26 September 2018
L. Alan Winters CB is Professor of Economics and Director of the UK Trade Policy Observatory and Nicolo Tamberi is a Research Assistant in Economics for the Observatory
The brusque dismissal of elements of Mrs May’s Chequers plan at the informal meeting in Salzburg last week has stimulated feverish attempts to revive the case for a deep and special UK-EU Free Trade Agreement (FTA), under the title of a CETA-plus agreement. This effort received substantial reinforcement from the Institute for Economic Affairs’ paper of 24 September 2018. None of the discussion, however, has dealt seriously with the fact that an FTA will require the introduction of border formalities on UK-EU trade and that these will both violate the commitment to the absence of a border in Ireland and create serious congestion at those ports dealing with UK-EU flows, which will increase trading costs and cut trade with the EU.
None of this is new – the UKTPO, for example, has been pointing it out since 2016 – and some parts of government are perfectly aware of it – see, for example, Cabinet Office Minister, David Lidington, on the dangers it entails. However, in the (over-done?) enthusiasm for the Chequers solution over the last few weeks we may have lost sight of the disadvantages of the alternatives, and now we are on the rebound, we need to be realistic about what they provide.
The proposed Canada-style deal will be a Free Trade Agreement in goods with some form of liberalisation in services trade. With this type of agreement, the UK could regain control of its trade policy – being free to set its external tariffs independently from the EU. However, FTAs have to have rules of origins (ROOs) for the goods traded between them, in order to say what will qualify for zero tariffs and what will not. In the absence of ROOs, a third country could export everything to the lower-tariff member of the FTA and then re-export it to the other member duty-free. ROOs require paperwork in order to prove origin and also an official procedure for checking that they are adhered to. This does not often require checks at the border, but it does require the possibility of such checks as the ultimate enforcement mechanism. Similarly, both private and public procedures will be required to prove that exports meet the regulations of the importer and also to administer the VAT system. While mutual recognition agreements may alleviate some of the regulatory burdens, these are difficult and time-consuming to negotiate and will never cover all trade. However big or small these issues are, they still require the establishment of a physical border where they are checked.
One of the things over which the UK and the EU agree is the joint commitment to not impose a hard border between the Republic of Ireland and Northern Ireland. Having the island of Ireland border-free is crucial for two reasons: first politically, given its past history, and second economically, considering the deep integration of the Irish and Northern Irish economies. As we have just shown, any FTA, no matter how many ‘pluses’ we add to its name, will require some sort of border controls. Although part of these controls need not be done at the border (indeed most ROOs are not checked at the border already), they need to be done somewhere and inevitably at least occasionally on the border. If this is not politically acceptable, the FTA route is not feasible.
Leaving aside political feasibility, it should be recognised that a Free Trade Agreement is not as ‘free’ as the combination of the Customs Union and the Single Market is. Trade-related paperwork will fall most heavily on the ports used for UK-EU trade. It will require new infrastructure and border officials to deal with the increased bureaucracy. They will add time to every transaction, and, as several commentators have pointed out, even a small delay at busy ports could cause heavy congestion. Moreover, not only will time be added for processing and queuing, but that time will be to some extent unpredictable: in the recent UKTPO survey of the industrial product manufacturers 79% of respondents said unpredictable border delays would add significant or major costs to their businesses. The use of ports other than Dover would certainly help to smooth the flow of trade, but only at the expense of greater cost and longer delivery times.
How much will this affect the economy? Japanese firms, many of which set their European headquarters in the UK, precisely to export to the EU, think costs will be high enough to make them move to the continent. Having built most of their business around just-in-time production, increased delivery times and uncertainty due to customs checks could render these firms unprofitable. Likewise, the report by EURIS and UKTPO showed that British industrial product manufacturers, who account for a least one-fifth of UK goods exports, depended critically on value chains and argued that new border formalities would put much of their business in jeopardy.
A UK-EU FTA option will allow the UK to ‘take back control’ of its trade policies. But unless currently untried technology and modes of organisation suddenly and magically overcome the trade-frictions that firms identify, Canada-plus will leave the Irish border issue unsolved and curtail UK trade with the EU.
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.