Out with a Bump

- Sunday, 27th November 2016

 

Sunday Times

 

This article was originally published in the Sunday Times.

 

The Remain campaign were right when they said that the most damaging consequence of Brexit would be uncertainty until a new relationship is settled.

 

Recognising the danger of prolonged uncertainty has three implications.

 

First, our main objective should be a speedy conclusion to negotiations. The claim in the government's referendum leaflet that the process would take 10 years should be consigned to history. The two years laid down in Article 50 is a maximum. It need not take that long. Negotiating to join the EC took barely two years. That was far more complex than leaving: we had to introduce Value Added Tax, transform farm support, implement existing EU law, replace Commonwealth Preference by EU tariffs and much else. The North American Free Trade Area took only 14 months to negotiate.

 

Second, it is better to end uncertainty by reaching a second best outcome speedily than haggle endlessly over a better deal which may never materialise.

 

Third, every extra week costs taxpayers £200million in our net EU contribution.

 

The key item for negotiation will be the terms on which the EU and UK will trade with each other.

 

Three options have effectively been ruled out by the government.

 

Remaining in the Single Market. There is no such thing as the Single Market. EU law refers to the Internal Market – the combined market of Europe's member states. You cannot be in it unless you remain an EU member subject to European Law, which the Prime Minister has ruled out. In any case the Internal Market programme - which I implemented as Trade and Industry Secretary - primarily involved harmonising product rules – sensible, since businesses can now make one product range for the European market, not 28. But that benefits non-EU exporters as much as EU firms.

 

Remaining in the European Economic Area like Norway. Phillip Hammond, said “the most often-cited model, Norway, would offer us, quite literally, the worst of both worlds. Paying [a contribution], subject to EU rules, and obliged to observe the principle of freedom of movement.” Moreover, it would preclude Britain from negotiating trade deals benefiting our service industries.

 

Staying in the Customs Union. This would preclude us from making any trade deals with the rest of the world let alone become the 'global champion for Free Trade' as Theresa May promises. Nor could we help 'just about managing' consumers by cutting tariffs on items of food and clothing we don't produce – tariffs which subsidise inefficient firms elsewhere in the EU at British consumers' expense.

 

So that leaves only two realistic outcomes for Britain's future trading relationship with the EU. Either the UK and EU27 continue trading freely with each other without tariffs. Or we both apply to imports from each other the WTO tariffs which we currently apply to the EU's biggest trading partners.

 

Both options are pretty simple. Unlike negotiations to remove complex tariffs between countries, retaining zero tariffs is simplicity itself. Applying the EU's external tariff to each other, which happens automatically if there is no trade agreement, requires no negotiation at all.

 

Moreover, both are acceptable and better than our present situation. A continuation of tariff free trade would be preferable if it could be agreed speedily. Anyone with experience of negotiating knows that a good deal is only possible if you are prepared to walk away with no deal. Moreover, the other side must know that is the case. Fortunately, Britain can afford to walk away with no deal i.e. trade on a WTO basis. Indeed, it would be the sensible outcome if the alternative is prolonged uncertainty.

 

America, China and Russia all trade with the EU on WTO terms which has not prevented them becoming its three biggest trading partners. America exports more to the EU27 than we do but imports less from them.

 

The average tariff our exporters to the EU would face would be about 4% (that includes agricultural products – manufactures average 2.4%). In any case the 15% exchange rate movement since Brexit means most British exporters will remain better off.

 

Car manufacturers would be most affected since the tariff on cars is 10%. However, given our large trade deficit, the Treasury would reap tariff revenues of £12billion whereas our exporters would pay only £6.5 billion. So we could compensate them through tax cuts, support for research and reimbursing tariffs on components - leaving billions to cut general taxes.

 

There are no tariffs on services, but financial services firms can obtain 'passports' to serve clients via branches or directly. Without this they may have to establish a subsidiary in the EU. They will retain the right to do that under WTO rules but it is more costly than setting up a branch and involves some transfer of staff. However, many already have subsidiaries – including nearly all mutual funds operating under the UCITS directive and major banks.

 

The value of passporting rights, though worth keeping, should not be exaggerated. I say that as the Minister who negotiated the first passporting directive.

 

British financial companies export very successfully without passports to our largest markets like the USA and Switzerland. Most of British financial services business is wholesale whereas passports are largely designed for retail business. The EU already grants access to certain financial services companies from US, Singapore and Guernsey whose regulatory systems are deemed to have 'equivalence' as would the UK's. Under WTO rules Despite some fears, equivalence could not be withheld or withdrawn capriciously.

 

London is preeminent because its services are valued. If EU governments try to stop their firms accessing the London capital market they will probably set up offices in London – offsetting any outflow to man financial firms' new subsidiaries. Historically many foreign financial firms set up in London to escape their home country regulators. Long before the Single Market was established there were more American banks in London than in New York to escape America's Regulation Q.

 

Oliver Letwin has suggested that it would be worthwhile paying a contribution to the EU to retain passporting for our financial services firms. If so, they should pay. I suspect that at the hint of a levy, they would suddenly discover other ways of accessing their customers!

 

In short, the UK would prefer the status quo – no tariffs and keep passports/equivalence. But if the prospect of that is distant and uncertain we do better to opt for a speedy move to trading on WTO terms.

 

Everyone assumes the UK will make the choice. In fact, the EU will decide whether we continue tariff free trade or trade on WTO terms.

 

If their main concern is their citizens' economic wellbeing they will opt for continuing free trade. The UK is their biggest single export market. They export £90 billion more to us than they buy from us. The EU tariffs levied on our exports would not suffice to compensate their exporters for the UK's tariffs.

 

However, if EU leaders judge that Britain must be seen to suffer to discourage other countries from following suit, or to bring us back into the fold, they may insist on imposing WTO tariffs and obstacles to services trade. In so doing they would inflict greater total losses (though smaller per head) on their own citizens than on the UK.

 

Such a policy would be doubly illegal. UN resolutions forbid the use of economic power to coerce other countries (unless sanctioned by the UN). And the EU's own treaties1 require it “to establish an area of prosperity and good neighbourliness” with neighbouring countries. Oddly, it is Euro enthusiasts who assume that the EU will disregard its own and international norms. Maybe they are right. But it would be craven to bow to illegal bullyig.

 

If the European political class want to try to 'punish' us and are prepared to punish their own citizens, we cannot negotiate that away. But we can try to raise counter-veiling political pressures by alerting continental business and employees to how much punishing us will cost them.

 

Both the need to maximise democratic pressure on EU leaders and to minimise corrosive delay, we should aim to bring the issue to a head before the French, German and Dutch elections.

 

We should simply announce that we will continue to give EU imports tariff free access – unless they choose to impose WTO tariffs on us, in which case we will reciprocate.

 

The onus would then be on the EU 27 to continue free trade or take the blame for triggering tariffs on their exports to their biggest market. Continental governments threatening this would face the wrath of German car makers and unions, French wine growers, Dutch horticulturalists etc. for initiating an unnecessary tariff battle in which they lose more than we do. Workers who risk losing their jobs, to make a political point, are unlikely to be placated by assurances that proportionately more British employees will be affected.

 

We must recognise that if the EU puts punishing us, or forcing us back into the fold, ahead of its own citizens' wellbeing, by refusing a free trade deal, we will have to accept that for the time being. Fortunately, as explained above, Britain can ensure that our traders are better off even under WTO terms than before the referendum.

 

1. Article 8 of FEU: The Union shall develop a special relationship with neighbouring countries, aiming to establish an area of prosperity and good neighbourliness, founded on the values of the Union and characterised by close and peaceful relations based on cooperation.

 

 

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