25 December 2018

Best of 2018: Britain’s best Brexit bet? The Jersey option


In Christmas week, CapX is republishing some of its favourite articles of the year. This piece first appeared on February 12.

The UK government spent last year urging the EU27 to start discussing their post-Brexit trading relationship. But now that the negotiations are finally due to move on to trade, ministers cannot decide what they want.

The latest battle is over whether the UK should remain in a customs union with the EU after the post-Brexit transition period. Proponents argue that this would allow goods to continue being traded freely with the EU, reducing the economic damage from Brexit and keeping the Irish border open. Opponents object that this would prevent the UK from reaping the benefits of striking its own trade deals with the rest of the world. Neither side is right.

The case for keeping trade with the EU as frictionless as possible is compelling. As the government’s own impact assessment highlights, shifting to trading with the EU according to World Trade Organisation (WTO) rules would lower economic growth by eight per cent in the 15 years after Brexit. Trading with the EU along the lines of its agreement with Canada would still deal the economy a five per cent blow. High-value manufacturing exports such as pharmaceuticals, cars and chemicals would be hardest hit.

Realistically, a trade deal with the United States could not compensate for such losses; the government estimates it would boost GDP by only 0.2 per cent. Deals with other major trading powers would deliver gains of no more than 0.4 per cent of GDP. So a sensible post-Brexit trade strategy involves keeping trade with our biggest partner as frictionless as possible, as I have previously explained in CapX.

But joining Norway in the European Economic Area – which would cut growth by only two per cent over 15 years – is not an option if the UK wishes to control EU migration. Hence the interest in the half-way house of a customs union with the EU.

Leaving the EU entails leaving the EU customs union. But with the EU’s agreement, the UK could join a customs union with the EU. This would ensure that goods covered by the agreement could still be traded with the EU tariff-free – and require that the UK set the same tariffs as the EU does on imports from the rest of the world. UK-made cars could be sold in the EU without import duties, and vice versa, while the UK would need to continue charging the 10 per cent EU tariff on car imports from the rest of the world.

But such a customs union would not ensure “frictionless” trade with the EU that does not involve customs controls. If you google “customs border Turkey Bulgaria”, you will see images of cars and lorries backed up at the Turkish border with Bulgaria even though Turkey is in a customs union with the EU. Delays like that would be prohibitively costly for UK-based manufacturing businesses, such as car makers, that have complex supply chains in EU countries and rely on just-in-time production.

To avoid a customs border, several other things would be needed too. For a start, unlike the EU’s agreement with Turkey, an EU-UK customs union would need to be comprehensive. Unless it covered all goods and agricultural produce – basically anything that needs to physically cross a border – checks would still be needed on any products that are not covered, as well as to ensure that goods that aren’t covered weren’t being smuggled in duty-free. So if the customs union excluded fruit and vegetables, there would need to be checks to ensure that cabbages weren’t being smuggled in with the cars.

Second, the UK would need to keep all its standards and regulations pertaining to goods and agricultural produce aligned – i.e. identical – to the EU’s. For instance, UK-made cars would need to conform with EU rules on everything from fuel emissions to passenger safety, and to be certified as such by EU-recognised bodies.

Third, services necessary for goods trade would need to be liberalised. For instance, UK-licensed lorry drivers and haulage companies would need to be free to operate in the EU (and vice versa).

Fourth, the UK would need to remain in the EU’s value-added tax (VAT) system. Imports from the rest of the world are typically liable for VAT when they arrive in the EU, as anyone who has ordered something from a US website knows. Within the EU system, VAT is payable later in the destination country when the customer acquires the goods.

In short, in order to avoid a customs border, Britain wouldn’t just need to stay in a comprehensive customs union with the EU, it would, in effect, need to remain in a single market in goods too.

Would that put Liam Fox out of a job? No. For a start, the International Trade Secretary would need to try to replicate the trade deals with third countries that the EU has already struck and strikes in future. So if, say, the EU concluded a deal with Brazil involving two-way tariff-free trade in cars, the UK would need to persuade Brazil to strike an identical deal so that British-made cars benefited too.

Indeed, it’s more complicated than that, since preferential trade agreements involve rules on how much of, for instance, a UK-made car needs to be made in the UK to benefit from the preferential zero tariff. So there would also need to be an agreement on rules-of-origin cumulation, so that car parts made in the EU were counted as local content in a UK-made car (and vice versa).

Second, Dr Fox could try to negotiate deals with third countries to liberalise trade in services, in which the UK specialises. That will be tough. Apart from the EU single market, existing trade agreements around the world do little to liberalise services trade. But the task would be tough even if Britain was not in a customs union and a single market in goods with the EU – which is precisely why remaining in the latter makes so much sense. And, who knows, perhaps the UK can blaze a trail here.

Would the EU accept such a deal, though? The EU is understandably loath to compromise the integrity of the single market, incomplete though it is in services: it sees the four freedoms of movement for goods, services, capital and labour as a package deal. UK efforts to maintain the market access that it enjoys in services while imposing controls on EU migrants – many of whom are in effect, services providers – have been roundly rebuffed. Would a deal that excluded both services and labour be acceptable.

It just might. Indeed, as John Springford and Sam Lowe of the Centre for European Reform point out, the crown dependency of Jersey already enjoys such a relationship with the EU.

Were the EU to accept such a deal with the UK, it would certainly impose additional conditions. It would insist on a mechanism to monitor potential violations of the agreement and an arbitration system that took account of relevant European Court of Justice (ECJ) decisions. This might be modelled on the Efta court and supervisory authority that performs such a role for Norway and other European Free Trade Area (Efta) members that are part of the European Economic Area (EEA). It would doubtless also require the UK to continue paying into the EU budget, albeit much less than now; Switzerland’s payments per person are around half of Britain’s even though it is much richer. Controls on EU migrants would also need to be light.

The UK would need to continue to respect state-aid rules; that shouldn’t be a stumbling block for a Conservative government that believes in competitive markets. It would also need to continue abiding by EU social and employment laws; while that might seem more problematic, such rules have scarcely prevented the UK from having flexible labour markets. Indeed, UK requirements on, for instance, maternity leave are well above the EU-mandated minimum.

Under the Jersey model, the UK would hardly be an EU vassal state. It would regain regulatory autonomy in services, which account for four-fifths of the economy, and in other policy areas currently covered by EU law.

If the Jersey model still seems unacceptable, consider that the measures needed to avoid a customs border in Ireland are the same, obviously, as those needed to avoid one at Dover. While some still dream of untested and unlikely technological solutions that would avoid a hard border with Ireland, suggestions such as drones and blimps to prevent smuggling aren’t going to fly. And unless Britain satisfies the EU that it will avoid a hard border in Ireland, it won’t obtain an orderly exit deal or a transition period, let alone a post-Brexit trade deal.

In short, then, the Jersey model is the furthest that the UK as a whole can diverge from the EU if it wants to avoid a chaotic no-deal Brexit, whose catastrophic economic and political consequences I previously explained for CapX. The only alternative would be for the Jersey model to apply only to Northern Ireland, which would entail a customs border between Northern Ireland and Great Britain. Good luck persuading the Democratic Unionist Party MPs at Westminster who are propping up Theresa May’s minority government to agree to that.

Philippe Legrain is a senior visiting fellow at the London School of Economics’ European Institute and the founder of OPEN, an international think-tank on openness issues.