26 March 2016

The Canada-EU trade deal is no model for Brexit

By Fredrik Erixon

A new and rather surprising turn in the Brexit debate is the idea that the Canada-EU Free Trade Agreement (CETA) would be the right substitute for full EU membership if the UK votes to leave. It raises several questions, and the most obvious one is why the UK should aim for a trade arrangement that so obviously would reduce its current market access and increase the cost of trading with Europe? CETA may improve Canada’s market access in Europe, but that does not mean it would fit the UK economy.

There are three major problems with the idea. Let’s start with geography. Distance is everything in real trade. Canada, for instance, is not a good place to produce and assemble a car that is destined for European consumers because the cost of transporting the car across the Atlantic eats away the margins. Nor are fresh products good items for exports, to take another example. If you ship yoghurt from Canada it will be sour cream by the time European consumers can pick it from the shelves.

Obviously, the UK has a different location than Canada, but that also makes its composition of trade very different. Britain’s trade with Europe is almost eight times the size of Canada’s trade with the EU. Less than 30 companies represent the lion share of all trade between Canada and the EU, while UK trade with the EU is spread out on several thousands companies involved in direct trade, and several thousands companies selling intermediary goods and services directly to the trading companies.

This is just a different way of saying that UK firms form part of dense production networks and regional value chains involving many companies in different parts of Europe. British firms link up with European firms in a far tighter way than Canadian firms, and their integration goes far beyond trade in finished goods and services. Britain needs more than a trade agreement with Europe; it needs deep market integration. Like it or not but 25 years of the single market have provided a fairly advanced division of labour in Europe – certainly one that rivals all other forms of specialisation between countries in the developed world.

While you can take the UK out of Europe, you cannot take Europe out of the UK. Its location demands a much closer form of economic cooperation with Europe than what CETA offers.

Second, CETA’s design reflects the industrial profile of trade between Canada and the EU, not the profile of trade between Britain and the EU. Goods that Europe does not produce in big volumes – or at all – dominate Canada’s exports to Europe. Take Canada’s top export items to the UK. Last year, gold represented more than 60 percent of Canada’s export of goods to the UK, followed by nickel intermediate products, metals waste and scrap, uranium and other radioactive elements, and oils. Canada’s trade with the entire EU is similar; pearls, precious metals and mineral products dominate. If that’s the composition of trade, a country can be pretty relaxed about behind-the-border barriers that UK trade policy aspires to cut. These commodities are already duty-free and welcome with open arms in Europe because there isn’t much production of them here and they are needed as intermediary inputs for Europe’s industries. Compare that to Canada’s service exports to Europe, adding up to merely 10 billion euro – half of which is tourism and transportation. Close to 110 billion euro, British exports of services to Europe are about eleven times the size of Canada’s, and it’s dominated by financial and business services.

The actual design of CETA follows what you would expect from two entities with the above industrial profile of trade. Canada’s interest in CETA was not to knock down regulatory barriers to trade or open up for a lot more services export. Its priorities were to improve conditions for commodities, agricultural products, and some manufacturing products (and their associated services). But these interests are not shared by the UK. With a trade profile with Europe that is vastly different from Canada’s, a CETA-style agreement would neglect key British trading interests.

That takes us to the third point – a UK trade arrangement based on CETA would seriously reduce Britain’s current market access in Europe, and the gap between current and future market access will only grow as Europe deepens its single market for capital and the digital economy. While Canadian and European governments are now talking up the benefits of CETA as they are selling it to their constituencies, anyone with knowledge about trade agreements and the single market will immediately recognise that CETA is pretty far away from the single market in providing for real market access and commercial integration.

Partly for that reason, the most revealing aspect of CETA is its insignificant contribution to jobs and growth on both sides. The Joint Study by the Government of Canada and the European Commission concluded that, if a high-calibre CETA had been in place between 2007 and 2014, the Gross Domestic Product (GDP) of the EU would only have been 11.6 billion euro higher (or 0.08 percent of the EU’s GDP). Canada’s GDP would have gone up by 8.2 billion euro.

Yet the size of the actual gains may not compare well with that estimate because the final agreement fell short of its ambitions. A good benchmark of a trade agreement is if tariffs are eliminated on 100 percent of all products – not 98.6 percent as in CETA. While that number sounds impressive, the actual reality is that heavy lifting is not required to achieve a target for tariff removal just south of 100 percent, especially in a bilateral trade deal between two trading partners that cannot sell all products at competitive prices and quality. A quarter of all EU products are already duty free under World Trade Organisation (WTO) agreements. Most products have so low tariffs that they don’t serve as protection against foreign competition; the trade weighted duty level in Canada-EU trade, for instance, is only 2 percent. It’s the peak tariffs that are interesting – and, in the case of CETA, the litmus test is if Canada and the EU have agreed to eliminate the peak tariffs on goods that they realistically can sell in large quantities to each other.

CETA fails on that ambition. Peak tariffs on both sides are in food and agriculture – and both sides will maintain protection, even if export quotas will go up for a handful of products. Canada will take away high tariffs on processed agricultural products like wine. However, politically sensitive products will remain protected, also in the EU. CETA does not cover subsidies to farmers, which are equally trade distortive. Nor does it touch agricultural non-tariff barriers like labelling and food-safety regulation that drive up the cost of trade. So the CETA logic is this: for highly-protected goods that the two sides actually can sell to each other in large volumes (e.g. beef), CETA simply does not offer free trade.

Tariffs on industrial goods are less important in CETA because both sides are open economies by that measure. More indicative, however, is the weak improvements that CETA offers for cutting technical barriers to trade – the costs to trade, far higher than tariffs, that come from technical regulations and standards. CETA reconfirms already existing agreements in the WTO and calls for more cooperation between Canadian and European regulatory authorities, including the establishment of a new Regulatory Cooperation Forum.

However, there is no agreement on common standards or mutual recognition of standards in CETA, and the agreement makes a point of the fact that neither Canada nor the EU commit to such outcomes in the work of the Forum. There is an agreement about conformity assessments in a handful of sectors where global standards already are strong. Yet CETA has no disciplines on actual regulations and standards, and in reality regulations can be changed for trade-protective purposes without any consequence for the agreement. Nor does CETA provide for de or re-regulation; the EU actually prides itself for not having to change one single technical regulation as a consequence of CETA.

Absent substantial removal of technical barriers to trade, CETA is far away from Europe’s single market, where harmonisation or mutual recognition is the norm rather than the odd exception. A CETA style agreement for the UK would therefore raise the country’s technical barriers to trade with the EU, and that is far more damaging than nuisance tariffs for an economy plugged into Europe’s value chains. A Britain outside the EU and its single market cannot trade anymore under harmonised or mutually recognised technical regulations for medicines, automobiles and aircraft equipment, to take three examples.

Moreover, if the UK leaves the single market for goods, traditional rules-of-origin regulations would apply for the UK’s export to the EU. If the non-EU import content of the UK’s export gets too high, it will lose duty-free access for some sensitive industrial goods, notably automobiles. This is a problem also for Canada, despite some small improvements in CETA, since it cuts export opportunities when products are based on heavy input from the U.S. However, for the UK, which is far closer to the EU market and a gateway into it for foreign producers and investors, standard rules-of-origin regulations would have more drastic effects.2

A CETA-style arrangement would additionally disadvantage UK trade in goods. The right to use trade remedies would be reintroduced if Britain leaves. More importantly, the UK would also lose protection against trade and competition-distorting state aid on its export markets in Europe. There are no equivalents in free trade agreements like CETA to the hard state-aid rules that are applied and policed in the single market.

Nor is CETA providing for free trade in services. Anyone under that illusion should consult the CETA annexes, listing hundreds if not thousands of reservations to free cross-border access in services and other modes of services delivery. Just like Canada, EU member states have retained the right to discriminate against Canadian service exports. If the UK would adopt the same model, its exporters would be exposed to a raft of new restrictions such as economic-need tests. It would lose the full right to post intra-corporate transfers in all sectors where EU member states have not agreed to full liberalisation. A British engineering company exporting to Austria, Denmark or Finland, for example, wouldn’t be protected under current single market rights to send staff as “temporary visitors” to these countries. For British companies that can’t or won’t establish a subsidiary in other EU countries, a CETA arrangement would take away a critical condition for services export – that company staff can work in the export market for a while.

CETA expresses aspirations but contains nothing of hard substance on mutual recognition of professions. It would be surprising if it did, because both Canada and the EU have incoherent rules for professional standards. Without full recognition, however, Canadian architects, designers, or engineers can’t freely sell his or her services to EU countries. Nor will Canadian exporters of financial services get a financial passport in the EU, enabling them to trade freely inside the EU. Like most advanced economies, neither Canada nor the EU employ trade-preventive market-access restrictions on the classic form of cross-border supply of financial services (what in trade parlour is called “mode 1” supply). The actual restrictions rather concern regulation of other forms of services delivery and demands to apply or conform to host-country regulation. And CETA allows for a surprisingly generous amount of restrictions. Nor does it mutually recognise financial regulation.

If the UK would have to work under similar conditions, it would seriously reduce actual market access for its financial sector. Furthermore, outside the single market, Britain will lose its current protection against regulation discriminating UK providers of financial services because of their origin. If you don’t think that is important, consult the court complaint by the UK government against the ECB for its policy to demand large-scale trade and clearing in the euro to move inside the Eurozone for prudential reasons.

In a CETA-style agreement between the UK and the EU, cross-border data flows will be at risk of similar disruptions as data flows between Europe and the US (or, to be more precise, countries with extensive mass-surveillance operations to protect national security). Data flows have rightly been called the new oil of the world economy; in CETA, however, they are conspicuously absent. They are marginally dealt with in a chapter on e-commerce that reconfirms WTO rules on e-commerce and proposes a “dialogue” between Canada and the EU on issues like intermediary liability. Yet all other cross-border data flows, going far beyond e-commerce, are simply not parts of CETA.

A British departure from the EU and its single market would be the largest programme of re-regulation and re-protection of trade in advanced economies since the Smooth-Hawley tariffs in 1930. Substituting single-market access with a CETA-style trade agreement would not change that. CETA works for Canada – an economy that is distant from Europe and with an export profile based on commodities. For the UK, whose trade with the EU are in sectors highly exposed to regulatory protection (finance, nuclear power equipment, pharmaceuticals, et cetera) it would lead to a serious loss of market access and commercial integration.

Co-founder of the European Centre for International Political Economy (ECIPE) and Director of its Five Freedoms Project