Tuesday, 5 February 2019

A customs unicorn


Customs unions have very specific operational features and provide very specific benefits. These benefits tend to be modest and achieve very little if one approaches trade from the perspective of maximising economic integration between two trading partners. The gulf that exists between the scope and functionality of the single market, and that of the EU Customs Union, is remarkably wide.

But, what is also important to recognise is that the drawbacks of customs unions are also vastly over exaggerated. This is mostly because, as this blog has previously explored, global tariffs have seen widespread reduction thanks largely to globalisation. In their place, non-tariff measures have crept up on trade actors to pose the really noticeable threat to the international system.

Countries who find themselves bound by common, harmonised tariff schedules, like the EU's member states, will experience a reduction in the independence of their trade policy. Note that this does not entail foregoing total independence, for customs unions deal only with tariffs: they construct a common external schedule and abolish quotas and duties between members.

Talk of tariffs must also include rules of origin, the main obstacle eliminated by continued customs union membership. Rules of origin is the device used by exporters to prove they qualify for tariff-free preferential treatment stipulated in any relevant trade agreement with another country. Likewise, importers need to identify the exact source of a good entering their customs territory.

In summary, a safe assumption can be made that any good found inside a customs union either originates within that territory or came from the outside and has filtered through the common external tariff. Checks between members of the customs union for origin are therefore not necessary, and this is where the customs union links in with the preservation of the Northern Ireland border. Here the benefits of customs unions find their end.

It is often argued that while left in a customs union, members cannot make their own independent bilateral trade deals, but this is not technically true. To placate the hard Leavers angry at the prospect of a comprehensive customs union with the EU I like to make the point that various other trade agreements are possible. Because we are only removing tariffs from the equation, other elements of trade policy are left broadly untouched.

Agreements covering services, customs cooperation, some non-tariff measures and facets of mutual recognition can still be dealt with. This does not sound like much but in essence trade oughtn't be steered by what media and politicians find politically entertaining. It is a specialised branch of statecraft as well as an important tenet of foreign and economic policy. Trade is not simple and the UK will need to re-learn it as a distinct customs entity.

And so relearning trade begins, as with anything else, with establishing the facts. What is not possible in a comprehensive customs union with the EU is to retain a say in the direction and rulemaking of the customs union, especially with regard to negotiating tariff reductions for implementation within preferential trade agreements. This is for the birds and totally negates any close inspection of existing customs union models.

The most useful template with which to work would probably be Turkey, a third country which negotiated a distinct, bilateral customs union with the EU in December 1995. The customs union does not fully replicate the EU version; it doesn't include agriculture, coal and steel products or public procurement, and as such it is incomplete. But that does not mean we cannot learn lessons from it.

Turkey's arrangement with the EU leaves it in a sub-optimal position from a negotiating perspective on several fronts. Firstly, the usual gravity models of trade apply and Turkey simply cannot outweigh the influence and size of its customs union partner. The EU in tandem will not tolerate any compromising of the integrity of its internal market, so the customs union offered will extend EU terms to Turkey and not the other way around.

To me it should not matter that the UK is a larger economy. It is a former member and precedents must be set. Any UK manipulation of the common external tariff forces the EU into a position where parts of the single market are left vulnerable to backdoor circumvention and this very real prospect will govern much of the EU's attitude towards any future customs union with the UK.

In practice, therefore, Turkey does not set the tariffs which make up the fabric of the customs union arrangement. These are set by the European Commission and are based upon the existing EU model. The customs union agreement between the two partners states in rather unalterable terms:

"From the date of entry into force of this Decision, Turkey shall, in relation to countries which are not members of the Community, apply provisions and implementing measures which are substantially similar to those of the Community’s commercial policy.”

This should not come as any surprise. Regulatory superpowers get their way and this is something the UK will need to face up to post-Brexit. Turkey has no practical involvement in setting the agenda(s) of the external tariff or of the Common Commercial Policy, ensuring it trails behind the EU in all of its subsequent trade negotiations and any conclusions of agreements.

Secondly, in the event of the EU securing an FTA which provides for tariff reduction, like with Canada or Japan, Turkey is required to automatically apply the concessions unilaterally and seek the necessary reciprocity afterwards, with no Treaty guarantees of reciprocity in the works. It is here where a somewhat bleaker picture of things can be painted. The UK would not have the right to demand liberalising reciprocity from any EU FTA partners. 

Interestingly, the customs union agreement does provide some space for trade remedies between Turkey and the EU. Turkey can fight back if it feels an imported products are causing undue or disproportionate harm to its domestic industry, but this privilege is also granted to the Commission. According to the World Bank, "Decision 1/95 allows both Turkey and the EU to retain their rights to initiate, investigate and impose TDIs in cases of import surges in both their bilateral trade and trade with third countries."

By TDIs we mean trade defence instruments. Types of defence might include anti-dumping measures or emergency countervailing duties. Any comprehensive customs union between the UK and EU would likely also make use of trade defences, but this would be the extent of any unilateral powers granted to the UK and no amount of Labour Party posturing will change this.

In more general terms, though, Labour need to be clearer about what exactly a customs union with the EU can achieve. Corbyn talks lazily of protecting 'free and frictionless trade', but as I have been at pains to point out at this blog, customs unions do not get us anywhere near this line. If Labour were to come out for the single market I'd be all for it, but any pretence that a customs union removes the need for border friction is intellectual dishonesty of the highest order.

Sunday, 3 February 2019

GATT Article XXIV does not soften a no deal Brexit


Keen observers of Brexit will know by now that nobody has a weaker understanding of WTO rules than the very advocates of a no deal Brexit. Perhaps marred by desperation, the no dealers have retreated back to one of their favourite policy safe spaces in an attempt to avoid any kind of second thought or realisation that may have made errors. It is, as Roland Smith put it just recently, the 'I have no solutions and can't be arsed to think option'.

What makes the whole ordeal so frustrating is that their track record on understanding the issues and communicating them honestly is so disgracefully poor. They told us the WTO's Trade Facilitation Agreement would prevent any kind of hard border with the EU post-Brexit. They told us that new non-tariff barriers to trade governing the EU's sanitary and phytosanitary regime would be prevented under WTO rules. And now they contend that GATT Article XXIV paves the way for some kind of transition, allowing for a continuation of terms for a reasonable length of time.

The new line, echoed this week by Nigel Farage in the European Parliament, essentially argues that a no deal Brexit can be softened through the use of the Article XXIV mechanism built into GATT. Presumably the no dealers envisage it to be some kind of lever used to help WTO members transition from one trading relationship to another. And to some extent this is true, but important details are being missed out and the provisions outlined in the agreement are specific enough in their scope for us to understand where the hardliners are going wrong.

The overall narrative is that the main purpose of GATT Article XXIV is to outline the criteria by which WTO members can deviate from the principle of non-discrimination, known formally as Most Favoured Nation (MFN). This, we know, is the rule which allows countries to afford certain other countries special treatment so long as it manifests within the form of either a free trade area or customs union. This is also why tariff free trade is permitted bilaterally or multilaterally in say, the EU, or CETA, for want of a more recent example.

In addition, the Article makes space for members to establish 'interim agreements' designed to lead up to the formation of either a free trade area or customs union. The WTO outlines that Article XXIV has application across "customs unions, free-trade areas, and interim agreements leading to the formation of a customs union or free-trade area." The interim agreements part of this provision is interesting for two reasons. Firstly, it is wrongly assumed to apply in the context of Brexit, and secondly because it is almost never used.

Paragraph 5 sub-para c notes that "any interim agreement referred to in subparagraphs (a) and (b) shall include a plan and schedule for the formation of such a customs union or of such a free-trade area within a reasonable length of time." The comment at the end about a reasonable length of time is often used to propel the idea that we could in effect have a transition period after a no deal. This is a fallacy. The space for a reasonable length of time simply refers to the adoption of an interim agreement. And the key word here is, indeed, agreement.

The point about no deal is that there is no agreement in place between the UK and EU. There is no notification lodged at the WTO that the both sides have concluded the formation of a customs union or free trade area, or that they have concluded a 'plan and schedule for the formation' of a customs union or free trade area. So the provision simply doesn't apply. Since GATT Article XXIV's main mission is to encourage the proliferation of preferential trade agreements, it wouldn't make much sense for its provisions to apply to a bare bones, WTO-based trading relationship.

On March 29th, unless anything substantial changes, the UK leaves the EU with no agreement and overnight becomes a third country. The EU's third country regime automatically kicks in and community law no longer applies to the UK and is no longer applied to the UK. No dealers like to forget the second part of that fact because, of course, specialising in cakeism is a great way to avoid tackling detailed and complex problems. There is no interim to anything. The withdrawal issues do not disperse and negotiations to conclude an FTA or customs union do not kick in.