12 June 2017, 

L. Alan Winters CB, Professor of Economics and Director of UKTPO.

Suddenly everyone is talking again about the UK’s new trading relationship with the rest of the EU. Given the structure of the new Parliament, any party’s views may turn out to be pivotal. This blog is partly about what the parties say and partly about making conversation between them fruitful by clarifying the language.

What does it mean to ‘stay in the Customs Union’?

The UK is currently a member of the European Customs Union and of the European Single Market. The Customs Union applies to trade in goods (as opposed to services). Membership commits the UK to having no tariffs on trade with other EU members. It also compels it to apply exactly the same tariffs and trade policies as other EU members to non-EU countries. This necessarily includes membership of any free trade agreements that the EU has with non-EU countries, so the UK surrenders its independent trade policy. The big attraction of the Customs Union is that any import from a non-EU source faces identical treatment wherever it enters the union and so, once inside, can circulate freely between members. It is a necessary condition for abolishing customs formalities on internal borders. This is in contrast to a Free Trade Agreement in which members have zero tariffs within but (potentially) different tariffs outwith the group, and which thus requires internal border controls (and rules of origin) to ensure that goods destined for one member do not enter via another that happens to levy a lower tariff.

Membership of the European Customs Union is restricted to EU members but the UK could seek to negotiate a new Customs Union with the EU. The EU already has a so-called customs union with Turkey, but it is subject to various carve-outs and consequently has quite onerous procedures for EU-Turkey trade in order to identify what qualifies for customs union treatment and what not. If the UK wished to avoid such frictions, the UK-EU customs union would need to cover all goods. And even then, the UK and EU authorities may feel the need for some border formalities to check compliance with standards and levy Value-Added Tax. (Once outside the EU, the UK will need an independent VAT system.)

A key reservation about standard customs unions and free trade agreements is that they omit services. This is serious for the UK because 80% of the economy is services and in trade with the EU services exports generate more income in the UK (as opposed to gross sales) than do goods exports.

What does it mean to stay in the Single Market?

The European Single Market is quite different. It is designed to foster competition within the EU by eliminating differences in (a) regulations that segment markets and (b) the terms on which labour and capital are employed in order to ensure a level playing field. It is a ‘regulatory union’ in which members are bound to adhere to common regulations (except for specific carve-outs – of which the UK already has several – e.g. on working hours), and it is  enforced by a strong legal system culminating in the Court of Justice of the European Union (aka ECJ). Because Single Market members apply the same regulations and share the same enforcement mechanism, goods and services that satisfy one member satisfy the rest, and so there is no need to check the conformity of imports with standards at the border.

The EU view is that the Single Market is indivisible so that membership is not compatible with any significant dilution of the freedom of movement of labour. (This is a political position, not an inescapable technical one.)  The EU also feels that members must contribute to the costs of the EU budget if they are to benefit from the Single Market. The Single Market covers goods and services as well as capital and people.

The Single Market currently applies to EU members plus members of the European Free Trade Association (EFTA) (Iceland, Liechtenstein and Norway, via the European Economic Area (EEA) Agreement, and Switzerland, via a web of separate bilateral agreements covering goods, free movement of labour and some services). There is some consultation about the regulations, but basically the model is that the EU designs regulations and the other apply them – ‘pay, obey, but no say’. On the other hand, it offers very open access to EU markets in goods, services, capital and people. The non-EU EEA members are not members of the customs union but have a free trade agreement with it providing tariff free trade for goods originating within the EEA except in the areas of agriculture and fisheries. Consequently there still have to be customs posts and procedures between EEA and EU countries.

Weasel words

The current debate suffers from two sets of weasel words which mean whatever the speaker wants them to mean at the time. First, ‘customs agreement’ does not have an accepted definition. It typically entails procedures to minimise the waiting times and paperwork associated with crossing the border. Experience elsewhere suggests that there are good practices to follow, but they require lots of cooperation and investment in hard and soft infrastructure, and can never reduce trading costs, let alone tariffs, to zero.

Second, ‘access to the Single Market’ is not membership of it. Any country that exports to the EU evidently has ‘access’; rather it is the conditions that matter. Even if the UK had a customs union and identical regulations for services as the EU, ‘access’ would be less than membership. Not least this is because within the Single Market any individual or firm can bring a complaint against perceived unfairness, whereas a trade agreement implies intergovernmental dispute settlement, which is much less reliable. Thus the degree of cooperation possible within the Single Market may no longer be viable under even the strongest trade agreement because economic players will have less confidence in the enforcement of their rights.

Who says what?

The government’s current policy is that the UK will leave both the Single Market and the Customs Union, but seek a ‘customs agreement’ and a ‘deep and special’ trading relationship with Europe that gives ‘access to the Single Market’ (Davis Davies starts at 2.10 minutes).  The Scottish Conservatives, on the other hand, wish to remain in the Single Market.

The Democratic Unionists, who now also figure in this debate, list many manifesto objectives for the relationship with the EU (p.18). Among them,

2. Ease of trade with the Irish Republic and throughout the European Union
3. Strengthened relationships across the four components parts of the United Kingdom with no internal borders
4. Particular circumstances of Northern Ireland with a land border with the EU fully reflected
5. Progress on new free trade deals with the rest of the world
6. Comprehensive free trade and customs agreement with the European Union
7. Customs arrangements which facilitate trade with new and existing markets
8. Arrangements to facilitate ease of movement of people, goods and services

Their summary is ‘The stronger and more positive the agreements reached, especially on trade and customs relationships, then the better…’. This list is not wholly internally consistent, but the policy that achieves the most of it is membership of the  Customs Union plus something very like membership of the Single Market. (The customs union precludes the UK signing its own free trade deals, but new deals would still be feasible via the EU.)

The Liberal Democrats ‘continue to believe that there is no deal as good for the UK outside the EU as the one it already has as a member.’ And failing that ‘… any deal negotiated for the UK outside the EU must ensure that trade can continue without customs controls at the border, and must maintain membership of the Single Market.’

The Greens agree, and the Scottish National Party states that ‘there is no rational case for taking Scotland, or the UK, out of the Single Market’. Arguably, but not indubitably, in the same vein, ‘Plaid Cymru will ensure that Wales can continue to buy and sell to Europe without any costly barriers.’

Finally, the Labour manifesto places barrier-free access to the EU at the centre of its strategy with a strong statement about “retaining the benefits of the Single Market and the Customs Union”. This is not quite committing to remaining inside these institutions, however, and subsequently when asked by Andrew Marr if Labour would seek to keep Britain in the Single Market and Customs Union, Jeremy Corbyn said only that “there will have to be an arrangement made.” Pressed about whether the UK would leave the EU, he said: “Absolutely. Where I frame it is, we want tariff-free access to the European market” , which omits reference to services and regulations. Sir Keir Starmer, Labour’s Brexit Spokesman, on the other hand, has sought to avoid ruling out the Single Market from the very start.

In summary, the larger parties recognise the benefits of the current close trading arrangements with the EU, but rank them lower than those of maintaining some of the declared red lines over migration, the ECJ, the budget and an independent trade policy. The UK smaller parties, on the other hand, largely take the opposite view. There are thus two great uncertainties: will the larger parties re-consider their views if the economic cost of the red lines appears to be high, and would they ever consider co-operating with each other to leave the Single Market and the Customs Union rather than compromise with a subset of smaller players over the nature of Brexit?

 

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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