Thursday, 1 March 2018

A further complication


I am coming to the end of my body of work on the EU's Customs Union, and on customs unions in general. Most of the content here can now simply be re-plugged, rather than added to, and I thank readers who spend their time sharing it. I mentioned in my post on Tuesday that there were a couple of little residual issues left to write about for the sake of informing those invested in these issues. One of them is the relationship between services and customs unions, tackled here, and the other is the variety of exemptions from the Customs Union afforded to poorer, developing countries.

In truth I should have grappled with this stuff before the referendum but it wouldn't have made much difference. The level of knowledge of the features of customs unions in the Commons is so dire and I have no real way of influencing public policy. All I can hope to do is inform the informers, which I rather think must continue with broad clarification on the relationship between trade in services and customs unions. This issue has been left uncharted thanks to stoic agreement that tariffs do not apply to services, but there are important exceptions to this rule that are worthy of discussion.

Thankfully, grasping a broad outline of services trade is not especially difficult. The WTO's General Agreement on Trade and Services (Article 1.2) outlines four international modes of service. Mode 1 is cross-border, where a customer in country B receives a service from country A by means of post or telecommunications. Think architectural drawings or medical advice. Mode 2 is where consumption takes place abroad, for instance in the case of a patient travelling to another country in order to benefit from some kind of medical service.

Mode 3 services are transmitted by commercial presence abroad, where a company based in country A sets up a subsidiary in country B and offers services from that sister outlet (such as EasyJet in Vienna). Mode 4 services involve the movement and enterprise of persons. An individual, such as a caseworker or consultant, moves to a different country and provides services in the new country. An argument can therefore easily run that since services do not relate in any way to customs duties, they are not affected by a (or the) customs union.

Except this is not technically accurate. And to understand why we need to delve into changes to manufacturing techniques and examine the role of service inputs in goods, or 'services in a box'. This we have come to term Mode 5 services, which have fallen completely under the radar of trade discourse and the WTO's website. This is perhaps useful as the simplicities of the Customs Union have themselves been difficult enough to grasp for the relevant politicians. Further complication of discourse is arguably ill-advised for those who do not consider themselves Brexit or trade obsessives.

Mode 5 services are goods to which a service (or more) has contributed or accompanies. An example of a Mode 5 service might be a software package embedded within a bundle of IT hardware or design engineering accompanying an automotive part. They are services which are inseparable from and embedded within goods, which then rely on GATT for general trading guidelines, meaning that they count as goods and that they may be subject to duties. This means that if the value-added service element appears within a product which qualifies for a duty, we know we have a Mode 5 service.

For manufacturers the external sourcing of service content, whether domestic or international, represents an increasingly quantitatively significant part of production. We refer to this trend as the 'servicification' of manufacturing and Mode 5 services exports now form around 35% of the EU27's merchandise exports, according to 2009 TiVA statistics. This is a mathematically important chunk.  Typically, merchandise exports will mean retail goods, as they are unnatural products which are produced in response to consumer preference and market demand.

So services relate to the or a customs union in so far as a service element is added to a good which must filter through some kind of duty. Inside the EU, UK exporters exporting to Europe are not presented with any additional hurdles. The very fact of the CET being wrapped around EU members and (theoretically) eliminating the possibility of circumvention means that preferential treatment is assumed. A good will either originate from within the EU or it will have been fed through the CET. Tackling tariff differentials becomes a problem for customs officials at the EU's external frontier.

In leaving the EU's Customs Union and not establishing a bespoke alternative, Mode 5 services are likely to face documentary hurdles since they will simply be treated as goods. This could mean they qualify merely for MFN tariffs or FTA-negotiated tariffs depending upon the nature of the future relationship. Customs officials will simply treat them as they would other physical goods. Their job is to assess whether the relevant VAT and tariff has been paid and translate any transactions to HMRC upon scanning paperwork. The fact of an internal service element existing will mean nothing.

What makes this interesting is that often Mode 5 services add substantially to the value of a product. We might be looking at research and development or we might be looking at some form of marketing consultancy. All indicators point towards Mode 5 services gaining traction as an influential aspect to modern trade and this may be an area where tariffs have a more discernible impact. And beyond tariff rates, a post-customs union UK will need to accompany Mode 5 service goods with certificates of origin in order to prove qualification for preferential treatment.

Another important point here is that plain to see are failings at the WTO. Exporters are in urgent need of a global redefining of trading rules to accommodate significant changes to the ways in which services are actually administered. Effectively trading actors have jumped ahead of the rules and find themselves in need of guidance. The omission of Mode 5 services in both GATS and GATT reflects how far multilateral trade negotiations have actually fallen behind developments in manufacturing and globalisation. Global talks are long and arduous, technological change is often very rapid.

The end result is that we have yet another sizeable gap in Britain's understanding of trade. Just as it embarks upon the greatest shift in trade policy in living memory.

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