British departure will hit trade with Europe hard—this is whyby Alex Dean / March 16, 2018 / Leave a comment
We all know by now that Brexit will be bad for British trade. Britain’s frictionless relationship with the continent is set to end, with severe economic consequences. This overarching principle is well-understood. But as ever with Brexit, the real story is in the detail.
When Britain leaves, it will collide with international trade law. Regulation on health and safety, quotas and so on will transform into a bureaucratic nightmare. One aspect currently sending shivers down the spines of some in business—one you may not have heard of—is rules of origin. As Article 50 ticks down the issue is increasingly pressing.
“Rules of origin are going to be one post-Brexit additional cost to business that no amount of innovative thinking or new and unusual technology can stave off,” Sam Lowe, a trade expert at the Centre for European Reform told me. The CBI agrees. “For the 135,000 businesses who currently only export to the EU,” it writes in a new report, rules of origin will “be a huge and unprecedented administrative challenge.”
Just like all bits of trade law, rules of origin exist to help govern the global trading system. The World Trade Organisation (which has partial oversight of them) says they establish “the criteria needed to determine the national source of a product.” Essentially: different countries trade on different terms, meaning we need a system for working out which items “originate” from where.
The basic principles here are fairly intuitive. In the modern interconnected economy, however, the details can get complicated. Goods may be exported from one country but have their “economic origin” in another. While a small, simple item like a child’s toy might have parts from two or three different countries, a larger item might have components from three dozen.
At the moment, Britain is part of the largest free trade bloc in the world: the EU customs union (and single market) streamlines the trading process completely. UK businesses don’t have to think about any of this when exporting to the continent. But post-Brexit, Britain is set to leave the CU. The plan is to then strike an FTA with Europe. Tariffs will be eliminated on goods. Items will be able to flow freely between Britain and the EU, encouraging trade and leaving us both better off.
“This is one post-Brexit cost to business that no amount of innovative thinking can stave off”
At least that’s the theory. But rules of origin complicate the matter. For in an FTA the parties in question still need them. If party A strikes a deal with party B, it needs to make sure it only grants preferential access to goods from B—not to someone else.
For an item made solely in B, all this is relatively straightforward. But what about when it’s a product with lots of components from all over the world? Despite the two parties having struck an FTA, tariffs can still apply on the product.
And there’s the rub. The reality is that Britain could strike a free trade deal with Europe and yet still face hefty tariffs on some of its most important exports. Lowe confirmed: “Even if the UK enters into a free trade agreement removing tariffs on goods—which seems likely—some UK exporters may struggle to qualify for it due to the product they are selling having insufficient local, UK, content.” This isn’t because the system will have broken down in some way, but because of how global trade works. But it’s hardly the vision sold by the “Leave” campaign.
Is there any hope? In short: yes, some. In practice, FTAs do not tend to exclude all goods of diverse economic origin. Instead a kind of threshold is applied: to qualify for tariff free trade a certain proportion of the good must originate in the exporting country. Typically, this is around 50 per cent.
Still there are problems. For starters, 50 per cent is a high bar to clear in 21st century business. Mike Hawes, Chief Executive of the Society of Motor Manufacturers and Traders, gave evidence to the Business, Energy and Industrial Strategy Select Committee recently. He said that the average car made in the UK uses “20-25 per cent” domestic parts. “To move from where we currently are… to 60 per cent will take many years. There is not necessarily the capability here in the UK,” he added, forebodingly. Businesses who do not meet the threshold could spend years readjusting in order to qualify, and then still not make the cut.
There is another potential solution: something called “cumulation.” UK businesses could in theory meet the 50 per cent threshold by combining UK origin parts with components from other named countries, for example countries with which the EU already has an FTA. Take Japan, which has just finalised an FTA with the EU. In future, it may be that the EU allows the UK to export goods in tariff-free if they are 50 per cent UK or Japanese origin. There is precedent for this, and it would deal with the problem in part. But there remain reasons for deep concern.
For even if Britain does strike an FTA and it includes provisions for cumulation, and a business meets the 50 per cent threshold, it will still have to prove that it does so. This will be time consuming and, at least initially, confusing for businesses who currently have little experience of such a process. Chris Grey, a Brexit expert at Royal Holloway, confirmed that “any firm exporting to the EU27 will have to produce quite complicated paperwork on where the good originates from.” Yes—any firm.
“Even if a business meets the 50 per cent threshold, it will still have to prove that it does so”
This is one reason why border checks will be required post-Brexit. The consequences we know well. Grey said: “Even if there are only spot checks, that has the potential to disrupt delivery schedules, whether of part-finished goods as part of a transnational supply chain or of completed goods being shipped to customers.” Given that many products cross back-and-forth into the EU half a dozen times during production, the disruption to British trade will be immense.
Theresa May hopes for an unprecedented “deep and special partnership” with the European Union. But she will not circumnavigate the rules of origin problem altogether.
Cumulation and so on might work. There is also the point that the EU and UK could decide between them to keep the “threshold” very low, meaning the tariff issue went away. My understanding, having run this possibility past a few experts, is that the EU will not do this. The evidence to date suggests it is unlikely that Europe will go soft on Britain at any point in these negotiations. None of its other FTAs set the “threshold” especially low, for fear of compromising the integrity of the EU market. It will not want to set a “cherry-picking” precedent now.
So the scramble for half-solutions continues in think tanks and in Whitehall. Proposals are drafted and redrafted. There is at present some talk of joining the “Regional Convention on pan-Euro-Mediterranean preferential rules of origin.” I won’t bore you with that too.
As things stand, the government itself estimates that the costs to business of new rules of origin will range from 4 to 15 per cent of the value of the goods exported. Let that sink in. Then consider the fact that this is just one of the trading problems presented by Brexit—albeit a big one.
It all serves to illustrate one of the great Brexit paradoxes: while the “Leave” vote was in part a strike back at Brussels bureaucracy, exit will mean a whole lot more of it. This is a theme we will return to on the Prospect website in due course.