17 October 2018

Dr Michael Gasiorek is a Senior Lecturer in Economics at the University of Sussex and a fellow of the UK Trade Policy Observatory.

UK-EU negotiations are in a mess. There appears to be a genuine impasse, where the stumbling block is the issue of no border in Ireland. The EU has indicated it is for the UK to make a better offer, while the UK is arguing that the EU needs to be more reasonable.  Both are right, if they want to avoid ‘no deal’.

There are two aspects to this issue of the Irish border. First what form of customs arrangements between the UK and the EU would not necessitate border controls? Second, there are the Single Market issues, and notably how to control for standards and regulations and proof of conformity to these, without some form of border controls?

The UK position with regard to each of these is: (a) on the customs arrangements the UK is proposing to stay in the EU Customs Union for a limited period until such time as a UK-EU trade deal can be agreed and it would like the future deal to be based around the Chequers proposal in some form; (b) with regard to the Single Market issues the UK government would like the EU to accept some version of the common rulebook approach which also appeared in the Chequers agreement.

If the EU could agree to this there could be a resolution to the Irish border issue. However, the EU’s position is that both the proposed Facilitated Customs Arrangements (FCA) in Chequers (FCA) and the common rulebook approach is unacceptable.  The EU concerns fall into two categories. The first category, which primarily (but not only) applies to the FCA is practical, and concerns whether what has been proposed is technically possible. The second, and more fundamental category is that the EU wants to ensure the integrity of the Single Market.  It does not want the UK to operate a different regulatory regime which could result in UK firms having a competitive advantage – this is the issue of the level playing field. It has also raised concerns about a third country (the UK) raising tax revenue on behalf of the EU.

Underlying all this, there is a more fundamental and less transparent concern for the EU. The concern is that it does not want any agreement to provide any systemic risk to the EU. Systemic risk is a broad term but the essential imperative for the EU is to ensure that no other member state is tempted to leave or negotiate a different bilateral arrangement with the EU.

If the EU sticks to its current approach in the negotiations this would require the UK accepting being in the Customs Union until such time as an alternative agreement is reached (which could be indefinitely) and to accept regulatory checks on exports between Britain and Northern Ireland. Domestic politics make that impossible. Equally, the UK cannot simply say ‘please be more reasonable’. So sticking to current positions leads inevitably to a no deal.

For there to be a compromise or a fudge, both the customs arrangement issue and the Single Market issues need to be addressed. Could this be achieved?

On the customs arrangements, the EU has indicated that Chequers is unacceptable. But this is worth unpicking and testing. There are two plausible readings of the FCA component of Chequers.  This is a bit complicated but the key difference concerns the treatment of intermediate goods imported by the UK from a third country, which are used to produce a final good which is then exported to the EU. In summary, the differences are:

• Version 1 – UK tariffs on the imports of intermediates from a non-EU country would apply only if there is sufficient UK origin in the good. Hence UK goods would need to meet the Rules of Origin in order to be exported duty-free to the EU. If the firm cannot establish UK origin then the good can be exported duty-free because the UK will ensure that the EU tariff will have been levied on the intermediate. This version of the FCA essentially means the UK has a Free Trade Agreement-style relationship with the EU, except when it cannot prove origin. This is the version of the FCA which the UK government probably intended in Chequers.
• Version 2 – EU tariffs are applied on all intermediate goods imported from third countries which are used in the production of any final good which is then destined for the EU. This version avoids the need for Rules of Origin between the UK and the EU where intermediate inputs are used. UK tariffs on the intermediate goods imported from third countries can be applied if the good is not destined for the EU market. This version of the FCA essentially means that the UK has a customs union style relationship with the EU, while offering the possibility of (more limited) FTAs with third countries.

It is not difficult to see why Version 1 is not acceptable to the EU. It is administratively very complex and raises level playing field concerns because it opens up the possibility of the UK to buy intermediates at a lower cost than the EU, and therefore possibly give it a competitive advantage. It also does not really solve the need for Rules of Origin checks, and therefore some form of border controls.

Version 2 is also problematic but at least it means that when trading with the EU, the UK is in a Customs Union-style relationship and does away with the need to conform to Rules of Origin. For UK firms to be able to import third country intermediates with lower tariffs, the burden of proof is still substantial but, on an optimistic reading, that burden falls on UK firms and should not arise in considering UK-EU trade.

So one partial step forward would be for the EU and the UK to agree that in the future negotiations on the nature of the trade agreement between them that Version 2 is not off the table. This does not mean that the EU has agreed to Version 2, it simply means it is prepared to discuss it further. This would be a significant step forward and domestically would allow Theresa May to argue that an independent UK trade policy has not been negotiated away.

This does not resolve the regulatory Single Market issues. On this, I suspect that the best that could be achieved is that both parties agree that discussions on this continue during the transition period with the aim of finding a mutually acceptable set of arrangements which allay the EU’s concerns with regard to the level playing field and the integrity of the Single Market. This will not be easy, but at this stage should not be given up on by either party.

Even if the preceding could be agreed upon in principle, it does not solve another key concern of the EU which is to do with the backstop. What happens if the UK and the EU continue to disagree and cannot come to an agreement? It seems to me that there is only one ‘simple’ solution to this. If there is no agreement then there is no deal. There does not appear to be any other form of backstop which allows for an agreement between the UK and the EU and which satisfies both parties.

So the UK would be faced with a transition period, during which time the EU agrees to discuss customs arrangements and regulatory issues further. The UK would need to persuade the EU that its proposals are feasible and do not provide any systemic risk to the EU. If an agreement cannot be achieved, then the EU and the UK agree to no deal.  If such a transition period cannot be agreed then we bring forward the likelihood of a no deal to 31 March 2019. It is surely better to attempt to find a solution. To find a solution by the end of December 2020 and to put in place the requisite measures is unrealistic. Therefore the UK and the EU should also agree to a longer transition.

One final thought: All of the preceding is predicated on the assumption that both the EU and the UK really do want a deal. Hence, agreeing on the preceding should not simply be a form of words to allow both parties to continue talking. It should be a form of words which provides parameters for future discussions with a clear indication that both parties are prepared for genuine flexibility. The UK government clearly wants a deal, and the EU probably wants a deal. However, while the EU has so far, by and large, done an excellent job in singing with one homophonic voice it is important to remember that in fact what we have here is polyphony. While much of the EU would quite like a deal, this does not necessarily mean that all of the EU wants a deal that much, but has needed to assuage the concerns of countries such as Ireland and the Netherlands. It may be that the EU is fully prepared to sacrifice these concerns in order to maintain what is perceived as the integrity of the EU, and may, therefore, continue to prove inflexible. If that is the case, it should say so.

 

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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