Stephen Booth is Director of Policy and Research at Open Europe. Henry Newman, the regular author of this column, is away.
We must hope that, over the course of the next week, the tortuous process of uniting the Leave and Remain factions in the Cabinet behind a common Brexit plan can be concluded. Time is in short supply and the Prime Minister must finally set out the Government’s position with greater clarity. The European Council on 22nd and 23rd March is meant to kick off talks over the UK’s future relationship with the EU, with ‘heads of terms’ of the deal expected to be agreed by the autumn or winter of this year.
As we know, the future trade relationship is the really tricky issue. In recent weeks, it feels as though we’ve had the same arguments rehashed again and again. Will the UK opt for regulatory alignment or divergence with/from the rules of the Single Market? Should the UK be in ‘the’ Customs Union, ‘a’ Customs Union, or a Customs Agreement with the EU?
The choice at the heart of these questions is whether to prioritise a high degree of preferential access to EU markets or whether the UK can shape its own rules. Despite the seemingly intractable stalemate, the skeleton of a possible Cabinet compromise has become more discernible in recent weeks.
Broadly, this is likely to mean the UK seeking to secure a high degree of continuity in market access for manufactured goods on the basis of aligning itself with EU regulations. The UK could regain its own tariff schedule outside of a formal customs union but mirror the EU’s tariffs for certain industries for an extended period, beyond the formal transition set to end in December 2020.
Meanwhile, the UK is likely to prioritise the freedom to diverge from the EU on services regulation and accept that this means less preferential access to the Single Market. Such a compromise would reflect the profile of UK-EU trade and the UK’s broader economic strengths. In 2016, the UK exported 48 per cent of its goods to the EU but only 37 per cent of its services.
UK-EU trade in goods is dominated by the high-tech, supply chain manufacturing industries. Complex manufactures such as cars tend to be made in factories close to their primary market. UK goods destined for the EU will need to comply with Single Market standards in any case. Supply chains have developed because of geographical proximity but also because the EU’s Single Market has fostered ever-deeper integration in these sectors. The UK cannot easily replicate its participation in these supply chains with other partners, so the upside of regulatory divergence is likely to be small.
In his speech last week, Boris Johnson stressed that the UK should not be “obliged” to obey EU rules, nor should they be “imposed”. However, he accepted there are likely to be several sectors, such as “EU standards for washing machines or vacuum cleaners or hairdryers or whatever”, where it may “very well make sense for us to be in alignment.” This is not a new problem. Switzerland chooses to align its rules with those of the EU so that its manufacturers can participate in the Single Market for goods on the basis of mutual recognition of standards.
However, it makes little sense for the UK to commit itself to future alignment with EU rules for services. Services are a growing share of global trade and the UK is already a globally oriented exporter, less dependent on the EU market than it is for goods. Going its own way on services will introduce restrictions on UK services exports to the EU, but the Single Market in services fails to live up to expectations in many areas. For example, a recent KPMG study for the Dutch government concluded that cross-border accountancy services “will be impacted by Brexit only to a limited extent”, noting that, even as an EU member, UK accountants “must obtain an additional professional qualification in the EU member state where they want to work.”
Equally, the advantages of freedom from EU rules on services are clear. Mark Carney, the Governor of the Bank of England – not known for his love of Brexit – has already identified areas where he thinks the UK should make changes to EU financial services regulation. Phillip Hammond has spoken of the need for “regulatory innovation” in the digital technologies of the future, such as AI. Neither would be possible if the UK were to become a “rule taker” from Brussels.
There is another reason why the UK should accept the short-term costs and long-term opportunities of diverging in services. The more the UK asks for from the EU – and trying to replicate existing market access for financial services is certainly regarded as a ‘tough ask’ in many European capitals – the more Brussels will ask in return. The EU will want the UK to follow future rules in many other areas, such as taxation, employment law and the environment. The Foreign Secretary is right that this would be politically unacceptable and unsustainable for the UK.
Ultimately, the post-Brexit UK-EU relationship will be dynamic, since both parties will evolve over time. The more closely the UK ties itself to the EU, the bigger the potential for a politically explosive disagreement with Brussels over any inevitable divergence. The UK will always have the right to disregard EU regulations in the future, even in the areas where it chooses to be aligned at the outset. The question is what happens to the overall relationship when the UK or the EU opts to diverge from the status quo. There is only so much divergence that any dispute resolution mechanism negotiated now can take.
It is very likely that future UK governments and European Councils will need to periodically revisit the terms of any deal. But the UK needs to set out a workable proposition that is politically sustainable, domestically and with the EU, for say ten years. A compromise based on managed alignment for goods and regulatory divergence for services may not be popular among the purists of either persuasion. However, in order to move Brexit forward, the political reality requires tough choices and pragmatic solutions.