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Jürgen Matthes IW-Kurzbericht No. 58 16. August 2017 Don't try to square the circle

The UK Government tries to mitigate the disadvantages of exiting the EU customs union through innovative proposals. However, it is hard to imagine that this approach will work out.

Don't try to square the circle
Jürgen Matthes IW-Kurzbericht No. 58 16. August 2017

Don't try to square the circle

German Economic Institute (IW) German Economic Institute (IW)

The UK Government tries to mitigate the disadvantages of exiting the EU customs union through innovative proposals. However, it is hard to imagine that this approach will work out.

The United Kingdom faces an apparently insoluble dilemma:

  • It has to leave the EU customs union in order to be able to determine its own external tariffs against third countries. Free trade agreements (FTA) with the US, Japan and China are an essential part of the British Government’s „Global Britain“ strategy.
  • The withdrawal from the customs union, however, leads to new trade barriers because a customs border to the EU becomes necessary. This entails considerable costs and, in addition, threatens to become a major problem with regard to the highly sensitive issue of the border between Northern Ireland and the Republic of Ireland.

Usual FTAs – like the one aspired between the UK and the EU – are accompanied by a customs border that implies significant bureaucratic barriers. If a customs union is dispensed within such an FTA, both partners will usually have different external tariffs for imports from third countries for various product groups. Hence, tariffs of the partner with the higher external tariffs for certain goods (i.e. the EU) could be undermined by the import of goods from third countries through the trade partner with the lower external tariffs (i.e. the UK) when these goods are transferred duty-free to the one with higher tariffs. Even in the case of intermediate goods, complex precautions are necessary, which are called rules of origin. If the low-tariff country imports and processes intermediate goods from third countries, rules of origin require that the intermediate goods are not simply marginally altered and then exported duty-­free to the high-tariff country.

All this is associated with a variety of documentations and inspections at the customs border, which causes a lot of paperwork, costs and time delays. Especially in Dover, the additional inspections may cause long-haul queues with corresponding waiting times. According to the UK Chamber of Shipping, around 8,000 trucks are handled destined for the EU every day (The Guardian, 2017) – and so far without any significant time lag. Without a customs union, a customs border would lead to long and chronic transport conges­tions. The same applies to the cross-border traffic between Dublin and Holyhead in Wales.

The UK Government is determined to eventually leave the customs union, but makes two proposals for the problem described, one conventional and the other innovative (HM Government, 2017):

  • The conventional one proposes cost reduction strategies for the new customs border. The complexity of the documentation as well as the bureaucratic burden of control processes and of the application of the rules of origin can vary substantially. This means that there is room for maneuver to limit costs and expenditures through a UK-EU-agreement, which should be of interest to both (Matthes/Busch, 2016). One existing example is the customs border agreement between the EU and Switzerland (Swiss Federal Council, 2015). The UK Government seeks further improvements through the use of modern technologies. However, they are well aware that a certain extent of relevant additional costs simply cannot be avoided when a customs border is introduced.
  • With an innovative idea, the British want to avoid the problems regarding a customs border and still be able to negotiate their own FTAs – without formal membership in the EU customs union. To this end, they are considering voluntarily assuming the external tariffs of the EU, at least in the case of import products in the UK which are exported to the EU directly or indirectly as intermediate goods from the UK after having been significantly manufactured and altered in the UK. With such a pseudo-­customs union, they try to square the circle.

But this proposal does not appear feasible, even if it has a certain appeal. Although it does not eliminate the disadvantages of leaving the customs union, it may make some of them more bearable:

  • FTA negotiations with third countries would be possible. However, in the case of the products which ultimately go directly or indirectly as intermediate goods to the EU, the UK would not have any real sovereignty to negotiate the level of its own preferential tariffs. This is not that detrimental in the case of third countries with which the EU already has a FTA that the British would have to negotiate for themselves. They could offer the same tariffs as the EU. This may weaken their negotiating position, but it is a conceivable way.
  • It is much more problematic, however, for FTAs with economic heavy-weights like China, the USA or Japan, with which the EU has not (yet) reached an agreement. If the UK offers lower import duties below the level that the EU currently has in play, the EU duty is likely to be undermined. The concept of a pseudo-customs union can only work in the product groups relevant to the EU, if British importers, despite actually lower negotiated tariffs for US goods, still pay the higher EU external tariffs for US products. In case the imported goods remain in the UK, the British Government is considering reimbursing the tariff difference to the British companies concerned. However, it is questionable whether China, the USA and Japan would accept such arrangements. In the end the UK tariff reduction for goods destined eventually for the EU would again be leveled out – implying that the FTA is not relevant in a considerable number of product groups.
  • The UK Government knows that it has to track imported goods through an elaborate procedure in order to ensure that all goods entering the EU are facing the EU’s tariffs and that also other relevant EU rules are being followed. A tariff reimbursement procedure is also likely to cause considerable expenditures, especially because imported intermediate goods are often further processed sequentially by several companies in long and complex value-chains. But there would be one major advantage of the pseudo-customs union. The additional costs would arise domestically and not at the customs border (which can be dispensed in the case of a pseudo-customs union). Costs and time delays would effectively be more burdensome in the latter case, because of existing bottle­necks at the customs border, for example in Dover. As the ultimate complexity of the procedures is still uncertain, the British Government wants to obtain the opinions of the businesses first.
  • Whether the EU would engage in a pseudo-customs union with the UK is doubtful. The EU member states would have to rely on the UK to control properly – without being able to supervise the British control systems themselves. Furthermore, the EU will not deal with this issue immediately. In a first statement, Brussels stipulated once again that the formalities for withdrawal from the EU have to be dealt with before the future relations are to be discussed. Enthusiasm looks different.

For the period immediately following the withdrawal from the EU and the customs union, the British Government has proposed a temporary transitional period, in which it is seeking an agreement on a new version of a (real) customs union with the EU (HM Government, 2017). The formal withdrawal from the existing customs union, with which the British Government intends to implement the Brexit in a public­ly effective way, would be immediately thwarted with such a step, however.

All in all, the example of the customs union shows very well how much of the British Government's Brexit strategy is burdened with hardly solvable dilemmas and trade-offs. The still audible promises to the British people that the UK will benefit from the Brexit are appearing less and less credible.

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