Brexit Briefing No.35 - The False Customs Union Debate

More discussion of the customs union, even as both sides move towards the future trade relationship talks, and Brussels agrees new trade deals with Japan and Mexico, it was another busy week in Europe and for the Brexit negotiations. 

This week has seen the debate over the Customs Union rear its head yet again. 

The UK position appeared to be settled last January when the Prime Minister said the UK would be leaving the Customs Union. Subsequently both Conservative and Labour manifestos committed to leaving the Customs Union at last year’s general election. However, this position has never been accepted by the EU negotiators, with Michel Barnier in particular repeatedly saying that leaving the Customs Union is not compatible with the EU demand to ensure the Irish border remains open. 

If a week is a long time in politics, a year is an eternity. The Labour position is evolving on Customs Union membership, last week the government suffered a defeat in the House of Lords on an amendment calling on it to consider a Customs Union option, and the European Union is still holding the door open for a Customs Union U-turn by the government. All of the above have meant the possible prospect of a defeat in the House of Commons for the government on the Customs Union has reappeared on the agenda, the numbers are extremely tight given the government does not have a majority. 

Palace of Westminster

The news that the EU had reached agreement on two new free trade agreements, with Japan and an updated deal with Mexico, was greeted with great fanfare in Brussels. They show the EU continuing to expand its trade horizons and are good news for the UK too, but also highlight the difficulty of the Customs Union option for the country. Both deals will be implemented before Brexit, and both countries have said they will apply the deals to the UK during the transition period and seek to conclude new agreements with the UK after December 2020, their respective governments have talked with the UK government about those future deals as well, including Theresa May’s visit to Tokyo. So they set a good precedent for the UK to build on, and in the short term will provide a boost to UK exporters. 

They also highlight the fact that the current debate on the Customs Union is devoid of reality, as it misses the crucial point that being in the Customs Union outside the EU is not the same as being in it inside the EU. This is the main reason that even Norway & Switzerland will not join the Customs Union and Turkey is the only major non-EU country in it. 

The stark reality of this week’s trade news is that if the UK remains in the Customs Union after Brexit both these deals will morph into very bad deals for the UK and unbelievably good deals for Japan and Mexico.

This is because both deals offer the elimination of all tariffs on goods. For a post-Brexit UK in the customs union this means the UK eliminates tariffs on Japanese and Mexican imports into the UK. However because the UK is not an EU member but only a member of the Customs Union, Japan and Mexico can reintroduce tariffs on British exports.

Mexico

As trade deals are about one side opening up access to its market to ensure its exporters can get better access to the other market, Customs Union membership puts the UK in a disastrous position. It will have to open up its market whenever the EU does a deal with a third country with no chance of getting any concessions in return. This may be good for British consumers, but it is not good for British companies or exporters, who would face much greater competition on their domestic market, with no access to markets in third countries. If they wanted to export to the EU, Japan & Mexico they would be better off relocating to Europe as they would then have tariff free access to all those markets, which they could not get from the UK.

This situation would also make it much easier for the EU to strike trade deals, as part of a negotiation the EU will be able to offer a third country additional unrestricted access to the UK market (the world’s 5th biggest economy) whilst keeping restrictions on British exports to that country. It would probably allow the EU to get an even better deal for their own exports.

Trade

There is little wonder then that the EU is keen on being in this position and it suggests that the EU’s strong line on the Irish border is actually more about locking the UK into this impossible trade situation. What is astounding is that some in Britain are also advocating for this position and that these repercussions are entirely absent from the domestic debate about the Customs Union, which assumes, incorrectly, that the status quo applies and that the UK would automatically benefit from EU trade deals in future. 

The reality is that this entire debate is a bit of a red herring as even if the UK was to agree to such a relationship, it is unsustainable in the long term. Once these repercussions became apparent, a future British government would be seeking to get out of it. So it does not present the template for a deep and sustainable relationship between the UK and the EU. 

What this debate does do is show just how difficult it will be for the government to get its vision for Brexit through domestic opposition and sets the grounds for future battles on the single market and the future immigration policy.  

Visas

Whilst this debate rumbles on both sides are now beginning to discuss the future relationship, even if the Irish question has still not been solved. 

Originally the intention from both sides was for an annex on the future relationship to be included in the final withdrawal and transition deal text due to be approved in October and for it to be detailed and precise with regards to trade and security and many other elements of the future partnership.

That approach appears to have changed in Brussels and the EU will now push for a much less detailed text, which will mean that even after the UK has left the EU in March, it will still be unclear what the future relations are likely to be post 2020.  

Detailed negotiations will therefore need to continue well after the UK has left. 

For the UK it is unclear whether this is good news or not. It hoped to have detailed clarity with regards to future market access well before it left the EU, as the general assumption is that the UK has more clout in the negotiations whilst it is still an EU member state. The EU is clearly hoping that the British government U-turns on the single market and customs union during the transition period. However once outside the EU it may be easier for the UK to negotiate as a third country as it will already be able to start on remaking its relations with third countries around the world. 

Yet it appears clear that the terms of any future relationship will still be very much up for debate after March 2019.

Diary

It is clearly in both sides interests to reach an agreement, but given the UK has a massive export surplus in services with the EU27 it is that part of any free trade agreement which will prove most difficult. Services have historically always been the hardest part of trade agreements to conclude, and the UK is asking for more services access than any previous free trade agreement has included. Even if the October agreement remains light on detail, that still does not allow a lot of time to conclude a free trade deal, with a new deadline of December 2020 when the transition period is supposed to end. The possibility of the transition period being extended has not been concretely ruled out by either side, but even if necessary that has disadvantages to the UK. It means a longer period as a ‘rule taker’, even with the protections negotiated in place, and there is the possibility UK budget contributions will rise during the period, as a non-member and with the status of the UK’s rebate as a member not yet clarified. Even after transition, the individual costs of participating in EU programmes and agencies will rise from their current level as a member, although overall budget contributions will be lower.

So it is in the interests of the UK to negotiate the future relationship as quickly as possible. Despite the difficulties as the government repeatedly reminds the EU, both sides start at the same point on regulation, and the UK has already committed to maintaining alignment in a number of economic sectors, and in some areas is recognised as having stronger regulations than Brussels. So many parts of a free trade agreement will be significantly easier than other such deals to arrange. Financial services is the key part of the future services relationship for the UK, but with increasing numbers of businesses providing remote online services there are significant growth opportunities for other UK services industries in Europe. So a services deal is key. 

With five blocks of meetings planned before June’s European Council summit the only thing anyone can be certain on is that there will be a lot more speculation and expectation management and briefing and counter-briefing from both sides. The clock may no longer be ticking as loudly, but that does not mean there is no risk of it stopping, or needing some emergency maintenance, particularly as the Customs Union debate continues to stalk the negotiations.