The WTO option

The WTO option: ‘Going it alone’ through the WTO would reduce market access through increased tariffs on UK goods and services

After leaving the EU – its obligations and benefits – the UK could refrain from entering into any formal relationship with the EU and simply rely on the global multilateral trading system through the UK’s direct membership of the WTO, pursuing its own external trade agenda. In reality, however, the ‘WTO option’ alone is not sufficient: free movement of capital would technically remain, but in practice capital flows would be hit; regulatory compliance with EU rules would be likely to continue to avoid non-tariff barriers arising; and trading with third countries would require lengthy negotiation over access.

Advocates argue that the UK’s economic strengths and global power makes it well placed to ’go it alone’ in trading with emerging markets. They argue that relying just on the WTO would provide the benefit of absolute flexibility to trade with whomever the UK wished to trade without having any regulatory burden from the EU. This would enable the UK to refocus its trade away from Europe and towards emerging markets and historic ties with the Commonwealth. The UK could also continue to take a lead in driving the multilateral trade agenda. Leaving would also help the City, according to proponents of the ‘WTO option’ as freeing the services sector from the EU’s regulatory burden would give the UK a stronger base to become a hub for Middle East, Far East and emerging markets’ business.

Access to European markets on WTO terms would hit British exporters and importers with tariffs

Under the WTO framework, the key principle of non-discrimination requires members not to treat any trading partner less advantageously than any other, unless covered by a free trade agreement or laws giving developing countries preferential access.

For goods, this means that tariffs applied to the ‘most-favoured nation’ (MFN) must apply to all other countries too. The EU could therefore not apply discriminatory or punitive tariffs after a UK exit above or below its MFN levels. As Exhibit 62 shows, the EU’s average MFN tariffs have fallen consistently over time, and so the WTO framework would prevent the tariffs imposed on the UK from being as high as they would have been 20 or even 10 years ago. Nevertheless, new tariffs of economic significance would still be imposed on around 90% by value of the UK’s goods exports to the EU, causing most UK exporters to become less price competitive than their EU competitors or companies from countries with which the EU has signed FTAs.

Exhibit 62: EU external tariffs have fallen consistently since the early 1990s

If the UK – having negotiated in the WTO as part of the EU – were to inherit the EU’s common external tariffs as a starting point for its own tariffs, companies importing from the EU would be hurt as import tariffs would rise from the zero level for intra-EU trade to the level of the EU’s external tariffs. The implications of a move to an MFN trading arrangement for exporters and domestic consumers would vary considerably by sector. For instance the UK runs a £2.9bn trade surplus on liquefied natural gas that would be hit by a 4.1% tariff.

Trade in services between the UK and EU would also be governed under a WTO framework, the WTO General Agreement on Trade in Services (GATS). Under this agreement, all WTO members again have to respect the principle of non-discrimination, and varying levels of binding liberalisation commitments are made by WTO members in individual services sectors. As a ‘stand-alone’ WTO member, the UK would be faced with the same level of access to the EU services market as all other WTO members in line with the EU’s GATS commitments – a much lower degree of access to the free movement of services which is a central facet of the Single Market enshrined in the EU Treaties.

As tariffs and quotas have become less prevalent barriers to global trade, non-tariff barriers have become increasingly significant (see Exhibit 63). For example, a direct consequence of leaving and not preserving a common regulatory agenda with the EU would be that regulatory divergence would creep in over time and British businesses could face new non-tariff barriers that would harm trade with the EU.

Exhibit 63: The imposition of barriers to trade on UK exit from the EU

On exit from the EU, British businesses could face new barriers to trade such as burdensome customs procedures, discriminatory tax rules and practices, duplicate technical regulations, standards and conformity assessment procedures, sanitary and phytosanitary measures (SPS) and barriers to FDI.

According to a House of Commons note, market access for UK services exports would be “far more limited” were the UK  to leave the EU and not retain access to the Single Market.[2] This would hit the UK’s best-performing category of exports to the EU, which expanded 43% in real terms in the decade to 2012.[3]

No longer a member, UK firms would thus not have the right of commercial establishment which is guaranteed under EU Treaties and which significantly facilitates trade in services provided via the commercial presence of a foreign firm.

Firms enjoying passport rights – the right to establish in another member state while continuing to be regulated by the authorities in its home country – are likely to be affected. Several other restrictions forbidden within the internal market, such as different documentation rules or testing requirements, still apply to third countries and would therefore apply to the UK.

It is worth noting that British business operating in the EU, and European companies in the UK, might be partially protected by the ‘acquired rights’ principle, which allows a number of rights to be retained on withdrawal under international law.[4] However, there are many uncertainties linked to this principle, both whether it would be applicable in this particular case and to what extent rights might be sustained over time as the EU continues to change. 

By leaving the EU, UK firms would also lose a channel for settling disputes. If a UK firm today meets unlawful trade barriers in another member state, it can complain to the European Commission and, as a last resort, take the case to the European Court of Justice. Outside the EU, the UK would have to rely on WTO dispute settlement, which business experience suggests is less efficient and more politically charged than the EU’s settlement system.

The ‘WTO option’ would give the UK power to pursue FTA negotiations with any country of choice, but this freedom is offset by the risk of a period of dislocation and less advantageous deals

On exit, the UK would no longer have any other trade agreements because its agreements with other countries are negotiated through the EU. Although they are so-called ‘mixed agreements’, which need the consent of member states, none would be applicable to the UK without renegotiation upon withdrawal.

This would mean that the UK would neither have agreements with South Africa, Colombia, Korea, Norway, and Mexico nor be party to the potential future FTAs with the US and Japan. It would therefore have to start renegotiating the 30 agreements currently in place depending on the strategic priorities of its industries. Companies dependent on trade in these markets would face a period of uncertainty and dislocation until new agreements were settled, which would depend on how the UK managed to set up and drive through its own trade agenda in a competitive world. The increased flexibility would mean that the UK could, if it wanted, prioritise FTAs with countries currently missing from the EU’s ‘completed FTA list’, including Australia, Brazil, India, Russia and China.

In practical terms, to begin to pursue its independent trade agenda, the UK would first have to build up national capacity to replace its current predominant reliance on the European Commission for trade negotiation expertise; it is more than 40 years since the UK itself negotiated a bilateral trade deal, and FTAs have become increasingly complex to negotiate in that time. Moreover, the government would face significant pressure during the first few years given the sheer number of trade agreements necessary to avoid interruption in trade for businesses.

Beyond the practical short-term challenges, there are also a number of substantial risks relating to attempting to sign global trade agreements outside the EU. It is not certain that partner countries would prioritise negotiating agreements with the UK, nor on what terms they would negotiate. The time it would take is also unclear.

On the one hand, as was pointed out in Chapter 3, it is likely that starting FTA negotiations would be quicker as the UK would no longer have to agree priorities between 28 member states. However, on the other hand, the UK is a substantially smaller market with less to offer to potential partners in negotiations than the EU, which alone contributes a quarter of world GDP. Whether the UK has enough to offer could impact on the quality and depth of the FTAs the UK could manage to secure.

The draw of greater access to the Single Market allows the EU to conduct negotiations from a position of strength, which is ever more critical given that many trade barriers are increasingly difficult to get at, are often attributable to divergent regulations and standards, and can require political commitment and engagement at the highest level to achieve positive results. Critically, any commitments that could be secured on non-tariff barriers, such as standards convergence, would be of less benefit to UK exporters than if such benefits could be secured on an EU basis.

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The ‘WTO option’ would see new tariffs imposed on around 90% by value of the UK’s goods exports to the EU.

In many sectors, the EU has been a leader in advancing regulatory harmonisation at the global level, and it has pushed key trading partners to recognise global standards or ‘equivalent standards’ in EU FTAs. This has opened up possibilities for UK producers to manufacture a product which is fully compliant with product regulations both in the EU and in overseas markets, such as Korea. However, in the UK stand-alone scenario, it is very difficult to envisage how the UK could seek to break down such long-standing regulatory barriers except on the basis of common standards with its most important trading partner – the European Union.

It is worth noting that the UK’s global trade and market penetration does not rest exclusively on the existence of FTAs. For example, UK trade with China and Russia currently takes place without an EU FTA, meaning that market access would not be directly harmed through dislocation by the UK withdrawing from EU. However, given German export performance to China – selling four times more than the UK – under the same de facto market access parameters as the UK, there is little to suggest that leaving the EU would immediately result in an uplift in trade to these nations.

In the short run leaving the EU is not likely to reduce the availability of capital to companies, but lack of market access may decrease investment over time

Capital movement is the only freedom going beyond the boundaries of the Internal Market, as it also covers the movement of capital between member states and third countries. From 1 January 1994 all restrictions on capital movements and payments between EU member states were prohibited, as were restrictions between EU member states and third countries. Therefore, in the short run, operating under WTO rules would not remove companies’ rights to move capital between the UK and EU.

However, for one of the worlds’ largest financial centres, the City of London, leaving the EU would involve a number of risks (for further detail, see Exhibit 66 in “The UK option”). The UK’s financial services sector is closely linked to the EU: the UK accounts for 74% of the EU’s foreign-exchange trading and 40% of global trading in euros, 85% of the EU’s hedge-fund assets, 42% of its private-equity funds, half of its investment bank activity, and half of its pension assets and international insurance premiums.[5] Losing access to provide financial services in the Single Market on equal terms to companies from other member stateswould risk eroding the City’s position over time. The UK could still seek access as a third country provider of financial services, but lack of ‘passport’ opportunities and the added costs of ‘equivalence’ – where the EU gives the UK market access only once it has determine that UK rules are as strict as EU rules – would mean a substantial risk of losing out to competitors in Frankfurt or Paris.

Beyond the City, operating under WTO rules alone would impact on investments into the UK. The direct impact on FDI from an exit from the EU is hard to analyse. Investments are made for a number of reasons, and while a number of firms see the UK’s place in the EU as essential for their investments, others argue that the UK’s legal environment, time-zone and language are the dominant reasons for investment, suggesting that a UK exit would not necessarily harm FDI. Although not explicitly advocating a UK exit – along ‘WTO-option’ lines or otherwise – some analyses such as EY’s 2013 UK attractiveness survey have gone further, suggesting that less integration with the EU might in fact make the UK a more attractive destination for some foreign investors primarily from outside the EU.[6]

Nevertheless, those foreign investments that do depend on UK membership of the EU would decrease over time. For example, investment in companies producing goods that are likely to face tariffs under a WTO regime, such as cars, may well decrease. Moreover, lack of certainty due to trade deals and new tariff regimes could also lead to a period of uncertainty, which is not conducive to investment.   

Leaving the EU would give the UK complete control of its borders, but business would want to see the free movement of people continue

Leaving the EU would give the UK complete control over its own borders. The UK government would have to create a new national immigration policy, deciding who comes in from the EU and on what basis. Similarly, other EU states would be able to determine a new basis for allowing access to UK citizens.

However, many businesses in the UK today are dependent on either sourcing labour from the EU or deploying staff there. This varies across sectors, and therefore the reduced availability of high and low-skilled workers for businesses would be felt differently. It would particularly impact on sectors which currently employ a higher share of EU migrants in their workforce, such as accommodation and food services (9%), manufacturing (7%), financial services (6%) and ICT (5%). [7] A reduction in free movement of labour would be particularly harmful for the exporting services sector, where trade is facilitated by the presence of people in the territory of another economy.[8] Moreover, British citizens could no longer work and travel freely across EU member states.

Some European citizens might be entitled to stay in the UK depending on the acquired rights principles – and their rights could be specified in the withdrawal agreement with the EU – but overall, disruptions to labour flows could seriously impact on the ability of British business to fill skill shortages, bring the best talent to the UK or deploy staff abroad.

The UK could repeal all EU regulations, but the need for continued trade would point against doing so

Leaving the EU would free the UK from all its obligations to the EU, including implementing and following its rules. Companies exporting to the EU would still have to comply with EU product standards. Companies operating just in the UK would only have to comply with UK rules, while firms exporting elsewhere would only have to comply with the relevant rules of their trading partners. This could be a benefit if EU standards are perceived as costly to implement, reducing the cost of domestic production and non-EU exports.

However, this diversification of standards between companies in the UK could mean a reduction in overall exports. Some companies are set up to export and would therefore align their products to the relevant rules, whether they are European or global. But, although these ‘born global’ companies are increasing, most companies move from the domestic to a global scene. A company wanting to export to the EU would find the move more difficult if their processes and products were not already aligned with EU rules. The freedom to choose simpler domestic rules therefore becomes a disincentive to export. This is especially true for small and medium-sized firms, and could harm UK ambitions to boost the export performance of SMEs.

Added to this, the impact of leaving the EU would be felt differently across legislative areas - and would depend on the government in power. It is not a given that the UK would remove all legislation. In some areas, such as employment law, an exit is likely to spur a debate about the direction UK legislation should take outside of the EU. The UK government would face pressure from businesses to repeal or amend certain elements of more controversial laws, like the Working Time Directive or agency worker regulations, but not all elements would be removed as a significant amount of legislation is broadly supported by many parties. Taking the example of the Working Time Directive, few employers believe that paid rest breaks or holiday should be scrapped, nor do employers believe workers should lose the choice over the hours they work. It is thus clear that the current burden of regulation would not be wholly lifted outside of the EU.

In certain areas, the UK has been driving EU legislation and would be likely to keep the current rules, and possibly even go beyond in areas where the EU has restricted UK legislation. In other areas, rules have come from international commitments – such as those signed up to as part of the G20 – where the UK would remain a signatory even on exit. For instance, in financial services the UK has both pushed reform via interational channels and taken a lead domestically and, as a House of Commons Library paper on an EU exit found, it is likely that a significant amount of this legislation would remain in place after a withdrawal – including the majority of rules on capital requirements and obligations on the clearing of over-the-counter derivatives .[9]

Operating under WTO rules would free the UK from EU budget contributions, but the network benefits of European projects would be lost and the UK would lose influence over where the EU targets funds

Leaving the EU would mean that the UK would no longer have to contribute to the EU’s budget, saving the country £7.3bn a year. The UK would need to set up new funding arrangements in a number of areas based on UK priorities, but this would both take time and create winners and losers, as many UK businesses, regions and other stakeholders receive EU funding.

There are parts of the UK that are current net recipients of EU funding, such as Wales, where there is a large agricultural sector and many areas are eligible for the highest level of regional funding. Wales currently receives £163 per head, compared to the £123 per capita contribution from the UK to the EU budget. Based on 2009 figures, Wales would lose around £207 million in structural funding and £290 million in agricultural funding upon an EU exit. England, on the other hand, receives £52 per capita which means that it is a net contributor, and it would therefore gain from an exit. It would be possible to fund any regional or agricultural subsidy programmes using the dividends from net contributing regions, but the UK would lose the benefits of pan-EU research and funds.

Being outside the EU would remove all formal tools of influence over EU strategies and policies and severely limit informal influence channels

Leaving the EU would mean no voting power at the Council, no MEPs in the Parliament, and no absolute right to staff in the Commission. While the UK could still seek to build alliances to influence European decisions, its negotiating position would be seriously weakened. The UK would speak for itself rather than through the EU in a number of global bodies – including the WTO – so in theory would be able to exert influence on the EU and global trading rules unilaterally. However, the UK’s absolute influence in those forums would, in practice, likely decrease; it may be able to voice its objections more noisily alone, but it would be less able to achieve concrete results in shaping the agenda in these institutions, in part because it would lose its large voting weight that allows it to currently anchor alliances and push  UK interests more widely.

Being outside would mean a loss of influence over Europe’s future and its rules. But the UK would no longer have any influence over the rules and standards that ultimately companies would have to apply to sell and operate in the EU. As many UK companies would still be dependent on trade with the EU for the reasons set out in Chapter 1, this lack of influence would be a disadvantage.

Relying solely on WTO rules would not give the UK an overall better deal than EU membership

'Relying on WTO rules is not a model that would assist the UK in achieving the global trading role to which it aspires. There are some advantages, but these benefits would come at a substantial cost to the economy as a whole and for a number of key sectors in particular.'

As the analysis shows, ‘going it alone’ would give the UK the flexibility to design its own framework for trade, capital, labour and funding. Moreover, the UK would no longer have to pay into the EU’s budget or directly apply EU rules at home

However, British exporters and importers – and those in their supply chain – would face tariffs and non-tariff barriers reducing competitiveness in European markets, particularly harmful in services sectors such as financial services. The UK would also be likely to continue implementing EU rules in many areas to ensure that products were allowed into European markets. The UK would have less influence over the making of these rules, making Britain a standards taker. In other areas, the UK government would be likely to continue to regulate and, as in several cases in the past, it may even go beyond the EU level, applying stricter rules to its own industries and reducing their competitiveness.

The UK would gain the ability to negotiate its own FTAs, but is likely that it would struggle independently to get the agreements on its own that truly open up markets for British business. The UK’s £9bn budget contributions to the EU would end, but universities and companies would lose access to innovative European networks. The threat of tariffs combined with a likely reduction of FDI in the medium term, the risk of capital restrictions harming the City, and reduced flexibility for companies in accessing European labour markets make the WTO option an unattractive model for the UK.

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Relying on WTO rules alone would not work for the UK. Any limited advantages are easily outweighed by the significant costs to the economy as a whole

Accesibility Info

References

[2] House of Commons Library, ‘The economic impact of EU membership on the UK’, September 2013

[3] ONS Pink Book 2013. Export values are converted to constant prices using the UK GDP exports deflator (ONS).

[4]House of Commons Library, Leaving the EU, Research Paper, 1 July 2013

[5]TheCityUK, Key Facts about UK Financial and Professional Services, 2013

[6] EY 2013 attractiveness survey, No room for complacency, 2013, available at:

[7] House of Commons Library, The economic impact of EU membership on the UK, September 2013

[8] House of Commons Library, ‘The economic impact of EU membership on the UK’, September 2013

[9] House of Commons Library, Leaving the EU, Research Paper, 1 July 2013