28 July 2016

On top of the report in the Financial Times, the UK’s new International Trade Secretary Liam Fox also made it clear that he wanted the UK to leave the customs union in an interview with the Wall Street Journal. Raising questions as to why he felt the need to make such a statement, despite it seeming to be a given.

There will be an impact to leaving the customs union but it is not prohibitive

In our seminal Brexit report published 18 months ago we investigated and modelled this impact in depth – one of the few Brexit reports to actually pay attention to the issue. What we found is that, in the long run (up to 2030), there will be a permanent cost to leaving the customs union. This cost is around 1% to 1.2% GDP (see table below which shows the cost of border in the scenario where the UK negotiates a liberal free trade agreement with the EU).

Customs Union Table itemprop=

The cost comes in the form of the imposition of new time and out-of-pocket expense on cross-border trade, for example time spent at customs and the administrative cost of getting through customs. The admin cost will largely arise from what’s known as ‘rules of origin’, if the UK ends up securing a free trade deal with the rest of the EU. These rules essentially enforce the EU’s external border in countries where it has a free trade agreement (FTA). It must be proven that goods and products exported into the EU from the UK are truly UK produced (or at least the majority of inputs are from the UK) – otherwise people could simply import from the rest of the world with lower tariffs and then export into the EU single market. This therefore clearly involves admin before goods are shipped and checks at the border. As highlghted in the illustration below (from our Trading Places report), if these requirements aren’t met then the relative tariffs will have to be paid.

Tp Cust itemprop=

Importantly, nearly all of this is a cost which will occur no matter what is negotiated between the UK and the EU and it is a dead weight cost for the economy (not a transfer as with tariffs). This goes someway to explaining why there is always likely to be a small negative cost to leaving the EU in the long run.

But this cost is clearly not prohibitively high. Furthermore, as shown above, both Norway and Switzerland are outside the EU’s customs union and do significant levels of trade with the EU – over 70% of Norway’s total trade is with the EU for example. So while it will take some adjustment, it is far from impossible to adjust to.

The biggest unknown is the impact on cross border supply chains. Introducing this new cost in terms of a customs border and associated admin may change the nature of supply chains and mean areas which added value before no longer do. That said, this area needs far more investigation and the data is poor. If the value added is not easily replicable elsewhere, then less disruption can be expected.

The alternatives are less palatable

Furthermore, the alternative approach of staying in the customs union but trying to leave the EU also makes little sense. It means the UK would not be able to strike its own trade deals. This significantly limits the scope for offsetting the other costs of leaving the EU – potentially reduced access to the single market for example. (As I outlined in a briefing yesterday, there opportunities out there in terms of global trade.) Within this there are only really two paths which could make this work:

  • Be like Turkey – one option would be to adopt the Turkish model, inside the customs union but outside the single market. This would maintain tariff free, border free and rules of origin free trade in goods between the UK and the EU. It could also mean an end to free movement. However, it would mean the UK could not negotiate its own free trade deals and would have to accept whatever the EU agrees to with other parties. The UK would have no say in the negotiation of those deals either. The UK would also have no say over the EU’s rules on tariffs or on product standards despite being bound by them. It also includes no provision for services, meaning the UK would be entirely out of the EU single market for this.
  • Essentially stay in the EU – the other alternative is to try to stay in the customs union but also negotiate an FTA with the EU or even adopt some version of the EEA (similar to Norway). But under such a scenario the UK might as well simply stay in the EU as there would be very little difference other than potentially repatriating control over small areas such as fisheries and agriculture.

Why are we still talking about this?

As laid out above, there is a cost of leaving the customs union but it is not all that high in the long run. The alternative would mean being in a far from optimal position with little room for manoeuvre or essentially staying in the EU. The former would be economically disruptive and the latter would be politically explosive. The only real question then is why this is even a “live debate” in Whitehall? It is concerning that, at this stage, the UK government seems to still be debating the most basic tenets of Brexit when the time is upon us to be drafting a detailed approach. This ship sailed some time ago. The focus needs to be on judging what level of single market access UK businesses really need and how that can be married with the democratic vote in the referendum. Let’s pull our collective fingers out shall we.