The Trade Policy Implications of Brexit: High Risk, Murky Rewards

What is clear is that the UK has left only two options open: a “semi-hard” Brexit, where some kind of a bespoke Free Trade Agreement (“FTA”) would be negotiated, or a “fully hard” Brexit, falling back on just the standard relations among members of the World Trade Organization (“WTO”). Even the first option will have substantial economic costs for both sides – though probably more for the UK. By refusing not just continued participation in the EU’s Internal Market (what could be expected), but also the maintenance of the Customs Union, the UK chose an option leading to much more disruption in the established economic links. The reason for choosing this lowest level of preferential relations is explained by the UK to keep its full sovereignty to freely negotiate trade agreements with third countries. However, this freedom comes at a heavy price for the future EU-UK relations.

Trade in Goods: A Hard Customs Border and The Importance of NTBs

By leaving the EU’s customs territory, the introduction of a new customs border and customs controls between the UK and the EU-27 will be unavoidable. While the financial costs are not negligible, the impacts on traditional business relations, cooperation and production chains are much higher. Any time a part or a component will be supplied to a cooperating partner on the other side, it will need to cross the new customs border – possibly several times. Even if the future FTA relationship is deep and comprehensive, it will still be necessary to check whether there are differences in the tariffs applicable, and whether the product can be considered as “originating” in the UK or the EU-27, in order to prevent third parties benefitting from the bilateral deal.

If the EU-UK talks are successful, there are ways to lighten these burdens somewhat, to facilitate trade flows, but the two sides will still be separate customs territories. For products arriving from other parts of the world, at present the UK is often the EU’s external customs border. In the future, this border will move to the Channel – or to the Irish border. Therefore, it is not clear how the UK Government will honour its commitment to avoid introducing hard borders and controls between Northern Ireland and Ireland – not to mention the implications of a repeated, potentially successful Scottish independence referendum. It remains to be seen how Prime Minister May’s decision to call snap elections in June will influence the outcome of the Brexit talks.

While a strengthened negotiating position for the UK Government would be certainly useful, there are also other trade policy challenges. An important question will be the UK’s situation with respect to the EU’s numerous preferential arrangements. From the moment of Brexit, the UK will cease to be a party to these agreements and it will need to negotiate its own agreements with the EU’s international counterparts. It is not guaranteed that the terms the UK can achieve on its own will be the same as for the much larger EU-27. Partners may decide to reduce their own commitments, due to the reduced value of a UK-only agreement. A related issue is whether, and how, the UK could re-join the “Pan-Euro-Mediterrean” system of cumulation and origin – an important trade facilitation agreement between the EU and its European FTA partners.

Conditions of entry to the markets, and the measures applied at the borders (be they tariffs, or other type of limitations) are important. However, these days, the technical regulations, testing requirements, standards, health measures – i.e., Non-Tariff Barriers (“NTBs”) – are the real obstacles to trade. In the goods sector, these have been largely harmonized among EU Member States. The Great Repeal Bill ensures that, at the time of Brexit, there will be no differences in these terms, but thereafter all bets are off. Much will depend on the EU-UK bilateral arrangement, on the cooperative spirit of both sides. As long as the UK continues to apply the EU regulatory regime post-Brexit, there will be no problems. But how long will this last? It is clear that, once the UK starts its FTA negotiations with new overseas partners – be it the US, Commonwealth members or other major players – the NTBs inherited from the EU will be a focal point of contention. It is difficult to imagine that the U.S., for example, would not set a high price in the regulatory area for an FTA with the UK, after several years of unsuccessful Transatlantic talks (under the TTIP process). They will very probably demand the abolishment or at least substantial loosening of many EU health, sanitary, and environmental rules in the UK. Thus, the UK will face a difficult choice: to give either preference to an FTA with the U.S., or to continued easy access to the EU-27’s market.

Trade in Services

Most of the above refers to trade in goods. Services, a major factor of the UK’s wealth and competitiveness, pose different challenges. Many of the benefits from the free flow of services are linked to being part of the EU’s Internal Market. After Brexit the possibility of providing services in the whole of the EU by setting up a company, bank, etc. in the UK alone will cease to exist. Creating conditions for the preferential access of services will require individual negotiations with the interested Member States. Here again, the outcomes are difficult to predict and will depend on their relative interests, strengths and cross-sectoral linkages.

After Brexit, the UK will again become a fully sovereign member of the WTO. However, this will not be an automatic process: it will be necessary to find agreement with the other WTO members on the new conditions of its membership. Experience has shown that any change of the terms of WTO membership (e.g., to reflect EU enlargements) involve very difficult talks. The other WTO members, relying on the WTO practice of approving all agreements by consensus, always try to use such occasions to get additional market access beyond the level that would be legally due. Thus, the UK will probably also face lengthy and difficult negotiations. This process opens the risk of trade disputes and the mutual withdrawal of existing WTO concessions.

Conclusion: A Substantial and Uncertain Price to Pay

If the UK-EU talks are successful, the new settlement will come at a substantial price for both sides and will almost certainly take much longer than Article 50’s two-year deadline. The alternative, a UK economically much detached from the Continent, would be much worse. While the UK might eventually negotiate meaningful trade agreements with other partners, these will come at a heavy cost to its relations with the EU. The process might turn into a downward spiral: every new concession or measure that differs from those applied in the EU-27 will reduce for the latter the value of trade relations with the UK. This is especially true for such sensitive sectors as agriculture; but across the board, all regulatory diversion will create new obstacles. Thus, it is well advised that everywhere – be it in Whitehall or the Berlaymont, the business community, or the legal profession – the stark choices are well understood, and decisions are taken in full knowledge of the consequences.