What about the remaining 80 percent – services? The ‘Customs Union’ and ‘Unilateral Free Trade’ share the same flaw

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05 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’s ‘third 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.

 

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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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