Blog Post

Should the UK pull out of the EU customs union?

The UK Government appears divided on whether the United Kingdom should seek to remain within the European Union’s customs union after Brexit. The United Kingdom is likely to want to leave the customs union, even it remains in the EU’s single market. But the UK should try and keep to the EU’s commitments at the WTO, at least at the start, in order to minimise the trade disruption that Brexit entails.

By: Date: August 1, 2016 Topic: European Macroeconomics & Governance

The UK was a founding member of the General Agreement on Tariffs and Trade (GATT) in 1948. Like all other EU members, it retained its GATT membership after joining the EU and then became a World Trade Organisation (WTO) member when the latter was founded in 1995. As such it must respect general rules that apply to all WTO members as well as specific commitments made by individual WTO members.

These specific commitments are listed in documents called “schedules of concessions”, which contain specific tariff concessions and other commitments that WTO members have given during multilateral trade negotiations. For trade in goods, these concessions consist mainly of import tariffs, referred to as “most-favoured-nation” (MFN) tariffs. Members must apply these tariffs equally to imports from all WTO partners.

Generally, members of the WTO are only allowed to deviate from this non-discrimination rule and apply lower than MFN tariffs in two situations. One is where a WTO member participates in a free trade agreement (FTA) or a customs union (CU) with one or several trading partners. Both FTAs and CUs imply reciprocal free trade between participants, but customs unions also require a common external tariff vis-à-vis third-countries. The other situation where WTO members can deviate from the MFN rule is in the case of unilateral (i.e. non-reciprocal) trade preferences to foster economic development. For example, Generalized System of Preferences (GSP) schemes allow developed countries to grant preferential tariffs on imports from developing countries.

Although it is a WTO member, the UK does not have its own schedule of concessions. Instead it is part of the EU’s schedule, by virtue of the fact that the UK belongs to the EU and that the EU is a customs union enjoying a special status at the WTO. The EU is the only customs union which is member of the WTO.

The reason for this special status is that the EU is a special customs union. EU members share much more than a common external tariff. They share a common commercial policy that covers the full range of trade policy instruments which they have delegated to the EU, although they are all also WTO members.

Accordingly the UK’s current trading arrangement stands as follows:

  • it trades freely with all EU countries and with all non-EU countries with whom the EU has an FTA or CU;
  • it imports at lower than MFN tariffs from all developing countries that belong to the EU’s GSP scheme;
  • it trades on a MFN basis with all other WTO members, the MFN tariffs being those of the EU for the UK’s imports and of the partner countries for its exports to them.

At the moment the EU is a signatory to 30 FTAs and two CUs, with 56 partners that belong to the WTO as members or observers. These 32 arrangements cover roughly one-third of EU trade. The EU is also currently negotiating FTA agreements with a number of other WTO members (including Japan and the United States), which would cover another one-third of EU trade. Note that customs union arrangements are the exception. All the existing or currently negotiated trade agreements between the EU and WTO partner countries are FTAs, except EU-Andorra and EU-Turkey.

It is important to underline that free trade areas, rather than customs unions, are the typical trade arrangements between the EU and its partners, including those with whom it shares the European single market: Iceland, Liechtenstein and Norway, which belong to the European Economic Area (EEA); and Switzerland.

Hence, despite extremely close economic ties with the EU, these four countries, which together form the European Free Trade Association (EFTA), are outside the EU customs union. They trade freely with the EU and with each other, but do not belong to the EU’s CU and are therefore free to negotiate trade deals with third countries as they wish. For instance, Iceland and Switzerland each have a free trade agreement with China, which has been operational since 2014, while the EU is not even considering a similar deal at the moment.

Table 1 shows the current trading arrangements among the 28 EU countries, and between the EU and the other 19 European countries that also belong to the Council of Europe. The table highlights that membership of both the European single market and the EU customs union is presently reserved for EU members only (plus Andorra, Monaco and San Marino, the three micro-states geographically inside the EU). All non-EU countries either belong only to the single market (Iceland, Liechtenstein, Norway and Switzerland), to the customs union (Turkey) or to neither (all the others).

Finally, note that just as belonging to the EU single market implies applying EU rules and regulations, belonging to the EU customs union should imply applying the EU’s common commercial policy.

The reality, however, is different for a country like Turkey, which has a customs union with the EU but is not an EU member. Being outside the EU, Turkey is not able to take part in the definition of the EU’s commercial policy nor is it willing to fully abandon its sovereignty over trade policy and to mimic the EU’s before actually joining the EU.

See, for instance, the 2014 World Bank report entitled “Evolution of the EU-Turkey customs union”.

As a result, the EU-Turkey customs union is in fact a hybrid between a genuine CU and an FTA. This is demonstrated by the fact that Turkey has adopted the EU’s common external tariff for most, but not all, industrial products and only for some agricultural products; it applies additional customs duties for some textile products from countries outside the EU and the EU’s FTA partners; it applies trade defence instruments, such as anti-dumping and countervailing duties, in a totally different manner (for different products and countries) than the EU; and it has not concluded FTAs with some EU FTA partners (including Mexico, South Africa and Ukraine).

Not being part of the EU’s common commercial policy definition has meant that Turkey has been entirely excluded from the EU-US Transatlantic Trade and Investment Partnership (TTIP) negotiations, despite the fact that their outcome would have major implications for Turkey. This situation has created quite a bit of tension between the EU and Turkey.

Ibid.

What does it all mean for the UK? Once it leaves the EU, the UK will want to leave the EU customs union, even if it retains close ties with the EU single market. Leaving the EU but remaining a member of the EU customs union would mean that the UK would have little or no autonomy and no say in setting its trade policy. Turkey has been willing to accept this situation so far, but it is because it is negotiating its access to the EU and wants to adopt EU policies, even if only partially. If and when the prospect of EU membership were to disappear, Turkey will surely want to regain its autonomy in trade policy and convert the EU-Turkey CU into an FTA in order to regain sovereignty, even though it would entail some economic costs.

Leaving the EU customs union would mean that the UK would be free to set its trade policy with third countries, even if it maintains free trade with the EU. However, the UK already has deals with third countries as part of the EU. Before making bilateral free trade agreements with these countries or others such as China, the UK will have to obtain its own schedule of concessions at the WTO. It would also have to specify the level of its MFN tariffs for the several thousands of products of the trade nomenclature used by WTO members to exchange trade concessions. Only after its MFN tariffs have been established, would the UK be able to negotiate free trade agreements to eliminate tariffs with some partners.

Negotiating a fresh schedule of concessions with over 160 WTO members will be a time consuming affair. EU members have delegated trade negotiations to the EU and cannot negotiate on their own. So the UK would need to make a deal with its EU partners to start negotiating at the WTO before leaving the EU. Even if it manages this, reaching an agreement at the WTO will take time and prevent the UK launching bilateral negotiations in the meantime.

The only realistic option for the UK is therefore to propose to the WTO membership that it be allowed to adopt the EU schedule of concessions as its own. In principle, this should not pose too much of a problem to WTO members, as they would keep the same MFN access to the UK market that they enjoy at the moment. There is, however, one caveat. The WTO operates by consensus, and some large members may wish to improve their access to the UK market. They might feel that the UK was able to extract concessions from them during earlier trade negotiations, when it was part of the EU, that need to be rebalanced in accordance with the loss in relative bargaining power that Brexit implies for the UK.

But even if the WTO membership were to allow the UK to keep the EU schedule, this may not be acceptable to various interest groups in the UK, who may wish to use Brexit as an opportunity to depart from the EU’s common external tariff. There may be products that carry a zero MFN rate in the EU, where some groups would wish to have a higher MFN rate. More likely, there may be products with high EU MFN rate, typically food products, where the UK may wish to have a lower MFN rate.

It would be wise for the UK government to refrain from such demands and stick to the EU’s common external tariff, at least for the time being. The UK would still need to convince WTO partners not to seek renegotiations to improve their access to the UK market.

Assuming WTO members allow the UK to adopt the EU’s schedule of concessions quickly, the UK would then be able to launch bilateral trade negotiations relatively soon, including with trading partners with whom the EU already has an FTA (countries like Korea, Mexico, Norway, South Africa and Switzerland) or a CU (in particular Turkey) to which the UK would no more be a party upon leaving the EU. The UK will probably also wish to request negotiations with countries with whom the EU is currently negotiating trade deals (such as India, Japan and the United States). Finally, the UK will also have to consider whether it wants to adopt a GSP scheme and decide which countries will benefit from it and under what conditions.

The bottom line is that Brexit will lead to changes in the UK’s trading arrangement that will inevitably disrupt trade flows. The only way to avoid trade disruption being excessively long and costly is for the UK to adopt the EU’s WTO schedule of concessions, at least initially. This, however, is not just up to Her Majesty’s Government. It also requires the consent of WTO members.

The author is grateful to Petros C. Mavroidis and to Bruegel colleagues for extremely useful comments.

 

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read about event More on this topic

Past Event

Past Event

Europe's global positioning and its trade implications for Asia

This event, taking place in Hong Kong will discuss Europe-Asia relations in the context of global developments.

Speakers: Alicia García-Herrero, Peter Mandelson, David Tweed and Guntram B. Wolff Topic: Global Economics & Governance Location: Bloomberg Hong Kong Office 25/F, Cheung Kong Center, 2 Queen's Road, Central, Hong Kong Date: July 7, 2017
Read article Download PDF More on this topic

External Publication

Review of EU-third country cooperation on policies falling within the ITRE domain in relation to Brexit

What is the possible future relationship between the EU and the UK in light of Brexit? The report provides a critical assessment of the implications of existing models of cooperation between third countries and the European Union on energy, electronic communications, research policy and small business policy.

By: J. Scott Marcus, Georgios Petropoulos, André Sapir, Simone Tagliapietra, Alessio Terzi, Reinhilde Veugelers and Georg Zachmann Topic: European Macroeconomics & Governance Date: July 5, 2017
Read about event More on this topic

Upcoming Event

Sep
13
09:00

EU-China Economic Relations: Looking to 2025

This event will see the launch of a report on EU-China relations and discuss issues such as trade and investment, indusstrial cooperation and innovation and global governance

Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Podcast

Podcast

Global trade and Europe

Multilateral trade has generated a huge amount of wealth, and lifted many around the world out of poverty. But there is also growing awareness that globalisation is creating “losers”, and this risks feeding a backlash against multilateral trade. We explore the benefits and risks of multilateral trade, and ask how Europe should behave in a shifting context

By: The Sound of Economics Topic: Global Economics & Governance Date: June 30, 2017
Read article More on this topic

Blog Post

Can EU actors keep using common law after Brexit?

English common law is the choice of law for financial contracts, even for parties in EU members with civil law systems. This creates a lucrative legal sector in the UK, but Brexit could make UK court decisions difficult to enforce in the EU. Parties will be able to continue using English common law after Brexit, but how will these contracts be enforced? Some continental courts are preparing to make judicial decisions on common law cases in the English language.

By: Uuriintuya Batsaikhan and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article More by this author

Parliamentary Testimony

House of Commons

Exiting the European Union Committee

On 19 April 2017 Zsolt Darvas appeared as a witness at the Exiting the European Union Committee, the House of Commons, United Kingdom.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, House of Commons, Testimonies Date: June 20, 2017
Read article More on this topic More by this author

Blog Post

Brexit and the future of the Irish border

The future of the Irish land border has been thrown into uncertainty by Brexit. The UK's confirmation that it will leave the EU's single market and customs union implies that customs checks will be needed. However, there is little desire for hard controls from any of the parties involved. This is especially true for Theresa May's potential partner, the DUP. Creative solutions are needed to reach a solution.

By: Filippo Biondi Topic: European Macroeconomics & Governance Date: June 19, 2017
Read about event More on this topic

Past Event

Past Event

Substance requirements for financial firms moving out from the UK

In the run-up to Brexit, UK-based financial firms are considering how to organize their operations across the future divide between the UK and EU27. This event will discuss the regulatory requirements on how self-sustaining the operations in the EU should be, and implications for the single market and third countries.

Speakers: Gerry Cross, Simon Gleeson and Nicolas Véron Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: June 2, 2017
Read article More on this topic

Blog Post

How export growth achieved adjustment of massive trade deficits in the euro area

The reduction of current account deficits in euro-area countries since the 2008 crisis is strongly driven by increases in exports that dampened the effect on production of the fall in demand and imports.

By: Konstantinos Efstathiou and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: May 31, 2017
Read article More by this author

Blog Post

Pharmaceutical industry at risk from Brexit

Pharmaceuticals are a hugely important industry for the EU and the UK. The sector creates thousands of jobs, billions of euros in exports, and is Europe’s most research-intense industry. But will Brexit mean for pharma? Border delays, disruption to R&D and regulatory divergence all pose hazards.

By: Jianwei Xu Topic: European Macroeconomics & Governance Date: May 31, 2017
Read article More on this topic More by this author

External Publication

The future of globalization

This brief reviews the main features of the recent globalization, attempts to explain its persistence over the centuries and why it is likely to persist in the indefinite the future, examines the causes and prospects of the new protectionism, and concludes by drawing policy implications.

By: Uri Dadush Topic: Global Economics & Governance Date: May 29, 2017
Read article More on this topic

Blog Post

UK economic performance post-Brexit

What’s at stake: Almost a year after the UK voted to leave the European Union, its economic performance has showed mixed results. The risks of a Brexit-induced recession do not seem to be materialising. On the contrary, up until the end of 2016 the UK saw a continuation of strong consumer spending and strong output in consumer-focused activities. However, the UK economy is showing signs of slowing down in the first quarter of 2017, with weak growth in the services sector and business investments. In addition, strong consumption growth started to cool down as individuals’ purchasing power declines due to a weaker exchange rate. This leads to a question whether it is the beginning of the Brexit slowdown. We review the contributions made on this topic in the last year.

By: Uuriintuya Batsaikhan and Justine Feliu Topic: European Macroeconomics & Governance Date: May 15, 2017
Load more posts