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On the terms being offered, EU deal is not worth it.

withdrawl agreement
Written by Harry Western

Economist Harry Western argues that the government must resist the extreme demands of EU trade negotiators which would leave the EU substantially in control of the UK’s trade and regulatory policies, keep the UK under the EU’s judicial thumb and preserve the EU’s large trade surplus with the UK. None of this worth sacrificing to obtain a thin free-trade deal that in practice would be only marginally better than WTO rules.

We recently argued that the UK should seek a ‘bare bones’ trade agreement with the EU, which would preserve maximum flexibility for the UK in the areas of regulatory policy, tax, environmental and social policy and also give the broadest scope for striking trade deals with other key partners including the US.

This remains our view, but the events of recent weeks have made the likelihood of getting such a deal considerably lower. The EU has tabled a series of extreme demands and preconditions that would render such a deal not worth having. Their aim in doing this is to try to force the UK into accepting a very high degree of alignment with EU policies on trade, regulation, the environment, tax and also security. Essentially, the EU is trying once again to force the UK to remain a satellite state of the EU – the ‘vassal status’ that the government of ex-PM Theresa May agreed to.

To understand why the EU’s proposed deal is such poor value, let’s start by considering the economic benefits of a ‘bare bones’ or ‘thin’ free trade deal compared to trading with the EU on WTO terms.

Under WTO terms, UK exporters would face an average tariff rate of around 3% to sell into the EU. With UK goods exports to the EU being around 8% of GDP, this suggests a negative trade shock of 0.2% of GDP, or perhaps double that if we assume some multiplier effects. On the import side, assuming the UK maintains its liberal ‘no-deal’ tariff schedule published last year, the impact is smaller still – EU imports, worth 12% of GDP, would face an average tariff rise of around 1 to 1.5%, implying a trade shock (via higher import costs) of around 0.1-0.2% of GDP.

So, a very rough estimate of the overall difference from tariffs between a thin FTA and WTO rules is 0.3-0.6% of UK GDP, or £6-13 billion. In practice, shifts of exports and imports to other markets and domestic production rising to replace imports mean even this figure is probably too high, but as a simple basis for comparison, we can stick with it. It’s a pretty modest sum.

It’s important to note also that there would not be much difference in terms of costs related to non-tariff barriers. Estimates of these vary, but we think they might average 3-5% of UK export values to the EU in a WTO scenario. This would not be very different under a thin FTA which would not include much that would reduce them.

Indeed, the EU has recently gone out of its way to confirm this. It has made clear that even if the UK voluntarily aligned with EU product regulations, regulatory checks would still take place as if the UK were any other third country. It has also said it won’t sign an agreement for mutual recognition of conformity assessment to complement an FTA with the UK. This matters less than it might appear in economic terms, but the key point is that the baseline for NTBs facing UK suppliers to the EU in a WTO or thin FTA is going to be more or less the same. Much the same will be true of services – a thin FTA will not cover these in any great detail beyond the EU’s existing WTO commitments.

To get our rather modest gains of £6-13 billion, the EU has so far demanded that –

  • The UK continues to allow EU fishing fleets to take a large share of UK fishing stocks, essentially continuing the unbalanced (and environmentally disastrous) Common Fisheries Policy. The cost of this would be large – the study by Napier suggests long term gains of up to £3 billion per year for the UK of taking its proper share of fishing catches from UK waters. EU claims that if the UK doesn’t agree it won’t be able to sell its existing or extra catch make no sense. EU tariffs on fish are not prohibitive (8-12% on fresh cod, haddock and sole, 2% on Atlantic salmon), nor do SPS barriers prevent fish exports to the EU: a look at the UK’s recent fisheries trade shows substantial imports of seafood from outside the EU, including China, Vietnam and Canada.
  • The UK agree to strict level playing field (LPF) clauses, binding it closely to EU policies on tax, the environment, social and competition policy. In the case of competition policy, the EU is demanding the UK follow all current and future EU policies, with no say. These are unprecedented demands for a free trade deal and would have potentially huge ongoing costs. As we’ve previously noted, even if the UK only cut the existing EU regulatory burden by 25%, the EU’s own estimates suggest this could save UK business £20-30 billion. And who knows what additional business-damaging measures are in the pipeline?
  • The ECJ plays a key role in governing the trade agreement. To demand that the courts of one party to an agreement govern such an agreement is highly unusual and only seen in colonial-style relationships. The ECJ would not be a neutral actor.
  • The UK agrees to dynamic alignment on product standards and regulations. The suggestion here is that the UK agree to all existing EU rules in this area, and new ones – with no say. This would open the door to the EU using regulatory policy to damage UK industries, as has already been seen in the recent past, with no way for the UK to respond.
  • The UK to agree to free movement of people with the EU
  • The free trade deal to be part of an overarching deal including fisheries, financial services security and other areas. This ‘aggregation game’ is designed firstly to make the process of negotiations very long and tortuous and force an extension of the ‘transition’ period (meaning more UK financial contributions) and secondly to create ongoing leverage by threatening to remove free trade benefits if disagreements occur in other unrelated areas.

Are there no other benefits from agreeing an FTA with the EU? One possible area is financial services, where the EU has recently been talking up the idea of a trade-off with fisheries – you give us your fish and we grant the UK ‘equivalent’ regulatory status, supposedly yielding UK firms ‘access’ to the EU’s financial markets.

In fact, this is proposed trade-off would be an incredibly poor deal for the UK. ‘Equivalent’ status isn’t of much use to the UK. The great bulk of UK financial services are of the wholesale type, which the EU cannot effectively restrict without extreme measures such as bringing in exchange controls – a policy that would consign the EU’s hopes of making the euro into an international currency to the outer darkness and imply substantial economic costs for the EU.

The recent Swiss experience is also instructive. In mid-2019, the EU attempted to pressure Switzerland into signing a vassalage deal by withdrawing equivalence – which they can do, at short notice, with no reason. So far, the impact is indiscernible. Swiss financial services exports rose around 1% last year. Trying the same trick with the UK would be likely to backfire badly as it is EU funds that would suffer most from losing easy access to London’s markets, exchanges and clearing houses. Such a move might even prompt a stronger flow of EU firms setting up in London than already seen.

So, the fisheries for finance trade-off would involve the UK giving the EU value in terms of fisheries in return for the UK giving the EU value in terms of ease of access to London markets. It’s hard to imagine a less attractive deal.

What’s the EU’s endgame in all this? Clearly, as mentioned, the idea is to try to make the UK abandon its quest for a basic free trade deal and instead pursue a much deeper form of trade integration which would leave the EU substantially in control of the UK’s trade and regulatory policies, keep the UK under the EU’s judicial thumb and preserve the EU’s large trade surplus with the UK. Such a deal has already, rightly, been rejected by the UK government as inconsistent with the basic principles of Brexit.

How should the UK government respond? In our view, the EU’s extreme posture in recent weeks reflects a basic lack of interest in their part in having a free trade deal. Having already got what they wanted in the withdrawal agreement in terms of the financial settlement, Northern Irish protocol and citizens’ rights, an FTA is only of interest if it comes with all the other things on their wish list, which together add up to putting the UK in a position of economic and political servitude.

As a result, we would propose that the UK start making plans now for EU trade to move to a WTO basis at the end of the year, including reducing the costs of adjustment for UK firms by the maximum extent using various easements (delayed customs declarations, easier reporting rules etc) and laying out plans to help the small number of industries where trade dislocation will be considerable. In addition, we would suggest:

  • Accelerating free trade deal talks with the US, Japan, Commonwealth countries and other willing partners and downplaying talks with the EU.
  • For form’s sake, presenting the EU with a draft basic trade deal featuring zero tariffs and zero quotas – in the full knowledge this will be rejected. Once rejected, the UK should present another which excludes agricultural items and fisheries. This would be an inferior FTA to e.g. the Canadian deal in terms of coverage. If it is also rejected, that would make clear that the EU’s claims that its demands reflect the ‘unprecedented’ nature of the FTA the UK has asked for are hollow.
  • Table a fisheries bill as soon as possible that makes clear that the UK will assume full control of its fisheries at the start of next year with only limited access for EU boats based on swaps of fishing opportunities of strictly similar value.
  • Approach Switzerland for a bilateral deal on financial services. This would, among other things, render the EU’s withdrawal of Swiss equivalence largely redundant.
  • Kick any proposed security deal with the EU into the long grass. This seems entirely appropriate given the recent veiled threats that failure by the UK to grant open access to fisheries might lead to violent consequences.
  • Draw up a list of EU regulations that will be scrapped or amended in 2021. The government’s recent announcement that it will not implement the EU copyright directive is a great start, but the government needs to go much further than this.

All this will look very provocative. But it needs to be, as only provocation has any hope of shifting the EU from its current extreme and dogmatic posture. And all of the above ideas are good ideas in their own right.

Harry Western is the pen-name of a senior economist working in the private sector.

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Harry Western