BREXIT and the WTO

Jul 9, 2020

According to a report of the House of Lords on various BREXIT outcomes: “Trading with the EU under WTO rules alone would be the most disruptive option … this option is therefore unattractive for UK-EU trade in goods and in services.”

In a similar vein, a recent header of the Financial Times states:” The UK and EU are facing the most extreme version of Brexit … the UK’s trading regime could default to that of the World Trade Organization (WTO).”

The simple fact of the matter is that irrespective of the outcome UK-EU negotiations scheduled to end this year, the UK will be trading under WTO rules, and probably WTO rules alone.  Further, it seems to be erroneously presumed that defaulting to the WTO regime involves a degree of automaticity.

Nothing could be further from the truth.

The bold objectives for the future EU-UK trading relationship were set out in a 27-page joint UK-EU Political Declaration in October 2019 …  “an ambitious, broad, deep and flexible partnership across trade and economic cooperation with a comprehensive and balanced Free Trade Agreement at its core …”. In January 2020, a 535-page UK-EU Withdrawal Agreement was agreed to providing for a transition until 31 December 2020 to negotiate the sought after “comprehensive Free Trade Agreement”.

The Withdrawal Agreement provides for a once over the possibility to seek an extension of the transition period of one or two years if requested before end June. No such request was forthcoming. As ratification is required by the UK and EU member governments, agreement on the terms of the trading arrangements would have to be reached by October.

The negotiations have gone poorly as the two sides have sharply contrasting positions.  The EU seeks an ambitious wide-ranging agreement maintaining “frictionless” trade in goods and services coupled with a “level playing field” through the UK adoption of EU sanitary, phytosanitary, environmental and other standards.  The UK wants a free trade agreement rather like the deals struck by Brussels with Canada, Japan and South Korea removing most tariffs without an obligation to stick closely to EU standards. The EU-Canada FTA negotiation is typical in terms of duration and complexity; it took 7 years to complete and runs to some 1600 pages.

What is clear is that a “comprehensive FTA” with “frictionless” (duty-free) trade on a “level playing field” (according to EU standards) will not be negotiated in the next four months. The general perception appears to be that the only alternative will be a “cliff-edge” with “defaulting to the WTO”. This perception extends to the belief that there is a degree of automaticity in “defaulting” to the WTO. Nothing could be further from the truth.

To become an independent or standalone member of the WTO (rather than as a member of the EU) requires a great deal of additional negotiation. Four years ago, the WTO Director-General warned that trading according to the WTO regime would “mean pretty much all of the UK’s trade [with the world] would somehow have to be negotiated … Britain would face tortuous negotiations to fix the terms of its membership of the WTO.” These “torturous negotiations” are now underway. The Director-General also described these negotiations “as akin to” negotiations for countries wishing to accede to the WTO.  The last four accession negotiations averaged 15 years to be completed.

The bottom line is that the UK is now the third country in WTO terms and will need to negotiate its membership as a standalone member. This has led to some confusion. UK membership has variously been described as “defaulting to the WTO”, “trading on WTO terms”, “trading according to WTO rules” among others. As each of these terms has a different meaning, it’s not surprising confusion abounds.

Part of the confusion comes from the fact that both the UK and the EU are both founding members of the WTO. They have always “traded according to WTO rules” as do all 164 WTO member countries. The key rules include, importantly for current purposes, most favoured nation treatment (MFN), which means that along with all other WTO members, the EU (as a customs union including the UK) must grant the most favourable market access (e.g. via tariffs for goods and regulations for services) that it grants to any country. This is also true for all the other rules contained in the 491 pages of WTO agreements. These rules are not being negotiated and can only be changed if the other 136 WTO governments agree.

On the other hand, the terms of the trading relationship between the EU and the UK are indeed now being negotiated. The outcome of these negotiations will determine if there is a “cliff-edge” or not. This requires an explanation.

All WTO members record the specific terms according to which they trade with other countries in legally binding schedules indicating the available access to their markets for imported goods and services. These terms have been negotiated over the past 74 years, primarily in nine multilateral rounds of trade liberalising negotiations. As implementing liberalisation commitments normally requires a restructuring of the business, the national schedules (and there are 25,000 pages of them registered at the WTO) inform traders when the negotiated liberalisation is scheduled to take place.

The schedules indicate the terms under which trade will take place and are executed according to WTO rules (such as MFN).

Since the UK is no longer one of the 28 countries of the EU, for WTO purposes it is now a third country like the US, Australia, New Zealand and 133 others. It now needs its own Global Tariff Schedule (GTS) facing not only the EU but all other WTO members. As no country can unilaterally declare its degree of market openness, its schedule it must be negotiated (if necessary) and approved by all other WTO members, including the EU, to ensure a fair balance of commitments in the UK schedule.

In fact, the UK is now confronted with two sets of negotiations relating to schedules, both of which are underway. First, negotiating the approval of its Global Tariff Schedule with WTO members as a “third country” WTO member (like Australia). Second, the UK and EU are also negotiating the terms of their post-2020 trading relationship for goods and services, hoping it will be on more preferential terms (i.e. a FTA) than their respective Global Tariff Schedules. This is proving to be difficult. For goods trade, there are 9,379 individual product lines in the EU Global Tariff Schedule. The 90 pages of services schedules are even more complicated.

As FTAs or Customs Unions (such as the EU) are based on preferential market access they violate the MFN rule of non-discrimination. However, a WTO exception is provided for those countries wishing to liberalise faster bilaterally or as a group than they could in a multilateral context. The next four months will be dedicated to the EU and UK attempting to agree to the terms of such an FTA. However, the terms will have to meet the conditions set by the WTO for all FTAs. That is, they must cover a “substantial” share of their bilateral trade and not raise barriers to non-parties. Otherwise put, the outcome of the negotiations cannot be a “bare-bones” agreement in order to facilitate membership of the WTO.  The incentive for reaching agreement on an FTA is considerable. Apart from the advantage of preferential trade, the terms of the agreement can be implemented over a 5-10 year period by declaring it to be an “interim agreement”. This was the route taken for the EU-Japan FTA where motor vehicle tariffs, for example, will be phased out over a ten-year period.

So much for the EK- UK trading relationship. However, there are many more schedules to be negotiated. The EU (and the UK during the transition period) has 41 preferential trade agreements with 72 countries. At the end of the year, the preferences they contain will no longer apply to UK trade.  While they could be “rolled over” (i.e. continue to apply to the UK as they do to the EU) there has little success in doing so. Only 20 minor FTAs have been “rolled over” to date; with Israel, several African and South American nations – but not Japan, Canada or Turkey. At the end of the year, the UK will be free to finalise FTAs with other countries. Australia is currently negotiating a free trade agreement with the UK (as well as the EU).

There are numerous other matters to be settled before the UK has completed its WTO negotiations (e.g. Government Procurement Agreement, agricultural subsidies, tariff rate quotas etc.). Is it now perfectly clear that the end of year deadline provides nowhere near enough time to conclude a deal embracing all aspects of future EU-UK trade relations in the WTO.

What is important from a commercial perspective is that with a “cliff-edge” outcome, UK trade with EU (and the rest of the world) will, of course, continue to take place, but on uncertain terms, albeit in a confused manner. This is particularly the case with respect to customs clearances and recognition of standards.  Any breach of the rules would be dealt with by the WTO dispute settlement system, if only it had one.

To carry the Brexit process to a workable conclusion requires competent and bold leadership from the WTO Director-General just at the time his replacement is being sought. The incoming Director-General must be sufficiently prestigious and well-respected by ministers and heads of government to improve and enforce existing WTO rules and create new ones to fill existing gaps.

In short, the Director-General should come with the clout to force decisions on countries at times of blockage in the name of common sense. The UK and Brexit should be working hard to identify this person.

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