When, last Christmas Eve, the EU and the UK agreed a Trade and Cooperation Agreement, it was welcomed in the UK as a victory that the deal allowed tariff-free trade in goods. Considering the UK runs a sizeable trade deficit with the EU, this raises the question of who benefits from tariffs, the importer or the exporter, or perhaps neither. In recent years the EU has exported €320bn a year to the UK and imported over €190bn, for an annual goods-trade surplus of under €130bn. A naïve approach to trade would suggest tariffs would hurt the EU as the net exporter more than they would hurt the UK. On the other hand, to the extent that the UK depends on EU imports for the supply of certain critical products, tariffs just make these UK imports more expensive and raise prices. Then, conventional trade theory posits that tariffs hurt both importer and exporter because comparative advantage makes trade a win-win situation. All of this, however, presumes that non-tariff barriers to trade are relatively unimportant. In the months since the end of the UK’s transition period, the UK has learned the hard way just how important non-tariff trade barriers are.
Non-tariff reality bites
The UK exited the EU at the end of January 2020, but it stayed in the single market and customs union until the end of last year. Effectively exiting the EU has had immediate negative effects on cross-border hauling of goods, especially food and live plants and animals; or fishing, just to name a few sectors. The British government has described these troubles as “teething pains”, but changes are permanent. There are several reports of government officials advising UK firms to move part of their business to EU locations, and some of the adaptations companies need may make their business models altogether unprofitable. While moving manufacturing from the UK to the EU may preserve business profits, it erodes the UK’s jobs, tax revenue, and trade balance. It is also something that only companies above a certain size can afford to do. One favourite destination for UK firms is likely to be the Netherlands for historical, cultural, geographical, and tax reasons.
The most important obstacle to tariff-free trade is the rules of origin. Being outside the customs union, British traders need to document that their exports to the EU have been mostly produced in the UK. Otherwise it would be possible for third-country businesses to use the UK as a way to circumvent EU customs rules. This has disrupted one curious business model that the EU enabled, which was for food and drink to be shipped to the UK from elsewhere in the EU, repackaged in UK-based distribution centres, and then re-exported to the EU. This is hurting EU food distribution networks in the short term and, in the medium term, EU suppliers will need to stop relying on UK-based distribution hubs altogether.
But the UK being outside the customs union has other important impacts, for instance on hauling. Haulers endure long delays at the border, with a median waiting time of 15 hours at inland border facilities that were advertised in December as expecting a two-hour wait. They are also now finding that they need a financial guarantee of up to 40% of the value of goods being transported which wasn’t necessary before. As a result of all this, EU-based hauliers are rejecting UK contracts, freight is moving from sea to air when it is economical to avoid the UK altogether, and some car manufacturers are reportedly paying for empty lorries to cross from the EU to the UK.
Bucking these trends is Nissan, though, which has reaffirmed its commitment to preserve manufacturing at its Sunderland plant. In order for its cars to qualify as tariff-free exports into the EU, the Japanese manufacturer is having to move battery production from Japan to the UK. Smaller companies may not be able to do the same but, being the largest car manufacturer in the UK, Nissan enjoys economies of scale that allow it to relocate most of its supply chain to the UK.
Other big sources of non-tariff barriers are sanitary and phytosanitary standards, that is those applying to animal and plant products. Apart from the amusing but benign confiscation of ham sandwiches by customs officials, there has been a more serious issue of inability of the UK fishing industry to export fresh seafood to the EU because of the amount of paperwork necessary. As a result, Scottish fishing boats have resorted to landing their catch in Denmark or Northern Ireland. Though this increases the time and fuel spent at sea, it does save the business of the fishing boats themselves. But it does nothing for the ancillary industries in and around Scottish fishing ports. Another example is phytosanitary restrictions on the transportation of soil. These may prevent UK nurseries from exporting horticultural products from Great Britain to Northern Ireland, let alone to the rest of the EU.
Canada or bust
How did it come to this? It is a consequence of the UK government’s red lines on the negotiation of its future relationship with the EU. This was illustrated by Michel Barnier, the EU’s chief Brexit negotiator, at the European Council as early as December 2017.
But, once the UK was out of the EU with a political declaration on the future relationship, there was scope for either side to redefine the terms of the negotiation on the actual Trade and Cooperation Agreement. A story by the Financial Times on how this deal was negotiated shows that the UK government refused EU offers that would have eased a lot of the above-mentioned non-tariff barriers, with the refrain “give us Canada”. The UK government ruled out any requests for market access that would have enabled the EU to demand regulatory alignment. Defra, the UK government’s department of agriculture, raised the issue of sanitary and phytosanitary standards, but was dismissed. One of the most revealing passages in the FT story implies that the British government convinced itself that any industry asking for enhanced access to the EU single market was, by doing so, marking itself as not worth saving:
Pleading from exposed industries – food and drink, logistics, pharmaceuticals, chemicals, automotive and aerospace- was batted away with apparent disdain. “We are expecting the heaviest lobbying from industries that are in secular decline,” said one senior minister in early January last year, setting the tone for the negotiations.
According to the article, industry leaders who lobbied for EU market access found themselves unceremoniously dropped from further consultations by the British government.
Creative destruction is not a policy prescription
All of the above goes to show that geography and history matter. The UK has sought a Canada-style trade deal with the EU, when the UK not only is much closer to the EU geographically than Canada, but also has been deeply integrated economically with the EU for over 45 years. These close geographic and economic ties influence the structure of the economy, its infrastructure, and its business models, in ways that are hard to pick apart without major disruption. Some commentators find consolation in Schumpeter’s concept of creative destruction. But creative destruction should be understood as a colourful descriptive term for the process of recovery after a recession, not as a policy prescription. It is far from obvious that much creativity will necessarily occur after deliberate destruction of an entire economy’s business models.
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