IoD Policy Report February 2018

Customising BrexitA hybrid option for a UK-EU trade framework

Overview• It is a consequence of Brexit that the UK will leave the EU’s Customs Union.

• But this necessity has impeded debate over what type of trade framework the UK could seek with Europe.

• The IoD believes the UK should seek a bespoke, partial customs union with the EU.

• This partial customs union would cover all industrial goods and some limited processed agricultural goods, removing the need for UK manufacturing firms to face costly ‘rules of origin’ that could render a tariff-free deal meaningless for many companies in these sectors.

• At the same time, it would allow the UK the freedom to forge its own trade policy and seek free trade deals with other countries in areas not covered – meaning we could remove tariffs on most agricultural products from new markets - including in key developing countries.

• The UK should seek to complement this partial customs union with a wide-ranging free trade agreement with the EU on areas not covered by a new customs union.

• The UK can use the example of Turkey as a base to build upon when negotiating these agreements. Turkey is currently part of a partial customs union with the EU, and steps are already being put in place both to upgrade this with a wider-ranging free trade agreement, and to address some of the institutional deficiencies of the original customs union.

• The UK and EU should focus on outcomes, not process. The option outlined in this paper would provide the continuity needed by some of our strategic sectors, alongside the autonomy over trade policy that was put forward as an argument in favour of Brexit.

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Table of contents3 Executive Summary

4 Introduction

6 The Turkish Model – Trade-offs and Room for Improvement

8 A Hybrid Option for the UK?

10 Conclusion

Executive summaryThe UK still has some important choices to make in how it approaches its future economic relationship with the EU, ones which could have a profound impact on businesses with commercial ties to the bloc. This is more acute for those trading in goods with the EU, both directly and in wider supply chains, owing to distinct regimes for doing so as a third country compared to those for services generally.

The question of whether the UK moves away from any continued customs union with the EU involves some clearly defined trade-offs and dividing lines. This contrasts with the greater flexibility and options available to the UK when examining its future regulatory relationship with the EU, even outside the Single Market. Given the debate that has belatedly emerged over the future of the UK’s participation in a customs union with the EU, this paper seeks only to address this specific issue, while making clear it is only part of the overall puzzle.

There are important distinctions between the EU’s Customs Union – which the UK must inevitably leave as a result of exiting the EU – and a (continued) customs union agreement. It is not just a question of semantics, however the semantics have clouded a more fundamental debate about substance and outcomes. Moving away from any customs union results in some automatic consequences for business and the economy, which have not yet properly been addressed by Government.

However, black and white choices are not always as uncompromising as they might seem. And in the absence of a full, frank and costed discussion about the trade-offs of a continued customs union, understanding where flexibilities could still be afforded proves difficult. The introduction of rules of origin to trade between the UK and EU is a major distinguishing feature when moving to a pure free trade agreement. This will have major cost and compliance implications for manufacturing in the UK – particularly in Northern Ireland.

Rules of origin are not insurmountable for business – indeed they currently apply to trade with a number of existing countries outside the EU – but they can render preferential trade agreements meaningless if it becomes easier to deal with the normal tariff in place. Applying them to trade with our biggest single market represents a major hurdle to doing business for the sectors involved. While theoretically a further impediment at the border, this is not the principal way that this barrier manifests itself. Trusted trader schemes are of seriously limited mitigating value given they more easily address impediments relating to the introduction of things like customs declarations and a shift to import VAT for trading with the EU. Rather, rules of origin dissuade traders from taking advantage of tariff preferences to begin with, as the evidence on utilisation of trade agreements repeatedly shows.

A continued customs union with the EU would preclude the need for certificates of origin, which could seriously undermine the UK’s attractiveness as a base for further investment in manufacturing in the future. Meanwhile, cumulation arrangements, a necessary recourse in the absence of a customs union, rely on a great deal of EU goodwill, and remove neither the actual burden of compliance nor the resulting disincentive to use tariff preferences associated with rules of origin. A customs union would also help alleviate some of the problems relating to trade across the Irish border in particular.

Meanwhile, the arguments against the continuation of a customs union centre around the UK’s ability to control its tariff regime. However, there are precedents for customs unions that are partial in scope – notably in Turkey’s arrangement with the EU. The UK could retain control over large swathes of its wider external trade policy. A customs union covering all industrial goods as well as some limited processed agricultural products would avoid disruption for some of the UK’s key industries. It would also allow the UK to negotiate broad free trade agreements, including on important tariffs on food and wider agricultural items that critics of the Customs Union routinely point to in highlighting the EU’s distortedly high level of duty protection. Many of these cover areas where the UK does not have competing producer interests, and so the UK would be able to choose to negotiate these down in its own trade deals or do so unilaterally.

Turkey has experienced some asymmetry in reciprocal market access for the areas covered by its customs union when the EU concludes its own agreements, but steps are already on the horizon for redressing this in future. And as the Prime Minister has repeatedly stated, the UK should not simply be bound by existing precedents. A hybrid arrangement of a customs union with a deep free trade agreement tying off other areas, as the EU and Turkey are already moving toward, could very well suit the UK’s needs as well as its ostensible red lines. This paper briefly outlines the trade-offs involved and why this could be the best compromise for the UK’s future.

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1 HC Deb. 8 January 2018. 634 col. 63

2 HC Deb, 7 February 2018, 635 col. 1493

3 Yi, J. 2015. "Rules of origin and the use of free trade agreements: A literature review". World Customs Journal 9: 43-57. Available at: https://www.researchgate.net/publication/282935598_Rules_of_origin_and_the_use_of_free_trade_agreements_A_literature_review [Accessed 12 February 2018].

IntroductionThe UK is leaving the European Union, and with it the EU’s Customs Union. It is arguably less a matter of choice but one of necessity1, just as many of the fundamental tenets of the EU’s Treaties must fall away from the UK with EU exit. While a transition or implementation period may temporarily prolong its operational effects, any long-term continuity would ostensibly have to take the form of a new customs union. However, the inarguable fact that we are leaving the current customs union has obscured a much-needed debate and open set of arguments from the Government about whether the UK wishes to remain in any form of a customs union with the EU as an end-state. As a result, there has been a lack of frank discussion about the trade-offs involved in moving to a pure free trade agreement, which has in turn made it difficult for businesses to prepare for some of the automatic consequences that this would entail.

In her Lancaster House speech, setting out some fundamental starting guidelines for the UK’s envisioned new relationship with the EU – principally around what the Government did not want – the Prime Minister referenced the possibility of remaining “an associate member of the Customs Union”. The 12 months that have passed have produced little in the way of clarifying what this might mean in practice. In February 2018, however, the PM repeated her assertion that it was specifically the EU's Customs Union that precluded the UK from striking its own trade agreements.2

A future partnership paper on customs arrangements with the EU was produced by the Department for Exiting the EU in August 2017, which laid out two potential options. One was a ‘highly streamlined customs’ model which would rely on existing trade facilitation tools. The other would be an unprecedented ‘new customs partnership’ that would remove the need for a UK-EU customs border by differentiating between third country goods staying in the UK and those going on to the EU. This paper however dealt largely with technical facilitating arrangements, not a wider trade framework that the question of a customs union deals with. Since the publication of that paper, a Joint Report was agreed at last December’s EU summit that – ‘in the absence of agreed solutions’ committed the UK to remaining aligned to the rules of the Customs Union necessary for protecting North-South cooperation and the Belfast/Good Friday Agreement.

A major differentiator between a customs union and a

preferential trade agreement is the appearance of rules of origin, in particular preferential rules of origin (although non-preferential ones can also be an issue for businesses to contend with). They are required in the latter on the basis that two (or more) contracting parties’ external tariff arrangements can vary, and therefore proof of origin is needed to ensure only those firms entitled to use preferential duty rates are doing so. The ostensible purpose is to avoid “transhipment" of goods through countries with lower duty rates, thus reducing the scope for trade deflection and “tariff-jumping”.

Little in the way of official government policy papers have addressed this potential major new barrier to trading with Europe. The complexity and cost of complying with preferential rules of origin is identified as one of the key reasons for the underutilisation of free trade agreements by companies3. Their emergence under a pure free trade agreement would be an automatic consequence of the decision not to pursue any continued customs union with the EU. It is therefore confusing for firms to hear Ministers continually referring to the objective of barrier-free trade with the EU after Brexit given such consequences arise from reported Government policy choices.

Customs unions were once the prevailing model for formalised trade arrangements between countries in the early 20th century. The move towards – and subsequent struggles of – multilateralism has ushered in a new era of preferential trade agreements. These have accompanied the push for countries to tackle barriers that might occur when trading far beyond their immediate geographical proximity, and customs unions remain more relevant for regional integration. Were the UK considering whether to join a customs union or free trade agreement with the EU in the absence of any preferential arrangements, arguments would be substantively different from those occupying post-referendum discourse today.

But the current starting point acts as a major differentiating variable, and is not dissimilar from the balance of choices currently facing Turkey in modernising its customs union agreement with the EU. The UK’s level of economic integration with the EU far and away exceeds that of Turkey’s, and the potential disruption from moving back to a basic free trade agreement is much greater. However, the trade-offs involved – between regaining full control over trade policy, and the cost of barriers that moving away from a

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customs union to an FTA incurs – pose a similar question for Turkey as for the UK.

In spite of this, the overwhelming consensus in Turkey is that even if some asymmetries on trade policy persist, moving away from a customs union arrangement with the EU is not an option because of the threat this would pose to its manufacturing industry – as a result of the introduction of rules of origin. Modelling work and analysis undertaken by a range of sources – including impact studies from the World Bank, the European Commission, Turkish industry bodies, and think tanks such as Bertelsmann-Stiftung and the College of Europe – supports the argument that the economic welfare losses as a result make this the least attractive option. The preferred route is to expand the scope of the current agreement to include primary agricultural goods and further liberalisation of services, public procurement and competition policy via an additional free trade agreement.

Further input to EU decision making on areas covered by the current customs union agreement, as well as increased coordination between Turkey’s and the EU’s free trade agreements, is also seen as an important political facilitator. The arguable reluctance of Turkey to pursue as ambitious a path as the EU in respect of preferential trade agreements – which has also played a part in this asymmetry – puts it in a slightly different starting point to the UK.

There is a clear path to improvement and upgrading on the horizon for the EU’s customs union with Turkey, although the fraught political context with respect to foreign and security policy may complicate what should be a purely economic exercise. It is in the UK’s interests to consider whether a similar hybrid free trade agreement with a partial customs union is an option for its long-term economic relationship with the EU. This would ensure Brexit would not unduly damage the UK’s manufacturing industry, would facilitate the flow of goods across the Irish border, and simultaneously would allow the UK to pursue an independent trade policy – albeit with some coordination on the areas covered by a shared external tariff.

The UK would be able to create a new trade remedies regime and negotiate trade agreements both alongside and independently of the EU across a host of policy areas, where it could go further if desired, with substantial leverage on agricultural tariffs. Or it could

choose to reduce tariffs on these agri-food items unilaterally to the benefit of consumers. This option would not remove all the potential disruption for business – and the regulatory relationship is a much wider piece of the negotiations – nor will it remove every current constraint on the UK’s economic sovereignty. But as a compromise between the two, it is a course worth considering.

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The Turkish Model – Trade-offs and Room for ImprovementThe current customs union between Turkey and the EU was intended as a transitional step on the path to EU accession. Turkey was offered full access to the EU market for all industrial goods and some limited processed agricultural products in exchange for committing to progressive alignment with the EU’s preferential trade regime in the areas covered by its customs union deal. However, as accession is now seen as a politically fraught objective, improving on this agreement is seen as a viable economic alternative.

The asymmetries resulting from the current agreement were not immediately realised, chiefly because the EU’s trade policy ambitions were comparatively limited at the end of the 20th century. Indeed, it is the surge in the EU’s path towards preferential trade liberalisation with the rest of the world that has laid bare some of the shortcomings in the design of its original customs union with Turkey.

The beneficial economic impact of Turkey’s customs union on its economy has been clear. Bilateral trade flows since its inception in 1995 have increased markedly, and Turkey has become a hub for the manufacturing of intermediate goods sent to the EU. Turkey has become significantly integrated into European production networks owing to the absence of a requirement for certificates of origin that otherwise hinder the free circulation of goods into and within the EU market4. Manufacturing in the UK is in a similar position, with more than half of its intermediate imports coming from the EU as well as accounting for almost 70% of our exports to the bloc. These inputs are more significant in the UK's overall exports to the EU than they are in what we sell to the rest of the world.5

However, when the EU negotiates preferential trade agreements with third countries that have high tariffs on the areas covered by its customs union with Turkey, there is both a political and potential economic asymmetric effect. The extent of this economic impact in practice is fairly limited owing to the fact that globally applied most-favoured nation (MFN) tariffs on industrial goods are fairly low. Duty rates on specific finished goods like cars are among the exceptions to this trend. This stands in contrast to the incidence rate of high applied rates on many agricultural products, which largely remain outside the scope of Turkey’s customs union, and are likely to be tackled via improved tariff preferences from the EU.

The political asymmetric impact is more noticeable. Turkey negotiates its own trade agreements, and it is not subject to the EU Treaties and therefore formally excluded from the EU’s Common Commercial Policy. This hands responsibility for external trade relations to the Commission for Member States, and thus no matter how the UK leaves the EU, it will be responsible for negotiating its own trade agreements. However, Turkey unsurprisingly does not wish to be left at a theoretical disadvantage in opening up its market to third countries that the EU negotiates with, without being afforded some reciprocal market access for its exporters on tariff preferences in areas where the EU lowers or removes import duties that are covered by its customs union deal. Of course, if there was a preference for unilateral action on tariffs in Turkey, this asymmetry would not be a problem.

More often than not, these third countries have been willing to negotiate preferential agreements with Turkey alongside or shortly after their negotiations with the EU. In some instances, Turkey has chosen not to pursue immediate reciprocation. In a limited number of circumstances the third country has declined to heed EU requests for it to begin immediate parallel negotiations with Turkey (such as South Africa, USA). These instances have largely resulted from third countries' foreign policy reservations over Turkey. The European Commission has initiated a practice however of seeking to add a ‘Turkey clause’ to its negotiating text, and, while non-binding, these declarations usually provide the impetus for subsequent agreements between Turkey and third countries.6

For some reason, Turkey has only recently begun to embark on negotiations with markets with whom the EU does not currently have nor foresee deals with in the near future. This is despite being perfectly entitled to do so, and speaks to its relative ambivalence about pursuing an ambitious liberalising trade policy agenda. Tariff protection remains extremely high for most agricultural products -averaging around 80% across most of them7, and Turkey is among the top 10 most active users of trade defence instruments in the WTO8. Whereas the EU has progressively been prioritising services within its more recent trade agreements, Turkey has yet to do so apart from its deal with South Korea – despite having full control over services regulation.

4 Yalcin, E., Aichele, R., Felbermayr, G., 2016. Turkey’s EU integration at a crossroads. BertelsmannStiftung. Available at: https://www.bertelsmann-stiftung.de/fileadmin/files/BSt/Publikationen/GrauePublikationen/NW_Turkey_s_EU_integration.pdf [Accessed 12.02.18].5 Levell, P. 2018. Firms’ supply chains form an important part of UK-EU trade: what does this mean for future trade policy? [Online] Available at: https://www.ifs.org.uk/publications/10302 [Accessed 14 February 2018]. The importance to the UK manufacturing industry of being a hub for EU supply chains is clear.6 See ‘Turkey clause’ declaration in the EU-Korea trade agreement as an example, cf. Tekçe, M. (2017) The Current and Future State of Turkey-EU Economic Relations, in: Santagostino, A., The Single European Market and Trade Policy. Cambridge: Cambridge Scholars Publishing.7 WTO. 2016. Trade Policy Review – Turkey. [Online] Available at: https://www.wto.org/english/tratop_e/tpr_e/s331_e.pdf [Accessed 12 February 2018].

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Regardless of some of this mitigating circumstance on the shortcomings in Turkey’s current economic relationship with the EU, both sides have recognised both the scope and asymmetries in their agreement to date should be addressed. After numerous official studies recommending the upgrading of its customs union with Turkey, including from the World Bank9 as well as one sponsored by the British Embassy in Ankara10, the European Commission requested an official mandate from the Council in December 2016 to begin negotiations on modernising the agreement.

These studies clearly lay out that the asymmetry relating to trade policy is only one of a number of issues that need be dealt with, often laying more emphasis on the need for expanding the overall scope of its bilateral preferential trade framework (BPTF). For example, EU road transport quotas for drivers are one of the most important challenges for Turkey under the current BPTF. Several structural options are routinely put forward – full accession to the EU, deepening the customs union to include further provisions under an additional FTA, or rolling back the entire customs unions to a deep and comprehensive free trade agreement (DCFTA).

While the first of these is generally thought to be unrealistic, the third is the least-favoured option economically, owing to what is referred by some as the “rules of origin shock” in moving away from a customs union altogether. Both for the EU and Turkey, it is calculated that even liberalising all other non-tariff barriers for goods and services under a DCFTA would not be enough to make up for the trade costs that arise from the introduction of requirements relating to certificates of origin11. This is an important consideration for the UK to bear in mind when weighing up any complete move away from a customs union to a free trade agreement. It is also worth noting that at a roundtable held by the IoD in November 2017 with representatives from TUSIAD – Turkey’s largest independent business representative organisation – there was a unanimity of view against dispensing with a customs union altogether.

There are a number of recommendations made for upgrading the scope and institutional design of the customs union and wider BPTF across all studies that

the European Commission’s impact assessment includes alongside its recommendation for a mandate to start negotiations with Turkey. Dealing specifically with the problem of asymmetry in respect of trade policy arrangements, the Commission commits to the aim of ensuring Turkey can reciprocally benefit from trade preferences in EU FTAs as well as greater formalised ‘consultation/involvement’ for Turkey across various stages of their development where it would affect any shared tariff rates of the customs union. It also explicitly floats coordinating the point at which respective agreements with the same third country come into force. This would not harmonise the agreement itself, and nor would the EU assume negotiating responsibility for Turkey, but rather it would achieve a coordination of implementation, specifically where the EU was already negotiating with the third country in question.

Taking all the above into consideration, it is essential when discussing the suitability and feasibility of a continued customs union of some form between the UK and EU to note that the challenges facing Turkey are not static and are already on the way to being addressed.

8 Export.gov. 2017. Turkey – Import Tariff. [Online] Available at: https://www.export.gov/article?id=Turkey-Import-Tariff. [Accessed 12 February 2018].9 World Bank. 2014. Evaluation of the EU-Turkey Customs Union. [Online] Available at: http://www.worldbank.org/content/dam/Worldbank/document/eca/turkey/tr-eu-customs-union-eng.pdf. [Accessed 12 February 2018].

10 TÜSİAD. 2015. A New Era For The Customs Union & Business World. [Online] Available at: http://tusiad.org/en/reports/item/8685-a-new-era-for-the-customs-union-business-world. [Accessed 12 February 2018].

11 European Commission. 2016. Impact Assessment. [Online] Available at: http://ec.europa.eu/smart-regulation/impact/ia_carried_out/docs/ia_2016/swd_2016_0475_en.pdf. [Accessed 12 February 2018].

A Hybrid Option for the UK? The UK and Turkey are clearly in different starting positions – the UK is attempting to unwind some aspects of its economic integration with the EU, while Turkey’s ultimate aim is to go further in the opposite direction. However, they face a similar set of challenges in trying to maintain as many existing customs union benefits as possible while increasing their levers of control as non-members of the bloc.

While the idea of narrowing the scope of areas covered by a customs union might seem strange in principle, in practice it may be what is needed to achieve the desired blend of autonomy and business continuity for the UK. It is important to stress that a continued customs union for all industrial and some limited processed agricultural products would not remove the need for rules of origin entirely – as it would apply to the industrial/processing element of the end product. Some agri-food products would still have to prove origin to continue benefiting from a zero-tariff deal with the EU. However, whereas with industrial goods the component parts can be significant in number and be sourced from a number of third countries, perishable products tend to be larger in component size and not sourced from such great and varying distances.

And some level of increased paperwork is to be expected at – or relating to – the border even with a new customs union because of other issues relating to the UK becoming a third country. As the Irish Revenue Commissioners office made clear shortly after the referendum, the reappearance of basic customs formalities and procedures is likely regardless of the final nature of any agreement between the UK and EU.12 Retaining independent membership of the EU’s Security Area, like Norway or Switzerland, could preclude the need for advance entry summary declarations that were introduced for third-country cargo shipments into the EU in 2006.

However, the continuation of a customs union for all industrial goods would be essential to ensuring the continued competitiveness of the UK's manufacturing industries. Avoiding the application of tariffs for heavily-traded sectors with scores of component parts going into final assembly is essential, particularly given how often these goods cross UK and EU borders. Yet this is likely to become virtually unavoidable even under a tariff-free deal, should rules of origin apply. The chemical industry has made clear that the cost involved of tracking, adjusting and proving origin for trade with the EU would "clearly outweigh the benefit of duty-free sales".13 Only a small

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minority of IoD members exporting goods outside the EU use trade preferences in accessing third country markets, which does not bode well for their ability to use preferential rules of origin with the EU after Brexit (see Graph 1). Of particular importance is the integration of third country firms across UK-EU supply chains through investments dotted across the UK. The Japanese government has already taken the uncharacteristically bold step of issuing an open letter, warning that “the introduction of inconvenient rules of origin could delay and increase the costs of logistics operations, which would have a significant impact on business operations14”.

Following a meeting of senior Japanese business executives at Number 10 Downing Street in February, the Japanese Ambassador made clear that any such restrictions on EU market access would affect the ability of firms from his country to continue operations in the UK15. This touches on another important consideration for the UK: the implications of its end-state relationship with the EU for extending existing third-country agreements.

The sudden application of rules of origin to trade in industrial goods between the UK and EU would also pose a serious challenge for replicating these agreements. It would mean the involvement of the EU and its goodwill in rolling these over will almost certainly be required – likely at some tradeoff cost elsewhere in negotiations. Maintaining a customs union for industrial and some processed agricultural goods will significantly facilitate a smooth transitioning of the UK’s current customs union arrangement with Turkey in particular, where rules of origin are currently very limited in their application.

12 Revenue. 2017. Brexit and the Consequences for the Irish Border. [Online] Available at: https://www.revenue.ie/en/corporate/documents/research/brexit-and-the-consequences-for-irish-customs.pdf. [Accessed 12 February 2018].13 House of Lords European Union Committee. 2017. “Brexit – trade in goods” in the 16th Report of Session 2016-17, HL Paper 129. Chapter 5: Non-tariff barriers. [Online] Available at: https://publications.parliament.uk/pa/ld201617/ldselect/ldeucom/129/12908.htm. [Accessed 14 February 2018].14 Japanese Ministry of Foreign Affairs. 2016. Japan’s Message to the United Kingdom and the European Union. [Online] Available at: http://www.mofa.go.jp/files/000185466.pdf. [Accessed 12 February 2018].15 BBC News. 2018. “Japan's man in UK says unprofitable firms could not stay”, BBC News, 8 February 2018. [Online]. Available at: http://www.bbc.co.uk/news/business-42994603 [Accessed 12 February 2018].

Yes20%No54%

Don’t know23%

No, my organisation only sells to/operates in the EU

4%

Graph 1

Has your (primary) organisation ever taken advantage of EU free trade agreements with third countries to facilitate market access into that country?

97 respondents, survey conducted in January 2018

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While a customs union or preferential trade agreement must (following WTO rules) cover “substantially all trade”, the precedent exists in the EU-Turkey deal for the exemption of most agricultural products. A free trade agreement would still be needed to cover arrangements relating to services, as well as areas in which the EU has made clear it wants a continued level playing field, in order to maintain any reciprocal preferential market access. This would also need to cover tariff preferences for agriculture not tied off by a new customs union, as is the case with Turkey currently.

Under such a hybrid arrangement, the UK could choose to unilaterally remove tariffs on produce such as cheese, chocolate, oranges, or raw cane sugar, which is imported into the UK from developing and emerging markets for processing and refining by companies such as Tate & Lyle. It would be up to the UK Government to decide if it was a priority to remove tariffs on such products in an attempt to benefit the largely developing countries from which they originate. The UK would also be entitled to negotiate for itself reciprocal market access with third countries on goods like fresh/chilled meat while minimising the impact upon integrated processing supply chains with the EU.

It is likely that the UK would still be able to broadly execute its own trade remedies regimes, suited to its own economic interests, without being expected to automatically apply all EU anti-dumping measures. Under a derogation in the Turkey-EU customs union decision of 1995, trade defence measures are excluded from alignment and/or normal coordination procedures of the agreement16. It may be, however, that under a new agreement with the UK, the EU would push for an aligned regime for imposing defensive duties on those products that are still covered by a shared external tariff.

This would in turn necessitate greater UK involvement and consultation in some EU trade policy discussions at an earlier stage – something that has been suggested for improving the institutional design of the EU’s customs union with Turkey. The EU is also keen to restrict the incidence of trade defence instruments being enacted between itself and Turkey for goods covered under its customs union, identified as a key barrier to its proper functioning. This will necessitate much closer alignment on state aid restrictions and competition policy, which in itself is a desirable area of continuity for a level playing field between the UK and the EU. Moreover, as put forward by a number of think tanks, including the Cato Institute, it is in the interests of both parties to continue avoiding the deployment of trade remedies against one another after the UK exits the EU17.

As discussed in the previous section, a framework integrating both customs union and preferential trade elements would necessarily involve continued coordination and alignment on some areas of trade policy. The UK would still be free to negotiate its own agreements, and go further than the EU across a number of chapters, including on many key areas of agricultural market access where tariffs remain a key negotiating lever. It would also mean that on these areas, the UK Government would be accountable to the public and various domestic constituencies for its decisions rather than the EU.

It would be in the UK’s interests to negotiate agreements with third countries in parallel to EU deals wherever possible, not least to minimise the potential for trade deflection and diversion. This would still be the case even if the UK did not remain in any kind of customs union arrangement, and the EU has already started negotiations with most of our priority markets. Given that the European Commission has proposed more formalised Turkish input into its trade policy processes at an earlier stage – for those specific areas covered by its customs union agreement – the UK could expect to be extended similar terms under a new customs union with the EU.

The EU’s agenda for trade liberalisation is growing at an unprecedented rate, and many of the countries already on its target list are near-identical to the UK’s own priority list. This reflects a growing tendency of regionally-linked countries to negotiate as a bloc – even outside of the confines of a customs union. It is, moreover, very unlikely that many of these markets would not welcome a parallel agreement with the UK, given its strong economic position, size and preferences of its consumer base, and possibilities relating to temporary labour mobility exchange and knowledge/skills exchange.

Coordination on timing and implementation -as well as on content where feasible and desirable – of respective third country agreements would serve to reduce the concern for possible asymmetries. Moreover, the EU might find itself in a position where the UK taking a lead on new third country negotiations would incentivise its own push to ‘keep up’ and ensure it is not left at a competitive disadvantage. And it is important to stress that the content of UK and EU deals with third countries need not be harmonised apart from those areas limited to its external tariff or where the UK separately desired to continue aligning to EU rules, just as agreements like the Trans-Pacific Partnership contain a variable geometry of commitments specific to individual participants.

16 European Commission. 1995. Decision No 1/95 of the EC-Turkey Association Council. Chapter IV, Section III, Article 45. Available at: http://trade.ec.europa.eu/doclib/docs/2003/december/tradoc_115267.pdf [Accessed 12 February 2018].17 Lester, S., 2017. “Sometimes the (Trade) Remedy Is Worse than the Disease,” Huffington Post, 10 September 2017. [Online]. Available at: https://www.huffingtonpost.com/entry/sometimes-the-trade-remedy-is-worse-than-the-disease_us_59da1e19e4b08ce873a8cedd [Accessed 12 February 2018].

ConclusionThis report does not seek to lay down a comprehensive blueprint in exhaustive detail for how a new UK-EU customs union would function, but rather encourage a discussion on how a hybrid arrangement in conjunction with a trade agreement might offer a suitable compromise. The EU’s inevitable desire to limit any competitive advantage gained by the UK from Brexit may make such a series of compromises difficult to attain. But the precedent of its arrangement with Turkey acts as a useful base for the UK to build on, particularly given the EU's commitment to redressing asymmetries already identified under that agreement.

The UK will have its independent trade policy restored no matter how it exits the EU. This need not preclude a discussion on how a partial customs union could help minimise the cost to industry that Brexit inevitably entails in the short to medium term. A discussion on where alignment and coordination, including on limited areas of trade policy, would continue benefitting both parties is well overdue – as is a debate on those areas of trade liberalisation where UK action could feasibly go well beyond EU aspirations.

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Underpinning all of this must be a focus on outcomes rather than processes, a feature often lacking in the political systems of both the UK and the EU. In Westminster, the objective of ‘taking back control’ of laws can on occasion seem to eclipse all other priorities. Policy makers in Brussels, on the other hand, have a tendency to focus on adhering to the rules for their own sake. Tight time constraints for negotiations do not help facilitate a move away from this kind of thinking. We should not, however, think of the future relationship between the UK and EU as static. It is both likely and desirable that this deal be constructed as a “living agreement”, capable of growing and evolving over time. Mutually-shared interests, that are a function of both geography and political and economic interdependency, should be capable of being accommodated beyond existing structures. Flexibility and a focus on shared challenges and outcomes will ensure the new deal is capable of standing the test of time.

Author

Allie leads the IoD’s work putting forward the members’ priorities for Brexit, and explores methods of expanding the UK’s global reach in trade and investment.

Allie RenisonHead of EU and Trade Policy