December 19, 2016
Inside the customs union, outside the single market
Looking at it dispassionately it appears to us that - even six months after the UK referendum - the two sides still pretend as though they are campaigning. We presume that the long wait until the trigger of Article 50 is making people nervous on both sides. But in reality some of the fog is lifting. The UK is now seeking a transitional agreement. And over the weekend some of the contours of that agreement have become visible. Liam Fox, the international trade secretary, said it would involve continued membership of the customs union (which is not the same as membership of the single market). During that period of unknown duration, the UK and the EU would hope to negotiate a free trade agreement. Fox was looking at the EU/Turkey trade agreement as a model for the transitional period. That agreement theoretically allows Turkey to strike third-country trade agreements, but in practice the EU has the right to annul them. We would assume that Britain would be negotiating FTA's during the period of the transitional period, for implementation at the end of it.
Membership of the customs union without membership of the single market makes sense as a transitional agreement, as it would give everybody a bit more time to prepare. Manufacturing companies in particular cannot plan on a shorter notice.
While the contours of such a sequence appear logical, the devil is in the details, and the process could still come unstuck. The FT reports this morning that the EU will insist on settling the terms of the divorce before agreeing any transitional agreements. There is, of course, the issue of what newspapers call the divorce bill. There is an unofficial number of €60bn, and the Daily Telegraph has identified the "monster hardliner" close to the Commission president - no prizes for guessing who - wanting to sabotage the entire Brexit process.
But sequencing is an issue, and it is possible that the negotiations may get stuck at some point. Simon Nixon makes the following observation in the Wall Street Journal this morning.
"The U.K. government therefore faces a paradox: Its threat to walk away from an Article 50 divorce is only credible if it starts preparing for the hardest of Brexits—and, in doing so, incurs the very costs it is trying to avoid. Yet if it can’t credibly make this threat, its leverage is minimal. Resolving this paradox will be a formidable test of Mrs. May’s negotiating skills and political leadership."
But what about the other side? Do we really think that the EU wants to pursue a hard Brexit without a deal if the risk is that the UK would deport over a million citizens from eastern Europe - almost 1m from Poland alone - most of whom would presumably go to Germany? There were already reports of the UK blocking progress in the international fight against tax evasion at the G20 level. Neither the UK nor the EU can really afford a hard Brexit, and we think it is pretty pointless to estimate who can afford it less. If, say, Michel Barnier thinks he has the stronger negotiating position, and lets the process drive to a wall, just wait from the reaction from Germany as we approach B-day. It is far easier for a single government to maintain unity, than for the EU-27.
Chris Giles has an excellent analysis in the FT, in which he looks at the economic impact of both tariff and non-tariff barriers, and concludes that it may not be all that large. The tariff barriers are on average only 2.3% - though with significant variations. Non-tariff barriers are more important. But he qualifies even that statement. When the UK leaves the EU, the products will still have have the Conformité Européenne attached to them. And 80% of the standards are voluntary. What the UK, however, cannot do is enter into a trade agreement with the US and recognise US regulation as compliant while remaining in the customs union. We agree with Giles' conclusion that
"there is no obvious solution that satisfies all the UK’s goals of simple and cheap regulations, easy trading relationships with the EU, deals with non-EU countries and full sovereignty over regulations."