation with the EU, and begin vigorously exploring FTA options with other major trading partners outside of Europe.

Division within Cabinet is an argument over the worst option (remain in the Customs Union) versus the least worst option (leave the Single Market).  It is also an argument over clinging to a past, rejected in last year’s referendum — and a future where the UK can pursue multiple trade policy options without being constrained by Brussels. In many respects the desire to remain in the Customs Union is consistent with  a long tradition of UK Whitehall thought about the EU: muddled and wishful thinking.

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