Brexit

A Modest Proposal for Brexit: Turning the tables on the EU

BY Briefings For Brexit   /  2 August 2018

A senior private-sector economist, who prefers to remain anonymous, suggests an alternative to the Chequers White Paper. This involves ditching the transition period and instead adopting a temporary period of unilateral free trade that will radically alter the dynamics of the current negotiation process with the EU.

With the government’s Chequers plan having unleashed a wave of discontent in the Conservative party and among the voters, it is time to seriously examine an alternative strategy to the failed process of piecemeal capitulation the UK has engaged in over the last 18 months.

Two key problems have led us to the current situation: a pathological fear among politicians and the civil service about the economic consequences of the UK moving to WTO rules-based trade with the EU; and the UK allowing the EU to dictate the terms of the exit negotiations in order to put constant timetable pressures on the UK, forcing one unpalatable concession after another.

Both these problems can be got around. On WTO-rules based trade, official concerns are hugely exaggerated and have been fuelled by Treasury modelling that is based on flawed methodology and unrealistic assumptions.

Under WTO rules, UK industry would face average tariffs of 3-4%, with 30-40% of UK exports to the EU facing zero tariffs – including pharmaceuticals and civil aircraft. This is a relatively modest trade barrier – only for a few sectors, mostly agriculture, will tariff barriers be significant. Car tariffs currently are 10%, but a multilateral deal is on the horizon, in response to pressures from the US, that may eliminate these.

Much has been made of non-tariff barriers. The Treasury has claimed these might average 20-30% of UK export values to the EU. This number is as much as 10 times too high – a careful study by Kee & Nicita suggests the average tariff equivalent of NTBS facing UK exporters to the EU, weighted by imports, would be just 3.4%. A detailed study of post-Brexit NTBs for several sectors in the Netherlands found they might total around 1% of trade values.

There are also viable work-arounds for some non-tariff barriers UK firms might face, which are already being put in place by forward-thinking UK firms. For most UK exporters, who already produce to EU standards and can self-certify their goods as EU-compliant, the only significant change they need to make is to use an EU or EEA-based importer – this can be an agent, a subsidiary, or the end customer. For chemicals and car firms there are greater, but far from insurmountable barriers. Notably, the US exported $8bn of pharmaceuticals and $2.8bn of organic and inorganic chemicals to Germany in 2017, versus $2.7bn and $1.8bn respectively by the UK.

With viable workarounds and overall trade barriers facing UK exporters to the EU in a ‘WTO rules’ scenario averaging perhaps 6-7%, and the price elasticity of many of these exports relatively low, the likely decline in UK exports of goods to the EU would be quite modest – perhaps as low as 5-6%. This is a small fraction of Treasury claims. This equates to around 2.5% of total UK goods exports and 0.5% of GDP.

So we should not be scared of the impact of shifting to WTO-based trade with the EU as many of the supposed downsides for exporters are relatively modest or can be largely mitigated. There are a number of areas where agreements would be helpful – on aviation for example and mutual recognition of automobile approvals. But for many of these issues, there are existing third country precedents that can be invoked. The EU itself has made clear it wants a deal on aviation.

Studies claiming huge costs from a WTO-rules based Brexit also generally assume the UK immediately imposes the current pattern of EU tariffs and various administrative barriers (e.g. cumbersome customs checks) to imports from the EU, raising costs and damaging UK firms and businesses. But in fact there is no reason the UK necessarily need do this, and this leads us on to my proposal for an alternative Brexit strategy.

My proposal is for a temporary period of unilateral free trade that will radically alter the dynamics of the current negotiation process with the EU. This would involve the UK ditching the proposed transition period and announcing that from March next year, an independent trade policy will be followed. Initially, the UK will not apply any import tariffs against any country – as it is allowed to do under WTO rules – and will recognise EU goods as being compliant from a regulatory perspective. The UK will also conduct minimal border checks, perhaps 0.1% of consignments from the EU. These can be dispensed with entirely for large trusted firms such as the car manufacturers.

For agriculture, removal of tariffs would allow increased access for imports from the rest of the world which would put some pressure on domestic producers. In order to reduce this pressure, I would propose maintaining the current level of subsidies for agriculture during the two-year period and the EU’s current SPS (animal and plant health) regime. The SPS rules are a trade barrier in themselves and I propose these be put on the table for negotiations with the US, Australia, NZ and other farm product exporters during the two-year period. Removing tariffs would, in the meantime, spur some diversion of UK agricultural imports away from EU producers – French and Italian wine producers would face sharper competition from Australia and California, citrus fruit imports from non-EU destinations like South Africa would also be encouraged.

This period of unilateral free trade will last two years, at the end of which, the UK’s MFN tariffs will revert to the current rates applied by the EU, meaning substantial tariff barriers on UK agricultural imports from the EU and the 10% car tariff. At the end of the period, the UK will also adopt its own set of product regulations which imports must conform to, having built the capacity to do this in the meantime. During the two-year period, sensitive sectors such as agriculture will continue to receive subsidies broadly similar to now plus assistance to alter their pattern of production.

This proposal has the advantage of not punishing UK consumers and firms (including just-in-time manufacturers) in the immediate aftermath of a ‘no deal’ Brexit. This is important as many of the negative consequences of such a ‘no deal’ exit claimed by the Treasury and other bodies are largely based on the idea that British consumers and firms will be hit by higher prices and logistical disruption.

But crucially, this proposal also allows the UK to turn the tables on the EU on trade. During this two-year ‘open border’ period, all the UK’s trading partners will be invited to talks on free trade agreements, to avoid having to face MFN tariffs at the end of the two-year period. Trade partners such as the US, Australia, New Zealand and perhaps the EFTA states will be keen to reach agreements with the UK as soon as possible to lock in their improved market access and steal a march on EU producers.

Will the slower-moving EU be able to act in time to prevent a considerable loss of competitive advantage in the UK market? German car producers would go from having a 10% cost advantage now over producers from much of the rest of the world to a 10% cost disadvantage – a 20% swing that would risk sales collapsing. Such unfavourable swings in the tariff ‘preference margin’ would be far bigger for other EU sectors such as wine and meat producers.

One downside from this plan is that initially some UK exporters in sectors like cars, agri-food and clothing, where EU tariffs are relatively high, would be at a disadvantage versus their current situation – facing sharper competition at home from non-EU imports (due to zero UK tariffs) and higher barriers to exports to the EU. However, their disadvantage versus EU suppliers would only last two years: at the end of the interim period either an FTA with the EU would be in place or MFN tariffs would kick in, levelling the playing field again. Moreover, EU suppliers in these sectors would (as noted above) also be hit by greater competition in the UK market from non-EU firms. The UK would also have the option of watering down my proposal slightly by immediately imposing the MFN tariff on car imports and one or two other sensitive sectors (there would be a cost to consumers here, though).

It is likely that the EU will eventually decide to strike a broad-based free trade deal with the UK under these circumstances. But even if an EU trade deal is not struck in the two-year period, the UK will have had time to build an efficient border system for trade with the EU and put in place a new and independent regulatory system, allowing future trade frictions to be minimised.

Crucially, the UK will also have had time to diversify its imports. And once UK firms find other suppliers and restructure their supply chains away from the EU, they may not be keen to change back – a factor the EU might want to consider carefully.

This was originally published by Briefings For Brexit