Saturday, October 14, 2017

UK risks going over the cliff edge with WTO option

There has been much discussion in the last week over where the Brexit talks are going with some espousing the view that Britain should prepare for a so-called "no deal" option.

The no-deal option has been described as a hard Brexit or a WTO option. It is perceived to be by many Brexiteers as an easy option and that Britain could simply fall back on WTO rules when it comes to trade.

But falling back on WTO regulations and tariffs is not as simple as many might think.

What is the WTO option?

The WTO option involves trading solely under rules set by the World Trade Organisation [WTO], which govern things like tariffs and quotas.

The WTO Option is an approach to Brexit much favoured by some groupings. It is an approach where the UK leaves the EU without having negotiated any trade agreements with the EU, either within the framework of Article 50 negotiations, or on the margins. Instead, it relies entirely on multilateral WTO agreements covering trade-related matters.

The general thrust of the WTO Option argument is that, "Were the UK to leave the EU, it would continue to have access to the EU's markets, as World Trade Organisation rules prevent the EU from imposing unfair, punitive tariffs on UK exports". In reality, the WTO rules only afford very limited protection against discrimination, and then only in respect of tariffs - which are no longer central to trade matters.

Could the UK simply go ahead and trade under WTO terms as soon as it leaves the EU? The short answer is no. In practice, the UK would have to detach itself from the EU and regularise its position within the WTO before it could sign its own trade agreements, including with the EU. As Roberto Azevêdo, the WTO's director-general, said soon after the Brexit vote, there is no precedent for a WTO member extricating itself from an economic union while inside the organisation.

The process would not be easy and would likely take years before the UK's WTO position was settled, not least because all other member states would have to agree. Indeed decisions amongst the other WTO members has to be unanimous and there are currently 164 WTO members.

Complicated matters

Matters are even more complicated than many might realise. The WTO site points to both short and long term issues Britain might face.

There are Regional Trade Agreements which are "by their very nature ... discriminatory". Under WTO rules, an amount of discrimination against third countries [and that would include the UK] is permitted. But the WTO observes modern RTAs, and not exclusively those linking the most developed economies, tend to go far beyond tariff-cutting exercises. They provide for increasingly complex regulations governing intra-trade [e.g. with respect to standards, safeguard provisions, customs administration, etc.] and they often also provide for a preferential regulatory framework for mutual services trade. Indeed the most sophisticated RTAs go beyond traditional trade policy mechanisms, to include regional rules on investment, competition, environment and labour.

Regulatory frameworks

The crunch issue is the "preferential regulatory framework". Unless goods seeking entrance to the EU Single Market [i.e. British exports] conform to the regulations which comprise the framework, they are not permitted entry. Thus, the assertion that, if the UK left the EU, "it would continue to have access to the EU's markets …", is simply not true. And ,  to spell it out,  if it's not true, it's false.

It would be under such conditions that might well create situations as envisaged by some of long lines of lorries queueing up to get into Europe.

Tariffs in themselves do not prevent access to a market. They might make products more expensive but the biggest issue is one of regulatory conformity.

Tariffs simply impose a tax on entry. Regulatory conformity,  generally as a non-tariff barrier [NTB] or, sometimes, as technical barrier to trade [TBT] is the bigger hurdle.

It is generally recognised that, in order to access the Single Market, goods must comply with EU rules. Conformity is the way of overcoming the NTB. But what advocates of the WTO option have not realised is that there is more to it than that . Potential exporters not only have to ensure their goods conform, they must provide evidence of their so doing. This requires putting the goods through a recognised system of what is known as "conformity assessment".

The point about the Single Market is that border checks have essentially been eliminated. The common rules are monitored by relevant national authorities and there is mutual recognition of standards. Thus one can load a truck with grommets in Glasgow and ship them all the way to Alexandroupoli on the Turkish border, with just the occasional document check.

Delays & costs

But the moment the UK leaves the EU, this stops. The component manufacturer may still comply with exactly the same standards, but if the product requires independent testing , any testing houses and the regulatory agencies are no longer recognised. Thus the consignment would have no valid paperwork. And, without it, it must be subject to border checks, visual inspection and physical testing.

What that means in practice is that the customs inspector detains the shipment and takes samples to send to an approved testing house - one for the inspector, one for the office pool, one for the stevedores and one for the lab is often the case. While estimates vary the cost of a container inspection, detention costs for anything up to ten days and testing fees could result in extra £2,000 to deliver a container into the EU.

Aside from the costs, the delays would be highly damaging. Many European industries have highly integrated supply chains, relying on components shipped from multiple countries right across Europe, working to a "just in time" regime. If even a small number of consignments are delayed, the whole system starts to snarl up.

Then, as European ports start having to deal with the unexpected burden of thousands of inspections, and a backlog of testing as a huge range of products sit at the ports awaiting results, the system will grind to a halt. It won't just slow down. It will stop. Trucks waiting to cross the Channel at Dover could conceivably be backed up the motorway all the way to London.

For animal products exported to the EU, the situation could be worse . Products from third countries, which post Brexit would include the UK, are permitted entry only through Border Inspection Posts [BIPs]. Only at these can they be inspected and, if necessary, detained for testing. But, for trade between the UK and EU member states, the capacity of BIP is entirely inadequate. Until more capacity has been provided, trade in these products post Brexit would essentially stop dead . This would be disastrous for the UK since it accounts for some £9 billion in Britain's export trade.

Two way streets

Of course Brexiteers quickly point out that it would be in the EU's interest to negotiate and come to an agreement on these issues.

If the way out of the UK becomes blocked, the return route and incoming trade from the EU would also suffer. Goods from the EU might be delayed or even stop being delivered. Manufacturers which depend on imported components would struggle and may even be forced to close. The resultant job losses could run into millions.

But other countries use WTO rules, don't they?

WTO option advocates will often say that countries such as China, the United States and Australia all trade with the EU without formal trade agreements, and therefore operate under WTO rules. So why would the UK encounter any problems? The answer is remarkably simple. These countries don't rely solely on WTO rules.

Both WTO option advocates and even many critics have focused obsessively with tariffs, but failed to address the issue of non-tariff barriers.

One of the most important types of trade agreement is the Mutual Recognition Agreement [MRA] on conformity assessment. This gets round the problem of border checks, as the EU will then recognise the paperwork on product testing and conformity certification. Agreements on Customs cooperation to ensure that official paperwork and systems mesh  and trouble-free border crossings may possibly proceed.

China, for example, has a Mutual Recognition Agreement on Economic Operators, signed in May 2014. The United States has one on conformity assessment which runs to 81 pages, agreed in 1999. Australia also has one on conformity assessment.

All of these are outside the remit of the WTO but they are nonetheless trade agreements, and vital ones at that.

Nonetheless while WTO advocates claim countries like Australia has no trade agreement with the EU, the EU and Australia conduct their trade and economic relations under the EU-Australia Partnership Framework of October 2008. This aims, apart from cooperation on the multilateral trade system and trade in services and investment issues, to facilitate trade in industrial products between the EU and Australia by reducing technical barriers, including conformity assessment procedures.

In fact there are 82 agreements between the EU and Australia, of which 18 are bilateral. There are 65 between the EU and China, of which 13 are bilateral. Between the EU and the United States, there are 135, of which 55 are bilateral.

Such is the importance of agreements such as the MRAs that the UK would have no option but to seek a deal with the EU, for which there is a facility within Article 50. But, the moment it sought such deals, it would no longer be relying exclusively on WTO rules. It would now be seeking bilateral agreements along the lines of the so-called "Swiss option".

This comes with as many problems as the WTO option, if not more, not least the length of time it would take to agree a Swiss-type arrangement. Indeed some estimates suggest up to ten years if not longer. And that's assuming the EU wants another complex Swiss-type arrangement.

Complicated negotiations

Issues concerning the WTO will even shape the Brexit negotiations themselves. The government is desperate to ensure that Britain's big exporters do not suffer from Brexit. It has explicitly assured Nissan, a major car manufacturer, that it will not suffer. But WTO rules can make such sectoral deals hard. If Britain were to agree bilaterally with the EU not to apply tariffs on cars, the WTO's "most-favoured nation" principle might force it to offer tariff-free access to other countries as well. Channelling government money to boost exports is also something of which the WTO would disapprove and Britain may come under fire from the 164 other members.

So what is the realistic short-term prospect for WTO access to European and other markets? "None of this is impossible," says Peter Ungphakorn, a former WTO official, "but it won't be sorted out quickly." [FT]

While the schedules are being agreed, the UK's legal status as a trading nation will be undetermined, with all that implies for uncertainty and business decisions. The speed of the UK being able to trade on WTO terms in its own right will partly depend on political will. Yet even if other governments co-operate and accept London's proposals, the legal processes and paperwork are likely to take years.

The Government says that it plans "to replicate our existing trade regime as far as possible in our new schedules". This is a sensible approach. It involves minimal disruption and so reduces the scope for other WTO members to object to the UK's new schedules. For tariff levels in particular, copying and pasting should be straightforward.

But the copying and pasting approach will not work for all aspects of the schedules. There are some areas, notably on quotas and subsidy limits, where the UK must reach an agreement on what share of the EU figure it takes. This will in truth be a three-way negotiation, between the UK, the EU and other WTO members, because it will also lead to a reduction in the EU's quotas and subsidy limits

Bumpy roads ahead

The WTO option may seem like an easy way out for post-Brexit Britain, but that road is, in reality, covered with bumps. And there are already signs of the problems Britain will encounter should it pursue the WTO option.

As Brexit talks stalled in the last week Britain and the EU formally informed members of the World Trade Organisation how they planned to split up the EU's tariff quotas and farm subsidies after Brexit. But the plans had already been rejected by the White House and several other nations [BBC / Guardian].

WTO chief Roberto Azevêdo has pointed out any post-Brexit trade talks must start from scratch and only after a complete divorce from the EU. Pascal Lamy former WTO Director General has said it would be a long and bumpy ride. Why? Essentially there are some 164 countries with which the UK would need to renegotiate, which could take up to a decade, if not longer.

Once the UK has a draft of its schedules, and once it has left the EU, it can start trading off them. The WTO does have a formal process for approving schedules – known as 'certification' – which requires unanimous approval from every WTO member, i.e. 164 countries.

However, WTO members can still trade off schedules that have not been certified. The EU, for instance, has not certified its schedules since 2004, but in the meantime, has altered its schedules to reflect successive waves of enlargement.

At some point the UK will want to certify its schedules, requiring the consensus of all WTO members. But the certification process does not pose an immediate threat to the UK's ability to trade post-Brexit.

Once the UK has declared its schedules and started trading, other countries in the WTO may object, particularly if they can demonstrate that the UK has in some way reduced the level of market access on offer.

If there are challenges, these could be lengthy and expensive for the UK to contest. However, the disputes are likely to take several years to resolve, during which time the UK would be able to continue trading off its schedules, whether or not they have been certified.

There are three big trading partners in the world, the EU, US and China, and they might be the most difficult partners to reach an agreement with. Brexit is a divorce between the UK and the EU, and there will certainly be some tension after the fact. The other issue in constructing a deal with the EU is that all member states have to agree to the terms, which can lead to a stalemate fairly quickly. President Trump has been very vocal about wanting to invest at the national level, at the expense of international trade, to "make America great again". With his "America first" policy in mind, it is not clear how the Trump administration will approach a trade deal with the UK.

China does not have the political involvement of the other two, and may want to maintain or even increase export volume to the UK by minimising tariffs and remaining competitive on a global scale, but it still could prove difficult to organise a deal quickly.

In summary the WTO option will be a long, arduous and potentially expensive exercise with no guarantees that Britain's trading position will improve. Indeed the evidence seems to point to the fact that Britain could lose billions of pounds in lost trade in the near term and may take years to establish new trading relationships.In October 2016 David Davis, the Secretary of State of Exiting the European Union, admitted that businesses would face a cliff edge should Britain fall back on the WTO regulations [Independent].  "We need to conclude this [the EU negotiations] within the two years to avoid any cliff edge," the Brexit secretary said after being quizzed concerning the risks of reverting to WTO rules.

Brexiteers want to turn the UK into a global trading powerhouse. But until the country has sorted out its legal standing, it risks merely sitting on the sidelines.

Sources and links: Guardian / Institute for Government / CBI / FCO / LeaveHQ / Stowga / Economist / Reuters

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