James Arnell is a partner at Charterhouse. He writes in a personal capacity.
In this continuation of my notes, originally published in December 2017, to Steve Baker, who was then the minister charged with contingency planning for a no deal Brexit, this article will cover the trade and regulatory arrangements the UK will adopt after Brexit:
- A proposed tariff regime
- Customs arrangements, including proposals for the Northern Irish border
- Proposals to ensure a finding of regulatory equivalence between the UK and the EU in financial services
- Arrangements for the takeover of functions currently undertaken by EU agencies
- Prioritisation of FTA discussions with other states
A proposed tariff regime
If we cannot secure an acceptable free trade agreement with the EU before 2019, most observers have suggested that we move to a WTO tariff regime. Successive negotiations and bilateral arrangements between states have reduced the impact of tariffs, which is why there are very substantial trade flows between markets even without free trade agreements. The WTO tariff regime effectively amounts to an “almost free trade agreement” between all the signatories.
The WTO tariff regime has 99 chapters, covering goods of all descriptions. Within each chapter, there are sub-categories of goods down to a very specific level, and each one has its own tariff, and some also have allowances for importation of certain quantities on a reduced or tariff-free basis. The basic principle is that, in the absence of a comprehensive FTA which trumps the WTO tariffs (such as the EU Single Market), then any reduction in tariffs by a signatory state needs to be extended to everyone. We can’t “pick on” the EU.
Tariffs, even at a low level, are a frictional cost of trade and are therefore bad for trade. Agreeing FTAs with as many states as possible will be an urgent priority for the UK after Brexit, but it will take time. In the meantime, we will have to consider what tariff regime we want to follow.
In determining this, I would propose the following as the key considerations:
1) We should reduce tariffs as much as possible, while maintaining leverage over trade partners to bring them to the table for wider FTA discussions. This has many benefits:
- Reduces costs to our importers;
- Reduces costs for our consumers;
- Increases the UK’s importance as a trading partner to the rest of the world;
- Reduces the complexity of management of the tariff system for our customs officers.
2) Specifically with regard to the EU, we should retain tariffs in those sectors which cause significant pressure on individual EU states, in order to encourage the EU to agree a FTA with the UK in due course.
3) We should reduce tariffs on intermediate goods and raw materials, while maintaining tariffs on some finished goods. This will stimulate growth in higher value-added sectors of the UK economy. By way of example, we could reduce the tariffs on components for cars to zero, while maintaining the tariffs on finished vehicles.
I would propose that we radically overhaul our import tariff regime to coincide with Brexit in 2019.
I propose that the UK suspends tariffs on many WTO chapters, and charges tariffs on imports on just 23 of the 99 chapters. If at all possible, it should reserve the possibility to increase tariffs back to the WTO level in other chapters, should there be unexpected economic impact.
These 23 chapters account for £154 billion of imports from the EU and £149 billion of imports from outside the EU, i.e. 65 per cent and 64 per cent of imports respectively. £83 billion of non-EU imports would become zero-tariff imports. The net addition of tariffed imports as a result of the introduction of the proposed new tariff regime would therefore be £71 billion, an increase of 30 per cent over current tariffed imports. This uplift should make the transition much easier for our customs system to manage.
The UK would ‘lose’ tariff income (as compared to a standard WTO tariff deployment) of £2.8 billion on EU imports and £2.3 billion on non-EU imports. This would reduce frictional costs of trade (as compared to a standard WTO tariff deployment) by £5.1 billion. This benefit would be felt by UK importers and consumers (although care would need to be taken to monitor the effect on local producers).
Further refinements to the tariff regime should be considered for electrical goods and machinery. In these areas, there are substantial flows and it may be advantageous to reduce tariffs to zero on parts and components, while maintaining tariffs on finished products. I have taken this assumption for automotive, but data is opaque for other sectors. The Government has all the figures, but they are not easy to find in consistent formats. This should be a core focus for Dexeu’s team in the very short term, so that changes to the tariff system can be very precisely and intelligently targeted.
Customs arrangements, including proposals for the Northern Irish border
Our responsibility is to control our imports. We will no longer be responsible for collecting the EU’s external tariff. That responsibility will lie with the EU. It is therefore for the EU to inform us as to how they propose to implement the external tariff on goods coming into the EU from the UK.
(UPDATE: The Prime Minister has said on her visit to Northern Ireland on 20th July that this approach – that it’s their problem – is not a suitable position for a responsible country to take. I address what I think we should offer below, but I cannot resist stating my opinion in passing, no doubt shared by many, that the Northern Ireland border has been the “tail that wags the dog” in May’s Chequers deal. The refusal to confront the hard choice – a tech-enabled border with the Republic, or a customs border at the Irish Sea – has led to the ridiculous situation in which she ties the UK to EU regulation of goods into perpetuity, with no input to that regulation. There is no way to diverge without an Irish customs border. May has declared that neither form is possible. It follows that we can never diverge, which means no really effective bilateral trade deals in goods with any countries outside the EU. It is farcical. I see two options to escape from this conundrum, both of which are so obvious that May’s refusal to entertain them convinces me that she has used the Irish border issue as cover for her desire to implement a very soft Brexit. The two options are: 1) Use a technology border as proposed by Boris Johnson and many others. I refer her to the border around London (which controls the congestion charge) as an illustration. 2. Buy off the DUP, and put the border at the Irish Sea. This would, in my view, have significant economic benefits for Northern Ireland and any financial drag could be easily compensated by additional transfers from Westminster. The Irish situation is already unusual. We have the Common Travel Area, and we have an integrated energy system. Having the anomaly of a customs border at the Irish Sea is simply a reflection of the fact that Ireland has our only land border with the EU. No more, no less. There is no need to conflate issues of long-term sovereignty with issues of administrative convenience. The DUP will no doubt demand other assurances from the UK as to their long term future in the Union, and the government should give them. These might include the relocation of major UK government facilities, and so on. We can afford to be generous, as the current impasse risks costing us a fortune in lost trade deal opportunities. To be clear, I prefer option 1.)
As I suggested in my last article, our divorce payment to the EU should be made subject to satisfactory arrangements being set up for customs borders, and then implemented fairly. We should expect our EU partners to seek to put pressure on us by delaying import clearances and we should plan for that.
Two urgent priorities spring to mind, beyond attaching a condition to our divorce settlement:
1) Companies may need to build local stocks in the EU to ensure that they can continue to supply their customers as the new arrangements bed in. The UK Government should create a dedicated stock financing fund to allow UK companies to build those stocks ahead of Brexit and move them into the EU;
2) As we have heard repeatedly, there will need to be an expansion of capacity for the export infrastructure of the UK to allow for customs checks on outbound traffic if that is part of the agreement with the EU. We should offer to fund this and to administer this as much as possible, as it will free us from the threat of deliberate obstruction of export flows.
As for imports, the tariff regime proposed above will lead to a net 30 per cent increase in goods entering the UK being subject to tariffs. This should be manageable, but it will require the hiring of more customs officials and it may also require additional physical capacity.
Should the conclusion be reached that this cannot be put in place before March 2019, then the consequence should not be that we increase the size of the cheque we offer to the EU. We should instead explore the option of simply suspending tariffs or increasing quotas on a wider basis for a period, to reduce customs load while we build additional capacity. Tariffs could be raised or quotas reduced as and when the capability is in place, provided that the same treatment is applied equally to all WTO signatories.
Finally, what to do on the border between the Republic of Ireland and Northern Ireland or between Northern Ireland and the mainland UK?
Once again, the external tariff is an issue for the EU. It is their job to manage flows from the UK into the EU. That is not our problem.
Our problem is therefore simply: how do we check on and charge tariffs on goods coming over the border from the Republic of Ireland to Northern Ireland? My proposal would be that we create an obligation on the part of companies and individuals to declare such flows and to pay the required tariff online, with any failure to do so punishable by up to 5 years in prison, with those sentences applicable to company directors if the rules are broken.
Spot checks of vehicles whose number plates have been identified as having recently crossed the border should be authorised by legislation, and anyone carrying goods over the border should be obliged to carry a receipt from the online tariff payment system.
The Government has proposed an even more flexible arrangement in its position paper, proposing to exempt smaller businesses from duties and other formalities and focusing on compliance visits to larger companies at their premises. I am not convinced that this will suffice, and I am not sure that WTO rules would allow tariff-free access for those smaller companies without extending that to other nations. (UPDATE: see above for my preference.)
Either solution assumes that the UK will in any event unilaterally recognise EU regulations for goods and agriculture, so no additional border formalities will be required to enforce compliance with product standards. This will reduce workload very substantially at the UK / mainland Europe border as well, of course.
Proposals to ensure a finding of regulatory equivalence between the UK and the EU in financial services
The City is a very important part of the UK economy, and it is theoretically vulnerable in the case of a no deal Brexit.
Freshfields Bruckhaus Deringer, the law firm, has published a detailed paper on the likely legal consequences of Brexit on the City. From it, a few things are clear:
First, if the UK is accorded regulatory equivalence with the EU (as is the case for the US, Japan, etc) then this very significantly reduces the size of the problem. The EU will want to continue to access the City’s services and therefore should have a clear incentive to accept regulatory equivalence. They can also hardly argue that it is not equivalent as it is currently part of the EU system.
Second, after a finding of regulatory equivalence, the next most important thing appears to be the extent to which delegation of activities is accepted. By way of example, the management company of a particular fund may need to be located in the EU, but if that company is then free to contract with another company (in the UK) to secure advice on the management of the fund, then nothing much really needs to change. The fund manager can continue to sit in London.
Third, even where regulatory equivalence and delegation do not allow the maintenance of today’s structures, there are often other structures which can be put in place which will minimise the impact of Brexit and minimise the displacement of activity to the EU.
These findings lead me to conclude that seeking a regulatory equivalence finding from the EU Commission on the broadest basis is an urgent priority (they can take their time…) and must be a condition of our divorce payment. We should be prepared to play hard ball here if required. While, in most areas, I would propose unilaterally recognising and maintaining access for EU products and services to our markets (subject to our tariffs, of course), this is one area where I would make it clear to the EU that, if they seek to withhold regulatory equivalence from the City, then we will refuse them access to it. They are not even close to ready to take on the City’s functions, and the hard deadline of March 2019 works in our favour in this instance. If the EU were to refuse regulatory equivalence, they would do themselves untold damage, and their refusal would be a clear example of trade discrimination.
(UPDATE: the White Paper is based on equivalence. However, I am concerned, given the weak positions adopted by the UK throughout these discussions, that we may fall into a trap here. We need to be clear what we mean by equivalence. It should NOT mean identical rules to the EU. It should mean any rules which are used by any other countries which are granted equivalence by the EU and any rules which achieve a set of mutually accepted outcomes, as determined by the global financial community, and not as determined by the EU.)
The Freshfields findings also reinforce my previously stated view that the critical thing here is to make sure that those who work in the City want to stay in London. That, for me, means suspending changes to non-dom status, ensuring that tax rates are kept low, removing banking levies, looking carefully at taxes on insurance, and so on. There needs to be a dedicated and technically capable team established as soon as possible to develop the “keep it here” plan for the City and there needs to be the political will to take the criticism for easing the fiscal pressure on those unpopular bankers. UK voters are not idiots: they can understand that there are times when you have to accept the lesser of two evils.
One other important move is necessary: we need to ratify the Hague Convention on Choice of Court Agreements, to which the EU is already a signatory. This will allow our courts to maintain their standing internationally in the resolution of disputes in cross-border and international contracts, which will be important for the City and other sectors.
Arrangements for the takeover of functions currently undertaken by EU agencies
(UPDATE: In my November article, I listed the various EU agencies and programmes and indicated those in which the government might reasonably remain engaged and those it might choose to substitute with alternative bilateral arrangements. I have updated my analysis following the publication of the White Paper, and sought to identify those areas in which I see a real risk of ongoing “entanglement”, in which the UK risks becoming the “vassal state” evoked by the ERG and others. These entanglement risk areas are
Goods, where we apply the common rulebook and, further, say that we wish to “participate in agencies that facilitate goods being placed on the EU market” (without a vote) and where the role of the ECJ is more prominent than many would like;
Competition, where we commit to close cooperation and joint enforcement actions;
Chemicals, where we seek to remain engaged in the European Chemicals Agency;
Defence, where there are very deep ties proposed, some of which seem to run the risk of undermining Nato;
External relations, where we express a desire (case by case) to participate in EU programmes;
Data Protection, where we seek close cooperation and joint enforcement. This can easily drift into rule taking. Adequacy should be assessed against an international, and not an EU standard;
Financial Services, where we seek equivalence. This can easily drift into rule taking. Equivalence should be assessed against an international, and not an EU, standard;
IP, where we intend to stay in the Unified Patent Court, which will be administered by the EU Patent Office;
Electronic Communications, where we seek equivalence of recognition and, again, it is important that this is set against international and not EU standards
Labour rules, where we give a non-regression undertaking, which seems to raise immediate questions around the “gig economy” and where there is a high risk of extension of the common rule book
The ECHR: we commit to retaining membership, with a high risk of jurisdictional drift
In short, the devil is in the detail, and for all the fanfare around the White Paper, it is not a detailed document. Far from it. There are many, many pitfalls still to be avoided, even if the EU were welcoming the White Paper with open arms.)
As well as considering the extent to which we might contribute to EU activities, an exhaustive effort should be made to identify which activities will be repatriated to which UK agency, what resources they will need to do the job and, vitally, which activities can simply be stopped as they were a waste of time and money.
Prioritisation of FTA discussions with other states
I don’t pretend to be privy to the discussions with other states around free trade agreements, but here’s a guide to prioritisation of those discussions which might be helpful:
First, we need to make sure that we renew any existing deals we have by virtue of our membership of the EU;
Second, we need to open new markets.
To choose the new markets on which to focus:
What are the total tariffs paid as part of the trade flow? What are they likely to be in five years’ time?
How concentrated are the tariffs by sector? The more concentrated, the better, as the easier it is to narrow down the issues.
What non-tariff barriers exist and how substantial are they?
How committed does the potential partner’s trade department (top to bottom) seem to be to a deal?
What discussions have there been in the past? Where they foundered on minor issues with the EU, can we dust down the agreements and get the deal done quickly?
I hope this has provided food for thought, at least. My next article in this series will be on the need for detailed transition planning in certain areas already identified as particularly high risk.