24 October 2019

Michael Gasiorek is Professor of Economics at the University of Sussex and a Fellow of the UK Trade Policy Observatory. 

There has been some discussion that the unique arrangements outlined in the Protocol on Northern Ireland within the Withdrawal Agreement between the UK and the EU mean that Northern Ireland may get the best of both worlds – tariff-free access to both the EU Single Market and the UK market. This is because Northern Ireland will remain in the UK’s customs territory, however, for trade between Northern Ireland and the EU (and therefore the Republic of Ireland) the EU’s Union Customs Code will apply, with no tariffs or other restrictions. Northern Ireland will also remain within the EU’s single market for agriculture and manufactured goods.

The aim of this blog is to think through this carefully. Perhaps not surprisingly it turns out that it is not quite so simple. It is important to be clear about what is in the agreement with regard to trade flows and the imposition of customs duties because different tariff and regulatory barriers will be in place depending on the direction of the flows, and depending on the destination. For this, see the box below. At the outset, also, it is important to point out that to the extent that trade remains frictionless under the proposed arrangements, this only applies to trade in agriculture and goods. NI will no longer be in the EU single market for services trade, and therefore both services exports and imports will be affected.

Determining products ‘at risk’:

For the EU the concern is, where UK tariffs are lower, to prevent those goods from entering the EU via Northern Ireland and undercutting EU tariffs. Additionally, the EU wants to ensure that the EU’s regulatory requirements are met for goods entering the EU. With regard to the tariff issue, logically all those goods where the EU tariff is lower than the UK tariff should not fall into the ‘at risk’ category. The extent to which this will be the case is hard to determine as it will depend both on the UK’s MFN tariffs and also on any future trade agreements the UK may sign. Note that all intermediate goods are potentially ‘at risk’ if they are used in the production of final goods which are then exported to the EU.

Consider the impact of these arrangements proposed by the Withdrawal Agreement on existing producers in Northern Ireland. The agreement aims to preserve the status quo by allowing producers to sell to both the EU and GB with no tariffs and no regulatory checks. While there is no improvement in access for NI firms, if we assume that Britain’s future relationship with the EU is in line with the current Political Declaration, firms in Northern Ireland may have better access to the EU market than firms in GB. For existing firms, this competitive advantage may help to increase sales to the EU.

This may also lead to an increase in investment in Northern Ireland. Suppose a jam manufacturer is considering setting up a plant to export to the EU and the UK. If the plant is established in Northern Ireland, on the face of it, the jam can enter both markets duty-free, but if it is established in either the EU or GB, the product may be subject to the tariffs of the other customs territory.

The extent to which existing producers may have a competitive advantage and the incentives for investment are unclear as this will depend on the future agreement between the UK and the EU. The aim of the current government does not appear to be to have a very comprehensive or deep Free Trade Agreement (FTA) with the EU, so it is likely that some tariffs (possibly on agriculture) may remain between the UK and the EU, and there will be regulatory barriers.

However, the preceding example did not take into account other factors such as the sourcing of intermediates, nor what the implications of differential tariffs between the UK and the EU might be.

What if the UK tariffs are lower than EU tariffs?

Suppose that the EU tariff on sugar used in jam production is higher than the UK tariff, while the tariff on jam is the same. If the sugar is imported directly by NI, then the EU tariff will be applied at the NI border as is currently the case. If the sugar comes via Great Britain then the EU tariff will be applied before it enters the NI market and there will now need to be customs checks. In both cases, the sugar will also need to conform to EU regulatory standards, and there will be conformity checks both on the direct imports and also between Britain and Northern Ireland.

Where it can be shown that a good deemed to be at risk did not enter the EU, the Protocol allows for the customs duties to be reimbursed, but this is subject to EU state rules and limits. While this is not made explicit in the Protocol, conceivably therefore, if the jam manufacturer can prove that a certain proportion of the jam did not enter the EU, then they may be eligible for a rebate of the differential between EU and UK tariffs.

This process, of course, increases the administrative costs for the jam producer in two ways. First, there will now be a bureaucratic process for any intermediate imports from Britain. Second, there will be a bureaucratic process in order to obtain a rebate. If this proves too costly for the producer they can of course choose to operate on the basis of the EU tariffs and not apply for any rebates. However, they will now be disadvantaged relative to UK jam producers who can buy the sugar more cheaply. An alternative therefore might be to set up jam production in Great Britain, and sell to Northern Ireland and the EU. Of course, the jam may then be subject to EU tariffs. Which of these outcomes is preferable will depend on the tariff difference between the UK and the EU on both jam and sugar, on the cost of the bureaucratic procedures, and also on the share of sales going to the different markets.

What if the UK tariff is higher than the EU tariff?

Important here is that the UK government has said that there will be ‘unfettered access (i.e. no checks) on goods coming into Britain from Northern Ireland. However, the consequence is that the UK higher tariff risks being ineffective, and raises various possibilities of trade being deflected via Northern Ireland into Great Britain. A higher UK tariff may be more likely to apply to those products exported by countries with whom the EU has an FTA.

Suppose the EU tariff on sugar is zero, while the UK has a tariff of 10%. NI firms could source the sugar from the EU, or import it directly with a zero tariff and then transport the sugar to Great Britain for final consumption or for use by the British jam manufacturer. However, if the British jam manufacturer exports significantly to the EU, and if there are tariffs on those jam exports, there may be an incentive to set up jam production in NI. The jam could be sold to both the UK and the EU with no tariffs or customs checks.

Similarly imagine the UK retains a 10% Most Favoured Nation (MFN) tariff on cars. That tariff would apply on imports from Japan. However, the same car imported into Northern Ireland would not face that tariff because the EU has a Free Trade Agreement with Japan. On a £20,000 car that is a saving of £2000. There will be an incentive either for firms to ship cars over from Northern Ireland or for individuals to go and buy their cars in Northern Ireland and then cross over to Britain.

A similar set of issues applies to differences in regulations between the EU and the UK. Suppose hypothetically the EU signed a Free Trade Agreement with the US which allowed for the imports by the EU of the infamous chlorinated chickens. These could then be imported by Northern Ireland and then sold in Britain – even if Britain did not want these chickens.

Given the incentives to avoid UK tariffs, and given the issues arising from regulatory differences it is very hard to see that a policy of no checks on sales in Britain could be sustainable. One possible solution is that there are no goods on which the UK imposes tariffs on EU imports and no goods on which the UK imposes higher tariffs than the EU on imports from the rest of the world and no goods on which UK regulation is tighter (or just different) from EU regulation. That is also very unlikely.

There is an important related issue, which concerns WTO compatibility, and is related to the car example above. Britain could import, via Northern Ireland, any of the goods in the EU-Japan Free Trade Agreement (or indeed any other EU FTA) at the EU preferential tariff rate –  which for many goods would be zero. Hence, a Japanese car could enter the UK duty-free, while an American car would have to pay the MFN tariff – even though the UK has no trade agreement with Japan. I am not a trade lawyer but this does not seem compatible with GATT Article I, which calls for MFN treatment.

The Protocol could incentivise increased production and investment in Northern Ireland. However, this is not necessarily the case. It will also depend on whether producers/investors believe the arrangements are long-term and sustainable. The current default is that the Protocol lasts for an initial period of four years.[3] This short time horizon, doubts over the sustainability of continued unfettered access from Northern Ireland to Britain, the absence of information on a future trade deal between the UK and the EU, as well as the issue of WTO compatibility all lead to uncertainty. At a minimum, it will be some time before these issues are clarified, and almost certainly well beyond the current transition period. From the point of view of “taking back control” over UK trade policy, the arrangements are highly asymmetric. In practice, it may be hard for the UK to set tariffs higher than the EU or to set higher regulatory requirements.

---

Footnotes

[1] This was confirmed by Steven Barclay in evidence to the House of Lords EU Exit Committee, 21/10/2019. The declarations are not for customs purposes but for safety and security. On this, para 239 of the Government’s impact assessment simply states: “Some practical information will need to be provided electronically on movement of goods West-East.” https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/841245/EU_Withdrawal_Agreement_Bill_Impact_Assessment.pdf

[2] Ibid, para 259.

[3] The government’s position is that unless consent is explicitly given to continue the protocol, the default is that the protocol lapses after four years. https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/841309/Position_of_the_Government_on_terminability_of_the_Protocol_on_Ireland_Northern_Ireland_to_the_Agreement_on_Withdrawal_of_the_United_Kingdom_from_the_European_Union.pdf

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.

Republishing guidelines:
The UK Trade Policy Observatory believes in the free flow of information and encourages readers to cite our materials, providing due acknowledgement. For online use, this should be a link to the original resource on our website. We do not publish under a Creative Commons license. This means you CANNOT republish our articles online or in print for free.