30 July 2018

A simple alternative to a no-deal Brexit

By Tim Hammond

An interesting thing happened during the latest round of discussions about a no-deal Brexit. Theresa May acknowledged — inadvertently — that the only we reason we conduct trade in the first place is to import stuff.

As every economist (but apparently no politician) knows, it is imports that we consume, not exports, and imports that make us richer, by providing us with things we either cannot make ourselves, or cannot make as well or as cheaply. By definition, exports are the opposite: things we could have from domestic production if we wanted them. They are simply a way of paying for what we actually want. The fixation with exports that dominates so many discussions of trade is therefore strange. For politicians, it seems to be based on their obsession with jobs, and in particular their obsession with existing jobs rather than the future, better jobs they should care about.

And so the Prime Minister’s comments about stockpiling essential imports gives us a chance to focus on what really matters. She is right to worry about imports in the event of no deal with the EU but her plans are unimaginative and costly. Luckily there are two simple solutions. They are simple because they decouple imports and exports, in a way that most economists and consumers should support.

First, we should offer the EU a two year one-sided free trade agreement. This would allow the EU to import any goods and services to the UK without any tariffs or non-tariff barriers. We would not ask for anything in return except that during the life of the agreement, the EU will negotiate, in good faith, a comprehensive free trade agreement with the UK. There is no reason for the EU to refuse such a deal, and it could be negotiated very quickly, as would simply state that the terms of the EU’s imports to the UK will stay exactly the same.

The advantages are many. First, it ensures that immediately after Brexit, the UK can continue to import what it needs from the EU without any extra cost or delays. On exit from the EU, we will be completely aligned in terms of standards and regulations. It is very unlikely that the EU will diverge from those standards over the two year period of the deal in ways that would cause us concern. Indeed, we would expect that, if anything, the EU will impose stricter standards than now. We could therefore guarantee in the agreement that EU goods will be unconditionally accepted by the UK during the two year term.

Second, during the term, the UK would be free to diverge from EU standards as it sees fit. The EU could have no reasonable objection to that. We would therefore be free to reduce regulation, and change standards if that would benefit the UK. Exporters from the EU would be free to meet either UK or EU standards. Since the deal would not cover exports, there would be no rule-taking of any sort, and no need to even discuss ECJ jurisdiction.

Third, because this would be a free trade agreement within a limited group of members, we would not be required to eliminate tariffs on all goods and services from every country under WTO rules. Indeed, this would be an agreement that simply maintains the existing levels of tariffs rather than dropping them in a preferential way. There would therefore be no immediate threat to agriculture and low value manufacturing in the UK.

Fourth, in Ireland, the UK would have no need to harden the border on its side as there would be no change at all in terms of imports into Northern Ireland. What the Republic decides to do would be up to its government. There would be little or no need to do anything however. It could perhaps trial Max Fac for two years. Given Ireland’s geography, any significant increase in goods moving from the UK to the rest of the EU via Ireland would not be difficult to spot and monitor. That should allay the EU’s concern regarding goods entering the UK and then evading the EU’s hard border via Ireland.

Fifth, the UK would immediately be able to start negotiating free trade agreements with as many countries as it can. There would be no concerns from potential partners about the UK being an EU rule-taker. Negotiating new deals would put the EU firmly under pressure to negotiate fairly with us. The worst outcome for the EU would be replacement of their exports to the UK by other countries and our exporters shifting to other markets and thus reducing their reliance on the EU.

The second thing we can do is to announce that, on exit from the EU, the UK will remove tariffs (i.e. trade under WTO rules with zero tariffs) from all products that do not directly compete with products made in the UK. That would mean a significant number of foodstuffs, such as tropical fruits, rice, tea and coffee, could be imported without tariffs from any country globally, as well as a wide range of manufactured goods.

This would bring an immediate benefit to everybody in the UK in terms of lower prices, but especially the poor, who spend a disproportionate amount of their income on food. It would also send a clear signal about how the UK will conduct trade in the future. An initial targeted reduction of tariffs would protect our agriculture and vulnerable manufacturing industries from the abrupt entry of competition that trading on WTO terms could bring, whilst bringing the benefits of tariff reduction to consumers in as many areas as possible.

There are, of course, some wrinkles. For example, there remains the possibility that goods from outside the EU could be re-exported to the UK from the EU. This is a non-issue however. We should not worry about standards since such goods will meet EU regulations. We may lose some tariff income but that would be very small. And since we would have had to live with any competition those goods represent for UK businesses had we stayed in the EU, Remainers can hardly complain if they have to live with that completion under this plan. Similarly, free-trade Leavers should be happy to have an effective pass-through of some of the benefits of EU free trade agreements.

These solutions do little for those businesses that export to the EU. But neither does no deal. It does at least offer some protection for supply chains in the short term. In the medium term, it allows us to negotiate new trade agreements that will benefit exporters. It also commits the EU to negotiate a comprehensive free-trade agreement and the EU will know that it has to negotiate properly with us or risk losing significant parts of the UK market to competitors. Removing tariffs from a range of imports should make the UK better off, and allow exporters to replace some of any lost EU sales with domestic consumption. But in the end, it remains a simple fact that it is imports that matter most, not exports.

Once you recognise that imports and exports are not one problem but two, and set aside the problem of exporting to the EU, it is relatively easy to find solutions to the import issue. Doing away with the benefits of imports from the EU, and delaying the benefits from opening up the UK to imports from outside the EU, are both hugely costly. There is no reason to suffer those losses just because we cannot solve the export problem at the moment. Let us instead decouple the two and recognise the reality of trade — we all consume imports, but none of us consumes exports. That is not to cast exporters adrift, but it is surely better to solve one problem now and try and solve the other over time, than to say that we cannot solve either problem unless we can solve both.

Of course it is not perfect, but no Brexit can be. Remaining in the EU is not perfect either, and involves a great many compromises. But these simple steps would meet most of the key conditions of ‘Brexit’ — we would retain many of the benefits of our trading relationship with the EU whilst leaving both the Single Market and the Customs Union, we would be able to negotiate new trade deals, we would take back control of immigration and neither the EU nor the ECJ would have any say in our law-making.  No, it is not perfect, but as with so many things, we cannot let the perfect be the enemy of good.

Tim Hammond is Managing Director of Lizard Point Limited, a consultancy that provides advice on M&A, trade and capital raising for governments and businesses of all sizes.