The UK option

The UK option: An advanced UK–EU Free Trade Agreement, while addressing some of the costs of EU membership, would fail to secure vital benefits for business

Each of the previous options provides useful lessons about the alternatives other countries have chosen for their relationship with the EU. All of them have significant drawbacks and do not provide the relationship with the EU that the UK – the world’s sixth-largest economy – requires in order to pursue its global trade ambitions. Were the UK to leave the EU, it is not likely to adopt an off-the-peg solution; rather, it would negotiate a bespoke relationship with the EU, reflecting its unique economy. The final option that should be considered is therefore a ‘UK option’ seeking to keep a relationship with the EU through an ambitious UK–EU Free Trade Agreement.

It is possible to set out a ‘best-case’ scenario if the UK were to leave the EU, incorporating the best aspects of all the alternative models, and analyse what would be possible to achieve and whether this would be better for British business than the type of relationship the UK currently has with the EU.

Advocates argue that, rather than replicate existing models – after all, the UK is not Norway, Switzerland or Turkey – the UK should be seeking its own unique deal, one that suits British business for jobs, growth and trade by repatriating UK competence on regulatory issues from Brussels while at the same time preserving the benefits of EU membership in terms of market access. The argument runs that the UK is more than capable of negotiating a bespoke deal that maintains market access without the membership fee.

Given the high level of economic integration between the UK and Europe, which has deepened since the UK joined the EU, as well as the importance of intra-industry and regional trade for reasons explained in Chapters 1 and 2, the UK is highly likely to secure a Free Trade Agreement with the EU, and such an agreement would be likely to be negotiated at an extremely high level of ambition relative to other FTAs.

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The EU is not likely to give any country a deal that in practice is better than EU membership with all the advantages and none of the costs.

However, negotiations would not be like any other trade negotiation: the UK would be trying to strike a deal with the very organisation it had just exited. Unusually, the ambition for negotiators would be to protect the level of openness that the UK and EU already share, rather than seeking to break down existing trade barriers. Whether negotiators would be successful in doing that would rely on the nature of UK withdrawal from the EU. A withdrawal could be constructive and diplomatic, but it is more likely that some level of political fallout could be expected among EU leaders and, even if dealt with diplomatically in public, this could easily be felt at the negotiating table. Poland’s Foreign Minister Radek Sikorski argued in The Times: “If you believe Britain could negotiate a trade deal that preserved all the advantages of the Single Market without any of the costs of membership. Don’t count on it. Many states would hold a grudge against a country that had, in their view, selfishly left the EU”.[54]

Nevertheless, looking at the long-term and factoring in the likelihood of political fallout from a British withdrawal, it can be assumed that the UK and EU would seek to negotiate some sort of Free Trade Agreement, given the economic importance of securing such an agreement for both the UK and, to a lesser extent, the EU. However, as  Sikorski implies, the EU is not likely to give any country a deal that in practice is better than EU membership with all the advantages and none of the costs. That would undermine the very existence of the EU and could provide an economic incentive for other members to consider withdrawal options as well.

Chapter 3 detailed how the EU’s size and clout makes it better positioned than the UK to sign deep and ambitious FTAs with third countries. The same argument would apply were the EU negotiating with the UK regarding a bilateral FTA and there are a number of factors that give the EU a stronger negotiating hand in any future trade talks between the two parties:

  • The EU28 (excluding the UK) has a 445 million market, compared to the UK’s 63 million, while its economy is almost seven times the size of the UK’s.[55]
  • The UK is more dependent on the EU for its trade than the EU is on the UK. Around half of the UK’s total trade is with the EU, while just 8% of EU trade is with the UK.[56] The fact that the UK happens to run a deficit in exports with the rest of the EU is much less relevant in terms of which economy is more dependent on the other than the relative proportion of total trade for each.
  • The open-market, free trading philosophy in the UK would likely lead to a default position on exit of low tariffs for all its trading partners (its WTO ‘Most Favoured Nation’ (MFN) bound and applied tariff rates). This would mean that, during UK–EU FTA negotiations, the EU may not feel pressured into lowering its own tariffs towards UK business, because it could (reasonably) assume that the UK would – no matter what the terms of the UK–EU FTA – pursue a unilateral open-market policy to all trading partners, including the EU.

Tariff-free access for the UK in goods and services would not be straightforward

A key demand from British business with a UK–EU FTA would be to retain market access to Europe. For goods trade, most FTAs, particularly those negotiated by the EU, substantially decrease or eliminate tariffs, and so a UK–EU FTA could be expected to also include such measures. However, while a zero tariff on all UK–EU goods trade would be the optimal outcome for business protecting the existing level of market access for UK goods to the EU and vice versa, this could not be guaranteed, and it should be noted that all EU FTAs, even the most ambitious such as EU-Korea, include exceptions from full tariff elimination and therefore do not provide complete coverage. 

As a result, simply to achieve duty-free access in an FTA between the UK and the EU, something that many people assume would be a given, may not be straightforward and would actually set a new gold standard that has not been fully replicated by any EU FTA partner, or by Norway, Switzerland or Turkey in their respective models. Even in Turkey, where a customs union with the EU is in effect, agricultural goods are not included within the scope. Furthermore, following UK exit from the Single Market, UK goods exports would be met with increased border bureaucracy and, as with the Norway and Swiss options, burdensome rules of origin would be necessary.

For market access in services, it would be in the UK’s interest to secure a very ambitious agreement to ensure minimal disruption to services providers across all sectors, building on the WTO GATS framework. However, services trade negotiations are extremely complex, because the provision of services exports not only relies on the ability of a company to provide a service ‘cross-border’ from a base in the UK (e.g. to provide legal advice via phone or email) but can also rely on the ability of a service provider to set up an office overseas (Mode 3 – establishment overseas) or to ensure that its staff can physically move across borders (Mode 4 – temporary movement of persons).

In order to preserve the same benefits as the UK currently gets from EU membership in terms of services trade, noting in particular the freedom to provide cross-border services as set out in Article 56 of the Treaty on the Functioning of the European Union (TFEU) and the freedom of establishment in Article 49 of the same Treaty, as well as the 2006 Services Directive and the ECJ’s role in enforcing the directive, the UK and EU would have to negotiate an FTA that goes way beyond any other EU FTA that has been negotiated to date. While such an FTA may set a world standard globally, with – in a best-case scenario – more sectors fully covered under ‘right of establishment’ and longer permissible temporary movement of persons than seen before in other FTAs, this would still represent a severe deterioration from the status quo, even accounting for the incomplete nature of the current internal market for services.

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The UK would no longer be in a position of strength in FTA negotiations with key trading partners.

Furthermore, there could be practical restraints that prevent the EU from agreeing to such a high level of ambition, even if this was the desired outcome. For example, in the EU–Korea FTA, there are clear provisions implying that, were the EU to negotiate more ambitious commitments on trade in services  with another FTA partner, those benefits would have to apply to Korea as well (unless as part of a regional agreement). Consequently, even if the EU was to agree to very ambitious FTA commitments on trade in services with the UK, it would have to open up these benefits to its other FTA partners as well, which could present problems for the EU, especially given that the pro-free trade voice inside the EU itself would have been weakened considerably following the UK’s departure from the EU. To avoid this, the EU could adopt an approach whereby it offers the UK the same terms as its model FTA partners, which cannot be compared to the current internal market for services.

Securing full market access requires regulatory convergence

The ‘going it alone’ WTO option clearly highlighted how the potential creation of new non-tariff barriers would be a major concern if the UK was to leave the EU, and a key focus of a UK–EU FTA would be to minimise future regulatory divergence on issues that can be closely linked to trade (as opposed to EU employment law, for example). With the EU responsible for nearly half of UK exports, the last thing that UK companies want is to produce a good or provide a service that meets UK regulatory requirements, but not EU requirements.

To avoid this from happening on many key regulatory issues, there is a huge risk that the UK would get pushed into being a ‘standards taker’, forced to align its own regulatory standards with the EU on issues such as safety standards and environmental regulations, yet would lose influence over how the EU rules are set without a say in the EU Council, Commission or Parliament.

There are provisions in other EU FTAs backed up by dispute settlement procedures that do seek to prevent new NTBs from arising. In modern EU FTAs, action to reduce existing NTBs that constitute a major trade barrier with a third party are increasingly important for the overall success of negotiations (the ongoing EU–US and EU–Japan negotiations are set to be major examples of this). However, commitments made on NTBs between two parties cannot be compared to the common laws and standards that exist inside the EU. The EU would not be likely to open its borders for British goods and services unless these standards were deemed to fulfil rules of equivalence, which could be established in three ways:

Following EU rules: The UK could continue to voluntarily adopt EU rules as they are outlined by the EU. This would mean that any regulatory burden would remain as if the UK were still a member, as happens to Norway.

A system of equivalence: The UK might be able to negotiate a system where the EU would acknowledge UK national laws as equivalent to its own. Such a regime – in principle the same as the EU’s own principle of mutual recognition – would, of course, have to be constantly updated as EU law changes. If a UK regime was thought outdated, market access would be at stake until the UK could satisfactory prove equivalence was restored. This system would, however, mean that the final decision of whether UK rules are ‘equivalent’ would be up to the EU and could therefore fall victim to politically motivated assessments.

A system of independent authorities: The UK and the EU could set up independent authorities similar to that of the EEA to authorise and monitor whether the UK’s regime is equivalent. This would take some of the powers away from the EU, but an independent body would be likely to involve costs. Moreover, for the EU to trust the body, it would have to be empowered with enough resources and powers to keep the UK’s regulatory development in line with the EU’s. In this scenario, the UK would find itself supervised by another body, which would not address the concerns of those arguing that leaving the EU would give the UK more power to set its own rules.

The UK would have an independent trade policy but suffer dislocation of market access as it negotiated many new agreements simultaneously, with no guarantee of securing market access on favourable terms

As with the Norway, Swiss and WTO options, being outside the EU would enable the UK to pursue its own external trade agenda, with the potential opportunities, risks and limitations that this entails. The UK would be able to pursue its own FTA negotiations with the trading partners it chooses, and could take forward its own strategy, factoring in its historic ties and long-term economic interests.

However, there remains an open question as to what would happen to EU FTAs with other third countries that are currently applied to UK businesses. At some point, perhaps after a short transitional period, these FTAs would have to be renegotiated, and the uncertainty around this issue is a key cause for concern for many exporting businesses. It would take time for the UK to first regrow the capability to negotiate FTAs and there would be a period of dislocation – perhaps for many years – while new UK bilateral deals were finalised.

PIn addition, the UK would no longer be in a position of strength in negotiations with key trading partners. Depending on the commitments it takes at the WTO on a multitude of trade issues (for example, the applied and bound MFN tariff rates it sets, its commitments under GATS and the GPA), the UK would not necessarily have much to ‘trade off’ in a negotiation, which could make the practical feasibility of concluding negotiations to get the best result for Britain increasingly difficult. Furthermore, the UK would become one of nearly 200 other WTO members when pushing its issues on the multilateral agenda and when defending its borders from trading practices by third countries that were inconsistent with WTO rules: its influence on global trade and related economic matters on the international stage would inevitably decline.

Investment is likely to drop, even with a deep Free Trade Agreement, and the impact on the UK’s financial services sector would be significant

In the event of a British exit, investment and capital flows would be likely to be disrupted as the legal basis for the UK investing in the EU, and vice versa, would change. Article 49 of the TFEU on the freedom of establishment would cease to apply, and the UK would need to secure new commitments protecting the ability for UK companies to invest in the EU with legal certainty, across all sectors.

Typically, EU FTAs do include provisions on capital movement – for instance to ensure that payment operations remain unrestricted and that transactions related to direct investment remain free of restrictions – although there are also clauses allowing for time-limited safeguard measures in case of serious difficulties for the operation of monetary and exchange rate policy.

48% vs 8%

Percentage of exports for the UK and EU respectively dependent on the other

A major concern, however, is that, even with a very ambitious UK–EU FTA that incorporated the above commitments and very ambitious provisions on ‘right of establishment’ to permit UK companies to attain the same equity stakes in other European companies as is possible today (and vice versa), there could still be a net capital outflow in this scenario, with overseas investors preferring to relocate their activities within the EU trading bloc.

It is possible that the City could remain as an offshore capital market for some EU companies. However it is more likely that, over time, rival capital markets inside the currency area would emerge and there would be political pressure following UK withdrawal from the EU in this direction to restrict EU dependence on the UK.


References

[54] Radek Sikorski in The Times, Seven EU myths you should never believe, 25 September 2012, available at thetimes.co.uk

[55] In Euro terms. Haver Analytics EUDATA & G10 databases/Eurostat

[56] ONS Pink Book 2013; Eurostat balance of payments database.