27 July 2016

Key points

  • UK-EU negotiations top priority – not entirely separable from negotiations with other countries, as the closer tied in the UK is with EU, the less flexibility it will have in trade deals with others.
  • FTAs via the EU mean a further 14% (on top of 49% with the EU) of UK trade takes place of preferential terms. Securing these should be a priority.
  • Within these Switzerland (3% of total UK trade) and Norway (2.6%) are of particular importance. A quick way to secure these would be for the UK to join the European Free Trade Area. This might also allow the UK to join up with some of EFTA’s trade deals such as with Canada – though the UK may eventually want to negotiate its own more in depth agreements.
  • Setting a baseline of tariffs, quotas and subsidies agreed with the WTO will be a crucial early step. Hard to negotiate any FTAs unless countries know on what terms the UK will trade with the rest of the world.
  • The WTO process is not as simple as assumed and will require support from all 162 members. Simplest for the UK would be to adopt its proportionate share of the EU’s ‘schedule of commitments’ at the WTO. To smooth this along the UK should appoint an Ambassador to the WTO.
  • In terms of new FTAs, the UK should prioritise the likes of US, China, India and Brazil.
  • Taking a separated approach to FTAs would make sense. The UK should seek to strike quick, goods focused deals with high tariff nations (China and India) which can be revisited later for services integration. Any deal with the US will rely on services, particularly financial services harmonisation, and as such will take longer. Despite cultural similarities, in regulation terms the UK and the US remain quite different.
  • Be patient – rebalancing will take time; many large developing economies do not yet have significant demand for imports of services, and financial services in particular. But this is likely to change in future.

What can the UK do while still a member of the EU?

Technically, while it is still in the EU, the UK’s trade policy is still conducted at the EU level. However, in practice, the UK is going to be having informal talks with a number of partners regarding future trade deals. Of course, where informal negotiations end and formal negotiations start is far from clear and the EU could try to make things difficult, but this seems unnecessary. Reported plans for a ‘code of conduct’ between both sides – which might allow the UK flexibility to have informal talks on other trade deals combined with a UK promise to honour its commitments while still inside the EU – would make sense.

What should the UK’s trade priorities be?

It’s no doubt correct that the UK should signal its willingness to be open to the rest of the world and it is very encouraging that it has already embarked on informal talks with a number of states. But Brexit is a complicated process and requires and orderly approach. As such, from a trade perspective, this is what the priorities for the new Department for International trade (and the government more widely) should be in broad terms:

  1. Negotiate UK-EU deal (both withdrawal agreement and trade agreement)
  2. Secure current FTAs (30+ agreements with 60+countries)
  3. Implement UK specific WTO schedule of commitments (tariffs, quotas, subsidies etc.)
  4. Begin negotiations with other states on FTAs

As has been widely reported, the UK will have to expand its capacity (in terms of trade) to achieve this. Furthermore, it is likely this agenda will dominate much of government resources for the next few years.

Of course, these are not all entirely separable and the lines between them will become blurred. In particular, 2 and 3 could be negotiated in parallel, though the UK’s partners will likely keep an eye on the UK’s WTO schedule to ensure they have not opened up their market for terms which are less than favourable than they first appear (more on this below).

UK-EU negotiations not entirely separable from talks with the rest of the world

Beyond the obvious reason for trying to sort out the UK’s trade relationship with the EU first, it should also be kept in mind that negotiations with the rest of the world on trade agreements are not entirely separate from UK-EU talks. This is because many states will want to wait and see what deal is struck between the UK and the EU. There is a practical reason for this. Ultimately, the UK’s ability and freedom to negotiate with other countries will partly depend on how tied in it remains with the EU (this is a point regularly made by Norwegian officials). This applies particularly on services and regulatory harmonisation. The closer tied in the UK is to the EU, the more likely it is to have to keep EU rules. As such, the scope for opening up to or integrating with other countries might be more limited (or at least not fully in the UK’s control). Similarly, issues such as where rules on ‘cumulation’ (what percentage of a product can be produced outside the UK or EU) are set could impact the path for countries selling into the EU via the UK and therefore impact trade negotiations with the UK.

Securing existing EU FTAs makes sense

As the graph below highlights, the UK already does fairly well from EU membership and its related FTAs (at least in trade terms) given that they allow for preferential terms on 63% of the UKs trade. Maintaining this is logically one of the first steps. The most important of these relationships are actually ones closely tied to the EU – Switzerland (3% of total UK trade) and Norway (2.6%) in particular. As such, striking a free trade agreement with or simply joining EFTA would be a good first step to secure these. Turkey, South Korea and Singapore would also be worth trying to secure quickly, each counting for around 1% of UK total trade.

Open_Europe_graph_largest_trading_partner itemprop=

Setting a baseline at the WTO will be important

The importance of getting things sorted early at the WTO should not be underestimated. In fact, in practical terms, the lack of a WTO baseline is one of the primary issues which could delay more advanced talks on trade deals with other countries – they need to know what terms everyone else is being offered before negotiating preferential terms for themselves.  The baseline refers to what approach we adopt at the WTO, for Most Favoured Nation (MFN) tariffs and quotas – these will apply to any WTO member with which we do not have a preferential trade agreement. While at first glance this may seem simple – we just adopt the EU’s current tariffs and quotas – in reality a process has to be followed, which could be more or less straightforward, depending on how the UK plays it.

The current EU’s WTO ‘schedule’ of commitments was negotiated by the EU as a bloc and as such the UK will need the agreement of the other 162 WTO states to set its tariffs at the same levels adopted by a bloc of 28 states. The WTO operates on consensus, so in theory even one objection can hold up the process. Looking back at WTO negotiations, there are some countries that are traditionally tricky to negotiate with – Brazil, India and China come to mind; while certain issues, such as agriculture, are often the source of disputes.  Additionally, the UK also needs to decide for its part where it wants to set its own tariffs – for example does it want to keep the same level of agricultural tariffs as the EU? There will no doubt be lobbying from international partners and domestic interests on this, probably in opposite directions.

In all likelihood, it might therefore be easier to put off these questions and simply stick with the EU approach for now, but any changes will need to be decided and negotiated at some point. Furthermore, the WTO commitments don’t just apply to tariffs but also quotas – on the imports/exports of certain goods at lower tariff levels – and subsidies. Given these were negotiated for the EU28 as a bloc, it needs to be negotiated what share of the quotas will now apply to the UK.

This process, of the UK having its own WTO schedule, looks as if it can happen in two ways: ‘rectification’ or ‘modification’ (since the UK is already a WTO member in its own right). The former should be relatively simple, and only requires that no-one raises any objections to be approved (or ‘certified’). It could also happen in a matter of months rather than years. A full modification process would likely require rounds of negotiations over the tariffs and quotas and could become bogged down for years. The dividing line between the two is determined by whether any WTO member believes the changes made will result in any alteration in the scope of concessions – i.e. whether they believe they will be any worse off under the new rules. If not, rectification should be doable. This would all also be aided if the UK could quickly agree with the EU that it will simply adopt its share of the EU’s schedule thereby presenting a somewhat united front of a large group of developed states to the rest of the WTO – making it harder for others to object. To help facilitate all of this the UK should appoint an Ambassador to the WTO as soon as possible. Whoever takes this role should be able to quickly begin the technical negotiations and keep a permanent presence to manage them.

Which countries should the UK prioritise trade agreements?

As we discussed in our liberal, free market guide to Brexit, the UK will need to consider which states to prioritise when it eventually gets round to formally negotiating additional trade agreements. The table below outlines some of the contenders.

OE_table_WTO itemprop=

Of those included in the table, the highest average tariff countries that the UK does not yet have FTAs with are India (13.5% MFN), Brazil (13.5%) and China (9.6%). In terms of the UK share of the export of goods that these highest tariff countries make up, China is the largest (7.4%), then India (2.1%) and then Brazil (0.6%). Striking even basic agreements with China, India and Brazil (in reality this would likely be a deal with the South American Mercosur trading bloc) could deliver gains for the UK, not just in terms of reducing the cost of current trade but opening up new avenues.

Needless to say, the longer-term goal for the UK would still be to conclude agreements that provide for the fullest possible liberalisation of trade in services – and financial services in particular. The obvious example where this is true would be the US. While it accounts for 12.6% of UK goods exports, it accounts for 23% of UK services exports. As such, the largest returns from an FTA with the US would come from integration on services by removing regulatory barriers and duplication.

This raises the prospect of an idea which we floated in the same report – multi-stage or separated trade negotiations.  When negotiating a free trade agreement, the EU’s preferred approach is ‘nothing is agreed until everything is agreed’. The inherent risk with this strategy is that a single issue can potentially hold up an entire deal for months or even years. A multi-stage approach could allow the UK to secure duty-free trade in goods with a larger number of countries in a shorter period of time – as scrapping tariffs is usually the easiest bit of a trade deal – while more complex areas would be addressed at a later stage. This is not without risks – the latter talks on services may never get off the ground while it also potentially reduces the UK leverage given services/capital account for a significant part of the UK economy. But it could at least allow a route for the UK to secure basic agreements quickly and help the UK Government to more easily juggle the many priorities with limited resources.

All this said, the UK will have to be patient – diversification will take time. In many cases, the high growth, developing economies do not yet demand a big part of what UK produces – namely services. This also highlights why the risks of a multi-stage approach may be less than first feared.

Trade Structure Graph itemprop=

As the chart above shows, the UK’s export mix and the import mix of the BRICS countries are not that well aligned. 70% – 80% of what they import tends to be goods, while that is less than 60% of what the UK exports. These are often not the same types of goods – they import significant amount of energy related products as well as telecoms equipment, though there is some overlap in cars (a big UK export and a big BRICS import). Furthermore, once goods related services, transport and travel are stripped out, in 2015 the UK alone exported almost as much in services as Brazil, Russia, India, China and South Africa combined imported. In 2015 the value of financial services which the UK exported was six times the value imported by all the BRICS combined. Only in Brazil and Russia do business services, the other big UK services export, come close to accounting for 10% of imports.

This highlights the need to maintain good links with the EU and strike a free trade agreement with the US (two regions which do demand services) whilst also preparing the ground for future expansion into these growth markets and making sure the UK is ready to take advantage of any opportunities. As these countries develop (an uncertain and non-linear path of course) they are likely to demand more of what the UK provides – in particular business and financial services.