Wednesday, 16 August 2017

Thoughts on UK Governments "Future Customs Arrangements" paper

Some thoughts on the Governments "Future customs arrangements" paper published yesterday (Tues 15th August 2017).

Firstly, we should note that the paper deals just with issues associated with a new customs border: customs declarations, tariffs/Rules of Origin and routine customs controls for UK/EU trade.  For all those complaining that that this ignores issues arising from regulatory barriers - note that this paper states (para 24) these will be covered in a subsequent report.

Much of the paper is familiar territory which I've covered in detail on my EU Question blog:
  • A repatriated trade policy where UK seeks continuity of existing trade agreements and replicates the EU's WTO schedules; 
  • A new customs border mitigated by streamlined customs processes and requiring an interim period to implement new infrastructure / systems / processes; 
  • A customs agreement with EU is required to carry over existing arrangements (e.g. mutual recognition of Authorised Economic Operators (AEOs), Common Transit Convention, (CTC) continued exchange of data/information etc. ) and implement an interim customs arrangement based on mirroring the EU's external tariff and third country agreements.
While inside the EU, the UK applies the EU's external tariff and makes use of the EU's FTAs with non-EU countries (while being unable to agree it's own independent FTAs). Thus all imports from outside the EU undergo routine customs control, paying relevant EU duties, when crossing into EU territory (including UK customs border). Once customs formalities have been cleared, the goods than move freely throughout the EU without the need for further customs formalities.

The interim customs agreement will seek to extend current customs arrangements - the UK will replicate the EU's external tariff and not implement any new FTA's concluded under the UK's newly independent trade policy.  To completely mirror the current situation, diagonal cumulation will be required - allowing distributed supply chains to continue to benefit from tariff-free trade. The EU's proposed FTA with Japan includes proposals for "extended cumulation", i.e. extending cumulation (hence tariff-free supply chains) to third countries where the EU and Japan have tariff-free arrangements in common.

Of course, it is possible that the EU will agree new FTA's to which the UK will not be party (having left the EU). In that case, the UK will probably have to provide tariff-free access to the EU's new third country trade partner without any guarantee of reciprocated tariff-free access for the UK to the third country in question. The best re-assurance against this is that it is an unlikely scenario, given the EU's famed inability to conclude FTA's quickly.

"A new customs partnership with the EU"

The interim customs arrangement breaks down once the UK implements any new FTA's which the EU is not party to.  The Governments paper includes a radical proposal of "A new customs partnership with the EU" to address the issue raised by new UK FTA's. Imports would be separated into 2 customs streams:
  • Imported goods destined for consumption in the EU will be charged the normal tariff (as per the external tariff and FTAs that UK and EU have in common) - essentially a continuation of current arrangements; 
  • Goods imported under a new UK FTA that are destined to be consumed in the UK will qualify for tariff-free access.
In short, this proposal seeks to avoid the burden of proving that a product has sufficient local content/input under Rules of Origin to qualify for tariff-free UK-EU trade. Instead, goods will be deemed to qualify for tariff-free UK-EU trade provided there is assurance that any content obtained via UK's independent FTAs has had the relevant EU tariff levied.

Companies with complex supply-chains are anxious to avoid the complexities of Rules of Origin (RoO) and have much to gain from this proposal. The UK's annual goods export to the UK amounts to £122 billion, of which £38 billion (over 30%) is content originally sourced from outside the UK (see update at bottom of post). Not only can RoO result in a significant administrative burden, (estimated as equivalent to a 4% tariff by Open Europe), but also some current supply chains may not qualify for tariff-free trade under the complex rules around product content and origin.

Smaller businesses focussed on trade with the EU would also wish to avoid the administrative burden of customs formalities and RoO. The impact on marginal costs may well be enough to make exporting / importing uneconomical. This is particularly relevant for companies operating across the Irish border on an "island of Ireland basis".

This proposal will need a "robust enforcement mechanism" to reassure the EU that goods imported from the UK do not contain goods that have evaded the EU's tariff (i.e. goods imported to the UK tariff-free via one of the UK's independent FTAs). The Governments paper suggests either a"tracking mechanism" where imports to the UK via a new UK FTA are tracked until they reach an end user, or a "repayment mechanism" where all goods are charged the higher of EU or UK tariff on entry to the UK, but traders reclaim the excess paid for goods when sold to an end-user in the UK.

It is possible to see similarities with current customs processes such as transit (where goods are securely transported across national borders with customs formalities suspended until the final destination is reached) and inward processing (which provides relief from import duties for goods that are imported solely for incorporation into a product to be re-exported). It may even be possible to implement this proposal as a trade facilitation available to trusted/accredited traders whose accounts and supply chain management would be subject to audit - this is similar to some ideas proposed for companies operating across the Irish border.

This proposal is an attempt to benefit from customs union membership for current trade and add the benefits of new UK FTAs for UK consumers.  EU traders will also benefit in avoiding disruption to UK trade and the proposal has the potential to be applied to other trusted third countries - the EFTA states would be obvious candidates given the volume of EFTA-EU trade and their status as highly developed economies. Theoretically, the concept of "extended cumulation" could be replaced with this approach - so that where partners have FTA's in common, low-friction customs-union style trade could be enabled.

However, it is difficult to see the EU accepting such a proposal lightly. It would not be unreasonable for the EU to demand that import duties levied by the UK are forwarded to them - certainly for goods imported via new UK FTA's that are destined for consumption in the EU - possibly for all imports in a continuation of the current customs union regime. Nor is it difficult to envision the EU rejecting this proposal as simply another British attempt at "having our cake and eating it too".

Agreements & Timing

The biggest issue with the proposed new customs partnership is perhaps time. Negotiating such an agreement with the EU and implementing the required enforcement mechanisms is not likely to be quick.

Moreover, the Government paper also emphasises the need to be ready for "every eventuality", including the failure to agree a negotiated settlement with the EU. Brexit at end March 2019 is just over 19 months away. The EU's continuing insistence on its rigid negotiating sequence of settling the exit bill before discussing future trade agreements puts this deadline in severe peril.

As such, preparations for March 2019 must be the priority. Is the UK Government progressing with streamlining the customs process (new infrastructure / systems / processes) ?  The Government paper suggests that the new Customs Declaration Service (CDS) is on track to deliver by January 2019 - I along with many commentators remain sceptical. Are UK importers / exporters preparing for routine customs controls and Rules of Origin ? Are the UK Government and business blithely assuming an interim customs agreement will be reached ?

There is also public concern that any interim agreement could turn into a permanent agreement - with UK Government and business eternally delaying the issues associated with leaving the EU's Customs Union. It seems to me the Government needs to actively demonstrate the UK's readiness for March 2019 in order to strengthen it's negotiating position.

Of course, if no negotiated settlement is reached with the EU and no FTA is agreed, then tariff-free trade with the EU will end - at which point the complexities and costs of Rules of Origin are moot - importers will simply have to pay the tariff. As I discussed in detail on my EU Question blog "Tariffs & Origin", tariffs in most sectors outside agriculture are actually quite low. Finished cars are one of the highest tariffs for manufactured goods at 10%, but car components typically have much lower tariff rates. Furthermore, "inward processing" can avoid impact on complex supply chains, e.g. where car parts or part-finished cars are shipped across the channel multiple times in the manufacturing process - only the tariff on the finished car will apply.

It may just be that the path of least resistance ends up being acceptance of tariffs offset by lower currency and lower taxation for UK exporters - combined with some repatriation of supply chains (a process that is already underway in the UK car industry). Unless of course, the UK Government & EU are able to make headway on trade and customs arrangements - but we are fast running out of time for that - UK Government and business really do need to be prepared for every eventuality.

Update: (17/08/2017):
This post originally stated "The UK's annual goods export to the UK amounts to £122 billion, of which £38 billion (over 30%) is content originally sourced from Asia, America and the rest of the world."  Having been prompted to check this figure and finding the source (Credit Suisse research quoted in a uk business insider article), the £38 billion figure seems to apply to UK exports to the Eu that were of all non-UK origin, including the EU.

The uk business insider article also points out that "many of the raw materials that go into the $158 billion (£121.9 billion) worth of UK-made goods exported to the EU are likely sourced overseas too". So, there would appear to be no clear figures on non-UK or non-EU content of UK exports to the EU.


  1. Paul - do you know where this 30% figure for non-EU foreign content of exports comes from? It looks very high.

  2. Re, the above - the OECD stats show the import content of UK exports (total) was around 20% in 2011. Therefore a figure of 30% for non-EU foreign content (even if it's just exports to the EU) looks highly implausible.

  3. I got the figures from Hugh Bennett's article on Brexit Central. I've asked him for source.

    The OEC stats suggest 22.9% import content of UK exports (total). 30% RoW content in UK goods exports to EU does not seem so far removed. Given that a Customs Union avoids Rules of Origin and minimum content rules, you might expect higher RoW content in EU exports.

    The 30% figure is in line with what I've seen for car manufacturers supply chains. This is the source of some anxiety as some current supply chains may not qualify for tariff-free trade under minimum content of EU's rules of origin once we move outside Customs Union.

    1. Paul - about 30% import content in goods exports is right. But the government paper is implying 30% non-EU import content. This cannot be right I think.

      In the context of an FTA with the EU, EU imported components then re-exported would presumably be counted as local under bilateral cumulation? If so, then this 30% number is going to slump to probably 15% or even less which I would have thought was OK for content rules?

  4. I'd hope expect UK would be part of pan-Euro-Mediterranean (PEM) cumulation if we get negotiated settlement with EU - giving a wider pool of "local" content including UK, EFTA, EU & some other neighbouring countries.

    Rules of Origin vary by sector. For cars, I believe 60% local content is required, leaving up to 40% for RoW. Even so, some manufacturers are worried about the location of their supply chains.

    1. Hugh Bennett has provided me with his source:

      Having looked at this source , I think you are right, Hugh & I are wrong.

      UK exports of $322bn to EU breaks down as follows:
      - $158bn UK VA (UK origin goods consumed in EU);
      - $115bn RVA (UK origin goods exported to EU & consumed outside EU)
      - $49bn FVA (non-UK origin goods re-exported & consumed in EU)
      As far as I can see, the FVA figure covers goods imported from EU *and* ROW which are then re-exported to EU.

      Then again, the article also states "many of the raw materials that go into the $158 billion (£121.9 billion) worth of UK-made goods exported to the EU are likely sourced overseas too". So there appears to no clear measure of RoW content in UK exports.

    2. Paul - I would have thought as a first approximation you can estimate ROW content in UK exports by applying the non-EU share of UK imports to the total foreign content data from WTO/OECD but this won't be precise at a sectoral level. It may be possible to derive more information from world input output tables.

  5. Cars would be one of the highest sectors for non-UK content, but most of that content would be EU so again I can't really see the issue here in an FTA context. In a non-FTA context, RoO are presumably no longer an issue anyway and is the government's option 2 even viable then?

    1. I saw an article recently on UK car supply chains which estimated UK + EU content of UK exported cars as ranging from ~55% to ~90%. So some might have problems with RoO even allowing for EU content as local. Typically, I can't find this article now !

      If we have a UK-EU FTA including cumulation (bi-lateral or PEM) then broadly speaking European content is "local" content, RoW is not. Most UK exporters should then meet the mimimum threshold, but they'll need to analyse their supply chain to be sure & some may well fall short.

      If we dont have an FTA with EU, then as per my blog, RoO is a moot point as there is no preferential route - the tariff will have to be paid. Given that Open Europe estimate RoO as being equivalent to 4% tariff and in many sectors (including car components) tariffs are 5% or less, the value of tariff-free trade for many industrial goods is perhaps marginal.

    2. Thanks Paul. You might note there are several studies of FTA arrangements that show a substantial share of firms in some sectors choose to pay the MFN tariff rather than go through the RoO process.

      That said, are RoO costs actually recurring at 4% (or whatever - there are various estimates) or is a chunk of this going to be a one-off cost (assuming your input mix isn't constantly changing)?

      btw 55% for UK+EU content sounds incredibly low for a car firm - that would have to be some kind of assembly plant for an Asian firm or similar. The OECD/WTO data suggests total foreign content in UK motor vehicle exports was 44% in 2011. That may have come down a touch now.

    3. Actually Paul it is possible to get a finer breakdown of foreign content in UK exports from the OECD/WTO database.

      For all industries inc services the numbers are
      % 2000 2011

      Foreign 18.0 22.9
      EU 8.3 9.5
      ROW 9.6 13.4
      EU+UK 90.4 86.6
      UK 82.0 77.1

      For motor vehicles and trailers

      % 2000 2011
      Foreign 29.6 44.4
      EU 16.8 23.9
      ROW 12.8 20.5
      EU+UK 87.2 79.5
      UK 70.4 55.6

      I shall now desist from using up your bandwidth

  6. Thanks - I was aware that in many cases importers simply pay the tariff to avoid RoO.

    The Open Europe 4% RoO estimate is an across the board estimate. There'll obviously be variations in actual cost depending on size of the production run and complexity of the supply chain.

    So while car manufacturers have complex supply chains, the cost of RoO is spread across large number of units and big companies are obviously more able to absorb this admin cost. For car companies, the main concern is meeting the threshold. If UK-EU FTA includes cumulation (inevitable I'd say), then most will meet the threshold.

    I'll keep looking, but still can't find the article I saw which gave a range of figures for non-EU content, suggesting some car companies might struggle. but a few points to bear in mind:
    - Parts imported from the EU will often have non-EU content as well. Supply chains do extend beyond the EU. USA supplies some parts.
    - There may also be an issue with grand-fathering EU's FTA's. EU-Korea FTA requires 55% EU content on cars exported to Korea. Unless we agree diagonal or extended cumulation with EU & Korea, UK exporters will have to fulfill 55% UK content (not UK+EU content). EU manufacturers would also find UK content does not qualify, meaning they source components elsewhere.
    - Similarly, UK car companies sourcing content from Korea, either directly or via EU company, will find Korean content doesnt count towards threshold for EU exports unless we agree diagonal/extended cumulation.

    The figures I've seen suggest UK car manufacturers struggle to reach 40% local content (after years of trying to improve UK supply chains). See para 136 of evidence to HoL select committee:

  7. Thanks Paul- I agree re. diagonal cumulation. That I suspect is one of the reasons (apart from sheer trade weight) that getting a grandfathered and perhaps extended deal with Korea has been highlighted by HMG as one of the priorities.

    I'm interested as to why there should be a divergence between the WTO/OECD figures on local content for the motor industry and the HoL quoted numbers, it may be there is a definitional difference or the full universe of manufacturers is not being covered by the latter study.

    I think we can conclude overall that in an FTA case this threshold issue is unlikely to be a big problem, given normal and sensible cumulation rules. The more pressing issue would be how to work round a situation where we don't get an FTA I think.

    1. Haven't found the article I read, but I have found the source of figures quoted :

      "In the UK, 37% of the total value of spend in the supply chain
      (£33 billion in 2012) is currently sourced locally. Depending on
      the manufacturer, between 20-50% is imported from the EU
      and the rest from outside the EU." (page 6)

      This is consistent with other reports I've seen, including efforts by UK to increase local content in UK cars from low 30's 20+ years ago. UK+EU content according to 2012 report will range from 57%-87%. Note also, this just measures the location of suppliers - EU suppliers will have some non-EU content in their parts.

      I suspect many UK exporters are not 100% sure about RoO compliance as they've never had to worry about it. Some sectors outside cars will have higher thresholds of course. All UK exporters (cars & other sectors) ought to do due diligence and look at RoO compliance in anticipation of a UK-EU FTA (assume PEM RoO as baseline) - some may find the need to make supply chain decisions.

      If we do not end up with an UK-EU FTA, then RoO is irrelevant of course. Mitigations against tariffs then should consist of:
      - Ensure complex supply chains which criss-cross the channel make use of inward / outward processing rules to avoid import duties on parts. Tariff should only need to be levied on the export of the finished product.
      - Invest in UK supply chain. Nissan called om UK Govt to do this in car sector.
      - Exporters margin will be critical. Govt can help via Lower tax burden & WTO-compliant Government targeted assistance.
      - Even with an FTA, routine customs control (declarations, RoO, VAT) will become a hurdle. Government must accelerate IT / infrastructure programs and also trade facilitation measures ("streamlining the customs process" in Govt paper).

    2. Thanks Paul - I remain puzzled by these SMMT figures though I note they are talking about the value of spend **in the supply chain** which to me implies bought-in materials and components rather than value-added. These concepts are not equivalent. You could in principle source 100% of your **supply chain** from ROW but still have a very high local content in value added terms if labour input was high and materials input very low.