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Brexit 2020: Australian Deal is the new No Deal

In a televised speech on October 16th, which followed weeks of deteriorating confrontations between Brussels and London, UK’s Prime Minister Boris Johnsons warned the public to expect an ‘Australia-style’ trade deal with the EU. How did we get here, and what does this mean for the UK/EU trade relationship from January 2021?

Chronicle of a Fight Foretold

As we wrote back in November 2019, the Northern Ireland Protocol negotiated by PM Johnson achieved the remarkable combination of leaving the Prime Minister in a better political position at home, in view of the then-upcoming elections, while leaving the UK in a worse negotiating position vis-à-vis the EU. Johnson’s version of the Protocol set the stage for a more competitive EU-UK trade relationship, as evident in the fact that the commitment to level playing field only remained in the non-binding Political Declaration, where the UK stated it aimed for an ambitious “relationship on the basis of a free trade agreement (FTA)”.

As the UK government was dispelling any doubts on its wish to retain more flexibility, we argued that the EU would also be less willing to offer deep trade concessions: the best deal that the UK could extract from the EU was one on the terms of CETA – the FTA the EU currently has in place with Canada. Under CETA conditions, 99% of the EU-UK trade would be tariff-free and the tariff impact on current UK exports to the EU would be minimal (a weighted average rate of 0.5%). While being a good deal, CETA is not that great deal for Brexiting Britain: the problem with any EU-UK FTA was always going to be trade in services, where 46% of UK global export occurs (Figure 1). Even CETA, which is the most comprehensive agreement the EU has ever signed with regard to trade in services, would not lift restrictions in the sectors where most of the UK’s services exports are concentrated. A ‘most-favoured nation treatment clause (MFN)’ in CETA also limited the ability of the EU to offer the UK better conditions on services than those offered to Canada. The objective of the May government had been to keep the door open for an agreement that could be better than CETA on services. That kind of agreement however required a closer degree of regulatory alignment with the EU than what Canada has in place: the new Northern Irish Protocol agreed by PM Johnsons made clear that the UK was not willing to ensure that degree of alignment, and effectively shut that door.  

More importantly, the changes to the Withdrawal Agreement obtained by PM Johnson implied a risk that even CETA conditions may not be on offer, because the prospect of UK regulatory divergence had become more tangible. Ominously enough for a government eager to turn the UK into a “Singapore on Thames”, 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 was precisely that negotiated with Singapore. All these tensions came to a head last month, when the widely debated UK Internal Market Bill effectively formalised an intention by the British government to break international law by overriding some of the provisions agreed in the Withdrawal Agreement, which led to trade talks to break down.

The Cost of going ‘Australian’

What does ‘Australian Brexit’ look like? Exactly like No-Deal Brexit, it turns out. The tariff schedule that the EU applies to Australia – with whom the Eu opened negotiations for an FTA only in 2018 – is the same applied to all third countries with whom the EU does not have a deal. The UK would therefore be trading with the EU on WTO terms.

In 2019, 46% of UK exports went to the EU and 2.5% to other members of the European Economic Area (EEA) and Custom Unions (CU). In an ‘Australian scenario’ trade with the EU would be subject to the EU Most-Favoured Nation (MFN) tariffs. Compared to the tariff-free status quo, the EU MFN regime would imply a weighted average tariff of 3.4% on the current composition of UK’s exports to the EU. Naturally, EU countries would also be facing tariffs when exporting to the UK. As Table 1 shows, Member States would face a generally higher increase in tariffs under an Australian Brexit, compared to the UK. The effect is uneven across countries, and the hike would be especially hard on Italy and Spain – particularly if we only look at those sectors where the two countries are currently producing a trade surplus vis-à-vis the UK.

This effect is due to the different composition of the UK and EU trade baskets, but it is more than offset by the relative size of the respective trade flows. While the EU would be experiencing the increase in tariff on just 6% of its global export, the UK would be feeling the heat on 46% of its exports. Once we account for this, the impact on overall export prices of a No-Deal would be 1.6% for the UK, and only 0.25% on average across the EU (Figure 2). An ‘Australian scenario’ would impose a hefty toll also on UK households: assuming a 1:1 rise in prices, EUR 13 bn in tariffs on EU products would amount to an average of EUR 200 on every UK citizen annually, while on the EU side EUR 6.5 bln on imports of British products would imply an almost negligible impact of EUR 15 per capita. This compares with EUR 40 and EUR 2 respectively, should a compromise be found on a CETA-like deal.

And Global Britain?

What about trade with third countries? Outside the EU, EEA and CU, 12% of total UK’s exports still went to countries covered by some form of EU Preferential Trade Agreements (PTA), either fully (9%) or partially in place (3%). An additional 22% of exports went to countries with whom some form of PTAs is currently under negotiation. In 2017, former International Trade Secretary Liam Fox stated that the UK would replicate the existing 40 EU FTAs before leaving the Union, to ensure no disruption in trade conditions. As of October 2020, however, the UK has signed only 21 “continuity” deals covering 50 countries and about 8% of total UK trade. These deals pledge to replicate the existing conditions “as far as possible”, leaving ambiguity as to the leeway that trade partners will have. Conditions could change compared to today, even with countries who agreed to roll over. 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.

With those countries that did not agree to sign a continuity deal, trade will be subject to the WTO most-favoured nation (MFN) tariffs. In some cases, losing the preferential treatment would hurt: in the case of trade with Turkey, for example, the share of UK’s exports subject to zero tariffs would drop from 96% to 20% (Table 2). To this, one needs to add uncertainty about the 18% of UK exports that are currently outside of the EU preferential sphere of influence – most importantly those directed at the US, which is famous for being a tough trade negotiator. The Internal Market Bill might put the transatlantic ‘special relationship’ at risk, by casting the shadows of an Irish border on future trade talks. Former VP Joe Biden and House Speaker Nancy Pelosi, among others, have state clearly in recent weeks that breaking the Good Friday Agreement would likely mean that the UK – unlike Australia – would not get a trade deal with the US.

As a community whose very existence is rooted in international law, the EU has little political room to compromise and it cannot overlook a deliberate violation by the UK of a mutually agreed international accord. This is especially true at a time when a heated discussion is ongoing in the EU Parliament about how Member States’ violations of EU rule of law should be sanctioned in the next budget cycle. As a result, absent a backtrack of the UK on this controversial piece of legislation, No-Deal Brexit is again a probable scenario. If this scenario were to materialise, the UK would find itself trading with no deal with the EU and possibly no deal with the US, in the middle of a global pandemic. At that point, ‘global Britain’ would be little more than a faded illusion.

Silvia MERLER – Head of Research, Algebris Policy & Research Forum

Antonio FOCELLA – Junior Research Analyst, Policy & Research Forum

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