In its latest plot twist, Brexit delivered yet one more surprise. New election have been called by the government in reaction to the House of Common voting down the proposed timeline for implementing Brexit legislation. While awaiting to see what the British people will decide, we look at what PM Johnsons new deal would mean for the UKs future economic relationship with the EU. We conclude that while this deal might leave Johnson in a better political position at home, it also puts the UK in a worse economic position vis-à-vis the EU.
Who trades What with Whom
In 2018, 47% of UK exports went to the EU and 3% to members of the European Economic Area (EEA) and Custom Unions (CU). Outside the EU, EEA and CU, 14% of total UKs exports still went to countries covered by some form of EU Preferential Trade Agreements (PTA), either fully (11%) or partially in place (3%). An additional 20% of exports went to countries with whom some form of PTAs is currently under negotiation (Figure 1). This leaves only 16% of total UK exports completely outside of the EU preferential sphere of influence.
The UK Government has stated its intention to maintain the current position vis-à-vis third countries by replicating the rights that the UK presently enjoys under the EU preferential agreements. In some cases e.g. Switzerland, Turkey, Norway and Iceland – most of the products the UK exports would be subject to zero Most Favoured Nation (MFN) tariff even if the UK were not an EU member and traded on WTO terms. Exports to Norway for example would go from being 99% to 93% tariff-free under a regular MFN regime. In other cases, losing the preferential treatment would matter more. In Turkey, for example, the share of zero-tariff UKs exports would drop from the current 96% to 21%.
In 2017, former International Trade Secretary Liam Fox said that the UK would replicate the existing 40 EU FTAs before leaving the EU, to have no disruption of trade. As of October 2019, however, the UK has signed only 18 “continuity” deals covering 48 of countries and about 8% of total UK trade.
Moreover, the relevance of these deals is questionable. Some countries such as Iceland, Norway and most importantly Switzerland (the UK n°1 PTA partner) only agreed to roll over in a no-deal Brexit scenario, suggesting that they want to retain their flexibility under non-emergency conditions. Some such as Turkey and Japan have agreed to roll over in principle but are demanding deeper concessions than they got from the EU, so the deals will probably not be ready in time. Others Canada have simply ruled out rolling over existing conditions altogether.
Most importantly, continuity deals simply pledge to replicate the existing conditions as far as possible, leaving ambiguity. Even with those who did agree to roll over, conditions could change compared to current PTAs. For example, the UK Food and Drink Federation (FDF) estimates that 67% of UK food and drink imports and 54% of exports would be excluded from preferential treatment under the continuity deal signed with Switzerland.
The Irish Puzzle and the Future Relationship
Overall, it seems that PTA partners have all interest in waiting and seeing what the future relationship of the UK with the EU will look like a strategy that makes a lot of sense, also in light of the implication that Brexit might have on the application of rules of origins to UK trade. The shape of EU-UK future relationship is thus a key piece in the puzzle, and the new Northern Ireland Protocol has far-reaching implications for what that relationships may be.
The Northern Ireland protocol negotiated by May foresaw a temporary arrangement (the backstop) where the need to avoid trade-related checks at the Irish border was met by setting up a single EU-UK custom territory. For this to be possible, the UK would have needed to commit to a level playing field in several areas including State aid, environmental regulation and labour regulation, as well as to harmonisation of its commercial policy with the EUs. Because the protocol is part of Withdrawal Agreement, these commitments would have been legally binding and the UK would have shared common external tariff with the EU, for the time of application.
The new Protocol proposes a permanent solution whereby the whole UK (including Northern Ireland) is part of its own custom territory. This is achieved by means of a dual tariff regime that will introduce customs checks between Great Britain and Northern Ireland (in the Irish Sea), and treat goods differently depending on whether they are intended to stop in Northern Ireland or transit to the EU.
This new system has two key implications. First, the UK remains outside of EU custom territory and Northern Ireland is taken into UK custom territory. This means the UK is immediately free to set its own external tariff, and the trade deals it will negotiate will immediately apply to Northern Ireland.
Second, while Northern Ireland will still be subject to EU customs rules in order to ensure that no border is needed on the island, these requirements will not spill over to Great Britain because the latter will no longer be in a custom union with the EU. Accordingly, the UKs commitments to ensure a level playing field have been removed from the (legally binding) Withdrawal Agreement and they only remain in the (non-binding) political declaration.
Overall, these changes set the stage for a more competitive EU-UK trade relationship. The new political declaration suggests the UK now aims for an ambitious (rather than as close as possible) relationship on the basis of a free trade agreement. As the UK clearly wants to retain more flexibility, the EU will also be less willing to offer deep trade concessions to the UK. The new EU Trade Commissioner stated clearly that for the negotiation of an FTA to proceed quickly, the UK would need to sign up to level playing field provisions. What will this mean?
The Cost of going Canadian
In a by-now-famous presentation, EC Brexit negotiator Barnier pointed out that satisfying all the UKs red lines would imply a future UK-EU relationship looking at best like CETA or the South Korea FTA.
CETA is an extremely advance and deep agreement, under which 99% of the EU-Canada trade will be tariff-free. Under CETA conditions, the tariff impact on current UK exports to the EU would be minimal (an average weighted rate of 0.41%) especially when compared to EU MFN regime (3.3%).
Not all that shines is gold, however. First, even if the EU were to offer CETA, 40% of the UK global exports are concentrated in services, and no free trade agreement is famous for having achieved a deep liberalisation of services trade (Figure 2). Even CETA, which is the most comprehensive agreement the EU has ever concluded with regard to trade in services, includes restrictions in sectors covering almost 70% of the UKs services exports.
With respect to financial services, CETA only liberalises some types of insurance (maritime transport, commercial aviation and space launching and freight), reinsurance, some banking-related services and portfolio management. Most importantly, all these concessions can all unilaterally be curtailed for prudential reasons thus creating significant uncertainty, which may negatively affect trade and investment decisions.
Attempts to convince the EU to offer better conditions on services than those carved out in CETA will most likely be unsuccessful. CETA includes a most-favoured nation treatment clause that essentially locks in the privileged position of the signatories of those agreement, by ensuring that they will be able to benefit from any better terms that the other party might offer in the future to other partners, at least in the same areas covered by the agreement.
In practice, this means that if the EU were to grant the UK better access to its services markets, the same treatment would need to be extended to Canada (and South Korea, the CARIFORUM countries, Japan, and probably Vietnam and Mexico). There are ways around this, but they all seem to require for the UK to agree to a much closer type of relationship than it seems prepared to swallow (more precisely, either an internal market with free movement of people, or an approximation of legislation that very much looks like the now-scrapped commitment to level playing field). This adds a significant political dimension to the Brexit trade negotiations, as it limits the concessions the EU will be ready to make.
Second, the EU may simply not be willing to offer as deep an FTA as Canada. PM Johnsons talk of turning the UK into a Singapore-on-Thames will raise eyebrows throughout the Continent, and the EU may have cold feet offering concessions when confronted with such an aggressive strategy and the prospect of UK regulation diverging sizeably from the EUs. Ominously enough for the UK, the one new-generation FTA in which the EU did not feel like committing to a general MFN clause in the services and investment chapter is precisely that being negotiated with Singapore.
In conclusion, it seems that the prospect of rolling over all existing trade agreements with third countries is proving overly optimistic and that the UK is already getting a taste of what negotiating trade deals on its own will feel like. Strategically, partners have all interest in waiting to learn what the future EU/UK relationship will look like, before tying themselves to concessions. We believe that the newly agreed Northern Ireland Protocol, by removing the commitment to level playing field from the legally binding Withdrawal Agreement, has far reaching implications for the kind of EU/UK future relationship that can be achieved. Specifically, while the new deal might leave PM Johnsons in a better political position domestically, it also leaves the UK in a weaker economic position vis-à-vis the EU.
Silvia MERLER– Head of Research, Algebris Policy & Research Forum
Antonio FOCELLA Junior Research Analyst, Policy & Research Forum
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