3 April 2019

Dr Michael Gasiorek is a Senior Lecturer in Economics at the University of Sussex and a fellow of the UK Trade Policy Observatory. L. Alan Winters CB is Professor of Economics and Director of the Observatory.

Understandably the politics surrounding the UK’s exit from the EU are dominating current discussions. But the economics of the options still matter, and it is not always evident how well the core economic issues are understood.

In the light of the Government’s ‘approach’ to Labour to find a consensus and in the light of the indicative votes, the aim of this blog is to clearly outline the economic issues and summarise the likely consequences associated with two of the current (indicative) options.

First, it is important to note that two of the UK Government’s red lines (having an independent trade policy and leaving the Single Market) are each incompatible with having no border checks on trade between Northern Ireland and the Republic of Ireland (see our video on this, and ‘UK-EU Trade Relations Post Brexit: Too Many Red Lines?’). This is because border checks are needed both where countries levy different tariffs, and where production standards and/or ways of assessing conformity to those standards are different.

Second, it is important to highlight that there are two documents under discussion – the Withdrawal Agreement (WA) and the Political Declaration (PD). The WA is a legally binding document which does not specify the nature of the future relationship with the EU. The PD does focus on the future relationship but is not legally binding and is therefore not much more than aspirational.

The three key proposals for the future relationship with the EU seem to be: (1) the Government’s facilitated customs arrangements, which is currently in the PD; (2) a permanent customs union with the EU; (3) Common Market 2.0.

1. Facilitated Customs Arrangements (FCA):

• • This option is ambiguous in various ways but the key idea is to have an ambitious free trade agreement between the UK and the EU which eliminates the need for border checks through ‘ambitious customs arrangements’ and through ‘deep regulatory cooperation’. No existing agreement has ever achieved this, or anything close to this. It is therefore unknown, and more realistically, highly unlikely that this could solve the border issue.
  • The proposal allows the UK to retain control over labour mobility.
  • Services are neglected
  • In order to minimise negative impact on trade, the UK would wish to roll over / transition the existing free trade deals the EU has with some 70 countries, and as has become evident in recent weeks this is proving somewhat tricky.

2. A permanent customs union with the EU (the Ken Clarke proposal):

• A customs union with the EU would maintain the status quo with regard to tariffs. It would mean the UK would levy the same tariffs on trade with third countries as the EU, and there would be no tariffs on trade within the EU.
• However, the proposal would only potentially solve border issues with respect to the UK and the EU levying different tariffs. It does NOT solve the need for border controls where regulations, standards, and/or conformity assessment differs. And it may not solve the issue of VAT requirements. It would, therefore, increase costs relative to the status quo in these dimensions.
• The proposal deals only with goods trade only and does not deal with services trade. See the recent blog by Borchert and Magntorn-Garret which emphasises the importance of the UK services trade to the UK economy (80% of Gross Value Added), and to the UK goods trade. Hence UK services export would now face restricted access to the EU market.
• The proposal allows the UK to retain control over labour mobility.
• It gives much more limited possibilities for future independent trade deals, as these could cover only services trade. While some countries have signed services trade deals these have always been as part of a broader trade deal involving goods trade. A customs union with the EU, therefore, limits any potential gains from future trade agreements.
• The extent to which the EU would allow the UK to influence the common EU-UK trade policy (i.e. the level of tariffs, with whom we have agreements, levels of anti-dumping duties, etc) is unclear. The answer is probably that the EU would facilitate a little influence informally, but make no formal commitment to respect UK views.
• The UK would be required to roll over / transition the existing free trade deals the EU has with some 70 countries.

3. Common market 2.0 (the Nick Boles proposal):

• This would mean the UK would (re-)join the European Free Trade Association (EFTA), and be part of the Single Market. As the name suggests EFTA is a free trade area, hence this proposal gives much more scope for the UK to have a future independent trade policy and to negotiate and sign trade agreements with third countries
• Membership of the Single Market addresses the Irish border issues with respect to regulations, standards and conformity assessment, However, it does NOT solve the border issue with respect to different tariffs being levied on trade by the UK and the EU on third countries – unless the UK were to agree to (initially) levy the EU’s common external tariff which is what is some versions of this proposal would seem to entail.
• Being a member of the Single Market would address the issue of maintaining access to the EU market for UK services trade.
• Being a member of EFTA means the UK would have much less control over the mobility of labour.
• The UK would also need to roll over the non-tariff dimensions of the free trade deals the EU currently has with up to 70 countries.

All sensible analyses of Brexit have shown that leaving the EU will have a negative economic consequence for the UK, and this also applies to each of the options discussed above. It is harder to evaluate (1) as it is untried and virtually impossible to see how it could be achieved. Overall, Common Market 2.0 would almost certainly have a smaller negative impact. First, because it allows for continued access for UK services trade, which (we repeat) is so important. Second, because it maintains Single Market access for goods, and the loss of such access would have a bigger impact on the costs of trade than the introduction of tariffs. Third, because the greater mobility of labour implied by this proposal would be better for the UK economy.

Both options (2) and (3) are broadly consistent with the existing Withdrawal Agreement. This is because the WA does not, and was never intended to specify the precise nature of the future trading relationship with the EU. Hence, even if Parliament voted for either one of these options – this would not form part of the legally binding Withdrawal Agreement, and the Irish backstop would, in principle, still be needed, as neither of these proposals would resolve the border issue entirely.

This underlines the fundamental incompatibility between the original red lines (independent trade policy, leaving the Single Market, control over labour mobility with the EU, no longer under the jurisdiction of the European Court of Justice (ECJ)), and the Irish Border issue. If those advocating what has been termed a ‘hard Brexit’ continue to insist on all these red lines, then as we have previously argued (Briefing Paper 17) – the solution space is null, and ‘No deal’ becomes more likely.

Successful resolution will require compromise. As part of that compromise, solving part of the border conundrum may make it easier to find (future) solutions to the other elements of the conundrum. Each of the indicative proposals goes some way in that regard. Suppose, for example, the UK decided to go for Common Market 2.0. It could then try and agree with the EU that until such time as both parties could agree to an acceptable mechanism for behind the border customs controls (a.k.a. maxfac); or until such time as the UK could derive a set of alternative customs arrangement that are acceptable to the EU (something like the FCA), that the UK would apply the EU’s tariffs. This backstop, therefore, would not treat Northern Ireland any differently from the rest of the UK. It may be acceptable to the EU because it compromises with regard to the Single Market and with regard to labour mobility. Conversely, it is harder to see how the EU could compromise more with the Customs Union proposal unless the UK Government were prepared to offer something else such as accepting labour mobility, as the EU would still have concerns about cherry picking and the integrity of the Single Market.

The discussions between Theresa May and Jeremy Corbyn are therefore not just about what Parliament might be able to agree to, but also what would be acceptable to the EU. Remember, however, that any of these proposals will be recorded as part of the non-binding Political Declaration and thus not completely guaranteed even from the UK point of view.

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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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