Brexit Update

By Cameron Peek

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Following the conclusion of phase one (“the divorce”) of the Brexit negotiations last December, the United Kingdom and the European Union have officially entered phase two of the negotiations, discussing the framework for the UK-EU future relationship and deciding the arrangements necessary during the period transitioning to that relationship. Frustrated that the discussions have produced few concrete ideas of what this future relationship would look like, two weeks ago the EU’s chief negotiator, Michel Barnier, told UK leaders that the time had come to make a choice — will the UK be in or out of the EU customs union? Responding to growing concern within the Conservative Party that she might bend to opposition pressure, last week UK Prime Minister Theresa May made her position clear; the UK will “categorically [be] leaving the customs union.”

A Refresher on Customs Unions

A customs union is a type of trading block that unifies the tariff policy of all members. Customs unions are defined by two key features: 1) a free trade area between members (members do not charge duties on goods imported from other members) and 2) a common external tariff (any goods imported from non-member countries are charged the same import tariff, regardless of which member country the goods enter the union). Here, we should distinguish the EU customs union from the EU single market. The customs union unifies external tariffs, but the single market is what allows the free flow of goods, services, people, and capital. Thus, it is possible to be in the single market, but not the customs union (like Iceland, Liechtenstein, Norway and Switzerland), or be in the customs union, but not the single market (like Andorra, San Marino and Turkey).

May’s Position and the Way Forward

Leaving the customs union risks seriously disrupting the lion’s share of UK trade. The EU is the UK’s largest trading partner, comprising 43% of all UK exports and 54% of all UK imports. Exiting the customs union will put up new tariff barriers, depriving UK-EU traders of the duty-free access they currently enjoy. On the other hand, leaving the customs union would allow the UK to escape the confines of the common external tariff, thereby making it possible for the UK to implement its own tariff policy and negotiate its own trade agreements with non-EU members. As the EU itself has recognized that 90% of global growth is expected to come from outside the EU, this could be a worthwhile tradeoff for the UK.

Still, May is holding on to hopes of both having her trade cake and eating it too. In August of last year, May’s trade team released a “future partnership paper” outlining what is still the UK’s stance for negotiating the future UK-EU trade relationship. Most notable from the paper was the proposition of a “customs partnership.” Under this scheme, the UK proposed that it would synchronize its import policies for intermediary goods brought into the UK that are part of a supply chain for final consumption in the EU. Thus, for American widgets meant to be consumed in the UK, the UK could charge x%; but if those same American widgets were to be used in other products that would eventually be shipped to the EU, the UK would be charge the EU rate, y%.
Unfortunately for May, EU officials are underwhelmed at the idea, calling the UK’s proposal for a customs arrangement “unrealistic.” Even more doubtful is whether such an arrangement would comply the WTO’s non-discrimination principles. As the negotiations proceed, the UK will need to be warry not to compromise its obligations to the world trading system in the hopes of maintaining current access to the EU market.