Brexit Seminar - All Souls College, Oxford
- Friday, 9th September 2016
My main focus is trade but I want to put it in the context of expediting Brexit.
Project Fear did not become a self-fulfilling process. But Remain made the legitimate point that a prolonged period of uncertainty could damage the economy. So, while taking sufficient time to prepare properly, we should aim to complete Brexit as rapidly as possible.
Unfortunately, the impression has taken hold that Brexit is an interminable process. The haunting last couplet of the Eagle's hit 'Hotel California' has been likened to leaving the EU: "You can check out any time you like, but you can never leave!". Gus O'Donnell suggested that negotiations could go on for a lifetime; John Major predicted it will take over a decade.
But there is another line in Hotel California which describes their mental predicament: "We are all just prisoners here, of our own device".
As long as we don't devise our own obstacles to leaving there is no reason Brexit should be interminable.
In fact, it need not take even the two years arbitrarily specified in Article 50.
Joining the EC was far more complex than leaving: we had to introduce Value Added Tax, transform our farm support, implement all existing EU laws, replace Commonwealth Preference by EU tariffs and much else. That took barely 2 years.
I asked President Klaus whether splitting Czechoslovakia in two was long and difficult. He replied: "Simpler than you think - dividing our monetary union took a weekend, separating our countries, a bit longer".
To shorten the process, we need to be very clear about what it involves.
- We must distinguish between issues which are matters for decision by the UK and those which are matters for negotiation with the EU. There has been a widespread but erroneous presumption that everything is a matter for negotiation and, consequently, before we can begin doing anything we must laboriously assess what can be traded off against what in a multi-dimensional game of Diplomacy. Once we have identified the issues which are matters for our own decision Ministers can start taking those decisions immediately. That immediately reduces uncertainty. It also narrows the focus for negotiations which will render them simpler.
- The first decision we should take is to convert all EU legislation and regulations into UK law. It might seem paradoxical that Eurosceptics should propose this. But it has several benefits.
- It provides business with certainty: they will be able to run their businesses in the same way the day after Brexit as the day before.
- It means Parliament can amend, repeal or improve any law subsequently – as it can any of our existing laws.
- It will also ease the Parliamentary passage of leaving legislation by depriving die-hard Remainers of excuses to oppose the Brexit legislation.
The idea promoted by Gus O'Donnell et al that we need to go through the entire acquis communitaire item by item and reject, amend or incorporate it before we can exit - is absurd. But it is widespread and the source of much of the concern about Brexit not just in business but among environmentalists and the general public.
The Secretary of State for Exiting the EU has said that this is not straightforward. Maybe it will require more than a single clause – but by definition it must be possible. It is after all more or less what countries like India, Canada, Australia (and even the North American colonies!) did when they became independent – they simply adopted British laws as their own.
- Another issue we should resolve by our own decision rather than as part of a negotiation is to reassure EU residents already here that they will be allowed to remain. That will end uncertainty for them and their employers. Using them as bargaining counters in case EU member states threaten to expel UK residents – which none has and they would face international obloquy if the did - is abhorrent and unprecedented. When Uganda expelled British passport holders we did not even contemplate expelling Ugandan citizens.
- On the other hand, to prevent a 'closing down sale' influx from the EU, we need to announce that EU citizens arriving henceforth will face the same limits on work as apply to citizens of other friendly countries. (Incidentally, should such action be ruled out by the ECJ while we are still members of the EU we could, under the Vienna Convention, resile from the EU Treaties without going through the Article 50 process.)
The first rule of negotiation is to narrow your focus: or as Lynton Crosbey said in another context: "Scrape the barnacles off the boat"! The more such decisions we take, the clearer it will be to our partners what remains to be negotiated. The main item for negotiation will then be the terms on which the EU and UK will trade with each other.
- By ruling out free movement of labour we have closed off the unattractive option of joining the EEA. The EEA was devised for countries whose governments wanted to join the EU but whose people were reluctant. It is an ante-room, not a departure lounge. The EU has free trade agreements covering over 50 countries – only four (the EEA and Switzerland) involve free movement and a budgetary contribution to the EU.
- So there are only two realistic outcomes for the future trading relationship between the UK and the EU. Either the UK and the EU27 agree to continue to trade freely with each other without tariffs. Or the UK and the EU27 apply to imports from each other the WTO tariffs which we currently apply to the EUs biggest trading partners - USA, Russia, China. (In either scenario the UK post Brexit could reduce its tariffs below the present level either unilaterally across the board as some advocate or as a result of free trade agreements with new partners. If we did so while retaining tariff free trade with the EU they would naturally want to introduce Rules of Origin.)
- Both options are pretty simple. Unlike negotiations to remove complex tariffs between countries, retaining zero tariffs is simplicity itself. Likewise, the EU has a common external tariff which we will inherit. That is the highest tariff we could apply to each other. Applying that to each other is less desirable but equally simple and requires no negotiation at all.
- Moreover, both are acceptable to the UK and preferable to the present situation. The greatest mistake of all is the belief in some quarters that a 'favourable' trade agreement with the EU is essential. Any one with experience of negotiating – which excludes most of those who comment on the issue – knows that a successful outcome to any negotiation is only possible if you are prepared to walk away with no deal. Moreover, those you are negotiating with must know that is the case.
Fortunately for the UK, no deal – i.e. trading on WTO tariffs – is perfectly acceptable. The tariffs our exporters to the EU would face average about 4% - small beer compared with the 12% improvement in their competitiveness from the post Brexit exchange rate change. Even car exporters, facing a 10% tariff will be better off. By contrast, EU exporters would face a similar tariff burden on top of the 12% loss of currency competitiveness.
Moreover, we would be able to negotiate free trade deals to reduce the far higher barriers our exporters face in the fast growing markets of Asia, Africa and Latin America.
And because we have a large trade deficit, the Treasury would reap estimated tariff revenues of £12billion – hopefully used to cut tax burdens on UK firms – whereas EU governments would collect only £6.5 billion.
Some argue that we should go straight to trading on WTO terms.
- They believe there is no prospect of a trade agreement with the EU.
- Announcing a swift move to WTO tariffs will avoid prolonged uncertainty and enable business to plan for the future.
- If the EU then offer something better this will be seen as a UK success, whereas if we ask for continued free trade and don't get it, it will be seen as a defeat.
On the other hand it is argued:
- The prospect of a deal to continue free trade cannot be ruled out, given that it is as much in their interests as ours.
- The power of the status quo should not be underestimated.
- It is politically important that the onus should be on the EU27 to continue zero tariffs and the blame will fall on them if tariffs are imposed.
- In the event that continental governments prevaricate on reaching a trade deal we should simply announce that for the time being we will maintain our zero tariffs on imports from the EU – unless they choose to impose WTO tariffs on us, in which case we will reciprocate. (We need not worry whether retaining the status quo without a formal agreement after we have left the EU is compatible with WTO rules. Objectors would have to prove not merely that the rules have been infringed – which is debatable - but that they have been harmed. And that would take a long time.) It is important to let continental governments face the wrath of German car makers, French wine growers, Dutch cut flower growers et. for initiating an unnecessary tariff battle in which they lose more than we do.
- Tariff free trade with the EU, though desirable, is relatively unimportant because the maximum tariffs the EU could impose are mostly so low. The free trade deals that are really worth while are those with fast growing but still highly protected markets of Asia, Africa and Latin America. Remain campaigners claimed that no-one would want to do deals with us. Now countries are queuing up. So the sooner Brexit is complete, the sooner we can complete such deals. That will increase pressure on the EU to agree tariff free trade with the UK. For example, at present wine from Australia bears a tariff whereas French wine enters duty free. French wine producers would hate to see that advantage reversed.
- The claim that we need to retain "access" to the single market is misleading. It implies that our exporters risk being excluded from it. In fact, every member of the WTO – including over 160 countries which are not part of the EU - has guaranteed access to the single market and most are doing good business with it, a lot of them rather better than we are 1. (This is because the main feature of the Single Market Programme was to standardise product requirements so that manufacturers need only produce a single range for all 28 countries – which benefits American and Japanese companies exporting to the EU as much as German or British companies exporting within the EU.)
It would be more accurate to refer to tariff free access for goods (there are no tariffs on services) and passporting rights for some financial service companies – mainly in the retail sector, enabling them to sell their financial services/products either directly or via a branch regulated by the UK regulator. Without a passport companies must operate through a local subsidiary authorised and regulated by the national regulator.
- The value of passporting rights, though worth keeping, should not be exaggerated. I say that as the Minister who negotiated the first passporting directive and later implemented the Single Market programme.
UK based financial services firms have passporting rights as a member of the EU.
- But so too under the MIFID2 Directive will financial services companies from countries like the US, Hong Kong and Singapore whose financial regulatory systems are deemed to have 'regulatory equivalence' as would the UK's.
- Most British UCITS funds choose to operate via companies set up in Luxembourg and Dublin rather than using their passport from London. (This has not caused an exodus of jobs from London.) Moreover, they clearly find the value of low tax in these countries more than offsets the extra cost of setting up companies. This puts a pretty modest value on passporting.
- The growth in UK financial services exports to the EU does not show any marked change since passports were introduced.
- British financial companies seem to export very successfully without passports to countries like the USA and Switzerland – our two largest markets.
- Most of British financial services business is wholesale whereas passports are largely designed to facilitate retail business.
New trade agreements with Rest of World
We should initiate discussions immediately with: China and India, USA and Canada, Australia and New Zealand, Switzerland and EFTA. There have been indications from several of these countries of an interest in trade ties with the UK.
Where relevant, we should seek some quick fixes – e.g. simple deals covering the top priorities on each side, leaving the less important issues to be completed in a second phase. This could be important in boosting economic confidence and have internal political benefits.
For example, a deal with India reducing their punitive duties on whisky would be important for Scotland and impossible for Scotland to do if Scotland (in or out of the UK) remained in the EU because India has broken of trade discussions with the EU.
In the case of the USA we should not try to replicate the full TTIP negotiations, which in any case may well founder. The primary UK interests are a) to remove the remaining tariffs between the UK and USA, b) to minimise regulatory barriers (if any) to trade in financial and related services, c) to prevent discrimination between suppliers by nationality in procurement. Given that the USA is the largest investor in the UK and America is the largest destination for UK foreign investment there is no need to establish ISDS tribunals which are intended to give assurance to investors in countries where there are doubts about governance and legal protections.
With Canada, although there may be no need to replicate the full CET agreement, given that that is now complete, it may be worth taking it as the pro forma basis of negotiations to speed them up. CET also includes the unnecessary ISDS tribunals but they are of less significance given that, unlike some US multinationals, few Canadian companies would be likely to use them in the UK.
Existing EU trade agreements with Rest of World
Normally when a federation which is party to a trade treaty splits up, the successor states can and do inherit the treaty (cf break up of the USSR).
The EU has a series of Preferential Trade Agreements – mostly with former colonies and nearby states. We should ask these countries to 'novate' the treaty terms to us so that we can continue trading with them on the same basis. It is hard to think of any reason why they should be unwilling to do so.
The most significant EU PTAs are with South Korea and Mexico. Britain is a signatory of the former since it also covers investment which, unlike trade, is not an exclusive EU competence.
A third of these EU treaties do not include services. In due course, for those countries where there is a significant potential market in services, we should explore the possibility of extending the agreement to cover services.
Trade policy towards developing countries
The EU gives tariff-free, quota-free access to goods from the 42 Least Developed Countries under the Everything But Arms (EBA) agreement. However, the EU's complex and unnecessarily strict rules of origin have meant this has failed to boost imports from these countries as much as has the US Africa Growth and Opportunities Agreement (AGOA), which has far less onerous rules. Canadian policy to boost trade with poor countries has been even more effective.
The EU also offers preferential access to a number of other developing countries. But it highest tariffs still tend to be on labour intensive manufactures (like clothing) and agricultural products – precisely the goods countries in the earliest stages of development tend to export.
The UK should set an example to the rest of the EU and OECD countries by adopting a pro-development trade policy incorporating the best features of EBA, AGOA and Canadian policies and reducing or eliminating tariffs on goods typically imported from developing countries.
This could begin immediately if the EU opt to trade with us on WTO terms. If we continue current tariff free arrangements on an ad hoc basis while the UK retains the Common External Tariff it will not be possible to reduce tariffs vis a vis developing countries until a formal UK/EU trade agreement is concluded.
UK external tariff
Initially the UK should offer to retain the Common External Tariff until a formal UK/EU trade agreement is reached. However, if the EU opts to trade with us on a WTO basis we will be free to alter our external tariffs – not just by negotiating new trade agreements with third countries but also by making unilateral reductions.
One option is the Economists for Brexit proposal to abolish all our tariffs and move to unilateral free trade across with all countries. This has many attractions but is unlikely to be politically possible because it means:
- foregoing several £billion tariff revenue,
- loss of bargaining power to leverage reductions in tariffs on UK exports,
- resistance from domestic sectors protected by tariffs.
The UK should nonetheless reduce or remove, in particular, the highest tariffs on food and other sectors where the UK produces little. This will reduce the cost of living, and mean British consumers are no longer subsidising inefficient industries elsewhere in the EU. This was an invisible but nonetheless onerous cost of EU membership particularly to low income households.
1. UK exports to other 11 founder members of the EU single market grew at 3.09%pa from 1993- 2012; insignificantly less than 3.11%pa growth in UK exports to 8 OECD countries; but significantly slower than the 4.11%pa growth exports from those 8 OECD countries to the EU12. Myth and Paradox of the Single market, Burridge, Civitas 2016.
Brexit Seminar - All Souls College, Oxford
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Rt Hon Peter Lilley MP,
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