17 May 2018

Dr Michael Gasiorek is Senior Lecturer in Economics and Dr Peter Holmes is Reader in Economics at the University of Sussex. They are both Fellows of the UKTPO and Managing Director and Director of InterAnalysis respectively. 

The government’s two preferred options for post-Brexit trade with the EU are “Maximum Facilitation” whereby technological solutions are used to simplify trade procedures, and a so-called “New Customs Partnership”.

This blog discusses the implications of the New Customs Partnership (NCP) scheme. It must be borne in mind that the EU has so far rejected both and that in fact the degree of detail currently provided by the Government on either is so slight that we cannot be sure what is proposed. It is also arguable that they are not alternatives since under any scenario the government is keen to ensure the maximum simplification of procedures in order for trade to be ‘as frictionless as possible’. Even if they were viable, both the NCP and the Max Fac proposals involve significant trade-offs – namely that they involve firms in expensive set-up costs in order to be able to reduce transactions costs.

The Customs White Paper suggests the new customs partnership, “would involve the UK acting in partnership with the EU to operate a regime for imports that aligns precisely with the EU’s external customs border, for goods that will be consumed in the EU market, even if they are part of a supply chain in the UK first. The UK would need to apply the same tariffs as the EU, and provide the same treatment for rules of origin for those goods arriving in the UK and destined for the EU.”

The NCP scheme

The objective of the NCP is to allow the UK to have access to the EU market as if it were in a customs union while preserving the freedom to have different tariffs against non-EU countries. This means that if a good were exported from the UK to the EU it should be able to do so as if the UK still had a Customs Union (ie on the basis of the Common External Tariff) with the EU. At the same time, the UK would like to be able to levy differential tariffs on imports from non-EU countries providing they are not ultimately destined for the EU. In order to implement this, the idea is that the UK would collect tariff revenue at the relevant EU rate, preferential or otherwise, on all imports and then forward the revenue to Brussels if the item was re-exported to the EU. If the good stays in the UK, the UK would retain the tariff revenue. An importer could claim back money from the UK if the UK had a lower tariff and the product did not move on to the EU.

This dual system would be needed for several purposes.

• First, the aim is to ensure that there is no danger of trade deflection via the UK into the EU (or vice versa).
• Second to ensure that the UK’s external tariff offers the same degree of protection to EU markets as the Customs Union and the current Common External Tariff (CET).
• Third, in order to allow for reimbursement to domestic firms where products have lower tariffs in the UK and are not re-exported to the EU.
• Fourth to ensure that tariffs on goods destined for the EU go to the EU and consequently that the tariff revenue collected on behalf of the EU is passed on. It is not clear whether reciprocally the UK would also insist on the EU transferring tariff revenue, eg collected at Rotterdam on goods destined for the UK, back to the UK.

Problems with the NCP proposal

The proposal is problematic in several regards:

1. In a customs union where there is a common external tariff all goods receive the same degree of protection, including all intermediate inputs into production processes. The UK government wishes to replicate this arrangement via the NCP. However, if the UK wishes to maintain customs union equivalent market access to the EU, this would mean that the UK would need to apply the CET on all imported intermediates used in the production of goods destined for the EU market. Otherwise, it is possible that the UK could lower tariffs on intermediates, gain a competitive advantage in the EU and depress the prices of both the final good and intermediates in the EU. As Alasdair Smith pointed out, (Letter to FT March 19th) for the case of sugar, a reduction in the UK tariffs on sugar could mean a reduction in both the price of UK produced sugar which is exported to the EU, and a reduction in the price of goods using sugar as an intermediate which are then exported to the EU. Hence, the NCP has a serious problem for any product where the UK might wish to adopt policies that lower the domestic price relative to the EU. If the UK were to lower support prices or enlarge Tariff Rate Quotas for agricultural products this could potentially lead to lower-priced products going on to the EU market creating an EU demand for specific protection against the UK.

2. To operate and manage the NCP would require an extremely complex tracking system.  Firms would need to be able to track and prove originating status for each of the imported inputs that are used in goods which are then exported to the EU.  The system is complex when an imported input is supplied by a first tier supplier whose customer then exports (products) to the EU. For more sophisticated manufacturing supply chains the task becomes even more complex.

There may need to be a clear separation in the production processes used by firms between goods destined for the EU market and goods destined elsewhere. Otherwise, firms may have the possibility of using (cheaper) imported inputs to cross-subsidize the costs of production of goods intended for the EU market and also through economies of scale and scope. This may imply that firms would need to have separate plants and product lines for exports to the EU and separate plants for production destined elsewhere. The HMRC would need to have processes in place for dealing with different tariffs being levied on the same good being imported by the same firm depending on its use. This might apply to a single shipment, but also for shipments where the firm is using some of that shipment to produce a good for export to the EU, and some of the shipment to produce a good for export elsewhere.

3. The proposal does not do away with the need to comply with Rules of Origin, because the problem will simply be transferred from the issue of deciding whether a product is of UK origin and is therefore exempt from the EU CET, to one of deciding whether tariff revenue has to be handed over. An entirely new set of rules would have to be developed to deal with cases where inputs are transformed into goods that qualify as  UK origin. Would the UK have to hand over revenue for imported inputs that then acquire UK origin?

4. A further issue regards anti-dumping duties. It is not clear if the UK intends to apply the EU anti-dumping regime. All recent indications are that it will not. In this case, the same issues arise of how one keeps track of what steel (for example) goes into cars that are exported and what stays in the UK.

5. Even without these complications, the NCP would not be able to solve the Irish border problem. Customs checks are needed for many purposes, including the verification of compliance with technical standards. Unless the UK remains within the Single Market there would still need to be border controls to ensure that goods exported from the UK to the EU (and vice versa) comply with each other’s standards.

6. Any such system would need to be able to deal with fraud, and there are two elements to this. First, if UK and EU tariffs are different there is an incentive to cheat, and in a Free Trade Agreement border checks are there to deal with this issue. Under some form of NCP arrangement, the checking would have to be done by the UK on behalf of the EU for possible transhipments to the EU, and by the EU on behalf of the UK for possible transhipments to the UK.  Note that it is the responsibility of the importer at the ultimate destination to declare the shipments and pay the appropriate duties. Under standard Free Trade Agreement border arrangements therefore normally such fraud would be picked up and dealt with in the jurisdiction of the importing country. Under the NCP it would be the UK attempting to track fraud for the EU and vice versa. Essentially this hands over ‘sovereignty’ over managing this aspect of fraudulent trade to another country. This may be problematic. The second aspect concerns homogeneous goods – especially agricultural produce. Once a good has entered the UK with say a lower tariff, it would be subsequently difficult to prove that this was not a UK good when exported to the EU.

Conclusion

The UK government’s NCP proposal for post-Brexit trade with the EU is problematic in several regards, rather than making trade as frictionless as possible it makes it extraordinarily complicated in regards to tariff collection and a requisite complex tracking system and almost certainly fails to overcome the need for Rules of Origin. Moreover, the system does not have the capacity to deal sufficiently with fraud, as well as failing to solve the need for customs checks and hence a ‘hard’ border on the Island of Ireland.

 

Disclaimer:

The opinions expressed in this blog are those of the author alone and do not necessarily represent the opinions of the University of Sussex or UK Trade Policy Observatory.

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