Negotiating Britain’s new trade policy

Jim Rollo, L Alan Winters

For over four decades, the EU has managed most international trade policy on behalf of the UK. After Brexit, the UK government will have to reconstitute trade links with EU, with third nations while disentangling the UK from the commitments that the EU made on its behalf in the WTO. This chapter suggests some strategies for the UK government to follow in reconstituting its trade policy. The watch words should be simplicity and cooperation. Maintaining the goodwill of trading partners will be a very high diplomatic priority.

Editors' note: This column first appeared as a chapter in the VoxEU ebook, Brexit Beckons: Thinking ahead by leading economists, available to download free of charge here.

Watch Jim Rollo discuss the impact of Brexit on the UK's regulations in the video below.

For over four decades, the EU has managed most international trade policy on behalf of the UK. Brexit changes all this. The UK now needs to debate and define its ambitions for international trade and then negotiate them with its partners.

In leaving the EU, it will reassert its status as an individual member of the WTO and will need to determine all the details of its trade policy within the framework of WTO rules. However, WTO rules offer considerably less market access than do the Single Market in the EU or the FTAs that the EU has negotiated with other partners to their markets.

Moreover, extracting the UK from the EU’s commitments in the WTO entails complications and negotiation. This column warns that the 'WTO option’ for UK trade is not a simple or attractive way to continue UK trade – i.e. that maintaining exports requires that we do better than that. It also argues that the key to being able to do better is to cultivate cooperation and goodwill with the remaining members of the EU (the EU27) and our other WTO partners. It is a diplomatic challenge.

The situation today and after Brexit

Until the Article 50 procedures are completed, the UK remains a full member of the EU with access to the Single Market and trade policy determined by the EU and implemented by the EU Commission. All existing EU agreements with other WTO members would still apply and the treatment of UK imports from and exports to EU partners and third countries should receive exactly the same treatment as before the referendum.

After Brexit, the UK government has complete control over the treatment of imports (subject to WTO commitments) and it could choose to continue to apply the same measures as previously, which would be consistent with the tariff and services schedules it agreed to as a member of the WTO in the WTO’s Uruguay Round and as subsequently revised to take account of subsequent enlargements of the EU.

If Britain decides to raise barriers, this would, in principle, give rise to renegotiations with affected WTO members. We would strongly advocate against this. The UK should not raise barriers. It should maintain or even lower them from current levels and this for two reasons. First, this would be good policy, but second it would be efficient in terms of reducing the burden of renegotiations. Raising barriers angers foreign exporters in a way that would complicate many of the trade negotiations that the UK must conduct in the years to come.

The three big questions

As of today, we do not know what the British government’s goals are when it comes to trade policy. As a consequence, we do not know how other nations are going to treat UK exports. There are three classes of trading partners:

The EU27;

Those countries which have negotiated, or are negotiating, preferential trading arrangements with the EU (e.g. Turkey); and

Those countries which have a most-favoured nation (MFN) relationship with the EU based on tariffs and services schedules negotiated in the WTO (e.g. the US).

The relationship with the EU27 is complex because it is unclear whether the Treaty on the Functioning of the European Union (TFEU) allows negotiation of the post-Brexit arrangements between the UK and the EU27 in parallel with the Article 50-mandated negotiations on the terms of the exit.

If the EU27 will not allow a new trade relationship to be negotiated until the UK has left the EU, or if the trade agreement were not completed by the end of the exit negotiations, the default position would be that both sides treat each other on MFN terms, which is unlikely to be desirable for either. For example, 44% of UK exports go to the EU and face zero tariffs and very low non-tariff barriers courtesy of the Single Market. If that trade were carried out on an MFN basis, around 16% of UK exports to the EU27 would face tariffs exceeding 7%, of which half would be motor cars, which would face a tariff of 10%. The average MFN tariff levied by the EU is 5.3%.1

Disentangling the UK’s and EU’s commitments at the WTO

There are also some gritty little problems to resolve in traditionally very sensitive areas. For example, the EU’s expenditure limit on trade-distorting agricultural subsidies under the WTO’s Agreement on Agriculture is a single figure which will need to be divided up between the UK and the EU27. This will require a three-way negotiation with third parties, which may have material interests in the division because the UK and other members will subsidise different bits of agriculture.

Turning to services, the EU again takes about 50% of UK exports and is the single most important trading partner across all major types of services, of which the main components are, in order, professional, scientific and technical services, information and communications services, and financial and insurance services.

Here it is much more difficult to gauge the change in trade barriers that Brexit implies because the Single Market is incomplete (i.e. some services barriers persist within the EU even now) and because there is no uniform EU external trade policy for services. Rather the EU’s GATS schedule sets out a framework for market access which is punctuated by individual countries’ derogations in particular subsectors and modes of supply. The latter also means that the negotiation of a long-run agreement will be complex and time-consuming because it will require negotiations with all individual EU member states as well as with the Commission. Moreover, although EU members’ applied policies towards services imports are often more liberal than their GATS commitments, only the latter are guaranteed, so that even if the former are more favourable, they could be removed at any time and thus are afflicted by considerable uncertainty that does not pertain while the UK is within the EU.

A temporary extension of the status quo?

A gentler alternative to dropping straight to MFN trade would be to temporarily extend the status quo in EU-UK trade while a long-run relationship is worked out, although that requires finding a balance between access to the Single Market on the one hand, and free movement of labour on the other.

Other WTO members may object to this as a violation of MFN, but any dispute would take a considerable time and it is also possible (likely?) that, recognising the disruption of a sudden unprepared change, other WTO members would allow de jure or de facto temporary waivers to allow the EU-UK negotiations to continue without pressure from Geneva. Of course, that does assume goodwill on all sides.

The post-Brexit relationship with countries that have preferential trade agreements with the EU (mostly FTAs) may be easier than the EU27 one, because they may be more relaxed about having informal discussions about allowing the existing bilateral arrangements to continue while a formal FTA or similar agreement is drawn up. And the stakes are higher in these markets because in general, their MFN policies are less liberal than those of the EU. Trade with those countries in 2015 represented 14% of UK exports and the average MFN tariffs that they would face vary from under 5% (Israel) to almost 30% (Egypt) and, perhaps most notably, 17% in Korea. At a more detailed level, tariffs could be considerably higher.

The situation is similarly varied for services, but if the UK no longer received the terms of the EU’s flagship trade deal with Korea, for example, the UK would lose considerably.

It is not easy to compare the Korea-EU FTA and the GATS schedule because they differ in structure. For example, the FTA incorporates rules about the establishment of foreign firms into its investment conditions rather than as an element of services trade. Nonetheless, in many specific areas the EU-Korea agreement goes well beyond Korea’s GATS commitments. For example, in financial services it opens up the Korean market in several respects, and in particular allows EU firms the right to offer new financial services as they develop. It also opens telecommunications markets by reducing local ownership requirements, as well as the legal services and shipping services markets. Moreover, the Korea-EU FTA is similar to the Korea-US FTA, so that if the UK could no longer trade under the FTA, it would suffer disadvantages relative to both the rest of the EU and to the US.

The extension of current bilateral arrangements again requires goodwill – on the part of the partner countries and also, to an extent, on the part of the EU27 in not trying to block such extensions.

Finally, for countries with which the EU currently has MFN-based trade relations, a continuation of these after Brexit seems to be the line of least resistance. There is much talk about concluding trade agreements with some of these countries over the two-year exit negotiation period, so that they can be implemented immediately on exit. This underestimates the time and effort that is required to negotiate half-decent agreements under the best of circumstances, and also the complexity (on both sides) of the UK negotiating with third parties while its relationships with the EU and the current FTA partners remain unclear.

Moreover, there may be more important things to sort out than FTAs. For one, the UK has membership of the WTO’s Government Procurement Agreement (GPA) only through its membership of the EU; the EU ratified the GPA on behalf of its members but the UK has not, so far, done so individually. The annual value of procurement activities opened up to international competition by the 43 GPA parties amounts to US$1.3 trillion according to European Commission figures, and if it does not ratify/accede in the interim, the UK will lose its rights of access to all GPA members’ procurement markets on exit from the EU. Given its large market and the generally liberal attitude of British governments to buying foreign goods, an important share of the benefit of the EU schedule under the GPA to other members stems from UK purchases (PwC, Ecorys and London Economics 2011). This means that Brexit will change the deal third nations struck with the EU on government procurement. In the world of trade, such changes trigger renegotiations. Thus the new GPA deal for the UK will probably require a three-way negotiation (UK, EU27 and third nation) with each of the 18 other parties to the GPA. The complexity and need for goodwill is obvious.

Conclusions

Reconstituting UK trade policy will be complex and time-consuming, and if Britain is forced to trade just on 'WTO terms’ rather than with the preferences it has become used to on around three-fifths of exports, its trade performance will suffer. Thus the watch words should be simplicity and cooperation. The latter makes maintaining the goodwill of trading partners a very high diplomatic priority.

We recommend that the UK government should:

In the first instance, adopt existing EU WTO schedules covering imports of goods and services;

Try to extend current EU-UK trade arrangements (i.e. the Single Market or something very like it) for a finite period in which a new long-term agreement can be negotiated;

With respect to countries that currently have preferential agreements with the EU, push to initiate informal discussions immediately to maintain the access that these provide (where these arrangements are quite deep – as with Korea, for example – this will be important for service providers);

Not privilege negotiating new agreements above preserving/modifying those that already exist;

Examine the EU’s WTO commitments carefully to ensure that the WTO rights and privileges that Britain currently gains from its membership via the EU are preserved after Brexit.

Authors' note: This column is based on the Observatoryís Briefing Paper No. 1 "The World Trade Organisation: A Saftey Net for a Post-Brexit UK Trade Policy?", to which several other members of the UK Trade Policy Observatory contributed.

References

PwC, Ecorys and London Economics (2011), Public Procurement in Europe: Costs and Effectiveness, report prepared for the European Commission.

Endnotes

[1] MFN applied tariff, unweighted average, total trade 2014 (source: WTO tariff profiles)