The EU-UK Trade and Cooperation Agreement represents another step in a drawn-out, phase-by-phase Brexit, according to Dennis Shen (Scope Ratings). While the UK is expected to ultimately maintain significant access to the single market, the new customs border and uncertainties around the degree of future single-market access of UK services exporters raise economic costs. In the end, an end-state like a Swiss-esque model except accelerated with respect to the cumulative negotiation horizon, and negotiated in reverse with the UK having started from fully-frictionless trade, looks possible.
The last-minute agreement in December announcing a free-trade agreement was not a surprise compared with our expectations. The rolling over of tariff- and quota-free trade in goods was largely in line with the roll-over of existing preferential trade arrangements that the UK has pursued with other trading partners outside the EU as an intermediate step in exiting the EU customs union.
However, exit from the customs union – to be itself phased in over three stages and in full force only from 1 July 2021 in the case of imports to the UK – has nonetheless created trading friction with the EU and, as a result, has produced immediate economic losses as companies see longer delays, higher operating costs and lower productivity. This is even though grace periods granted – such as a one-year standstill on rules of origin documents – have eased the full scale of distress at the border.
The trade and cooperation agreement is nonetheless expected to ensure a substantive degree of continuity longer term. In part, this comes because a principle of “managed divergence” implies either party of the agreement reserves the right to retaliate in the case the other side is considered to have gained an unfair trading advantage. So, while the UK has secured greater sovereign privileges in determining its own laws, cooperation with the EU around regulation under a new “Partnership Council” and capacity for the other side to impose tariffs in the case deregulation is considered unfair are expected over time to mitigate disparities, and space out those areas of realised divergence (and resulting trading frictions) to over a longer period of time.
While December’s arrangement largely excluded services, this is consistent with the highly phased-in and drawn-out Brexit our agency has thought probable, in which divergence with the EU is achieved over successive phases after the three extensions of Article 501, a transition state, lately an exit from the customs union with associated grace periods, and, in the end, agreements around additional, complementary trading agreements with the EU impacting sectors excluded from December’s arrangement.
Brexit remains far from over, however – and this trade agreement, while thin, was never intended as a singular settlement but rather as a first fundamental framework around which ultimately a more-extensive set of trading agreements will be arranged, together defining the long-term economic relationship. As services were hardly discussed so far with prioritisation around agreement on goods trade in the limited ten months of negotiations prior to the conclusion of the implementation period, the focus for the UK should be upon coming to supplementary agreements similar to that for trade in goods for critical services industries such as financial services.
A non-binding memorandum of understanding is sought by March 2021 around the export of financial services including those services such as euro clearing currently operating with temporary access granted to EU markets as talks continue. However, more time is likely to be required than March before Brussels grants any fuller access for select UK financial firms even after a non-binding framework were in place. In part, it is in the self-interest of European counterparties to slow walk discussions. In addition, the UK could be incentivised to loosen areas of trading regulations to offset intervening damage to the City – exemplified in the allowance of trading of Swiss shares – however, this makes a broad blanket equivalence with the EU less likely. Any agreements around financial services are expected, in addition, to be dynamic – granting equivalence and thus market access for select UK financial industries to “passport” to the single market, and vice versa, but with an understanding that such equivalence could be retracted upon any divergence in regulatory standards – mirroring the agreement in goods.
Long term, the outcome of non-regression clauses embedded in the trade agreement alongside other restrictions to divergence – like the Irish Backstop that results in any friction in trade with the EU resulting directly in frictions in trading inside the UK itself – should reduce the long-run scale of separation and ensure preferential access to the single market for UK businesses longer term – consistent with a softer form of Brexit.
This could resemble something ultimately akin to a Swiss-esque framework except accelerated with respect to the negotiation horizon given support in accelerating talks from the series of self-imposed cliff-edge Brexit deadlines since Brexit talks began, and negotiated in reverse with the UK having started from fully-frictionless trade. However, as uncertainty will remain nearly perpetual due to a near-constant risk that changes to domestic UK law could reduce access to the single market, firm relocations of activities out of the UK will continue – ensuring a steadily growing cost from a “slow-burn” Brexit, even as the cliff-edge form of abrupt Brexit disruption has been successively avoided.
Specifically, the City of London faces permanent damage in waiting for a definitive agreement on financial services in the months ahead during which select UK financial services have at least transitionally lost passporting rights, such as investment banking and securities trading on behalf of clients in those EU countries where national regulators have not extended grace periods to UK firms. The European Central Bank has said banks have agreed to ultimately transition EUR 1.3trn of assets to the euro area. In the end, the UK has secured a deal for the trade of goods in which it has a trading deficit with the EU, but unfortunately not one as comprehensive in services in which it stands to see substantive losses to its trading surplus.
The introduction of customs with associated rules of origin and local content requirements has, in addition, increased economic costs – especially at a time during which strains from the virus have raised the importance of just-in-time supply chains. HM Revenue & Customs estimated that post-Brexit arrangements will add GBP 7bn (0.3 per cent of GDP) of bureaucracy to trade with the EU. We estimate that impediments to investment and costs related to Brexit contingency planning had already curtailed UK output by at least 1.5 per cent of GDP entering 2020.
The UK moreover enters this new Brexit phase amid the near-simultaneous introduction of its third national COVID-19 lockdown, which will add further strain on public finances. There is upside pressure on a government debt ratio already estimated at more than 110 per cent of GDP this year, up from 85 per cent in 2019, in view of a double-dip economic contraction, additional fiscal stimulus to address economic fallout from lockdown plus the added economic and fiscal costs of Brexit – the latter which, while much more modest and more spaced out by comparison with the sudden, severe costs of the COVID crisis near term, might pose more significant longer-term economic and institutional consequences.
This post represents the views of the author and not those of the Brexit blog, nor the LSE.
[1] Scope anticipated the three extensions of Article 50 in 2019 (see (1), (2) and (3)), similar to its expectation of the UK’s ultimate exit from the European Union on 31 January 2020.
This is an interesting and informed piece. Thank you, Mr. Shen.
Let me enlarge the scope of Mr. Shen’s article to include migration. Migration matters in economics. Talent can march out of the door, or talent can march in through the door.
Within the EU, we were hobbled by having to honour the free movement of peoples aspect of the Single Market. Therefore, if we wanted to restrict immigration, we had to bear down excessively on migrants from outside the EU. Effectively, we had to turn down brilliant software designers from India, because Bulgarian labourers fancied their chances over here. This is, I hope, self-evidently stupid.
We are in a very fortunate position. As our Covid-scarred economy contracts, we can encourage out-of-work EU migrants to return home. In other words, we can export our unemployment. We can import the world’s brightest and best. Indeed, Mr. Modi insists we take India’s brightest and best, as the condition for a trade deal. And that’s win-win for us.
So what impact will that have on our economy?
David,
even though I would love to agree with your reasoning, I am afraid it assumes a static world only: England will be able to trade Bulgarian workers for Indian programmers only if everything else remains the same.
In reality however England may become less and less attractive for programmers and India may not have to send the finest programmers abroad any more soon.
I hope that in 20 years post Brexit, English programmers won’t have to seek jobs in India, while English workers might head for jobs in Bulgaria.
Even before Brexit or transition end, most of immigration was not coming from the EU.
UK still have a government dedicating many ressources to prevent about 1000 people coming in the UK by crossing the Channel while in the same time it’s about 200 000 or 300 000 people coming to UK via planes.
Not all of them are engineers.
You also forgot that the average education level of EU people coming into the UK was above the average education level of native UK citizens.
There are far to many people in the UK already so we certainly don’t want any more migration from India. How about training some British people, what do you think about that as an idea, eh?
This is an overly UK-centric, UK optimistic view of events. Euro clearing is a car in point. EU ceded euro clearing only after a lossv in the ECJ (which HMG repudiates). It is still EU policy to bring euro clearing home, and it will be done in/about the best decade.
HMG left the Customs Union, UK posts losevtheir attractiveness as guys cannot enter’free-circulation’ in the EU by clearing at e.g. Southampton – duties (valuation including freight to the EU) are payable on entry to the EU, making land outside the EU costly (for an example see Cork Port after the Irish Free State left the Union (UK) in 1922! (Additional c.2bn lost to the Treasury from administrating EU Customs duties).
When Rules of Origin come into full effect in July and the full 65% required GB origin, there will be more attrition.. (I previously commented on the impossibility of Grimsby regaining it’s position as a major European fishing marketn- not proximate to customers & Scotland being over 24hrs to the EU.
Enabling free movement was an extraordinary achievement and entirely appropriate for a bloc comprising nations which hold similar democratic, economic and human rights values. Contriving simplistic equations, of a ‘win-win’ or ‘zero-sum’ nature and which pitch Bulgarian labourers agains Indian software designers does not amount to a realistic or thoughtful appraisal.
The hypothetical “Bulgarian Laborer” image characterizes the soft racism that Brexit evokes that in my view is only a fig leaf for more extreme xenophobia. The theory goes along the lines of now that we are no longer in the EU we are free to select the so called “brightest and best”from other parts of the world.
In my view this is the Nigel Farage and Anne Widdecombe logic that portrays the the UK as an oppressed country despite the fact that it voluntarily joined the EU or the EU as a racist institution because free movement discriminated against migrants from other parts of the world.
While those of us not suffering from extreme jingoism know that these people don’t like migrants full stop.
The fact is while Britain was in the EU there was effectively no limitation on recruitment from India and and most parts of the world once it was deemed that the labor could not be recruited domestically or within the EU.. I worked in the semiconductor industry in Ireland (Intel) where hundreds of skilled people were recruited into the industry in a matter of weeks to plug gaps in the labor force of the company. This recruitment came from South Africa and India in equal number. Ireland is not in the commonwealth so EU membership posed no impediment to recruitment from other parts of the world. In the same industry in Netherlands in a similar sized site (8000+ people) the largest minority group while I was there was Irish recruited from Ireland who for the most part were people who gained experience in the semiconductor industry in Ireland. But the thing is while most of these people were Irish and of Irish ancestry a substantial number were the children of people who migrated to Ireland from India, Africa and China. The largest group now is Chinese.
The second site I worked for in the Netherlands I was personally involved in the recruitment from Ireland which eventually made up 10% of the workforce of 400. But once again a quarter of these were children of Indian and African migrants to Ireland. Outside of this in the Netherlands and Ireland there are huge amounts of Software and Engineering graduates recruited from within and without the EU in particular India and China.
If you think Narendra Modi is going to allow a brain drain occur in India you are simply delusional. Any trade deal between India and the UK will be shaped by the fact that Indian bargaining power has increased due to the fact that Britain has left the EU and he knows Britain needs a trade deal with India more than it previously did.For this reason it will be highly unlikely that post Brexit UK will be dictate a trade deal with India that will restrict workers with more modest skill levels.
As an Engineer I have been working in the Netherlands for almost ten years now and ironically all of this time my business has been conducted through English.I still only speak a tiny amount of Dutch to my shame. But this only illustrates the folly of Brexit. The English language and free movement has provided me with invaluable access to skilled labor markets across the tech and industrial core of Europe.What Brexit has done has made this more restrictive for UK graduates and vice versa.This is the real consequence of Brexit.
The loss of freedom of movement means lost opportunities for Brits to live, work and freely experience life in a wealth of other cultures. It is exclusion from the European labour market. It means higher university fees abroad and essentially a ‘land locked’ pariah status. It sad many young people will not get to experience the freedom many of us did. The Bulgarian labourers you speak of have more freedom than any of us right now. This kind of freedom cannot be reduced to a mere equation or line on a spreadsheet. I see a reverse brain drain happening in the near future once covid dies down a little. Indeed, I know many people already plotting their escape, tired after the pandemic and toxic politics. Many rushed out too before the deadline.
I also don’t understand the logic of only allowing highly skilled labour in, would this not just create higher competition for the ‘good’ jobs whilst leaving Brits to pick up the less ‘good’ ones, albeit perhaps with slightly higher wages. I also know from the outside many scientist friends in the EU see the U.K. as a no go due to Brexit, the U.K. looks scary from the outside and not the free and cultural place it once was.