Sunday, 15 July 2018

Breaking the impasse (part 2) - Ditch the Common Rule Book

The Brexit negotiations appear stalled, with much confusion over the issue of alignment with EU rules and a proposed Common Rule Book. Michel Barnier has consistently made clear the choice facing the UK: we can either be inside the single market and follow all the rules, without dividing the 4 freedoms, so including free movement of people (i.e. Norway), or we can be outside the single market and free from the obligations of the single market (i.e. Canada).

A pre-requisite for Single Market participation is adopting the EU's Single Market Rule Book, or EEA acquis. Theresa May's proposed Common Rule Book is in reality the EEA acquis, minus some elements (services, free movement of people) that she hopes to exclude. Ultimately, the EU will insist on all the rules being included. It is also clear that in seeking a Common Rule Book, May is negotiating to stay in the Single Market, despite her repeated promises to the contrary. If we simply wish to trade with the Single Market, as per Canada, a Common Rule book is not required.

The leaked DExEU alternative proposes broad regulatory equivalence as an alternative to Single Market harmonisation and Common Rule Book, based heavily on the Swiss model. However, the EU have repeatedly stated they regret agreeing the Swiss model (agreed as an EEA alternative while the Swiss application for EU membership still stood) and the EU will not offer this model to anyone else, least of all a departing UK. In any case, the EU's measure of equivalence is barely distinguishable from full harmonisation. The Conservative Brexiteers have gone up a blind alley with this approach.

The main trade gain comes from using common standards. A UK product designed, manufactured & tested to harmonised European CE standards for the UK market can also be marketed in the EU/EEA  market without needing a separate design, manufacturing or assessment process. But of course, an independent UK can voluntarily choose to recognise and use harmonised European CE standards, without membership of the Single Market.

So the question arises - what are the gains from a Common Rule Book / Single Market membership  over and above the use of common standards ? Does being outside the Single Market for goods mean other expensive or insurmountable barriers to trade ? I'll try to answer that question with an overview of the impact of leaving the Single Market on UK goods.

Manufactured Goods - Conformity Assessment

As I described in a previous blog, all manufactured products conforming to EU harmonised CE standards are afforded "presumption of conformity" by EU legislation, whether the manufacturer is based in EU/EEA or third country outside the single market.

For the vast majority (~95%) of manufactured products covered by EU  harmonised regulations, the manufacturer certifies the product, issues a Declaration of Conformity (DOC) & affixes the CE label. A minority (~5%) require certification by an independent EU/EEA based Certification Assessment Body (CAB). The mitigation for this is straightforward:
● UKAS (UK Accreditation Service) is applying to retain membership of  EA (European Accreditation), so that UKAS accreditation will continue to be recognised by the EU.
● A Mutual Recognition Agreement (MRA) on Conformity Assessment would allow UK based CAB's and their certificates to be recognised by the EU (and vice-versa).
● In any case, UK-based CABs can use subsidiary/subcontract relationships with an EU-based CAB to allow their certificates to be recognised in the EU/EEA (and vice-versa).

The primary difference for third country manufacturers is the need to use an EU/EEA-based importer - who holds the declarations of conformity / technical file and acts as a contact point - but is not responsible for conformity assessment. Companies who have a subsidiary, office or even an individual based in the EU/EEA can act as their own importer. The end customer can act as importer. Shipping/Warehousing companies, agents etc. all offer importer services. It's not onerous.

Outside the Single Market, goods will become subject to regulatory checks at the border. Checks are determined on the basis of risk assessment, and even today EU-UK trade is subject to risk assessment and checks for contraband and counterfeits. Overall rates are low (just 1% of third country goods entering RoI are subject to checks) mostly checking paperwork or container seals / labels - only a very small number of consignments are subject to opening and physical inspection. Attention is focused on known sources of risk, e.g. counterfeit goods from the Far East. Non-compliance with standards is mostly identified via market surveillance (not at the border), which then feeds back as intelligence into customs risk assessment for future consignments.  The risk of increased border checks for regulatory non-compliance (as opposed to deliberate counterfeits and fraud, which is already checked today) is negligible, especially for established and trusted traders.

Highly Regulated Sectors.

Some sectors are more highly regulated, requiring product pre-approval via an EU agency. In her Mansion House speech, Prime Minister Theresa May identified 3 such key sectors : Chemicals, Pharmaceuticals, Aviation.

In the Chemicals & Pharmaceuticals sectors, the impact of leaving the single market is transferring approvals/authorisations to an EU/EEA based agency via an EU/EEA based individual (while manufacturing can remain in the UK) e.g.
●REACH registrations via an "Only Representative"
●BPR (Biocidals) product authorisations via an "Authorisation Holder"
●BPR (Biocidals) product suppliers via a "Representative"
●Pharamaceutical products via a "marketing authorisation holder"
Pharmacovigilance (batch quality control and monitoring of pharmaceuticals for adverse affects) via a "Qualified Person for Pharmacovigilance" (QPPV)

Standard third country MRAs (as enjoyed by Swiss, Canada, Australia, New Zealand, Japan etc) can mitigate barriers in Chemical & Pharmaceutical sectors:
● MRA on Good Manufacturing Practice (GMP) would allow Pharamacovigilance to be undertaken in the UK territory and simply signed off by the EU/EEA-based QPPV (and vice versa) - waiving re-testing of products on import.
● MRA on Good Laboratory Practice (GLP) would allow mutual acceptance of data generated in the testing of chemicals, which means approvals in both regimes can refer to the same lab tests.

In the aviation sector the EU Parliament Proposal (paras 31 & 32) exhibits a strong desire for a bi-lateral agreement on air transport and aviation safety, "in the interest of the passengers, air carriers, manufacturers and workers' unions", based on "similar agreements with other third
countries". The UK would need to adopt EU aviation safety law & ECJ rulings (as for example Turkey's "working agreement"). UK's Civil Aviation Authority (CAA) would then retain the right to issue EASA certifications of air-worthiness. Swiss-style observer status at EASA may also be a possibility. In time, CAA will recover capacity and a mutual recognition agreement with EU may then be more appropriate (as per USA, Canada).

Car industry

The Car industry is also a vital sector where product pre-approval applies. The UK's Vehicle Certification Agency (VCA) issues whole car type approvals which allow a model to be marketed throughout the Single Market

EU vehicle regulations are increasingly driven via UNECE WP.29, an international forum for harmonisation of automobile regulations. UN International regulations annexed to the UNECE 1958 Agreement provide mutual recognition of car component type approvals (even without any UK-EU agreement). UN Global Technical Regulations annexed to the 1998 agreement allow mutual recognition of regulatory equivalence for car components (included in EU's Free Trade Agreements  (FTAs) with Korea, Japan & Canada). This removes regulatory barriers for car components (where covered by UNECE regulations), and UNECE approvals can substitute for elements of the EU's whole car type approval.

What is missing is the continued recognition of VCA's whole car type approval outside the single market. Is there scope for a form of "working agreement" (as per the aviation sector) to allow VCA to continue issuing EU recognised whole car type approvals ? I think so:
● EU has tabled regulatory co-operation on vehicles for talks on the future trade agreement.
● Korea, Canada, Japan do not have national bodies for vehicle certification in any case. Whereas the Swiss do and the EU-Swiss MRA provides for mutual recognition of whole car type approvals in return for adoption of relevant EU regulations.
● At EU's behest, UNECE is developing Regulation 0 to provide for international whole car type approval. So EU is already actively planning to extend mutual recognition of approvals beyond the EU/single market.
● UK's VCA has also issued approvals for some EU and third country car manufacturers. Why should they be punished and denied EU market access ?
● UK's VCA would need to continue commitment to UNECE WP.29 and adopt EU regulations / ECJ rulings where UNECE has not (yet) legislated. In time UNECE regulations (including Regulation 0 on whole car type approval) will replace all EU car regulations.
● UK exports 800k cars to EU but imports 2.3 million from EU every year. Who loses by erecting a huge trade barrier in this sector ?

Agriculture

EU Sanitary & Phytosanitary (SPS) regulations provide a very high barrier to agricultural trade for third countries outside the Single Market. Third country meat/dairy imports face veterinary checks at Border Inspection Posts: 100% documentary/identity checks; varying percentages for physical inspections (50% for some products).  EU agricultural equivalence agreements with third countries allow for lower rates of physical inspections  (e.g. Canada 10%, New Zealand 2%).  The Swiss have harmonised their SPS regulations with the EU and are deemed to be part of the EU/EEA SPS regime, with no border checks required for Swiss-EU/EEA trade.

The EU's SPS regulations are particularly protectionist. They require UK to apply the same protectionist measures to third countries (as discussed in a previous blog here), ruling out FTAs with USA (chicken etc), India (Basmati rice etc), Liam Fox's hope of joining the TPP and a host of others. Scientific research & development in GMO is blocked. A WTO ruling/fine against the EU's ban on Canadian beef will be served on the UK if we keep EU SPS rules after leaving the EU. We are currently a captive customer for EU agricultural products, with a 3:1 trade deficit.

It is clear to me that we will be much better served leaving the EU's SPS regime. UK-EU trade will face border veterinary inspections in both directions, so UK meat/dairy exports to EU would be diverted to the domestic market. We can quickly strike agricultural equivalence & Tariff Quota agreements w/ Australia, New Zealand, Canada, Commonwealth states, South  America etc - removing tariff and non-tariff barriers to these alternate (and generally lower priced) non-EU suppliers. Subsidies (Green-box etc) & use of quotas should be deployed to protect the UK meat/dairy sector through a transition. But ultimately, we will end up in a much better place and secure more trade globally on the back of it.

Conclusion

In the manufacturing sector, there will be some relocation of individuals/roles to fulfill the requirement for an EU/EEA based importer/representative, but some EU/EEA individuals/roles will also relocate to the UK - a one-off adjustment but not a long term issue. The risk of extra border checks for regulatory compliance is negligible. Breaching the EU law/ECJ red line in the car & aviation sectors is a small price to pay and in time the need for EU jurisdiction in these sectors will pass. In the agriculture sector, there is a clear case for breaking free from the EU's protectionist SPS rules in the interests of consumers and greater trade opportunities globally.

We are likely to broadly continue using harmonised European CE standards in any case, so reaping the benefit of a single design, manufacturing & assessment process for both UK & EU markets. But outside the Single Market, we are free to diverge as and when it makes sense to do so - in full consideration of the interests of our domestic economy and global trade. We would also be free from the EU's indivisible 4 freedoms and free movement of people. This would make negotiaing and maintaing a new relationship much easier and cleaner. In short, we should ditch the Common Rule Book and become a fully independent and sovereign third country - like Canada.

The fly in this ointment is the NI border, which I will look at in my next blog.

Friday, 29 June 2018

Breaking the impasse (part 1) - Backstop as a Stopgap

The Brexit negotiations appear stalled, stuck on the thorny question of the Irish border. The EU and UK are at loggerheads over the EU's current backstop proposal, which even the supine Mrs May said "No UK prime minister could ever agree", and there appears to be no agreement in sight.

However, my reading of the  Phase 1 Agreement and NI Protocol in the Draft Withdrawl Agreement suggests that the EU has  already (if unwittingly) agreed to a backstop that is: (1) UK-wide, (2) Cherry-picked, i.e. covers free movement of goods only (excludes services) ; (3) excludes EU free movement of people, (4) temporary until a "soft" border solution is implemented. In other words, the backstop provides a UK-wide stopgap to a full agreement and solution.

Firstly, let's consider the general commitments made by the UK regarding NI in the Phase 1 Agreement:
  1. Avoid a "hard border, including any physical infrastructure or related checks and controls" (para 43). Not, as commonly mis-reported, a commitment to no border. There are already checks required today against counterfeits, contraband and to police the existing excise border. The logical interpretation is that controls or checks will be undertaken away from the geographical NI-RoI border.
  2. Protect "the integrity of the UK internal market and Northern Ireland's place within it" (para 45). The same paragraph also confirms that the "UK leaves  the  European  Union's  Internal  Market and Customs Union" - emphasising again that the UK commitment is simply to avoid a hard border, not avoid any border at all.
  3. Preserve the 1998 Belfast / Good Friday agreement, especially North-South & East-West co-operation (para 48). Note that:
  • The 1998 agreement quite explicitly clearly refers to two distinct jurisdictions (each side to remain accountable to the Assembly and Oireachtas respectively). Cross-border co-operation exists precisely because there are two distinct jurisdictions, each with their own legal and constitutional order. The 1998 agreement neither creates nor requires a single all-Ireland jurisdiction.
  • Contrary to much uninformed commentary, the 1998 Agreement says nothing about customs borders. It refers to borders only in the context of removing military & security infrastructure, which is not going to be reinstated due to any future trading relations.
Secondly, let's consider the specific commitments made regarding a backstop in the Phase 1 Agreement, which is intended to deliver the above general commitments in the absence of any other agreed solutions with the EU:
  1.  "UK will maintain full alignment" (para 49) - the backstop does not just apply to, or for, Northern Ireland - the whole UK is encompassed.
  2.  "with those rules of the Internal Market and the Customs Union ..." - i.e. not all rules. The backstop is clearly based on "cherry-picking".
  3. "The UK will ensure that no  new  regulatory  barriers  develop  between  NI and  the  rest  of  the  UK, unless ...  the  NI   Executive   and   Assembly   agree   that   distinct arrangements  are  appropriate  for  NI." The backstop must not create any new barriers to GB-NI trade and cannot imply an Irish Sea border, unless NI voluntarily decides to diverge from GB.
Thirdly, let's consider what are the selective " rules of the Internal Market and the Customs Union" that apply to the backstop ?  The NI Protocol in Draft Withdrawl Agreement  (chapter III) defines a common regulatory area:
  1. Article 4, covering Free Movement of Goods implies being inside the EU's Customs Union. References to  Regulation (EU) No 952/2013 require : Common Customs Tariff (i.e. Common External Tariff and preferential rates of EU's FTA's) must be applied to imports; ports will be subject to EU customs law and oversight.
  2. The section on free movement of goods also includes EU laws on goods, agriculture & fisheries, single electricity market, environment, North-South co-operation, State Aid.
  3.  Article 8 lists the areas of North-south co-operation as:  environment, health, agriculture, transport, education & tourism, as well as energy, telecommunications, broadcasting, inland fisheries, justice & security, higher education & sport. In other words many of the areas are not covered by EU laws on trade or are outside EU competence.
  4. Article 2 covers free movement of people, which refers to the UK/RoI Common Travel Area (CTA) and not to EU's rules on free movement.
  5.  Article 11 states the "Court of Justice of the European Union shall have jurisdiction".
It should be noted that much of the Draft NI Protocol is in un-highlighted text (indicating it is not yet agreed by UK and EU) most notably the jurisdiction of Court of Justice of the European Union. The only items highlighted in green (indicating UK & EU agreement) are Free movement of people (via CTA) and North-south co-operation. The State Aid clause is highlighted in yellow (indicating UK & EU agreement in principle). Nonetheless, the Draft NI protocol clearly outlines a single market and customs union in goods only, without EU free movement of people (agreed as covered by continuation of the Common Travel Area (CTA)).

Fourthly, let us consider how the Phase 1 Agreement and Draft NI Protocol make clear that the backstop is not meant to be a permanent arrangement:
  1.  Phase 1 agreement para 46 states that commitments made for the unique circumstances on the island of Ireland will not pre-determine the outcome of wider discussions on the EU-UK future relationship.
  2. Phase 1 agreement para 49 states the UK intention to address unique circumstances of Ireland via the overall UK-EU FTA, or via solutions specific to the island of Ireland - with the backstop only applying if no solutions have been agreed
  3. NI protocol article 15 states that the protocol (including backstop) will cease to apply if a subsequent UK-EU agreement addresses the unique circumstances in Ireland.
Given the  Phase 1 Agreement calls for (i) UK-wide "full alignment" and (ii) commitment to integrity of UK internal market (and NI's place within it) - the logical interpretation is that the EU have signed up to a UK-wide goods-only backstop without EU freedom of movement, that is only temporary in application. The EU may not like the implications of what they have agreed, but if they renege on their commitments to date, then what chance is there we can reach any kind of workable agreement ?

The current impasse has arisen because the EU insist the backstop can only apply to NI (which contradicts the phase 1 agreement) and because they show no interest in addressing the NI border issues via a UK-EU FTA or specific solutions (in effect they want and expect their version of the backstop to be permanent). At the same time, the EU believe (not without foundation) that the UK Government are trying to leverage the NI border issue to gain a permanent UK-wide Swiss-style regulatory equivalence and customs alignment deal. While such an outcome may be sought by the likes of Philip Hammond, it is not acceptable to Leavers, Re-Leavers, or the EU.

It seems to me that the only way out of this impasse is for both sides to agree a backstop that is temporary - essentially a stopgap - to allow time to implement a permanent "soft" border solution for the NI border. Such a stopgap will also allow businesses & customs authorities in both UK and EU to fully prepare for UK outside the Single Market & Customs Union. The stopgap arrangement should be written into the Withdrawl Agreement in unambiguous terms:
  1. Stopgap agreement should be unpalatable in equal measures to both sides. That way both sides have an incentive to move on from the stopgap to a full and final agreement. 
  2. The UK could concede on ECJ jurisdiction and some continuing payments for the period of the stopgap.
  3. The EU should concede on a UK-wide goods-only arrangement without EU's Free Movement of People rules for the period of the stopgap - as per what has been agreed already in Phase 1 and Draft Withdrawl treaty. The UK government should stand firm on free movement, despite hints May would like to compromise on this.
  4. A definition of (including proposed timescales) and commitment to a "soft" border solution in NI, together with a break or sunset clause so that the stopgap does not simply extend forever.
It is now crucial that all parties consider and agree how an overall UK-EU FTA and special solutions for Ireland can provide a "soft" border solution for Ireland. As you may expect, I have some thoughts on how these arrangements may work - but that is a topic for another post.

Saturday, 31 March 2018

A Brexit Turkey (part 3) - Customs Union is not a Brexit solution

Some bad ideas seem reluctant to die. The Institute of Directors (IoD) have published a "partial" Customs Union proposal (based on Turkey's Customs Union agreement with the EU), primarily to eliminate preferential Rules of Origin (RoO) in UK-EU trade.

In my previous post, I discussed how  preferential RoO are far from insurmountable. How significant are the costs associated with preferential RoO ? Open Europe assumed leaving the EU Customs Union would add 4% to cost of trade transactions (RoO costs & customs admin) leading to a 1% loss of GDP. Other studies suggest RoO adding less than 2% to transaction costs. One detailed study suggests RoO is a one-time cost that does not increase with increased volume of transactions.

A Customs Union seems a very blunt instrument to use, especially as trade with 3rd countries would still be subject to RoO. Are there other ways to address this issue ?

Rule of Origin Solutions

Blockchain technology has been touted as a way to simplify the administration & auditing of complex supply chains, hence minimising RoO administration costs. However, as promising as this technology may appear, we are probably a decade away from fulfilling this potential.

recent paper examined preferential RoO for the Food & Drink Federation, a sector which makes particular use of global supply chains:
- Five case studies are examined, identifying challenges provided by use of non-local content in qualifying for tariff-free trade via preferential RoO.
- Both Pan-European Mediterranean (PEM) RoO and CETA RoO are compared for each case.
- The first case study is UK wholemeal bread, which uses flour milled in the UK from grains sourced from UK, US and Canada: PEM RoO require grains to be sourced entirely locally;  CETA RoO limits non-local grains to 20% by weight of final product. Otherwise the EU tariff of 9% would be payable on exports to the EU.

Some context is required here: 
- Bread is primarily produced and consumed locally: 85% of wheat used by UK flour millers is home-grown, with most of the imports from Canada; UK domestic sales amount to £3.5bn per annum ("Bakery & Snacks"). 
- By contrast, UK bread exports to the EU amounted to just £87.5m for the first 9 months of 2016, i.e. ~£117m per annum ("BakeryInfo"). 
- The UK runs a massive trade deficit with the EU across the whole food and drink sector (Food & Drink Federation statistics).

The Food & Drink Federation paper makes a number of suggestions for addressing these RoO issues, which could also apply to others sectors:
- Allow 10% non-originating product content without losing originating status (already provided in PEM RoO, under article 5.2 (a) );
- Full bi-lateral cumulation in EU-UK trade so that EU content counts as local in UK exports to EU and vice versa - almost certain to be part of an UK-EU FTA;
- Full diagonal cumulation with EU FTAs, e.g. so that UK, EU and Canada can count each other's content as local in trade between themselves;
- Exempt Least Developed Country (LDC) origin content in UK-EU trade so that LDC content counts as local
- Exempt products / content where EU & UK have same MFN tariffs. i.e. count products as local where there is no risk of trade diversion arising from different MFN tariffs - a form of halfway house to the UK governments customs partnership concept);
- Allow origin to be determined on final value OR weight criteria (protects products where local processing adds high vale to a premium product);
- Simplify RoO documentation.
Another approach would be to abandon preferential RoO in favour of simpler non-preferential / Most Favoured Nation (MFN) RoO (as suggested by Hosuk Lee-Makiyama). Non-preferntial RoO typically determines origin on the simple basis of where last substantive processing was performed, rather than where inputs are sourced :
"... the world trading system could do without preferential rules of origin. Preferences can be granted on the basis of most favoured nation (MFN) rules of origin anyway. Empirical literature suggests that, if the purpose for enacting preferential rules of origin was to facilitate commerce or promote inward investment, then their implementation has in practice defeated the purpose. Beneficiaries of preferences often prefer to trade using MFN rules of origin, rather than going though cumbersome procedures to show that they can ‘benefit’ from preferential rules. Thus, in the end, preferential rules of origin are neither necessary for preferences to be granted, nor have they facilitated trade or investment. Our policy recommendation for the negotiators of the Harmonized Working Programme (HWP), which aims to establish common rules of origin for all WTO members, is to also decide to outlaw preferential rules of origin. "   Abstract from "The case for dropping preferential rules of origin" by Edwin Vermulst and P. Mavroidis 
Adopting amended or simplified RoO for UK-EU trade will of course be entirely dependent on EU agreement, which may not be forthcoming. Is there perhaps a more simple and radical way to avoid preferential RoO ?
- IoD's contention is that (i) preferential RoO is a significant trade barrier (ii) tariffs on manufactured products and processed foods are in any case low - so low that they offer no leverage in securing trade agreements with third countries.
- This actually chimes with arguments for "Unilateral Free Trade" as proposed by Economists for Britain, who argue that we should ignore preferential FTAs and instead unilaterally lower tariffs - favouring UK consumer interests (including  manufacturers sourcing inputs) over producer interests. Preferential RoO is removed as a consideration for all imports and exports. Attention can then be focused on removing regulatory / technical barriers to trade.
- Unilateral Free Trade offers a way to eliminate preferential RoO, without requiring EU agreement. If as IoD and others argue, tariffs are sufficiently low to not be an issue, why chase preferential trade deals - even with the EU ?

Partial Customs Union & Irish border 

IoD claim that a partial Customs Union like Turkey's would help alleviate issues with the Irish land border. But Turkish experience does not support this argument, with long lorry queues at the Turkey-Bulgaria border. A number of issues arise:
- Basic agricultural goods are excluded from the Turkish Customs Union and require full customs clearance is still required for these goods. Meat / dairy constitutes a significant portion of UK / RoI trade.
- An A.TR movement form must be presented at the Turkey-EU border, declaring all customs formalities have already been completed.
- Turkey is outside the EU's VAT union, so import VAT is also payable at the border. Does the IOD intend for UK to remain in the EU's VAT union as well ? (meaning UK could not cancel the "tampon tax" or eliminate VAT on household energy bills for example).
    Conclusion 

    The IoD's proposed "partial" Customs Union would not remove the need for a customs border.

    The IoD's argument for "partial" Customs Union rests entirely on RoO. RoO does not provide an insurmountable barrier. RoO administrative costs are subject to debate, appear low and may be negligible beyond an initial cost.

    A "partial" Customs Union would only avoid RoO for trade with the EU - any preferential trade with third countries (including other European countries such as EFTA  members) would still require preferential RoO.

    A "partial" Customs Union would not allow an independent UK trade policy, and will keep the UK tied into an EU-centric trade policy. This is counter to UK's strategic interests. The UK runs a huge trade deficit with the EU, whereas UK trade with the Rest of the World is broadly in balance. UK exports to the Rest of the World have grown and overtaken UK exports to the EU, mirroring the EU's diminishing share of global GDP.

    There are other ways to mitigate the impact of RoO. The worst case is that some supply chains may be repatriated to the UK - given the huge trade deficit the UK has with the EU, this may be no bad thing.

    Ironically,  Unilateral Free Trade offers a way to eliminate preferential RoO, without requiring EU agreement. If as IoD and others argue, tariffs are sufficiently low to not to be an issue, why chase preferential trade deals - even with the EU ? Perhaps a hybrid solution could be adopted - eliminate tariffs where UK has no domestic industry to protect (e.g. tropical fruits !) and also for inputs to manufacturing (e.g. car parts would be zero-rated), but retain higher-rated EU tariffs for key sectors / finished products to use as leverage in trade agreements (e.g. retain 10% tariff on finished cars, ~40% tariffs for meat etc.). The UK could then seek to negotiate FTA's to eliminate these high rated tariffs using non-preferential / MFN RoO.

    In short, we should reject  the IoD's proposal to keep the UK locked into a 19th century Zollverein Customs Union, designed primarily to promote European political integration. As Brexit solutions go, the IoD's proposal is a real turkey.

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    Sunday, 25 February 2018

    A Brexit Turkey (part 2) - Are Rules of Origin insurmountable ?

    Some bad ideas seem reluctant to die. The Institute of Directors (IoD) have published a Customs Union proposal (based on Turkey's Customs Union agreement with the EU), which as discussed in my last post, would result in the UK having no control over tariffs or Free Trade agreements (FTAs).

    Rules of Origin (RoO)

    So what is IoD's argument for a Customs Union ? Essentially it comes down to preferential RoO (Rules of Origin). Outside the Customs Union, assuming an FTA is agreed with the EU, UK exporters will be required to prove goods are substantially sourced or manufactured locally in order to qualify for preferential tariffs (so importing a product from a third country like China and sticking a UK badge on it does not qualify for preferential tariffs !).

    The IOD suggest that many exporters fail to take advantage of preferential rates in FTAs, deterred by the cost/complexity of preferential RoO. To avoid the complexity, they simply pay the tariff. The inference is that a UK-EU FTA would see companies failing to utilise the FTA and incurring tariffs - a problem avoided by a customs union with the EU.

    However there are plenty of grounds for questioning this rather simplistic narrative:
    • IOD cite a literature review of RoO and utilisation of FTAs. However the review itself contains statements such as “Research on RoO, however, is in its infancy “ ... “studies on FTA usage are very limited in scope" etc.  
    • IOD cite a survey of their own members suggesting low use of preferential rates in third country FTAs. But a recent report on utilisation of EU FTAs published by UNCTAD found utilisation at 66% by EU member states and 90% by third countries exporting to the EU market. 
    • Commenting on the UNCTAD report, Lucian Cernat (Chief Economist, DG Trade European Commission) suggested information / assistance to SMEs would help EU exporters better utilise FTAs. This echoes UK research by Peter Holmes & Nick Jacob (Sussex University) finding "a substantial minority of firms are unsure of how RoOs work and the options available to firms for compliance."
    • IOD cite an EU assessment of Turkeys CU stating the following RE costs of RoO:  "Based on empirical evidence that third country exports still use preferences even when EU duties are low (in the range of 2% to 3%), it has been decided to retain a conservative cost of 2%". 
    • The research by Holmes & Jacob also suggests that cost of compliance with preferential RoO was not as costly as previously thought, with much of the cost being an up-front investment to upgrade/set up systems.
    RoO & Car Industry

    IOD raises concerns for the car industry, quoting Japan's message to the UK & EU"the introduction of inconvenient rules of origin could delay and increase the costs of logistics operations, which would have a significant impact on business operations".

    Even from this snippet, it is plain to see that Japan's concern is with logistics and speed through customs clearance, rather than the cost of RoO compliance. This is even clearer when the full context is examined, where Japan requests that the UK & EU "maintain the simplified customs clearance procedures between the UK and EU, especially the framework for the mutual recognition of AEOs ... Changes in customs clearance procedures for exports to the UK and the application of complicated procedures due to the introduction of inconvenient rules of origin could delay and increase the costs of logistics operations".

    Japan also raise the issue of achieving RoO content thresholds when supply chains are distributed across the EU. They request that cumulative RoO apply in future UK-EU27 trade, which means components/processing sourced from either the UK or EU-27 count as "local" in the RoO determination - such "bi-lateral cumulation" is standard practice in FTAs. The fact that Japan raises cumulation indicates they are not requesting or expecting a future UK-EU customs union.

    RoO & Chemicals Industry

    IOD also raise concerns over the impact of RoO on the UK chemicals industry. Steve Elliott, Chief Executive Officer, Chemical Industries Association, in evidence to a House of Lords Committee described RoO as : “a substantial level of bureaucracy ...  in our case there could be several stages of synthesis involved … would clearly outweigh the benefit of duty-free sales”. (Tariffs for chemicals are typically around 6%).

    The EU, EFTA and various other Balkan, African and Middle-Eastern states are signed up to Pan-Euro-Mediterranean (PEM) preferential rules of origin, which state that :
    • Chemical products (Harmonised System chapters 28-38) are "sufficiently processed" to qualify as local origin if non-local content is below a given threshold (varies by material but typically 40% or lower of product value). 
    • Products incorporating non-local content that have been "sufficiently processed" count as 100% local when subsequently used as input to manufacturing another product. 
    • PEM rules also allow for "Accounting Segregation" to cater for use of interchangeable stocks of local and non-local material as input in manufacturing a product.
    75% of UK chemical imports are from the EU, suggesting that most inputs to UK chemical manufacturing will be of UK or EU origin, hence qualifying as local origin under bi-lateral cumulation as part of an EU-UK FTA. UK chemical products will likely meet the RoO threshold to qualify for preferential rates.

    So determining whether a product qualifies as local origin depends on knowing the source and cost of inputs to the manufacturing process - i.e. the core business processes of supply chain management and accounting. Where non-originating materials are used in the chemical industry, they would have to be tracked through several stages of processing - but tracking & auditing use of materials in the manufacturing process is surely standard practice ?

    60% of UK chemical exports are to the EU. Hence 40% are to the rest of the world - is none of this via preferential RoO ? Switzerland has an FTA with the EU and is a non-EU destination for UK chemical exports - is no advantage taken at all of preferential rates ? It is also worth noting that Switzerland has a successful chemical / pharmaceutical industry (larger than the UK's) integrated into European supply chains - despite the fact that Switzerland is outside the EU Customs Union and so faces preferential RoO barriers.

    It is hard to believe that the UK chemical industry makes no use of preferential RoO or is incapable of doing so. If third countries like Switzerland make use of preferential RoO for chemicals, then the UK chemical industry should take a leaf out of their book, make a one-off investment to upgrade systems to cater for RoO in order to utilise current third country FTAs as well as a future UK-EU FTA.

    Conclusion

    The argument that low FTA utilisation proves RoO is too burdensome is contradicted by the high utilisation reported by UNCTAD, and observations by Holmes/Jacob and Cernat that advice / information on RoO would boost exporters use of FTAs.

    Indeed, IOD themselves state: "Rules of origin are not insurmountable for business – indeed they currently apply to trade with a number of existing countries outside the EU." If companies invest in systems to provide RoO compliance for third country FTAs (an increasing proportion of UK exports), then RoO compliance for EU trade is a relatively small additional step.

    A customs union with the EU cannot be justified by RoO. I will examine alternative arguments and alternative options to a Customs Union in my next post.

    Friday, 23 February 2018

    A Brexit Turkey (part 1) - No UK Trade Policy

    Some bad ideas seem reluctant to die. Leaving the EU Customs Union has been stated government policy since Theresa May's Lancaster House speech, confirmed by the 2017 General Election manifestos and several parliamentary votes. Earlier this month, Theresa May again confirmed that the UK would not be part of any Customs Union with the EU after Brexit. Yet now we have the Institute of Directors (IoD) putting out a report with yet another Customs Union proposal.

    The Turkey model

    The IoD proposal is essentially the "Turkey" model, "a" customs union bi-lateral agreement with the EU. This has been dismissed as a Brexit option on many previous occasions because of the glaring problems of the Turkey model:
    • Described as a "partial" Customs Union, in reality this covers all industrial and processed food goods, i.e. substantially all goods except basic agriculture products (meat, dairy etc.).
    • The tariff rates for these goods are set by Brussels. Turkey has to sit out discussions at WTO/GATT on tariff reductions.
    • Turkey does not benefit from any EU Free Trade agreements (FTA), but third countries who have an FTA with the EU gain tariff free access to Turkey, without offering any reciprocal access to Turkey. Turkey considered ending its Customs Union agreement at the prospect of the EU sealing an FTA with the USA (the now defunct TTIP).
    • Turkey is obliged to harmonise with EU trade policy and negotiate FTA's with third countries to match EU FTA's. Unfortunately, a number of third countries have refused to negotiate with Turkey, as they already have tariff-free access to Turkey by virtue of their FTA with the EU.
    So much for an independent trade policy. The Turkey model would leave control of trade policy in the EU's hands. The EU will effectively be able to sell tariff-free access to the UK without any involvement or reciprocal benefit for the UK. Why would any third country bother negotiating with the UK when tariff-free access would be obtained by negotiating an FTA with the EU ? For that matter, why would countries like South Korea agree to grand-father their existing EU FTA into a UK bi-lateral FTA when it can get tariff-free access to UK for nothing ?

    This issue of FTA asymmetry prompted the EU and Turkey to start negotiating with 3rd countries in parallel. In one case, (Malaysia), Turkey has sealed an FTA ahead of the EU (EU-Malaysia talks stalled over a dispute) - meaning Malaysian goods have tariff-free access to the EU by trans-shipping via Turkey.  The EU is aiming to address FTA asymmetry via an upgrade to the Turkey Customs Union agreement which will provide Turkey with observer status at EU FTA negotiations.  But the relationship is still clearly based on Turkey following the EU's lead on FTA's.

    So it is difficult to see how the EU would grant the UK freedom to negotiate its own FTAs while in a customs union. Would the EU tolerate an UK-USA FTA that meant USA had tariff-free access to the EU market without the EU getting tariff-free access to the USA ? Of course not.  

    Trade in Services

    The IOD sugarcoat their "partial" customs union proposal by pointing out areas where the UK would be free to negotiate - tariffs for basic agricultural goods and more interestingly services.  However, the freedom to negotiate on services is hardly an argument for a customs union, as such freedom also comes with an FTA or the WTO option. It is in fact an argument against the Single Market - which would tie our hands on services regulation. Is this a tacit admission of defeat in the argument for retaining single market membership ?


    Conclusion

    The proposed Customs Union with the EU would be far worse for trade policy than EU membership, where at least the UK benefits from EU FTA's and has a vote. A Customs Union does not confer freedom to negotiate on services, that only comes by leaving the single market (which the IOD have opposed).

    So what is the argument for a Customs Union ? IOD rest their case on Rules of Origin (RoO), which I will examine in my next post.
    --0--

    Posts in this series:

    Monday, 19 February 2018

    End of Project Fear ?

    Will we ever see an end to Project Fear ?

    At the height of the EU Referendum campaign, George Osborne's Treasury produced a report predicting that even the act of voting to Leave the EU would cause immediate economic disaster. Even arch-Remainer Kenneth Clarke has poured scorn on these Treasury figures.

    Even EU officials in Brussels believe Project Fear is overdone, as Nick Gutteridge (Brussels reporter) observed: "I’m yet to speak to a single EU diplomat or official who thinks the economic fallout for the UK from Brexit will be anywhere near as bad as many British commentators predict." Even in Brussels, the expectation is a CETA plus outcome and no Brexit recession.

    There is a problem at the root of Project Fear - it is an attempt to argue that a marginal increase in cost of trade with the EU trumps all other concerns (political & economic), even when exports to the EU account for just 10% of UK economy. This is exactly the same argument made for the euro - "10% of our economy depends on EU, 3m jobs at risk" . Allegedly, the UK retaining the £ would result in the City & UK car industry decamping en-masse to the EU to escape the cost of currency exchange in UK-EU.  Some 15-plus years on, it is clear that these economic forecasts were pure bunkum.

    Of course, any forecast over a timescale of 15-years will almost certainly be proved wrong. Yet, in recent weeks we have seen leaked Treasury forecasts, suggesting UK GDP could be 8% lower over a 15 year timescale due to Brexit, paraded as "facts" by Remain supporters.

    It should also be noted that this forecast of 8% does not imply a recession, rather it is a forecast of slower growth, i.e. 1.5% per annum rather than 2% per annum in coming decade or so, so an economy worth ~£2tn at start of a year will only increase by ~£30bn instead of ~£40bn over that year, so that each year economic activity is ~0.5% GDP or £10bn lower than the counter-factual scenario.  Interestingly, UK membership of the EU also costs ~0.5% net per annum, i.e. ~£10bn economic activity taken out of ~£2tn UK economy and diverted to activity in Brussels or other EU member states. 

    It's not clear whether the Treasury forecasts have allowed for the gain from ending UK's net EU contributions in their forecasts. But it is interesting to compare the Remain campaign description of these 0.5% per annum contributions as a small price to pay for the economic benefits we get in return (as in a £70bn per annum trade deficit with the EU).

    Given UK exports to the EU account for just 10% of UK GDP, the forecast 8% loss of GDP is equivalent to losing 80% of our exports to the EU. While there will be a marginal increase in cost of trade with the EU, but this does not mean that UK exports to the EU will effectively cease - just as marginal costs arising from rejecting the euro did not mean the loss of 3 million jobs.  By contrast, a 2017 paper by World Bank & UNCTAD economists suggested UK exports are "price inelastic" and that in the event of a No Deal scenario, UK exports to the EU would drop by no more than 2% - a negligible impact.

    The Treasury also forecast that a Free Trade Agreement (FTA) with the USA would provide only 0.2% GDP gain over the same timescale. The USA economy is larger than the EU27 and with all the trade benefits of EU membership, UK exports to EU27 are about 3 times larger than UK exports to the USA. Yet the Treasury forecast suggests a GDP impact from Brexit and reduced EU trade would be some 40 times larger (not 3) than GDP impact of an FTA with USA. The Treasury forecast seems to assume that trade with the EU is uniquely beneficial to UK growth.

    Historical data does not support this assumption that EU membership has been uniquely beneficial:
    - In 2012, to commemorate 20 years of the Single Market and removal of internal customs borders, the EU Commission published a report claiming a 2% GDP gain (averaged across the member states). Even that figure is inflated, as the economic downturn from 2008 onwards was ignored.
    A similar study by European (and generally pro-EU) think tank Bertelsman concluded that the UK had only gained 1% GDP (with Germany the winner with a gain of 2.3% GDP).
    - In the same period 1992-2012, the UK economy grew by 67%. The introduction of the Single Market & removal of Customs Borders within the EU barely registers.

    Economies and markets will always adjust to shocks such as Brexit. Trade and commercial activity will divert to the domestic economy and markets with the Rest of the World. In fact, there is a strong case that the UK needs to pivot away from an EU-centric economy:
    - The EU's share of the global economy is in decline (having halved from a high of 30%, less once UK leaves).
    - As even the EU Commission concedes, 90% of global growth will be outside the EU in coming decades.
    - The share of UK exports to the EU (as opposed to the rest of the world) has steadily declined from a high of 55% at the turn of the century to 43% today, less if the Rotterdam/Antwerp effects are taken into account.
    - UK trade with the EU has shown a persistent and widening trade deficit, whereas UK trade with the Rest of the World is broadly in balance.

    All of which is a long way round to saying overblown economic scare stories, which have no foundation, take no account of other gains, ignore the 90% of economy that does not export to the EU - are pure distraction.  As we well know, the decision to leave the EU was to restore national self-Government & reject a future as a mere province in the Brussels bureaucratic empire. The whole sorry story of our entanglement with the EU has been attempts to deny the true aims of the EU coupled with Project Fear (right back to 1975 Referendum). June 23rd 2016 was the end of that.




    Wednesday, 13 December 2017

    Brexit Briefing - Customs

    As part of a continuing series of posts examining the Single Market and Norway/Flexcit option (as expressed in a "Brexit Briefing" blog post by Pete North) this post will examine claims made regarding the Customs Union.

    Customs Agreement

    North refers to requiring a customs agreement in addition to Single Market membership. Which is a tacit admission that EFTA EEA does not address issues arising from leaving the EU’s Customs Union, as I covered in an EU Question blog post.
    • The EEA agreement does include 2 protocols on customs matters (Protocols 10 & 11), but these are just basic framework & mutual assistance agreements common to many EU customs co-operation agreements with 3rd countries.
    • As EFTA's web page on Customs Matters states: “The EEA is not a customs union, thus most of the activities in the customs field are not relevant to the EEA Agreement …. Norway and Switzerland were able to find simplified solutions through bilateral negotiations”.
    • Norway and non-EEA Switzerland have concluded Mutual Recognition Agreements under the EU’s Authorised Economic Operator (AEO) scheme, whereby authorised operators can benefit from simplified customs procedures and “fast-track” through customs controls. The EU AEO scheme is based on the WCO SAFE framework, which encourages all WCO members to enter into such mutual recognition agreements. The EU has number of AEO agreements with third countries.
    • Norway and non-EEA Switzerland have also concluded bi-lateral customs security agreements, relieving traders of the obligation to lodge an ENS declaration at the customs office of first entry
    • The Common Transit Convention is a key pan-european treaty which allows goods to move though territories with customs formalities suspended until the goods either reach their destination or are exported outside the territories of the signatories. Signatories include non-EEA Switzerland, Turkey and non-EU Balkan states..

    EEA membership neither provides these arrangements, nor is EEA a pre-requisite for a customs agreement. Participation in the Single Market is only marginally more relevant to customs co-operation than participation in the Eurovision song contest.

    Rules of Origin (RoO)

    North suggests we need a customs agreement that deals with Rules of Origin (RoO). Rules of Origin (RoO) paperwork proves where a product originates from, based on where raw materials are sourced from or where substantive processing took place, in order to determine whether goods:
    • Qualify for a preferential tariff under a Free Trade Agreement (FTA).
    • Fall subject to Trade Defence Measures, e.g. products containing Chinese steel are subject to anti-dumping measures and hence a high tariff.
    • Count towards a Tariff Rate Quota, e.g. meat from New Zealand is subject to a lower tariff until a certain quantity has been imported, when a higher tariff applies.
    North suggests we can avoid RoO by harmonising our tariff regime with the EU's Common External Tariff (CET). Clearly that is insufficient, we will also need to harmonise Trade Defence Measures and continue to share TRQ's with the EU.

    Moreover, North has got very confused with regard to third country agreements, suggesting (wrongly) that the UK signing new FTA's with third countries risks higher rates of inspections to check compliance with single market product rules. As per the EU Blue Guide, importers will ensure manufacturers have fulfilled their obligations regarding conformity assessment – there is no constraint on where materials are sourced from. Manufacturers / importers with established track record of compliance will continue to be considered low-risk unless market surveillance feedback or other intelligence suggests standards have been breached.

    The real issue is that goods from third countries might circumvent EU tariffs if shipped via the UK – which is precisely the point of RoO. It is also why to escape RoO, UK trade policy would have to be subordinate to the EU's trade policy. The UK would only be able to agree preferential trade with a third country in so far as it mirrors the EU's agreement. Moreover, the EU could sign new FTA's with third countries meaning that goods from said third country would have preferential access to the UK without reciprocal access for UK to the said third country market.

    To avoid RoO, the EU would be trusting the UK to maintain its customs border in line with EU policy, preventing third country goods circumventing EU tariffs. The EU will likely demand continued oversight via OLAF (EU's anti-fraud body) and European Court of Auditors (ECA) and that the UK continues to send the bulk of import duty collected to Brussels.

    Frictionless Border ?

    Outside the Customs Union, import VAT also applies at the border (although importers can usually reclaim this). This could be avoided by staying in the EU's VAT union, which would mean the UK remaining fully subject to the EU’s VAT rules and a proportion of UK VAT being paid to the EU. Customs Declarations will also be required. Trade facilitation measures can reduce these administrative burdens (e.g. AEO scheme and Union Customs Code provides for monthly self assessment), but they are not eliminated.

    It seems to me the only way to maintain the current “frictionless border” with the EU is to remain in the EU Customs Union, which in turn requires membership of the EU. Turkey, which has a partial Customs Union “with” the EU, still has a customs border where Customs Declarations, RoO, Import VAT all apply.

    So a transition period that maintains the current border arrangements will require the UK to remain "effectively" in the EU by adopting the EU acquis in the areas of the Customs Union and Common Commercial Policy (not covered by EFTA EEA). The vital difference would be that the UK will regain competence to negotiate future trade agreements (both with the EU and third countries) while continuing to benefit from current trade arrangements with the EU and third countries. Which is why an Article 50 extension is not suitable for transition, as the UK would still be an EU member and would still not have competence to negotiate UK trade agreements.

    A longer term arrangement shadowing the EU Customs Union seems infeasible. The EU has no such arrangements with any third country (including the EFTA EEA states). Continuing to forward a proportion of VAT and Import Duty to the EU, remaining subordinate to the EU's VAT and Trade policy would be in conflict with the Government's stated aims. The UK Government must make preparations in terms of customs infrastructure and trade facilitation to mitigate the impact of our inevitable departure from the EU Customs Union.