Customs union membership is no way out of the Brexit trap

Insight
John Springford
16 December 2016

On the face of it, remaining in the customs union would be the best way to minimise the economic costs of Brexit while ‘taking back control’. But the customs union and the single market are not easy to disentangle, and the EU-27 would demand a high price for an arrangement that eliminates costly customs charges and checks.

Theresa May is in a difficult spot, caught between minimising the economic fallout from the referendum and the people’s desire to ‘take back control’, especially over immigration. Her decision to prioritise ending free movement and the supremacy of EU law means that the UK will probably leave the single market. But she has not ruled out membership of the EU’s customs union, which combines tariff-free trade between Britain and the EU-27 with a common external tariff on goods entering the Union. Since Turkey is a member of the customs union, and does not have free movement with the EU, some hope that remaining in the customs union might offer a ‘soft Brexit’ that is compatible with ‘taking back control’. But the problem is that the line between the single market and the customs union is not as neat as many people think.

Membership of the customs union appears to be more compatible than the single market with the British demand for national policy discretion and controls on immigration from the EU. The purpose of EU law, which underpins the single market, is to remove regulatory barriers to trade, investment and migration. EU law also creates certainty that companies’ and workers’ economic rights will not be taken away by member-states, that they will not engage in regulatory competition or that they will not subsidise domestic companies at the expense of foreign ones. But a continued stream of EU law is not needed to regulate tariffs: the UK and the EU-27 could sign a customs treaty that simply continues tariff-free trade between them and the common external tariff on goods imports to the UK. This would mean that, in theory, the web of goods supply chains that criss-cross the English Channel and the Irish border would not face disruption from delays, form-filling, tariffs or rules of origin, which determine whether tariffs should be charged on goods that have significant content imported from outside the EU. Oxford Economics, a consultancy, reckons that continued membership of the customs union would reduce the long-term cost of Brexit by 0.5 per cent of GDP.

But a one-off treaty would not be enough to stop customs barriers from being imposed. In order for British goods exports to be sold in the EU without customs checks, they would have to be made to EU standards, and there would have to be mutual recognition of the British and EU agencies that check that goods are made to these standards. Otherwise they would have to be tested and certified by officials in the EU. This leads us back to the single market – the EU-27 will demand that UK goods are subject to EU rules and standards if Britain is to retain customs union membership.

Any informal agreement that British rules will be equivalent to EU ones would not do. Turkey, which is in the customs union, but not formally in the single market, has signed up to large swathes of the EU’s acquis communautaire. Switzerland, which is outside the customs union, but has a series of bilateral agreements to reduce barriers to goods trade, has a comprehensive mutual recognition agreement with the EU. The EU allows Swiss authorities to check that goods are made to EU standards, and then those goods may cross the EU border unhindered, as long as tariffs have been paid on any imported content. But the Swiss-EU mutual recognition agreement is only so comprehensive because it has agreed to comply with EU rules and standards, pay a financial contribution to the EU, and accept freedom of movement.

Thus, in practice, the UK would need to sign up to both the single market acquis governing goods trade and the customs union to keep trade free from customs charges and checks. And were the UK to stay in the customs union but leave the single market, it would not have much control over trade deals. The EU would retain the power to negotiate tariff reductions on imports with other countries, and the UK would have to comply with the EU’s agreements. This would cause a domestic political problem for Theresa May; Brexiter globalists would kick up a fuss. But it would also have some economic effects. The benefits of trade deals are often exaggerated, and may not be enough to offset the cost of leaving the customs union. But the UK’s advantage in services – which now make up more than 40 per cent of total exports – means that services trade policy is unusually important, and Britain would lack the ability to open its goods markets in exchange for other countries opening their services markets. In short, without control of goods tariffs, the UK would have less negotiating power over services trade.

Customs union membership would also force the UK to try to copy EU trade deals with other countries. Turkey must offer countries with an EU trade deal tariff-free access to its market. But those countries are not bound to reciprocate, and may charge tariffs on Turkish exports unless Turkey manages to negotiate its own bilateral deal. Turkey has managed to copy some but not all EU deals. It has not yet finalised an agreement with Mexico, while the EU’s FTA with that country came into force in 2000. So Turkey must let in Mexican goods imports without charging tariffs, while Mexico does not return the favour.

Again, this asymmetry would not just be a political problem for a government that has championed the benefits of bilateral trade deals with countries outside Europe. While a US-EU trade deal seems impossible after the election of Donald Trump, the negotiations might be revived in the future. And the EU and the US would negotiate it based upon their interests, not the UK’s. If the US had tariff-free access to UK goods markets through the customs union, it would have less incentive to conclude a UK deal that opened US markets to British exporters.

Given the political difficulties, customs union membership seems an unlikely outcome in the long-term. But it would be a sensible arrangement for a transitional deal to cover the period between the Article 50 divorce, which will probably happen in 2019, and the long-term trade deal, which will take several years to negotiate. It will take the UK and the EU-27 time to organise customs and compliance systems capable of dealing with the huge volume of trade between them. A ‘hard’ Irish border with customs and passport checks could cause political trouble in Northern Ireland, because the nationalist party Sinn Fein may use it as a pretext to renew its push for a united Ireland. Such a border would certainly impose significant economic costs on the province, which is one of the UK’s poorer regions. But the question remains what price the EU-27 would demand for such a transitional deal, in the form of signing up to EU rules, payments to EU coffers, or free movement.

The best thing for the British economy, short- or long-term, would be for Britain to stay in the single market and the customs union. But a comprehensive long-term customs union arrangement would require Britain to sign up to EU laws (though fewer than now); would give it less power over its trade arrangements than it has as an EU member; and the EU-27 might insist that free movement continues. There is no easy way out of the trap Britain stumbled into on June 23rd.

John Springford is director of research at the Centre for European Reform.