What kind of Brexit for the UK?
The Prime Minister’s Lancaster House speech in January set the tone for expectations that the government was taking the UK towards a “hard Brexit”. Based on this speech, the expected negotiating position at the time the Article 50 letter was sent to the EU on 29 March 2017 was that the UK would not seek to remain in either the EU Single Market or in the EU Customs Union.
But then the Prime Minister called a snap election, with the surprising outcome that saw the Government lose its majority in the House of Commons. Following the election outcome, discussion has turned back to consider alternative Brexit options, including those that would provide for a “softer” Brexit. The withdrawal negotiations between the UK and EU have since commenced and it remains unclear exactly which option the UK government wishes to achieve, although this does not appear to be as “soft” as some had suggested immediately after the election. Nevertheless, the current uncertainty as to the likely end game makes it timely to revisit the range of Brexit options that are potentially on the table.
“Hard Brexit” is perhaps the easiest to define. It has been identified with the so-called “cliff-edge”, meaning that if by the end of the two year negotiating period anticipated by Article 50, the UK and the EU have not concluded a deal concerning its future trade relationship, trade between them will default to WTO terms only. The cliff-edge also implies that the UK will not remain part of either the EU single market (i.e. within which there is free movement of goods, capital, services, and labour) or the EU customs union (i.e. within which goods can be freely traded without customs duties and border checks, and in relation to which a common external tariff applies to goods from third countries). On top of this, absent the UK negotiating new agreements, the UK will lose access to the existing EU preferential trade agreements.
So, under a Hard Brexit, the UK will not have access to any preferential trade arrangements with EU member states and EU Customs Union members or with more than 50 countries that currently have preferred trade deals with the EU, including Korea, Canada, Singapore, Colombia and Peru.
In practical terms, it is important to distinguish between remaining in the EU single market and having access to it. Under the EU single market, the territories of EU member states are considered to be one territory in trade terms. This represents the highest levels of economic integration, trade liberalisation and regulatory convergence in the trade world. Goods and services move free of tariffs and the single market aims at the elimination of non-tariff or regulatory barriers. More importantly, members of the EU are decision-makers and rule-makers for political, economic and trade decisions including which third countries the EU negotiates preferential trade agreements with and the scope and depth of those agreements. Importantly, any option that includes continued membership of the EU single market implies acceptance of freedom of movement, contributions to the EU budget and accepting the jurisdiction of the Court of Justice of the EU over matters relating to that membership or access. The EU has been clear that this is non-negotiable if the UK wants to retain “membership”.
In contrast, any country that trades with the EU has certain level of market access. How favourable that access is depends on the conditions and concessions applying to that trade. For example, a third country can obtain a high and better terms of market access through a preferential trade agreement or FTA, compared to the level of market access obtained within the framework of WTO commitments. So, the level of access is negotiable and so too are the conditions of that access.
The EU single market covers not only EU member states but also members of the European Economic Area (EEA). The EEA is formed by the EU members and three EFTA members that joined the EEA: Norway, Iceland and Liechtenstein. These countries, while having full access to the single market, are nevertheless rule takers as they need to follow and adopt EU regulations concerning the single market. Importantly, these countries are bound by the four freedoms of movement of people, capital, goods and services, as stated in the EEA Agreement. On the other hand, as the three EFTA countries in are not part of the EU customs union, they are free to set their own set of tariffs and to conclude their own preferential trade agreements with other non-EU countries.
“Soft Brexit” is general regarded as having continued access to the EU single market but not through continued EU membership. So the UK could choose to remain in the EEA on similar terms to Norway, Iceland and Liechtenstein. For this purpose, the UK would need to return to membership of EFTA (given up when the UK joined the EU in 1973) and reconsider its redline concerning the free movement of people. Under this option, the UK would still be able to pursue its objective of entering into new trade deals. The UK would have its own trade policy and its own WTO schedules of tariffs and services commitments: hence it would be able to negotiate its own FTAs with third countries.
There has been recent discussion about whether the UK could remain in the EU customs union under the soft Brexit option, at least temporarily after the withdrawal as a component of a possible transitional arrangement. Of course, this would not compensate for the costs of leaving the EU as the customs union only applies to goods and not to trade in services. Also important to remember is that members of the customs union have a common set of external tariffs to be applicable to imports coming from non-members of the union. In the case of the EU customs union, its members also follow a common trade policy.
A customs union with the EU custom union has also been discussed – i.e. a type of associated membership of the EU customs union. This is, for example, the case of Turkey which has a customs union with the EU and applies common external tariffs to imports from third countries. This means that, while Turkey’s exports enter EU territory with zero tariffs, Turkey must apply the same common external tariffs to imports coming to its territory from any non-EU country, such as Brazil or China. Furthermore, Turkey is also bound by the harmonisation of commercial policy measures with the EU, which effectively means it is bound by the EU common trade policy.
In practical terms, were the UK to agree to some form of customs union arrangement with the EU or to remain temporarily in the EU customs union after Brexit, the common external tariff would impede the negotiation of preferential trade agreements for goods with third countries. In essence, the UK could not offer anything better than the EU’s arrangements with those countries.
A customs union with the EU custom union will not impede the UK negotiating an area of economic integration or an agreement for liberalizing trade in services with the EU. Indeed, under this option, the UK will be able to disentangle its trade policy and trade measures for services from the EU while keeping the link for trade in goods.
The more difficult question is whether this is the most attractive alternative for the UK to membership of the EU single market. The constraints imposed on the UK by having a customs unions with the EU customs union might in turn weaken any subsequent trade position as, without agreement from the EU, the UK would not be able to decide on future trade arrangements for the customs union covered products. The UK’s negotiating position and ability to offer third countries a comprehensive FTA would therefore be affected. Indeed, Turkey’s experience shows the limitation that a customs union has represented for its trade policy. Similar limitations might apply to the UK.
In comparison, a comprehensive FTA can incorporate the benefits of a customs union without the restrictions. FTAs have become more and more comprehensive and ambitious, they are “WTO extra” and “WTO plus” as they cover trade topics not covered by WTO agreements and they take liberalisation further than that provided by WTO framework.
In this respect, FTAs can provide the benefits of a custom union as trade in goods can be fully liberalised with zero tariffs and favourable agreements concerning rules of origin and customs checks can be crafted as part of an FTA. Also, as part of an FTA with the EU, the UK will not be bound by a common external set of tariffs or standard harmonisation of commercial policy measures.
On the other hand, the cliff-edge/trading on WTO terms-only option means complying with WTO’s agreement and rules. Trade is conducted amongst current 164 WTO members on the basis of the most favoured nation principle (by which a concession or advantage granted to any country must be immediately and unconditionally granted to all WTO members) and the national treatment principle (by which WTO members cannot differentiate between domestic and foreign goods, services and services providers).
It might be asked: if the WTO provides the framework for trade among 164 countries, including for bilateral trade between significant trade actors such as the US and China or the US and the EU - which do not have FTAs in place – why is it then the less favourable option for the UK compared to others?
The answer follows from the fact that the WTO offers only limited scope of trade liberalisation compared with that achieved through FTAs or the EU single market in terms of areas of trade and particularly in terms of ambition. FTAs bind parties to higher levels of trade liberalisation that go beyond WTO terms. In the absence of an FTA, members are only bound by WTO commitments. Also, and perhaps more importantly for the UK, the WTO mechanisms that deal with non-tariff barriers and regulatory issues are limited in scope and depth, and do not therefore provide frameworks for regulatory convergence, so trade on WTO terms is frequently affected by those barriers absent separate agreements between countries to minimise regulatory barriers. Regulatory barriers can be significant impediments to trade in services, and given the importance of services to the UK economy any new barriers to trade following Brexit could have serious effects to levels of trade between the UK and EU.
A comprehensive UK-EU FTA seems to offer then the best alternative to avoid the cliff-edge. In the range of options this sites in the middle between “Hard” and “Soft” Brexit, but the exactly where and towards which end will depend on the content of the agreement not whether an agreement is negotiated. Of course, the UK government’s aspirations are for “a bold, ambitious and comprehensive FTA”. Such an FTA will need to provide both parties with the best preferential conditions of market access. It will need to cover trade liberalisation in trade in goods, services and other trade areas, such as competition rules, trade facilitation, digital trade, state aid, government procurement amongst others. As the current UK-EU trade relationship is quite very broad by virtue of the UK’s existing single market membership, an FTA would facilitate maintaining a comparable comprehensive framework. Of equal importance, a UK-EU FTA will provide the platform for ensuring future regulatory convergence and providing mechanisms for cooperation on those issues to deal with the risk of new regulatory barriers to trade arising once the withdrawal from the EU has taken place.
Achieving a comprehensive agreement that provides for these factors and which ensures trade in goods and services that is as far as possible “frictionless” in comparison to that which applies today will be the true test of whether a negotiated agreement is “a good deal” or “a bad deal”.
The Brexit negotiations have only just started. We will need to wait and see how they unfold and which options the parties settle on as realistic and feasible to form the basis of a new trade relationship.