4“No deal”—Trading under WTO rules alone
Introduction
131.As we have noted, the Government is confident that it will get the agreement it wants with the EU27 by 2019 because such an outcome will be in the interests of both parties. However, as we have also noted, the Government has stated categorically that “no deal for the UK is better than a bad deal for the UK”.171 Consequently if no UK-EU FTA, or set of transitional arrangements, is in place by 2019, the UK will have to trade with the EU under WTO rules alone.172 (Furthermore, the UK will also have to trade with all of the rest of the world on the same terms if there is no “grandfathering” of EU FTAs, as we discuss in Chapter 5.)
Unilateral options
132.Trading under WTO rules alone is an option only in the sense that it is the “default option”, a fallback position in the absence of any other trading arrangement. Nonetheless, it would provide the UK with a degree of choice in respect of unilateral actions that could be taken.
133.As we have noted, MFN “bound” tariffs constitute a maximum or “ceiling” to which WTO members must adhere. Actual (or “applied”) tariffs can be set at lower rates, right down to zero, on a unilateral basis (i.e. irrespective of whether or not other WTO members are willing to reciprocate). It has been argued that the UK, once it is no longer an EU member, should adopt a unilateral free-trade model, removing all tariffs on imports, as some WTO members (for instance Singapore) have done. This approach has been promoted by one of our witnesses, Professor Patrick Minford of Cardiff University. Under this arrangement, the UK would not prioritise the seeking of a trade agreement, with the EU or anyone else. UK exporters would simply have to pay the tariffs imposed by the countries in which they sell their products. Professor Minford argues that this will result in a 10% fall in the cost of imported (manufactured and agricultural) goods. This is because, he argues, although the EU’s CET (which the UK must currently adhere to as a member of the EU) is on average 3%, once non-tariff barriers are taken account of, it actually amounts to 10%.173
134.This approach was criticised by others. In evidence to us, Dr Swati Dingra, of the Centre for Economic Performance at the London School of Economics (LSE), said that:
Professor Minford’s numbers rely essentially on comparing goods prices across different OECD countries, and it turns out that the UK, Netherlands, Belgium and Germany […] tend to have much higher prices for comparable goods compared to the rest of the OECD countries. What Professor Minford’s work does is attribute that to protectionism. What I am going to argue is that, in fact, that is not correct. […] That difference in prices cannot be attributed just to protectionism. It has to be attributed, at least partially, to differences in quality, which are good for the consumers, potentially, if they are willing to pay for it.174
135.Professor Minford, however, defended his hypothesis, saying that: “The price indices we use, which are aggregated across broad sectors, are based on very authoritative consumer price indices from the UN, national statistical agencies and so on. They have all been screened for quality.”175
136.Both proponents and opponents of the model agreed that by increasing imports of goods to the UK, unilateral free trade could have a negative effect on at least some parts of the manufacturing sector, although opinions differed on the effect on the economy as a whole. Professor Minford told us that:
manufacturing would be subjected to competition. The metal-bashing element, the pure making element, would reduce substantially and those industries doing that would go up the value-added chain and become more and more high tech.176
The British Ceramic Confederation took a negative view of the effect on manufacturing, saying that:
The basis of the “unilateral free trade” model is a hypothesis that by importing most of the goods it consumes the UK could focus on services, thereby becoming a more productive economy. This approach, even by many of its advocates’ own admission, would devastate UK manufacturing including in the ceramics industry. Unsurprisingly the BCC and our members would find this approach completely intolerable.177
137.Dr Anamaria Nicolae and Michael Nower, of Durham University, noted that the value of the unilateral free trade model depended on what one valued in the economy:
[I]t would be desirable for the UK to adopt a unilateral free-trade, low-tariff or uniform-tariff approach if […] [the Government] are prioritizing maximising UK productivity growth, consumption, or wages, and minimising UK price growth. However, if the UK government is prioritizing maximizing the number of firms (and hence employment), then adopting such an approach would not be desirable.178
138.A less radical form of unilateral action would be for the UK to reduce or abolish tariffs inherited from the EU that relate to protecting industries which are non-existent or less important in the UK. Peter Ungphakorn noted that “oranges have a very high tariff because the EU tariff on oranges is designed to protect Mediterranean producers”. Consequently, the UK could decide to change this tariff to give UK consumers access to cheaper oranges.179 Tate and Lyle Sugars Ltd suggested that the UK could drop the EU’s high sugar-cane tariffs, which are designed to protect producers that refine sugar from beet (which tend to dominate the sugar industry in a number of EU27 countries).180
139.Another form of unilateral action would be to form Free Trade Zones (FTZs). These are clearly demarcated areas in which goods may be imported, stored, handled, manufactured (or reconfigured) and exported under specific customs regulations (generally without any tariffs being levied). FTZs are typically located at major ports, international airports and national frontiers. The British Chambers of Commerce told us they favoured exploring this idea in depth.181 However, we also heard that FTZs are mainly of benefit for a particular type of industry, in which parts are imported and assembled, and finished products are all exported. For other business models, FTZs would entail costly and cumbersome bureaucracy that would have to be offset against any advantages. There is also the objection that FTZs are unfair in that they arbitrarily grant advantages to some producers but not others.182
Consequences for British exports to EU
Impact of MFN tariffs
140.Trading under WTO rules alone would mean that UK exports to the EU inevitably faced EU tariffs. UK exporters would, other things remaining equal, need to raise their prices, cut their costs or reduce their profit margins in order to maintain their position. It is true that most of the EU’s MFN tariffs are low; the EU’s average applied tariff in 2014 was just 2.7%.183 There are, however, a few significant exceptions (“peak” tariffs): the automotive industry; agriculture; and textiles.
141.Mr McGuire of the CBI told us:
If we fall under WTO rules we will then have to apply tariffs, and in some areas these tariffs can be significant. In the dairy/agri-food sector, it can be up to about 40%. In the automotive and automotive parts sector, it can be 10%. If you are operating in the automotive sector at the moment and have to put your prices up by 10% in a highly competitive, global economy automotive industry that puts UK manufacturers at a significant disadvantage, because we would have to apply the tariffs under the arrangements of the WTO. For us, the no deal and going into the WTO, operating in a tariff world would significantly dent the competitiveness of the UK industry at the moment […]184
142.The SMMT, warned of the consequences for the automotive industry:
[Trading under WTO rules alone] would see the application of a 10% tariff on vehicles and an average 4.5% tariff on components which will increase the cost of production, undermine competitiveness and potentially increase the cost of cars for consumers. SMMT analysis suggests that the UK motor industry faces a £4.5 billion tariff cost for cars alone which could add at least an annual £2.7 billion to imports and £1.8 billion to exports. Import tariffs could push up the list price of cars imported to the UK from the EU by an average of £1,500 if brands and their retail networks were unable to absorb these additional costs185
143.The automotive industry would particularly suffer as a result of its complex supply chains. The fact that some automotive parts cross the UK-EU border multiple times in the course of manufacturing raises the prospect of significant costs due to the compounding of tariffs.186
144.We also heard that the consequences would be significant for British agriculture. The National Farmers Union told us: “The impact assessment produced by the University of Wageningen shows that under this scenario [WTO rules alone] with the full abolition of direct support, farm incomes would fall on average by €17,000 [per year]”.187
145.It should also be noted that the imposition of tariffs would entail interposing a customs border between the UK and the EU, again raising the prospect of a “hard” border between Northern Ireland and Republic of Ireland. The Chancellor of the Exchequer told the Treasury Committee in December 2016 that, in the event of the UK having to trade with the EU under WTO rules alone: “We are talking about something like perhaps five times as many submissions and inspections being required on EU trade”.188 However, in subsequent evidence to the Committee (to which we have already referred), HMRC officials stated that preparations were in hand for the use of electronic systems which would minimise friction at the border resulting from such a substantial increase in customs checks.189 (As previously mentioned, this would apparently also limit the implementation of a “hard border” in Ireland.)
Impact of non-tariff barriers on trade in goods
146.WTO rules do not cover regulatory restrictions, geographic indicators and standards. Consequently, the UK cannot rely on WTO rules alone to prevent the occurrence of this type of non-tariff barrier in respect of accessing the Single Market. The SMMT told us: “WTO rules alone could mean “the prospect of having to certify exports as being compliant with EU rules which will create significant administrative burdens and additional costs”.190
147.The impact of trade friction at the border (and the implementation of a “hard border” in Ireland) in respect of conformity assessment can be mitigated by electronic systems and equivalence of assessment.
Impact of barriers to trade in services
Services in general
148.As we have noted, tariff barriers do not arise in respect of trade in services; in this sector, barriers to trade take the form of regulation. The UKTPO told us that gauging the extent of UK service-providers’ access to the Single Market under WTO rules alone was not straightforward, for a number of reasons:
First, applied services trade policies in the areas of cross-border trade, investment, and movement of people are typically more liberal than the EU’s commitments under WTO’s General Agreement on Trade in Services (GATS) prescribe. Second, unlike for goods trade, there is no uniform EU services trade regime for suppliers from outside the EU. Hence, upon leaving the EU, access for UK service providers will deteriorate in ways that differ across EU member states, sectors, and modes of supply.191
Professor Winters of the UKTPO told us in oral evidence that a third complicating factor was the complex interaction of the four different modes of supplying services on which the WTO’s rules are predicated.192 However, bearing in mind these provisos, he was able to tell us that:
If we dropped back to so-called World Trade Organization rules […] [UK service-providers’ access to the Single Market] would not be what is written down in the [EU’s WTO] schedules. It would be something more liberal, but it would be considerably less liberal than what we get at the moment in the single market. The financial services sector is one where we hear a lot about passporting, but there is a similar sort of regulation, I understand, about broadcasting. As you go through the various sectors there are things that we are able to deliver single market but are clearly not possible if we relied on the MFN position. So, no, I do not think it would just be the same. Most people think it would be very different.193
The Law Society told us that the EU’s schedule of commitments under GATS includes a whole slew of restrictions on legal practice which vary among member states. Some EU jurisdictions operate nationality requirements. In some cases right of audience before EU courts could be lost by UK lawyers. There might also be problems regarding clients’ ability to benefit from legal professional privilege.194
149.We heard from the law firm Hook Tangaza that:
Less than a quarter of the WTO’s 164 Member States have made commitments in legal services and none of those that have, match the quality of the UK’s access to the EU, which is based on full national treatment. Some large countries, such as India, are closed markets; and many other emerging markets severely limit access to foreign lawyers. The US market is fragmented and access ranges from good in some states through to impossible in others.195
Financial services
150.Trading in financial services under WTO rules alone would mean the loss of passporting rights, with no agreed substitute arrangement to fall back on. Thus, as Professor Moloney of the LSE told us, “there probably would not be any difficulty in setting up subsidiaries or branches, but the financial actor in question would be subject to the relevant law of whatever member state they were operating in.” Professor Moloney explained that there would also be another significant effect of trading under WTO rules alone:
[I]f I am a broker in the EU, there are EU rules governing how I interact with the rest of the world. For example, if I want to trade derivatives, let’s say, on a London exchange—and London is our third country—unless the UK has equivalent status, I cannot trade on that market. That is bad for the EU but also troublesome for the UK […]196
151.Mr Heath of the Daily Telegraph told us that the “worst-case scenario” for the City of London as a result of trading under WTO rules alone would be the loss of around 10,000 jobs.197
Overall impact
152.Some attempts have been made to quantify the likely impact on the UK economy of trading under WTO rules alone. The UKTPO told us that: “The Institute for Fiscal Studies’ synthesis of various models suggested that—under a ‘WTO rules’ scenario—trade between the UK and EU will fall between 17 and 29 per cent and GDP by between 2.6–3.1 per cent”.198 At 2016 prices, this would amount to a loss of between £48.6 billion and £58 billion, equivalent to between £741 and £884 per head of population.199 Such figures were contested by other witnesses.
153.An important constituent part of the effect on the economy will be that on direct investment. Here again, however, there seems to be little or no absolute certainty.
Dispute resolution
154.Where one WTO member is alleged by another to have broken the WTO’s rules, disputes procedures can be invoked to settle the matter. This is a judicial system, ultimately administered by the Dispute Settlement Body—which is the same body as the WTO’s General Council, on which all members are represented. Mr Abbott explained that in respect of disputes procedures:
[T]he WTO isn’t the same thing at all as the ECJ. The ECJ is a whole jurisdiction and it is clear there that they make legal rulings and so on. The WTO system has judicial elements and it has political and practical elements. You don’t have judges. You have an appellate body that has some judicial experience, and they produce rulings on interpretation of the WTO law.200
155.Mr Abbott told us that, under the WTO procedure, “We have had 400 or 450 disputes in the last 20 years and most of those have been resolved one way or another.” Nevertheless, “There are still one or two cases that are well known where you could argue it hasn’t really worked”.201
Contingency planning
156.Sir Andrew Cahn told us he doubted that the Government seriously intended to fall back on trading under WTO rules if its negotiating objectives were not met, given what the consequences of doing so would be:
It isn’t believable that the UK could, with equanimity, fall back on WTO rules, falling off a cliff edge without any transition or implementation-phase arrangements. It would be so chaotic, and so bad for British business and the British people, that it is not really conceivable that the British Government could allow that to happen.202
157.An indication of what might be the Government’s contingency plan in this event was given by the Chancellor of the Exchequer in an interview with the German press:
If we have no access to the European market, if we are closed off, if Britain were to leave the European Union without an agreement on market access, then we could suffer from economic damage at least in the short-term. In this case, we could be forced to change our economic model and we will have to change our model to regain competitiveness. And you can be sure we will do whatever we have to do. The British people are not going to lie down and say, too bad, we’ve been wounded. We will change our model, and we will come back, and we will be competitively engaged.203
158.The Government states in the Brexit White Paper that, while it is confident of reaching an agreement:
In any eventuality we will ensure that our economic and other functions can continue, including by passing legislation as necessary to mitigate the effects of failing to reach a deal.204
159.The Secretary of State was likewise thoroughly confident of reaching an agreement. He did say that modelling of various possible outcomes was “ongoing”205—but could say nothing about any contingency plans.
Conclusions and recommendations
160.The Government must set out as clearly as possible the likely consequences of trading under WTO rules alone. It must also show what contingency planning it is undertaking for that eventuality—including in respect of the legislation which it says it is prepared to bring forward “as necessary to mitigate the effects of failing to reach a deal”.
161.When considering policies such as adopting a unilateral zero tariff policy, the DIT should produce evidence showing the likely winners and losers, and the amounts involved. This should also be carried out with the involvement of the devolved assemblies and governments of the UK.
162.It is quite clear that “no deal” is in effect a deal to trade with the EU under WTO rules. The Prime Minister has said that it is her ambition to seek tariff-free trade with the EU and frictionless customs arrangements. It is clear that WTO rules would not permit this. Therefore, the “no deal” option should be discounted entirely.
171 HM Government, The United Kingdom’s exit from and new partnership with the European Union, Cm 9417, February 2017, para 12.3
172 The same also applies in respect of the non-EU EEA countries and Switzerland if the UK does not have FTAs in place with them at the point of Brexit.
173 Professor Minford’s views are summarised in “Brexit and Trade: What are the options?”, in The Economy after Brexit (2016).
183 This is the trade-weighted average tariff (i.e. total tariff revenue as a proportion of the total value of imports). The EU’s simple average tariff rate in 2015 was 5.1% – World Trade Organization, International Trade Centre, Conference on Trade and Development, World Tariff Profiles 2016 (Geneva, 2016), p 81.
188 Oral evidence taken before the Treasury Committee on 12 December 2016, HC(2016–17)387, Q303
189 Oral evidence taken before the Treasury Committee on 7 February 2017, HC(2016–17)387, Qq546–7, 567–77
191 UK Trade Policy Observatory (UKT0019). On the modes of supply under GATS, see footnote 97 above.
199 The IFS’s statistics derive from work by two other bodies. The Centre for Economic Performance at the LSE estimates that the direct trade effects of trading under WTO rules alone would reduce GDP by 2.6% in 2030. The National Institute of Economic and Social Research, incorporating some effects on foreign direct investment as well as direct trade effects, estimated that a static fall in GDP of 3.2% would result from trading under WTO rules alone—Brexit and the UK’s Public Finances, Institute for Fiscal Studies (May 2016), p 36; Office for National Statistics, Gross domestic product, preliminary estimate: Oct to Dec 2016, January 2017
203 “Philip Hammond issues threat to EU partners”, Welt am Sonntag website, 15 January 2017
6 March 2017