During the Brexit referendum debate, much was made of the prospect of the UK defaulting to global tariff rates and crude border processes. A landscape worthy of Hieronymous Bosch was laid before our eyes. To what extent is this unvarnished Project Fear, and what is actually at risk?
Theory versus practice
It has been suggested that those managing customs on behalf of our trading partners would have to open every crate to check goods for components. UK businesses would default to 1930s levels of paperwork to clear trucks through border crossings. Trade would log jam at points of entry and exit. The shops would run out of bread. Total collapse of Western civilisation, at least in Basingstoke.
Technically, this could happen. It is also technically possible that Customs waves a North Korean A-bomb through Heathrow. The question is one of actual prospect and of mitigation.
Currently, I am putting the finishing touches to a massive audit of potential administrative problems facing the UK after the referendum. The Red Cell Brexit Risk Register runs to over 200 pages listing everything from number portability in mobile phones to Special Treatment Certificates for animal medicines, via the All Ireland Ash Dieback Control Strategy and eel passes on river weirs. But in the overwhelming majority of those cases, it also identifies a negotiating objective that should be quite attainable.
In the context of such a complex register, tariffs are a comparatively simple problem to grapple with conceptually, which is why so much has been made of the danger. It starts to get more complicated when looking at third party quotas and the UK transitioning into them. Minimising the associated paperwork is a more complex issue still, depending as it is on areas covered in other pieces this week (and which would take a book to even summarise fairly). Here we’ll focus on just tariffs, and then turn to the associated question of Rules of Origin.
If there was absolutely no deal done between the UK and the EU on tariffs, then the terms set would be those set out under Most Favoured Nation (MFN) conditions, that is to say the default applied to all WTO states by a given signatory in the absence of a bilateral arrangement. These figures vary very considerably across sectors. In some areas, particularly in agriculture, tariffs can be high. In others, they are considerably lower: in many cases, rates are set at a figure within the bounds of normal currency fluctuations or are even zero-rated.
So the first key point is that the EU’s MFN rates would affect UK sectors very differently. But we should also add that this prospect for pain works both ways, and carries many consequences.
For their part, the more vociferous continental sectors would be amongst those worst hit. That means big corporations with the biggest lobbying power to push for a deal their end. But it also means a lot of angry French farmers from particular sectors burning tyres on roads (for once not because of wanting to block trade with the UK, but to facilitate it).
Tariffs also mean certain EU goods become more expensive at the till, but this also encourages, in the medium-term, increased imports from other sources and free trade deals being reached with non-EU countries. It further means that equivalent UK-sourced produce becomes comparatively more competitive within the domestic market, allowing for some diversion of UK exports into the UK market place. But tariffs on imports from the EU also generate government revenue. None of this is said to encourage their introduction, merely to recognise the facts.
Because of ground-breaking work by William Norton, we now know that the imbalance in UK-EU trade means UK exporters under MFN terms would have to stump up £5.2 billion in tariffs (on current export trends), but EU counterparts would themselves have to pay £12.9 billion to the UK Treasury. That revenue could be hypothecated (subject to WTO rules) to indirectly support UK sectors suffering from those new tariffs and still leave change.
Of course, this is before one goes into considering the deeper impact of trade diversion, and we leave the economically applaudable but politically vexatious question of unilateral abrogation of tariffs on EU imports (as advocated by Economists for Brexit) to another paper. But the point stands that imposing any new tariffs means reciprocal consequences.
The example of lamb
This is not to minimise the real prospect of harm to some sectors if MFN terms are triggered. Take lamb exports, an example shrewdly cited by Remain campaigners during the referendum. Third country duty for lambs under one year old are rated at €80.50 per 100 kg. If imported as carcasses and half-carcasses of lamb, fresh or chilled, the rate is upped to 12.8 per cent plus €171.30 per 100 kg. This rate has been set to hinder competitive Antipodean imports, but would also hit UK exports if unaddressed.
However, there is a flip side. Shetland Islands Council‘s recent submission to the Scottish Parliament also noted that for its agricultural sectors, most if not all of its exported products (such as store lambs) went to the UK domestic market. Farm groups also pointed to specific EU legislation that could be redrafted to be less onerous but still export compliant, such as sheep tagging requirements for hefted flocks. Market competitiveness can be gained from Brexit: the real question is really whether the opportunity will be seized.
But there is a reason why Remain picked the troubling example that they did, for it would be a mistake to see this as a universal exemplar. Dipping quite randomly into duty rates, garden umbrellas come in rated at 4.7 per cent tariffs; toilet paper at zero per cent; and buffalos (a niche sector unless you like mozzarella, but it was random) at zero per cent. Agreed, sectors come in different sizes and relevance to the UK economy, but the prospect of MFN rates meaning everyone falls off a cliff without a parachute (duty rate: 2.7 per cent) is a misrepresentation.
We mentioned quotas earlier in relation to tariffs, and the US beef example warns us of deeper complexities. The EU obstructed beef imports from the US over growth hormones. After escalating into a WTO dispute, mutual sanctions were lifted in return for a zero-duty tariff-rate quota (TRQ) for high quality hormone-free beef set finally at 45,000 tonnes. Over time though this particular quota came to be shared by five other major beef-producing states.
From a UK perspective, this raises many questions: whether the UK would become a seventh state seeking a share of this quota for its exports; what happens to the total quota share given the UK market is leaving the EU; if the UK has its own quota; the certification mechanisms for showing adherence to the quality controls associated with this class of beef; management of the Approved Listings scheme; rules on the quality control of the quality certifiers themselves (DEFRA vets or private labs) and so on. Yet once you start to strip these down further, one finds these are addressable points, particularly for a country starting from compliance with the rules, trusted systems, existing compatibility with IT systems, and a definable share of existing quota arrangements as a starting point.
Note, of course, that this US beef agreement is additional to ‘basic MFN terms’, as it is agreed as a supplemental. So it reminds us that the ‘WTO default’ is a myth unless Whitehall goes on holiday for two years and discusses nothing with the Commission.
Rules of Origin
An important element that will need to be addressed lies in Rules of Origin. These are so significant a form of Non-Tariff Barrier (NTB) that UNCTAD (the UN trade agency) defines them as a category of NTB in their own right.
Very simply put, Rules of Origin define where a product was made, because not everything is mined, smelted, turned into components, put together, and then painted in one country. So what to do if different trade arrangements cover exports from different countries in the final market?
The solution is to come to an agreement over cumulation, ie over how much added value is done at what stage of a product, and taking into account things like labour value, fuel, plant costs, overheads, and R&D costs.
There are four types of cumulation. Bilateral Cumulation means re-exporting raw goods back into the EU after using them: the European Commission is fond of using the example of EU cotton turned into an Israeli shirt and exported back into the EU. Diagonal Cumulation extends this process to another country that has an identical deal or is part of a regional deal – examples include the “pan-Euro-Mediterranean cumulation zone” (which counts amongst its members the Gaza Strip but also EFTA countries), while non-EU Balkan states form a separate cumulation zone. Then there is Regional Cumulation; extending the principle to operate between geographical entities or trade blocs, for example between the EU and ASEAN; or the EU and the Indian subcontinent. Or there is Full Cumulation, extending the principle even wider to include work done on products that don’t come from either party (ie they are ‘non-originating’) – within set terms. Examples here include the EU and the non-member countries of the EEA, or the EU and the Maghreb.
That gives a lot of precedent, especially for European states. If Gaza can find terms, and Algeria is able to get Full Cumulation, I suspect the UK can find agreement, too.
All this means a lot of work for our brightest in Whitehall. Take the new Approved Exporter System, which replaces UNCTAD’s old Form A and the EU’s movement certificate, EUR.1. The new IT has only been up and running for a few months, but calibrating the UK to remain as part of the system would constitute a major step towards cutting paperwork at borders. As an Approved Exporter, the process for customs accepting your goods as cumulation-compliant becomes easier, and reduces the need for checks at borders by shifting them higher up the transport and administrative chain. Agreements also need to be explored over a range of other facilitating mechanisms, some in specific sectors such as the role of the European Responsible Person over cosmetics.
The task for negotiators
Brexit negotiators do have their hands full. On top of the above, they have to ensure departments retain current definitions over such abstracts as Value Added, Minimal Operations, and Direct Transport. They have to define General Tolerance Rule Limits, and “No drawback” conditions. Logically, the route may be to test the water by focusing initial discussions on mechanisms covering supply chains in automotive, chemicals and aeronautical industries, where the greatest continental incentive lies and precedent can be set.
Above all, Whitehall will need to demonstrate its intent to preserve its existing marble-clad credibility as a pillar for maintaining international trade standards. Border formalities become less of a formality and more of a reality when customs officials are uncertain of the products before them. Key mechanisms do exist to move compliance checks away from border points and up and down stream. Thankfully, the UK has a credible set of professionals and administrators behind it. But another BSE scandal could easily blow that trust.
So, Brexit is like a Mandelbrot Set – it remains just as hypnotically complex and dazzling the deeper you zoom in, until you lose all sense of starting perspective.
Critics of making a robust break from the EU might spend the rest of the year digging ever deeper into problems of esoterica and ephemera, like the need for EUR.1 forms to be on a printed green guilloche pattern background for them to be legally admissible. Or they can accept that measuring the MFN against some mythical perfect deal is a nonsense.
By the time the UK ends up trading outside of the Single Market, whether on Free Trade Agreement terms or less, administrators on both sides will have been working for months on redefining and modifying hundreds of administrative structures. Some form of trade arrangement will be done that bolts on to MFN tariff defaults. Right now, we don’t know how comprehensive that will be.
Brexit is not easy, but fears need to be rationalised. There is no silver bullet. But there’s no werewolf, either.