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9 July 2018

Dr Michael Gasiorek is Senior Lecturer in Economics at the University of Sussex and Managing Director of InterAnalysis. He is a Fellow of the UKTPO.

In good part, the answer depends on the extent to which this agreement moves on from the Government’s previous position, is feasible, is credible, and is acceptable to the EU. It also depends on whether it will be acceptable to the Conservative party, which the resignations of David Davis and Boris Johnson throw into serious doubt.

In this blog, I focus on one aspect of this –  the extent to which the “facilitated customs arrangement” (FCA), which is central to the agreement notionally reached at Chequers, is substantively different from the previous idea of a “New Customs Partnership” (NCP).

Superficially there is not much difference. In both cases, the Government is suggesting that it can set its own tariffs, which can diverge from those of the EU. In both arrangements, in order to resolve the Irish border issue, the UK is proposing to operate a dual customs regime depending on the final destination of the good.

But in fact, there are substantive differences. First, as pointed about by many commentators (including in our earlier blog,) even if the issue of tariff differences could be resolved, border controls are still needed where there are regulatory differences. In the Chequers Agreement, the UK has now committed to EU standards for all (relevant) goods trade including agri-food – this is the ‘common rulebook’. This is a big step in the direction of not needing border controls, though may still not entirely obviate the need for them, and it represents a substantial shift. However, in a curious sop to national sovereignty, the UK parliament could choose not to apply the EU’s standards ‘recognising this would have consequences’. This is a Morton’s Fork arrangement.

Second, there is the possibility of a subtler difference between the FCA and the NCP. Practically, there are two ways in which a ‘facilitated customs arrangement’ could be managed:

1. Where the default is the application of the EU tariff: Where the good is destined for the UK only market only, firms can claim/register for the application of the UK tariff.

2. Where the default is the application of UK tariff: Where the good is ultimately destined for the EU market, firms notify the appropriate authorities and the EU tariff is levied.

The Chequers Agreement is ambiguous on this. All it states is that “the UK would apply the UK’s tariffs and trade policy for goods intended for the UK, and the EU’s tariffs and trade policy for goods intended for the EU.”

Note above I have used the term ‘UK only’, which is not a term in the current Chequers Agreement.  Why is this significant? Because, and as explained in our earlier blog this does not address the issue of which tariffs are to be applied on intermediates imported by the UK, used in the production of goods then exported to the EU. This is a complication which the Chequers three-pager is silent on. This also takes us back to the issue of rules of origin.

As I see it, one could envisage at least three possibilities here:

A) UK tariffs are applied on all UK imports of intermediates. Only if a good is going directly on to the EU, is the UK required to administer the EU tariff rate. This would be compatible with standard Free Trade Agreement (FTA) arrangements. This would require rules of origin between the UK and the EU. Yet, under the FCA arrangements, these would be managed at the first point of entry into the UK, hence avoiding the need for border controls between Northern Ireland and the Republic of Ireland.

Under the Brexit climate/circumstances, the EU may not accept that the EU tariff is applied only on final goods coming into the UK but destined for the EU. The EU may not be happy that UK firms might be given the possibility to import cheap intermediates and so increase their competitiveness in the EU market. Consequently, the EU may demand a stricter set of rules, such as:

B) UK tariffs on the imports of intermediates apply only if the rule of origin on exporting to the EU is met. Otherwise, the UK is obliged to levy the EU’s tariffs. Once again rules of origin and the tracking of the sources of intermediates used in exports would be needed. Under the UK’s FCA proposals this would again be managed at the first point of entry.

In practice this would mean that with regard to imports of intermediates: Firms who had clear evidence that there was a sufficient share of UK value added in each product they produced would pay the UK import tariff.  Firms who do not have that clear evidence or who are borderline (no pun intended) would have to track all the different sources of foreign supply and the correct EU tariff would have to be applied. Rather than CETA++, this is ROO++.

Why do I say all the different sources of foreign supply, as opposed to all the sources of foreign supply? Because some the third country imports may come from countries with whom both the EU and the UK have signed Free Trade Agreements with, and where (the UK government hopes) they will have agreed diagonal cumulation. In that case, the EU tariff on the intermediate may not need to be applied.

C) An alternative reading of the FCA is that it is intended to entirely avoid the need for rules of origin between the UK and the EU, and thus no need for border controls in Ireland. For this to be possible, this can only be consistent with a world where EU tariffs are applied on all intermediates imported by the UK which are then used in exports to the EU. While this does not require rules of origin, it does require tracking of the source of intermediates used in exports. It is not clear what tariffs would be applied where both the EU and the UK have an FTA with a third country.

Image courtesy of Matanel Ben-David. Flickr.

If the preceding sounds complicated – it is. No wonder that some businesses are suggesting the system is unworkable. Any FTA has the additional bureaucracy and costs associated with rules of origin documentation and verification. The FCA adds another layer to this!

And… we have not even gone into the additional (practical and jurisdictional) complexities of dealing with fraud, or other issues such as the correct application of tariff rate quotas, or how to handle the issue of trade remedies.

Let us return to the two ways of applying a FCA: From the EU’s perspective Option 1 above is more likely to be more palatable for the EU. The default is the application of the EU tariff, and the burden of proof falls on those firms that want the lower tariffs. If firms want a lower UK tariff they either have to prove the good is destined for the UK market only, or that there is sufficient UK value added such that the good meets the EU-UK rules of origin. It is much less likely that errors and fraud would occur with this arrangement than under Option 2. But this does not make it acceptable to the EU, and also depends on which of (A), (B) or (C) is being proposed. No wonder that the EU wants the UK to be more specific.

How palatable could this be for the EU? The best the UK government could hope for is that it commits to levying the EU tariff on all imports until such time that the UK could demonstrate the facilitated customs arrangements are feasible, would not be costly for EU firms, and that issues of fraud and compliance have been adequately dealt with. Only then would the EU consider a FCA. The UK government must be aware of this, which is why the Chequers three pager, makes reference to a ‘phased introduction’ and ‘becoming operational in stages’. The unstated sub-clause here is some version of ‘until the EU is satisfied’.

In turn, however, for third countries, this makes an FTA with the UK less attractive. Essentially, for the UK’s prospective FTA partner countries, the UK might be saying “we can offer you lower tariffs on goods x, y and z, but (a) not yet because we have not got our FCA sorted with the EU; (b) only for goods destined for the UK only, or for goods that meet our rules of origin with the EU” and (c) “the importer needs to be able to prove that this is the case, and notify the appropriate authorities”. This is not a very attractive negotiating position.

Note in principle you might think that the same FCA rules and procedures would need to be applied by the EU for goods exported to the UK. It scarcely conceivable the EU would agree to this. The only realistic option here is that the UK would forgo requiring comparable checks by the EU and would let all goods in duty-free from the EU, and if this was (A) or (B) above providing they met the rules of origin.

Both the NCP proposal which has now been parked (pun intended), and the FCA are in some ways an ingenious attempt to square the circle of leaving the Customs Union and some of the Single Market while maintaining the Government’s red lines and solving the issue of the Irish border. However, fundamentally both are very complex bureaucratically, currently impossible to implement, would almost certainly increase the difficulties for the UK in signing FTAs with third countries, are unlikely to be acceptable to the EU, and even if they were, would require a tremendous amount of goodwill and trust between the UK and the EU.

It is worth bearing in mind two further issues. First, the FCA focuses entirely on squaring the circle with regard to trade in goods. This ignores the more successful part of the UK economy – services – which comprises 80% of UK GDP (see blog by Alan Winters last week on this). More attention should be given to services.

Second, the closer the formal links with the EU, the less policy space the UK government will have, but the smaller the direct negative economic consequences will be arising from Brexit. Crudely speaking there is a trade-off here between policy space and economic effects. Brexiteers would have us believe that increased trade policy space would lead to higher net economic welfare. There are very few economists who believe this. The FCA is an attempt to widen the policy space while minimising the economic consequences. However, under current conditions, it is simply not feasible.

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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