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Analysis

The economic practicalities of Brexit

by Linda Yueh

The economic practicalities of Brexit

 

Trade agreements are about opening up markets, but they’re also about reducing the frictions of cross-border trade. In other words, the gains from international trade result from, among other things, the reduction of tariffs and duties, especially in an era of global supply chains.

Once Britain leaves the European Union, these economic factors will come into play.

The government’s January white paper detailing the UK exit from the EU confirms that Britain will not seek to remain in the EU single market or the customs union.

The UK will try to get preferential access for certain exports like cars into the EU. But, if there are differential tariffs and duties, there will be customs checks at the border to establish which duty should apply. These frictions largely pertain to manufacturing and agricultural products, and less so to services which make up more than three-quarters of the UK economy. After Brexit, there will be a lot more customs checks at Britain’s national borders.

Just under half of British exports go to the EU. They face minimal customs procedures. The principle is known as RORO or ‘roll-on, roll-off’. After Brexit, shipments to and from the EU will be subject to the same level of checks as non-EU trade. These include customs declarations at the border, assessing the tariff or duty to be paid, as well as inspection checks for lorries, ships and aeroplanes.

Direct and indirect tariff costs
The British Chambers of Commerce estimate that by 2019, owing to Brexit and the overall increase in global trade through Britain, the annual number of customs declarations will rise to 390m from 90m.

A quadrupling of the paperwork will require an IT system that can manage the additional load, as well as additional physical infrastructure to ensure that the customs checks don’t cause excessive delays for shipments or gridlock on the roads.

In a measurable way, additional customs requirements will increase the cost and frictions of trading with the UK.

There are also likely to be greater trading costs associated with the fall-back position of relying on the World Trade Organisation if there is no trade deal with the EU. Under the WTO, the UK would trade under ‘most favoured nation’ status with the rest of the world. Around one-third of British exports would be zero tariff and many would have tariffs of just 2%-3%. But for Britain’s biggest goods export – cars – tariffs would rise to 10% from the current zero. Others, mainly agricultural products, would be subject to higher tariffs.

Tariffs are an example of trade frictions that countries seek to reduce through free trade agreements. Although most tariffs are not large in magnitude, countries around the world have sought further FTAs in addition to their WTO membership to reduce these costs of trade further.

Competitiveness of British goods
An increase in tariff rates and customs costs may be manageable in the short term. But it adds pressure to the British government to maintain the long-term competitiveness of British goods exports by agreeing FTAs to bring those costs down.

What that implies is greater competitive pressure on British exports. EU officials have stated that Britain must trigger Article 50 of the Treaty of Lisbon before a trade deal can be discussed.

EU membership also means that Britain cannot formally negotiate trade agreements with other countries. Informal talks are taking place and groundwork has been laid in the US, but it still means the UK won’t have any FTAs in place when it finally leaves the EU.

One implication is that those British products which now attract zero tariffs when exported to the 50 countries with which
the EU has FTAs will see those taxes rise from zero to ‘most favoured nation’ levels after Brexit.

Therefore, the additional friction will increase not just for exports to the EU, but also for exports to places like South Korea and Canada.

WTO membership terms
Friction also surrounds the potential uncertainty regarding which tariffs or quotas apply once Britain has left the EU. The UK is a member of the WTO as part of the EU. It can replicate existing WTO schedules for tariffs and others by essentially crossing out EU and writing in UK for the most part, in a process called rectification. But there are two areas where that is not feasible.

WTO subsidies and quotas are set for the EU as a whole and not for individual nations. There are about 100 quotas for imports of mutton and the like which will need to be divided between the EU and the UK. The EU and UK then need to present the new schedules to the other more than 160 WTO members which must agree unanimously to the new WTO membership terms.

To avoid confusion over which quotas or tariffs apply after Brexit, it is in the interest of both the UK and EU to agree their WTO membership terms quickly. It’s the sort of trade friction that is avoidable and suggests that the Brexit talks with the EU can’t be wholly devoid of trade negotiations.
In other words, in a ‘no deal’ scenario with the EU, the UK will still need to do a deal with the EU. 

Linda Yueh is a Fellow in Economics at St Edmund Hall, University of Oxford, and Adjunct Professor of Economics at London Business School.

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