Leaving the Customs Union (part 1) - A repatriated trade policy

In 1973, the UK joined the EEC (as the EU was known then) and became the member of a customs union – the so-called “Common Market”.

By contrast, the Single Market is a more recent development. In 1987, the Single Europe Act came into effect and paved the way for the completion of the Single Market in 1992 (in fact it is still not complete even now – but that's another story).

It is perhaps surprising then that so much attention has been given to the Single Market, yet so little attention has been paid to the EU Customs Union. Particularly as leaving the EU Customs Union has potentially greater impacts on UK trade than leaving the Single Market :

• A repatriated trade policy will need new WTO Schedules and new 3^rd country trade agreements.
• Trade with the EU will face imposition of tariffs or Rules of Origin processing and a new customs border.

In this post, I will look at the impact of leaving the Customs Union and a repatriated trade policy.

WTO Schedules

The UK is a member of the WTO in its own right. But as a member of the EU's Customs Union and the Common Commercial Policy (CCP), the UK has no independent trade policy – all the UK's current WTO trade schedules are registered via the EU's WTO membership. In order to trade as an independent nation, the UK will need to establish it's own WTO schedules.

Prior to the Referendum, WTO director-general Roberto Azevêdo warned that the UK would face “long and difficult” negotiations. It was reported that unanimous consent from all 164 WTO members would be required to ratify new UK schedules – leaving UK in trade limbo for years.

This issue has been fully addressed by Dr Richard North (who takes an apocalyptic vision of UK trade outside the Single Market) and Peter Lilley. Depite the fact that North contemptuously dismisses the “likes of Lilley”, they arrive at a similar view. Lilley describes this as “an exaggerated scare story”. North says it is remarkable that “so much is being made of what is actually a relatively small problem in the grander scheme of things”. Post-Referendum, in a marked change in tone, Robert Azevedo has confirmed that there will be no disruption to UK trade.

Thre reality is, it is possible to trade using draft WTO schedules awaiting full ratification. The EU's schedules were amended following the accession of Romania and Bulgaria but have still not been ratified. WTO members can only raise objections on the grounds that a draft schedule leaves them materially disadvantaged. The UK can adopt a draft schedule based on current EU schedules to present a “no-change” scenario:

• Tariffs. These are the tariffs that apply to third countries with which the particular WTO member does not have a Free Trade agreement.  The UK should replicate the EU's tariffs schedule (as per the EU's Common External Tariff) into the new UK schedule.
• Services: Extract the UK schedule of commitments and exemptions on services from the EU schedule (see WTO web page on services schedules).
• Agricultural Tariff Rate Quotas (TRQ). TRQ's provide lower tariffs on a given product up to the specified quota or volume of imports, after which a higher tariff applies. The UK and EU will need to agree an apportionment of the EU's 87 TRQ's, which will involve some haggling:
  • A protectionist EU might wish to offload a high proportion of these quotas to the UK.
  • In some cases the UK uses a relatively high share of the EU's quotas (e.g. imports of New Zealand butter).
  • Other WTO members may object if the apportionment results in a higher tariff for access to the EU or UK market.

Should the haggling result in an impasse, a unilateral solution would be for the UK to forego TRQ's entirely by abolishing the higher tariff and allowing unlimited imports at the lower tariff.

• Agricultural subsidies. WTO identify 3 categories of subsidy :
  • “Amber-box” (trade-distorting subsidies);
  • “Blue-box” (trade-distorting subsidies as part of schemes to limit production via quotas or land set-aside);
  • “Green-box” (non-trade-distorting, including payments for environmental protection and regional development).

While Amber-box subsidies are limited (to 5% of agricultural production for developed countries), there are no limits on Blue-box and Green-box subsidies. So the UK and EU will need to agree an apportionment of current Amber-box limits. This is unlikely to be contentious, as the EU has only used €8.76 billion of the €72.2 billion limit agreed with the WTO in 2009/2010. Furthermore, 94% of subsidies paid under the 2010 CAP reforms fall outside the Amber-box limits.

• Agricultural special safeguards (SSG). The EU has negotiated 539 SSGs, which provide protection against a surge of imports by allowing higher tariffs when import volumes rise above a certain level, or if prices fall by below a certain level. The UK has a case for inheriting these safeguards, but this may prove contentious for other WTO members – it may also be more in line with a liberalising approach to Brexit to forego SSGs.

3^rd Country Trade Agreements

Customs Union are not simply Free Trade Zones. The EU Customs Union removes tariffs and import restrictions between member states, but also has a Common External Tariff (CET), set by Brussels. The EU's Custom Union also has a Common Commercial Policy (CCP), which means that Brussels has sole power to broker any new Free Trade Agreement (FTA) with third countries. In short, all external trade policy is the preserve of Brussels, not EU member states.

The Government dossier “HM Government Alternatives to EU membership” emphasised this point during the EU Referendum campaign:

The EU forms a Customs Union, with no tariff barriers between Member States, and a common external tariff on imports from countries outside. Aligning these is an inherent part of any Customs Union and is necessary to ensure consistent treatment of imports into any EU country. For this reason the EU negotiates and agrees Free Trade Agreements with other countries on a collective basis. To date the EU has 36 such agreements covering 53 markets. (page 9, section 2.10)

The process of withdrawal from the EU means that all existing trade deals with third countries would cease were the UK to leave the EU. This means we would no longer benefit from the trade deals which the EU has negotiated with 53 markets like Mexico, South Africa or South Korea, and those which it is currently negotiating with the United States and Japan.(Page 28, Section 3.40)

Free Trade Agreements (FTA's) with 53 nations sounds impressive, until you realise many are very small economies (e.g. Andorra, Monaco, San Marino, Iceland, Lichtenstein, St. Kitts and Nevis, St Lucia etc) or less than stellar performers (e.g. Zimbabwe, Occupied Palestinian Territory). The biggest economies in the 53 are South Korea, Mexico and Switzerland - all of whom are comfortably smaller than the UK's economy. The list of 53 does not include major trading partners like the USA, Japan, Australia etc.

However, these 53 FTAs, which specifically include tariff agreements, are not the full story. The EU has a plethora of “technical” trade agreements with countries around the world which facilitate “frictionless” trade (but do not include agreements on tariffs). The website for the EU's Treaties Office Database shows that the EU has 23 such agreements with the USA categorised as trade agreements. Some of the more important types of agreements include:

• Mutual Recognition Agreements (MRAs) on Conformity Assessment. Allows certificates issued by 3^rd country Conformity Assessment Bodies to be recognised in the EU (and vice-versa).
• MRAs on World Customs Organisation (WCO) Authorised Economic Operator (AEO), Customs Co-operation agreements. Provides for faster & more secure customs processing of imports/exports.
• Sanitary and Phytosanitary Equivalence Agreements, Organic Farming equivalence agreements. Allows agricultural and animal products to be imported/exported without safety checks at the border.

Can UK retain EU's 3^rd Country Trade Agreements ?

Clearly, the UK would wish to retain current trade agreements with 3^rd countries. But as Luis Gonzalez Garcia, Alan Matthews & Steven Peers (among others) point out, the UK’s rights and obligations under these treaties only apply to the UK in its capacity as an EU Member State.

• Most of the EU’s FTA’s are “mixed” agreements, meaning individual member states are signatories as well as the EU. However, the vast majority of FTA content falls under the Common Commercial Policy (CCP), rather than individual member state competence. When the EU treaties cease to apply to the UK, the rights and commitments conferred under the CCP will also cease to apply.
• EU FTAs use the term “the territory of each Party” defined as the “European Union and its Member States” with the third country as the other party. A post-Brexit UK will clearly no longer be within the territory of the EU and its member states.
• Some commentators quote the “presumption of continuity” and the “Vienna Convention on Succession of States in respect of Treaties” as a way for the UK to retain these trade agreements, citing the example of the “velvet divorce” of the Czech Republic and Slovakia. While the EU may be a super-state under construction, it is not yet recognised as a state in it's own right and similarly the UK continues to be recognised as a separate state. Technically and legally the UK is leaving a customs union and cannot claim to be a successor state, so the Vienna Convention does not apply.

There are also technical issues which would prevent these agreements from being adopted “as-is” by a post-Brexit UK:

• Institutional arrangements created for on-going co-operation and management of the agreement, dispute resolution etc. are of a bi-lateral nature (between EU and third country) and so inappropriate for UK outside the EU.

• Cumulation. The EU’s FTA’s often contain arrangements for bi-lateral cumulation (e.g. South Korea) – this allows supply chains distributed across the 28 EU member states and the third country to qualify for preferential tariffs under Rules of Origin. To continue these arrangements would need the bi-lateral treaty to be converted to a tri-lateral treaty (rEU27+UK+3rd country) with “diagonal cumulation” allowed.
• Many EU FTA’s both give and receive market access via TRQ’s. Getting the EU and third party to apportion these TRQs between the rEU-27 and the UK would involve amending the FTA and re-ratifying – which seems unlikely. More probably, the UK would have to negotiate additional TRQ access or alternatively the UK could scrap the higher tariff rate and effectively remove the need for TRQs.

Replacement 3^rd Country Trade Agreements

In practice, the UK will need to replace the EU’s FTAs and technical trade agreements.

The good news is that the UK Government is already looking at replacing the EU's FTAs by transitioning current trading terms, with initial focus on the Korea and Switzerland FTAs as they cover almost 80% of UK’s trade by value via EU FTAs. Fortunately it is possible to create WTO-compliant transitional arrangements in line with Article XXIV(5) of the General Agreement on Trade and Tariffs (GATT), which states that,

“The provisions of this Agreement shall not prevent, as between the territories of contracting parties, the formation of a customs union or of a free-trade area or the adoption of an interim agreement necessary for the formation of a customs union or of a free-trade area […] Any interim agreement […] shall include a plan and schedule for the formation of such a customs union or of such a free-trade area within a reasonable length of time.”

A memorandum of understanding between the UK and third country could be deposited with the WTO stating that existing trading terms will continue (with new arrangements for institutions, cumulation, TRQs etc as required) – allowing time for a full FTA to be agreed.

In addition, the UK will also need to agree a continuation of current trading with other trading partners with which the EU has purely “technical” trade agreements. Once again a Memorandum of Understanding should suffice (stating that existing “technical” agreements will be continued with new institutional arrangements as required) and then deposited with the UN rather than the WTO (since these agreements do not cover tariffs).

For some third countries where the EU does not currently have an FTA (e.g. Australia, New Zealand etc.), we may wish to enter into an interim free trade agreement with “zero-for-zero” tariffs alongside the “technical” agreements ahead of negotiating a full and comprehensive FTA.

Conclusions

As a result of leaving the EU's Custom Union and Common Commercial Policy, the UK re-patriates control of trade policy but has to reconstitute all external trade arrangements: WTO schedules; 53 FTAs; and a plethora of technical trade agreements with almost every other WTO member. Staying in the Single Market via the EFTA EEA option does not help one iota with these issues.

Fortunately there appear to be solutions to these challenges - and crucially these solutions are not dependent on agreement with the EU. But it is also clear that Liam Fox as Secretary of State for International Trade has his work cut out in the next 2 years.