Brexit provides an opportunity to agree new Economic Partnership Agreements with the world’s largest economies such as the US, China, and India. These cannot make up for the trade it will lose through leaving the Single Market, according to Swati Dhingra (CEP & LSE) and Josh De Lyon (CEP). Nevertheless, the UK has an opportunity to forge a new generation of trade deals that could help spread the benefits of free trade and address widespread unhappiness with recent waves of globalisation.
The UK is one of the most open economies in the world – and international trade and investment are the biggest areas of economic policy that the UK will need to decide on as it prepares to exit the EU. Greater integration with the EU can limit the economic costs of Brexit, and does not need to prevent the UK from pursuing beneficial Economic Partnership Agreements (EPAs) in the future.
All trade agreements begin with a sense of realism on which trade partners to prioritise for negotiations, which can be lengthy and demanding of resources. The EU is the UK’s most important trading partner, making up around half of the UK’s international trade and investments. The UK economy is highly integrated with the EU and separation would be very costly. It is estimated that a ‘No Deal’ scenario would cause a 40% reduction in trade with the EU over the next 10 years, translating to an average cost of £1,890 per household every year. These costs would be halved if the UK agrees a comprehensive ‘Norway-style’ deal with the EU. The evidence suggests that potential gains from greater integration with the US, India, and China cannot offset the losses of leaving the EU, at least in the near future.
The UK government has shown some level of appreciation for this: the so-called ‘Chequers’ statement set out proposals for a single market for goods between the UK and EU, and a customs arrangement that seeks to accomplish smooth trading relations with the EU while maintaining the ability of decide UK’s tariffs outside the EU. However, the proposal remains vague on practicalities. Most importantly, it provides few details on services, which make up 80% of the UK economy and where single market membership provides greater market access than even the most ambitious of EPAs.
Until the 1990s, trade agreements focused on reducing tariffs. Today, tariffs in most industries are low and the services sector – which has no tariffs – dominates economic activity in many countries including the UK. The bulk of modern trade agreements is about reducing the costs of doing business across borders by, for example, streamlining customs procedures or avoiding regulatory duplication between countries. These are so-called ‘non-tariff barriers’ (NTBs). The aim is to create an integrated international market where domestic and foreign businesses play by the same rulebook.
These modern trade deals can stimulate economic activity. But there is an inevitable trade-off between integration and national sovereignty as countries must agree to similar rules and standards. For countries with similar preferences over these standards, the costs of alignment are relatively small. For instance, the UK gives up some sovereignty when it applies the EU’s Toy Safety directive on its businesses but UK consumers are unlikely to object to safer toys.
EPAs aim to balance market access for businesses with the need to maintain high standards in products, services, environmental, labour and consumer rights. But they have not always been successful in striking this balance. The rules-based trading system is facing the pressures of the increasing dominance of multinational corporations, the centrality of global supply chains, and the growing importance of services trade. They have generally not been able to uphold the spirit of equitable rights across stakeholders. Dani Rodrik argues that the regulatory standards in EPAs tend to empower politically well-connected businesses, including international banks, pharmaceutical companies, and multinational firms.
The UK has an opportunity to help shape a model trade policy that recognizes the new realities of the rise in global value chains, services and multinationals and that takes on board the concerns of those who have been left behind by the growth of the last few decades. The UK could gain an advantage by leading the way on a new generation of EPAs that promote inclusive growth.
There is a concern that the UK could be pressured into a race to the bottom on domestic standards, especially when it is negotiating with large countries with very different standards. The UK can alleviate these concerns by drafting a modern EPA, which ensures that the same rules and rights apply to all stakeholders – domestic businesses, multinational firms, workers, consumers or investors.
Non-discrimination across stakeholders has always been the fundamental principle underlying EPAs, but it has been eroded by the fragmentation of production across borders. The key to the success of a post-Brexit policy will be the extent to which it reinstates the principles of National Treatment for all businesses and Non-Discrimination across all stakeholders.
Reinstating National Treatment for all firms
National treatment is a fundamental principle of most EPAs, which ensures that countries do not discriminate against foreign companies so that all businesses compete on a level playing field. The UK could take a leadership role in advocating national treatment by applying the same rules on the opposite side – multinational enterprises (MNEs) should be accorded the same treatment as smaller businesses and domestic firms.
MNEs directly account for half of global exports, a third of world GDP and a quarter of all employment. They have the ability to source inputs and credit from different countries and to shift profits across different tax jurisdictions. This amounts to MNEs facing different business conditions than firms that might be smaller or purely domestically oriented. Tax shifting is the most striking example of this. About 40% of multinational profits are shifted to tax havens globally, and non-tax haven EU countries, like the UK, are estimated to suffer the greatest revenue losses as a result.
It is feasible to plug the loopholes that enable MNEs to shop around for tax benefits and other cost reductions and the UK has been involved in previously negotiated tax treaties and data sharing. One approach for reinstating national treatment is through multilateral bodies to enable coordinated action, but many would argue that their multilateral provisions are weak because they are non-binding guidelines and do not prevent a race to the bottom whereby countries offer attractive tax breaks to attract MNEs.
The UK could support multinational efforts by implementing unilateral actions such as taxing all MNEs that sell in the country and enforcing equal treatment of all domestic firms and MNEs in terms of profits. Any planned action would need to involve carefully weighing the potentially conflicting commitments in previous tax or investment treaties with the objective of maintaining real competition. A post-Brexit reset in trade policy is an opportune political moment to have this overdue discussion.
Reinstating non-discrimination for all stakeholders
Non-discrimination has been eroded because many EPAs give greater rights to investors over other stakeholders. Since 1975, the UK has negotiated over ninety bilateral investment treaties, almost all of which include provisions to enforce investors’ rights. Until now, the bulk of these treaties have been with countries that are net recipients of investments from the UK, so the investment agreements were largely designed to protect UK investors from expropriation of assets in developing countries with politically unstable conditions.
With the fragmentation of supply chains, most EPAs today contain provisions regarding settlement of disputes brought by investors against host governments. These are often referred to as Investor State Dispute Settlement (ISDS) clauses. They give foreign firms the right to bring claims against the host country if they have not been given fair and equitable treatment. ISDS clauses are increasingly being used by investors to challenge governments in developed countries.
The main contention with ISDS clauses is that the language of what constitutes a violation of investor rights is too vague. This constrains governments from changing laws and can lead to a regulatory chill due to the fear of expensive litigation from foreign investors. Furthermore, the settlement procedure is typically opaque and costly. There is also a growing recognition that ISDS confers rights to foreign companies that are not available to domestic companies.
There still isn’t a standard solution to balancing the rights of foreign investors for fair compensation and the right to regulate for host governments. New solutions for balancing investor rights with regulatory discretion are being proposed, and the UK can join these efforts to develop workable proposals such as enabling countries in EPAs to opt out of ISDS as well as reviewing foreign investments in sensitive areas and providing safeguards in these sectors.
The UK could go further in ensuring that its public services and domestic standards are not compromised through ISDS procedures. One way that many EPAs do this is by including chapters on social clauses – environment, health and labour rights – and ensuring that stakeholders, like workers and consumers, have similar rights and dispute settlement procedures as those that are given to investors.
Instituting a new social compact
Wages have decoupled from productivity and many working families in the UK have never really shared in the prosperity that globalisation has brought to many global firms and their workers in the last few decades.
The UK economy has suffered as a result of the Brexit vote. Immediately following the referendum, sterling suffered its biggest one-day loss since the introduction of free-floating exchange rates in the 1970s. The sterling depreciation from the Brexit vote was expected to benefit UK exporters and improve the earning potential of domestic workers. But new research from the Centre for Economic Performance shows that wages and training of workers have fallen since the referendum. The rise in the costs of imported inputs have led to lower wages and fewer training opportunities for workers in the UK, which could reinforce the trends of anaemic wage and productivity growth.
As a starting point, what’s needed is an adjustment assistance fund that compensates people who are displaced by economic changes. A post-Brexit UK would be more inclusive of ordinary working families if they had access to an enforceable mechanism to compensate them for job losses induced by broad economic changes.
But compensation alone will not solve the problems of the constant churn to which workers are exposed. To undo the years of economic stagnation faced by many, a post-Brexit economic policy would need to commit to investing in skills so that people face lower risks of being left behind in the future. Ultimately, wage and productivity growth require re-training and upskilling of the workforce. The UK can ensure these policies are supported along with market access provisions in EPAs by linking clauses on labour rights, compensation and rehabilitation policies.
Multinational tax revenues raised through instituting national treatment could provide the funds necessary to support these upskilling activities. This is a practical proposal by Philippe Martin from the French Council of Economic Analysis to ensure globalisation and technological progress are politically and socially sustainable.
Anticipating exactly who will be hurt from a particular policy is always difficult – it can take years before the link between job displacements and economic policies becomes apparent. Whether the UK operates its post-Brexit trade policy independently or via a customs union with the EU, it should be pushing for EPAs that deliver market access without compromising the UK’s high standards on labour, products, services and safety.
It will be exceedingly hard to replace any loss of access to the EU market and to find trade partners that share the high quality standards that the UK has always maintained. Any new EPAs with China, India or the US need to respect these high quality standards. If it ends up outside of the EU customs union the UK’s best strategy would be to pioneer a new generation of trade deals that balances the rights of different stakeholders and addresses the new economic reality of global value chains and multinationals. The three rebalancing provisions – national treatment, non-discrimination and a new social compact – would be the first steps towards an inclusive economic model. In the current era of strong anti-globalisation sentiments, a post-Brexit trade policy must be re-geared to truly serve British society, not just free trade.
This post represents the views of the author and not those of the Brexit blog, nor LSE. It is an edited extract from Brexit and the Future of Trade by Swati Dhingra.
S. Dhingra, ‘Brexit and the Future of Trade‘, in G Kelly and N Pearce (eds.), Britain Beyond Brexit, The Political Quarterly, Vol 90, Issue S2, 2019, pp. 21-31.
Josh De Lyon is a Research Assistant at the Centre for Economic Performance at LSE and a DPhil Economics candidate at Oxford University.
Swati Dhingra is Associate Professor of Economics and Research Fellow at the Centre for Economic Performance at LSE.