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Image of Alan Winters05 July 2018

L. Alan Winters CB is Professor of Economics and Director of the Observatory.

Two years in and the Cabinet is still squabbling over the UK’s trade relationship with Europe. Among the options most discussed, if not most likely to occur, are

  • The Jersey option – arrangements to provide conditions equivalent to the customs union and the Single Market in goods;
  • Mrs May’sthird way’ customs partnership – where the UK collects EU-level tariffs at the border and rebates them only if UK tariffs are lower and firms can prove that the goods did not leave the UK. Until the UK can convince the EU that the technology to do the latter will actually prevent the leakage of lower-taxed goods into the EU, this is effectively the ‘customs union’; and
  • Unilateral free trade – ‘no deal’ followed by the immediate abolition of all UK tariffs.

This blog does not assess the relative merits of these arrangements, but notes that they share a common flaw: they ignore 80 percent of the British economy! The more successful 80 percent, in fact – the services sectors, in which the UK has a manifest comparative advantage (see below). The advocates of these plans gloss over this difficulty by claiming that the UK can negotiate services trade agreements both with the EU and with other countries. But this is easier said than done.

With Europe, it may be possible to sign a services deal, but as we have observed elsewhere, any trade agreement will fall far short of the access (in both directions) that the Single Market for Services provides. It entails areas like professional services taking a big hit. With the rest of the world, the challenges are greater.

Services agreements are difficult to do

First, negotiating services trade agreements is difficult and time consuming. Service restrictions reside almost wholly in regulations rather than simple tariffs (taxes on imports).

  • Regulations are complex, and often interacting or over-lain on each other; tackling them requires skill, experience and deep analysis.
  • In nearly all cases, regulations cannot be adjusted marginally to engineer a fine balance between negotiating partners, but only in discrete steps.
  • Bureaucratically, regulations do not ‘belong’ to the trade ministry but to other regulators and government departments which are both risk averse and often less enamoured of the virtues of international commerce; and,
  • Because different regulations ‘belong’ to different bodies, it is more difficult to trade one sector against another without considerable high-level political engagement.

No country has yet negotiated a comprehensive stand-alone services agreement

Second, each of the options noted above fully determines the UK’s policy on goods imports, so the UK will need to negotiate stand-alone services agreements. No country has ever done this before! All the regional agreements notified to the WTO that cover services also have a goods component.[1] The only substantive reservation to this is that investment flows and air transportation are, respectively, each handled by separate agreements outside the general trade regime.

Partners lack strong incentives to sign services agreements

But be bold and suppose that the UK can break the mold: consider the incentives for the partner countries. One of the most common arguments for signing a trade agreement is that “we can sell them lots more without having to take too much in return”. This gets roughly translated into signing agreements to liberalise trade with countries with which you have a surplus and avoiding ones with countries where you have a deficit.[2]

Table 1: Partners’ surpluses and deficits with the UK; mean 2014-2016

The problem for the UK is that it is scarily competitive in services and pretty mediocre in goods. Among major economic players the UK has the largest share of services in its total exports (44 percent compared with, say, 34 percent for the USA, 31 for Singapore and 28 for the EU). Most countries welcome access to UK goods markets and fear (rightly) that if they open up their service markets to the UK, the competition will be fierce. So, if the UK cannot offer the former in return for the latter, it is not generally an attractive prospect for a trade agreement.

Table 1 categorises the UK’s major trading partners by whether they have a surplus with the UK in services and in goods. Out of 39 non-EU countries reported in the UK Pink Book, only 10 have services surpluses with the UK compared with 24 in goods. 16 combine a services deficit with a goods surplus, while only two display the opposite. And the story is similar with EU Member States. In other words, the simple mercantilist arithmetic that drives trade politics is very unfavourable to the UK in the realm of services trade.

Moreover, several of the partners that the UK might prioritise for services negotiations already have agreements with the EU. Some of these agreements contain Most Favoured Nation (MFN) clauses on a substantial share of services policies. These mean that if, post-Brexit, the UK were to negotiate more favourable access to their services markets than it has already as a member of the EU, this would have to be extended to the EU – a six-times larger economy – ‘for free’. This makes it even more unlikely that these countries will extend any new concessions to the UK.

In conclusion

Seeking a goods-only agreement would be an easy outcome for the Cabinet to agree. But quite independent of whether it will fly in Brussels, it would sell the British economy seriously short. Services agreements with other countries will not just fall into place easily. This raises the stakes on achieving continued meaningful services access in the EU.

Even if the Jersey option is necessary to resolve the Irish border question (I think it is), the UK government owes it to its citizens to have satisfactory plans for the remaining 80% of the economy – and if that involves trade-offs, to be frank about them.

 

References

[1] The European Economic Area (EEA), notified its services components separately from its goods components because the former were notified as a bloc, whereas the latter were notified separately, e.g. EU-Norway.

[2] Think of the rhetoric in the UK around how much more the Germans want a deal with the UK than vice versa.

 

Disclaimer:

The opinions expressed in this blog are those of the author alone and do not necessarily represent the opinions of the University of Sussex or UK Trade Policy Observatory.

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5 Comments

  • David Roberts says:

    The natural deal for the UK to have treid to negotiate is one under which that the UK would stay in the Single Market for goods, thereby guarnteeing the EU its existing preferences in the UK market ,in return for the EU allowing the UK to retain a member of the Single Market for services. What Mrs May is proposing to offer is far less va;uable to the EU, because it doesn’t protect EU preference, and far less valuable for the UK, because it doesn’t protect the most important part of the UK economy. Clearly the reason for pursuing this sub optimal deal is because of ideologcially driven “red lines”. Odd that Mrs May warned other EU heads not to let “ideology” stand in the way of a good deal on security.

  • Glen Plant says:

    Spot on.

  • richard herd says:

    Prof Walters

    The description of the third way proposal presumably envisages fully frictionless trade with the EU 27. The UK then gathers the CET on imported ROW goods entering through a UK first port of entry for its own budget but sends the EU only the amount that is due on goods that subsequently go to the EU, legally that is. There will surely be goods that have received a rebate that are then smuggled to the EU, as with the VAT carousel.

    But what about ROW goods for the UK that enter via an EU first port-of-entry? In this case, the CET payment goes directly to the EU budget. Subsequently, a UK user of such goods will be able to reclaim the difference between the UK tariffs and the CET, presumably from the UK government. Will the UK then be able to reclaim these payments from the EU, or will the importer be able to reclaim directly from the EU? If not, there will be a continuing payment to the EU budget from the UK even if it does not show in the public accounts.
    What proportion of UK imports from the ROW come through an EU27 first-port-of -entry?

    Sorry if the answer to my question is in a published government document . If do a link would be useful

    • Charlotte Humma says:

      These are very good questions. Even after the Chequers Statement, it is not clear what the situation is – we have to wait for the White Paper.
      On the first, I think the default will be to charge the EU tariff on the border and rebate it only when it is clear that the good has been consumed in the UK. The remainder of the revenue will presumably be passed to the EU. This presumes that UK tariffs will be below EU levels – as the government always implies. If the UK tariff were greater, we would presumably levy that at the border and offer a rebate to people/firms who could prove they had subsequently exported the good to the EU. Charging the higher of the tariffs helps to avoid fraud – although not infallibly.
      On the second question, I think the UK government has given up on this. Anything from EU will enter tariff-free, no questions asked and no transfer of revenue sought. Even if this is not the UK policy, I cannot see why the EU would agree to all this bureaucracy for the sake of letting the UK have lower tariffs than it has. How much trade is affected by this so-called Rotterdam effect? So far as I know, we have no idea.

  • Kevin Steel says:

    There is no way the EU would allow a third country to control their financial services which slowly but inevitably will move to Paris Frankfurt and if some follow Rees Moggs example and advice Dublin.

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