As Britain takes the first steps towards exiting the European Union, much focus has been on how the decision will affect trade.
The system of trade agreements in the EU has been a matter of some debate, with economists, campaigners and politicians making claims about what will happen once Brexit is complete.
Ferret Fact Service takes a look at how EU trade works, and what the options might be for the UK once it leaves Brussels in March 2019.
How do EU trade agreements currently work?
The trade rules governing the UK’s relationship with Europe and the rest of the world are closely bound to its membership of the European Union (EU).
Currently, the UK is part of both the EU and the European Economic Area (EEA), a single market that includes EU member states and three members of the European Free Trade Association (EFTA) – Norway, Iceland and Liechtenstein. Membership of the EEA, and therefore of the single market, requires compliance with the “four freedoms” of the EU – the free movement of goods, services, capital and people.
The free movement of goods between these countries means no customs duties, no restrictions on the quantity or value of imported or exported goods, harmonised product standards, and a common customs tariff, which refers to the duty rates that apply to different kinds of goods imported from outside the EU.
The aim is to remove internal borders as far as possible so that goods can circulate as freely as they do within a nation.
Could the UK remain part of the EU’s customs union?
There are various future trading options for the UK.
In January, Prime Minister Theresa May set out a range of options—she suggested reaching “a completely new customs agreement”, becoming “an associate member of the Customs Union in some way”, or remaining “a signatory to some elements of it”.
The EU’s customs union comprises EU member states as well as other countries like Turkey. It means all countries charge the same import duties to countries outside the union, to ensure one member does not undercut the others.
However, the customs union with Turkey does not apply to service providers (like banks, insurers, and transport companies), which are an important part of the UK’s economy and account for around 79 per cent of GDP.
And in June, Chancellor of the Exchequer Philip Hammond ruled out the possibility of the UK joining the customs union.
What is a free trade agreement?
The UK government has ruled out the option of remaining in the single market. May has made it clear that her aim is to negotiate “the greatest possible access to the single market…through a comprehensive free trade agreement”.
A free trade agreement means that a group of countries have agreed not to impose tariffs (customs duties) or import quotas on goods or services within the free trade area. Unlike the customs union, there is no common tariff imposed on countries outside the free trade area.
EFTA is a free trade area in Europe, and has four members: Norway, Iceland, Liechtenstein and Switzerland. The UK was one of the founders of EFTA in 1960, but left in 1972 to join the European Economic Community.
One possible model for the UK is the approach taken by Switzerland, which is part of EFTA but not the single market. As part of its free trade agreement with the EU, Switzerland has negotiated a series of bilateral agreements over the years.
It is possible that the UK could re-join EFTA, but this remains very uncertain.
The UK is a member of the World Trade Organisation (WTO), which sets its own international trade rules. If the UK fails to negotiate any deal with the EU, it will revert to WTO agreements – this is the UK’s default trade position, and is often referred to as a ‘hard Brexit’.
All EU member states are also WTO members, but they currently act as the EU rather than individual countries.
Individual countries make lists of commitments (known as ‘schedules’) that give specific foreign products or service providers access to their markets.
The UK already operates under WTO rules as part of the EU. It could ‘copy and paste’ parts of the EU schedule, but not all of it. Tariff rate quotas (a set volume of goods from a specific country that benefit from lower duty rates) would have to be divided up between the UK and EU.
How does the WTO work?
The WTO sets out broad principles relating to goods, services and intellectual property. These principles specify trade without discrimination, meaning that countries must treat all their trading partners equally as a ‘most-favoured-nation’ (MFN).
There are exceptions to this. A group of countries can set up a free trade agreement that favours goods traded within the group (as in the case of the EU), or give developing countries preferential treatment.
WTO rules also aim to reduce tariff and non-tariff barriers, like product standards and customs controls, in order to make trade freer.
Countries agree not to raise tariffs above an agreed level in a bid to make markets as stable and predictable as possible.
How would the WTO option affect the UK?
Currently, the UK applies tariffs based on the EU’s schedule. If the UK did not agree a free trade agreement with the EU, it would face the EU’s common customs tariff – but EU importers would also be subject to a UK tariff.
Although EU tariffs for MFNs are generally low (its trade weighted average tariff was 2.7 percent in 2014), they are significantly higher for certain sectors, such as the automotive industry and agriculture. These industries are therefore concerned that such tariffs would make their business less competitive in the EU, because higher duty rates would have to be included in the price of the product.
Unless the UK agrees free trade deals, there would also be uncertainty over its trading relationship with countries like South Korea and Canada, which are currently governed by EU free trade agreements.
And it’s possible that passporting – which allows financial institutions to sell their services in other EU countries without having to obtain separate licences – would be lost under WTO-only rules.
What is ‘unilateral’ free trade?
Because the WTO rules set tariff caps on imported goods rather than specifying duty rates, countries can set their tariffs at zero. This is known as ‘unilateral’ free trade, and is favoured by those who see this as a way for the UK to achieve tariff-free trade.
But since import duties are put in place to give a price advantage to similar, locally-produced goods (as well as to raise government revenue), experts have suggested that such a move could damage UK manufacturers.
At this stage, there’s no way of telling what kind of deal the UK might negotiate with the EU. But even if the UK ends up reverting to WTO rules, it will still need to negotiate trade agreements of some sort to make sure that specific goods and services are not affected disproportionately.
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