Tariffs - what will the UK’s post-Brexit trade policy look like?

When the UK leaves the EU, it will have to create a new trade policy. So far the focus has been on whether the UK will remain part of the EU’s customs union post-Brexit. However, the debate is beginning to turn to what Britain will do with its new powers when, as the government has indicated it intends, the UK does leave the EU customs union in the future.

Britain is one of the world’s biggest economies, and it is also a major importer, importing $581 billion of goods and services in 2016, more than any other country of a similar size. This makes it a major export target for many countries who will want to ensure access to the UK market post-Brexit.

The UK is also one of the world’s biggest exporters, with exports worth $409 billion to the UK economy in 2016, so has a strong interest in seeking new export markets and maintaining and enhancing existing EU trade agreements with third countries.

Trade is a complex area, and it is far more than just tariffs, with quotas, non-tariff barriers, and state aid issues just as important. However tariffs are the most forward-facing and obvious signal of the trade policy a country has. They are also challenging because of the WTO Most Favoured Nation (MFN) rules, which means that a country has to apply the same tariff on a particular good to all countries. For example, the UK can’t just offer Norway a reduction in the beef tariff, they have to offer that new tariff rate to the whole world. The only exception is if a full free trade deal is negotiated with Norway. Then the tariff reduction can apply to Norway alone.

As the UK will not have free trade deals in place by the time it leaves the EU (partly because the EU won’t allow the UK to negotiate while it is a member), the UK will have to make a choice on what tariff policy it has with the rest of the world.

Tariffs raise the cost of imports and their proponents argue that they can protect domestic industries or punish foreign governments who are unfairly subsidising their exports.

Supermarket

In reality, as has been shown throughout history, tariffs do little to protect domestic industries. By offering protection in the domestic market, they reduce competition and therefore the incentive to innovate or to become more efficient as access to the domestic market is protected. In a big economy such as the UK it can encourage firms to rest on their laurels and as a result they can become less competitive internationally, reducing export opportunities. This has been demonstrated time and time again in economies around the world, sector specific protectionism can often seem attractive to 'save' threatened industries in the short to medium term, but rarely proves an effective treatment for the underlying disease.

Tariffs also raise the cost and lower the quality and quantity of goods and services for domestic consumers, raising the cost of living. Effectively all tariffs are paid by domestic consumers in the form of higher prices, which is why politicians on the left should be just as opposed to tariffs as those on the right.

However, tariffs can be used to encourage investment in a domestic market in the short term. After the US imposed punitive tariffs on Chinese solar panels, the Chinese companies announced they were moving production to the US to avoid the tariff wall. In addition, Jaguar Land Rover recently built a factory in India to avoid Indian car tariffs.

For the UK after Brexit, it in effect, has three choices.

1) To keep the existing EU tariffs,

2) To re-evaluate all tariffs and keep some whilst reducing others, or

3) To reduce or even eliminate all tariffs, the so-called “Singapore” option.

Keep Existing EU Tariffs

EU Tariffs

The easiest option, particularly given the issues with the WTO MFN rules, is to keep tariffs where they currently are. There are several advantages with this approach.

Firstly, nothing would change in the immediate aftermath of leaving the EU, secondly the UK and EU would have the same tariffs which would make a customs deal with the EU much easier to agree. Thirdly, as the UK would have some relatively high tariffs, particularly in agricultural products, it would allow UK trade negotiators to offer to remove some of these in exchange for access to other countries markets when they are negotiating trade deals.

Re-evaluate all tariffs

Citrus Fruits

However, if the UK is going to have an independent trade policy it does make sense to re-evaluate the current tariffs and see if they can be tailored in a way which better suits UK industry and consumers. For example at the moment there are high tariffs on the import of citrus fruits from outside the EU. The UK can’t produce citrus fruits given our climate and so it makes little sense to keep a tariff on these goods, which only makes them more expensive for consumers here. There are thousands of different tariff lines and the UK could go through each one and make a tailored tariff policy with a balance of ensuring lower prices for consumers whilst ensuring those industries that do need some protection, for example livestock farmers, can get it.

In the event of a no-deal Brexit the UK will not be able to differentiate between goods coming from Europe and those coming from the rest of the world. Meaning that some imported goods would become very expensive unless the global tariff was reduced. This would be a highly complex and delicate undertaking for the government but would be one that would tailor the UK’s trade policy towards UK interests.

Reduce or eliminate all tariffs - The “Singapore option”

Singapore option

The third option would be to unilaterally reduce all tariffs on all goods, giving the world access to UK markets.

There are advantages but also some significant pitfalls to this approach.

On the advantage side, it would drastically reduce the cost of imports meaning prices for consumers would likely drop substantially, and it would send a message to the world that the UK is fully open for trade. It may even help some manufacturers in the UK to have access to raw materials at a cheaper price than is available in other countries. However, there are several problems with this approach.

Firstly UK manufacturing and agricultural sectors would have little or no protection against products produced abroad with large government subsidies, which is one of the justifications for tariffs in some areas. In addition, if we fully opened up trade to countries who can produce meat at a much lower cost, such as Brazil, it would make it very difficult for our livestock farmers to stay in production given the higher costs of producing in the UK.

However the bigger problem would be that such an approach would mean that it would be very difficult for the UK to get a trade deal with any third country, because we would already have opened up our markets to their products. These countries would have little incentive to offer us access to their markets as a result, because they would already have all they need in terms of UK market access. For this reason I think it is unlikely that the UK would take this option except for those products which the UK doesn’t produce domestically.

The whole tariff discussion will be complicated and technical, but can have massive implications for our economy. It will therefore be very interesting to see which path the UK takes if it does, in the end, leave the customs union.