Brexit deal includes clever strategy for future trade

Economic opinion

There is finally a Brexit deal on the table, but it is already clear that the current draft version will not survive. The extensive document (585 pages) contains very valuable ideas, and it would be a shame if these are all suppressed in the political fight. In particular, the combination of a temporary customs union between the UK and the EU and the UK's right to conclude its own trade agreements is a good compromise and a clever move. This is the key to a successful post-Brexit future for the UK and the EU.

Temporary customs union

The EU Member States have been part of a customs union since 1965. This was an important achievement in the process of European integration. A customs union goes much further than a traditional free trade agreement which often, and certainly in older versions, solely ensures the abolition of tariffs in trade in goods. In a customs union, participating countries commit themselves to a common external trade policy. In other words, on top of free trade between the Member States, the same customs duties apply to non-Member States irrespective of which Member State they export to. This creates a level playing field and the basis for further economic integration between the Member States. Of course, a common external trade policy requires a shared vision with respect to international trading partners. In practice, this is the task of the European Commission, albeit with some checks and balances applied by the EU Member States, the European Parliament and often also by the national (and regional) parliaments (cf. the approval of CETA, the EU-Canada Trade Treaty).

Irish border

The draft Brexit agreement provides for a temporary customs union between the UK and the EU. The decision to maintain a UK-EU customs union is driven by the issue of the Irish border. Since both friend and foe realise that a hard border between Ireland and Northern Ireland will lead to major political problems, a customs union is a practical solution. Within a customs union, there are no border controls to be carried out, so, the fact that non-European imports are subject to the same rules throughout the union means that a single check on products imported from outside the UK-EU customs union is sufficient. For a while, there was the idea that only Northern Ireland would join a European customs union, but this was rightly rejected as a violation of the sovereignty and territorial integrity of the UK.

Britannia rules the world

A customs union therefore implies a similar trade policy towards non-Member States. The agreement provides for explicit consultation between the UK and the EU on future trade policy. A customs union also implies that the Member States themselves cannot conclude their own trade agreements with non-Member States. The current Brexit deal makes an exception for the UK. The British Government may negotiate agreements with other countries, subject to EU approval. These agreements can only enter into force after the transition period. This should allow the UK to develop a strong international trade and investment network, partly building on existing EU agreements. This largely meets the British call for more sovereignty, at least in the area of international transactions. The UK can make its own choices in this respect and there is a good chance that the market-oriented British economy will go much further in such agreements than the EU. This could give a strong boost to British exports and strengthen the UK's position in international networks.

EU as the winner

At first sight, such a scenario does not seem to be a good thing for the EU-27. In this case, the UK risks becoming an open gateway to the whole EU. Hence, the European door will only be allowed to remain open conditionally for British or international products shipped via the UK. A renegotiation of the temporary customs agreement is therefore certainly necessary. However, it is good that the starting point is a customs union and not a hard Brexit where the World Trade Organisation's principle of Most-favoured-nation tariffs would apply to British-European trade. The current proposal offers a much more positive perspective: to seek a number of correction mechanisms starting from the basis of free trade. Such mechanisms are, moreover, very common in existing international trade agreements. Particularly via country-of-origin provisions, a distinction could be made between genuine British products and goods transiting through the UK, based on principles to be agreed upon. However, the thorn in the side is once again the Irish border. The Brexit agreement is limited to a general commitment to an open border policy.

While this allows the UK to integrate into the world economy according to its own choices, it also offers interesting longer-term benefits for the EU-27. Despite the EU's open trade policy, it remains difficult to conclude trade agreements with a number of key countries for political, cultural and economic reasons. This is particularly so with India and China. The UK may succeed in reaching agreements with these countries, thanks to its historic sphere of influence and its current bilateral trade relations, which are sometimes more robust than those of the EU. Currently, the UK is the most active of all EU Member States in non-EU markets (57% of total UK exports - see figure). British agreements could then be the forerunners of European trade agreements. The presence of a strong competitor next door to Europe would also keep the EU on its toes. In general, there is indeed a risk that after Brexit, the EU will become less market-oriented and move towards more market regulation, in line with the Franco-German economic vision.

Figure - Share of total UK exports of goods and services

Source: IMF

It is already clear that the proposed Brexit agreement as it stands will not be accepted. But, hopefully this proposal for trade relations going forward will survive in the future. It will benefit both the UK and the EU.

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