The future of Northern Ireland after Brexit can only be secured if it remains in the customs union, a former secretary of state will tell the House of Lords on Tuesday.

The Labour peer Peter Hain, who as Northern Ireland secretary helped steer the peace process when the IRA was decommissioning its arms, will tell the Lords that the government’s position on Northern Ireland is “delusional, contradictory and potentially very damaging”.

Lord Hain told the Guardian that the government’s negotiating strategy in Brussels was incompetent. He was particularly scathing about its recently published position paper on Northern Ireland and Ireland, which suggests that an “invisible” border could be maintained if the EU agrees to waive checks on small businesses providing goods and services, including dairy and meat products.

He said the government knew that this was “pie in the sky” because EU law would require Ireland to have checks to prevent products such as hormone-injected beef or chlorinated chicken from the US from making its way into the EU.

“It seems that the government’s favoured way to … square this particular circle is to pretend that the circle didn’t exist,” he will say.

“It is in effect saying to the EU and Ireland in particular: ‘As part of the divorce settlement you can have the border. Do what you like with it. The Irish border will be your customs union frontier.’”

He also believes that the government’s position is contradictory. On the one hand it wants to control the border to stop rogue immigrants, criminals and terrorists, but on the other they can come in via a back door through a porous Ireland.

He says Brexit is jeopardising £200m worth of funding under the EU peace programme, which finances cross-border initiatives especially in border communities.

“These thorny and intractable issues would not arise around the border … if we remained in the customs union … In my view the only way of resolving the border conundrum is for Northern Ireland to be within the same customs union and single market as the Republic: either Northern Ireland alone or preferably the whole of the UK,” he will tell peers.

The Lords’ report on UK-Irish relations after Brexit was published nine months ago and warned that Northern Ireland must not be collateral damage in Brexit.

He will describe it as “a disgrace” that the issues in the report are no nearer to being addressed.

Hain, who was MP for Neath between 1991 and 2015 and secretary of state for Northern Ireland between 2005 and 2007, believes the government is playing a dangerous game with the Northern Ireland peace process.

His biggest concern is that Northern Ireland has become another bargaining chip in the Brexit negotiations.

Last week a senior EU source rejected British proposals for the Irish border, saying they were predicated on the EU suspending its own rules for customs checks at borders between the EU and third countries.

What was needed, the source said, was a standalone agreement.

Such a deal would be politically divisive. While Sinn Féin has called for special status for Northern Ireland, the Democratic Unionist party – which has a confidence and supply agreement with the Conservative party – has said it is opposed to any special status for Northern Ireland as it considers this would diminish its status within the UK.

The Sinn Féin MEP Martina Anderson told the European parliament on Tuesday that Ireland needed special status. “We don’t want sweet nothings whispered in our ears to say we don’t want a hard border” she said.

Earlier this year Hain pointed out that special arrangements were not without precedent in the EU as states such as Andorra, which is not in the EU, had a customs agreement with Brussels.

Andorra is one of more than a dozen territories in the EU or linked to the EU that have special status under EU laws.