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Theresa May must tread unbeaten WTO paths

Economic Report

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  • The economic damage caused to the UK by leaving the EU could be greater than many people currently foresee
  • The UK will probably have to negotiate new trade conditions not just with the EU (and third parties), but also with the WTO
  • These negotiations will probably be very lengthy
  • The result: long-term uncertainty and more barriers to trade, with the potential to seriously dent British international commerce

The economic damage caused to the United Kingdom (UK) by leaving the European Union (EU) could be greater than many people currently foresee. It is widely believed that the UK could always fall back on World Trade Organisation (WTO) rules after Brexit, but that it is actually far from certain. In fact, the British will probably have to negotiate new trade conditions not just with the EU (and third parties), but also with the WTO. That will lead to long-term uncertainty and raise barriers to trade, with the potential to seriously dent British commerce.

Alternatives to EU membership for the UK

Once British Prime Minister Theresa May triggers Article 50 of the Lisbon Treaty, the process of extricating the UK from the EU will begin. At the same time, negotiations on trade and other issues between the two sides are also initiated. The first possible outcome is that the UK remains part of the European Economic Area (EEA, see figure 1), which would give it almost full access to the EU single market. This is not an attractive option for the British, however, as it gives them no control over immigration from Europe – one of the main reasons why Britons voted for Brexit.

A second possibility is that the UK agrees a bilateral treaty with the EU, as Switzerland has done. This allows greater scope for bespoke arrangements. The British negotiating position is likely to combine control over their own immigration policy with favourable terms on the movement of goods and services, including the retention of passporting rights for UK banks. The EU, however, will be unable to accede to all Britain’s wishes in this respect. After all, too generous a deal might unleash a domino effect. Moreover, the EU has always made it clear that no-one can pick and choose when it comes to the four freedoms of the single market – it is free movement of goods, services, capital and people, or no free movement at all.

Should negotiations with the EU fail, then a third alternative enters the picture: trade based on WTO membership. This is least favourable scenario, since it would certainly give rise to tariff and regulatory barriers. But it is also not as clear-cut as it might seem, because the UK will find itself in a situation the WTO has no procedures for. Never before has a nation pulled out of an economic union which is itself a WTO member. Theresa May will thus find herself treading a second unbeaten path, parallel to that of withdrawal from the EU, as she is forced to renegotiate the terms of the UK’s WTO membership as well. And because this makes a Brexit falling back on WTO rules far less certain than had been thought, it also weakens the British position in their negotiations with the EU.

Figure 1. Post-Brexit trade scenarios – unbeaten WTO and EU paths
Figure 1. Post-Brexit trade scenarios – unbeaten WTO and EU pathsSource: Rabobank

The diagram above shows the various trade flows on which the UK will have to negotiate after leaving the EU. The outcomes of negotiations with the EU and the WTO are uncertain because Brexit gives rise to new situations with some as-yet unknown procedures. In the case of the WTO, we list three temporary scenarios (T1-3) for the short term. In the long term the UK will probably have to reach its own agreements with other WTO members in respect of import barriers.

Negotiations with WTO set to be lengthy

The UK will probably be able to remain a member of the WTO after Brexit (at present it is one by virtue of its EU membership). It is far from certain, however, what the conditions of that membership will be and which trade agreements will apply. Roberto Azevêdo, Director-General of the WTO, has indicated that the UK may have to renegotiate its agreements with his organisation from scratch. This includes all market-access arrangements for imports: tariffs for each product group, tariff quotas and access for services (see box 1). And it is bound to be a complex process, as the UK will have to reach agreement with all 162 other WTO members. Historically, accession talks with new entrants to the organisation have taken an average of more than nine years (WTO, 2015). Its regular negotiating rounds also last many years – the current one, the so-called Doha Round, has been under way since 2001. Yet Article 50 gives the British just two years to safeguard their trading relationships with the EU and other key partners. It is not even certain that the UK can begin talks with the WTO during those two years, since formally it is still a member of the EU. Completing Brexit without having trade agreements with the WTO in place is the worst-case scenario for the UK.

UK trade after Brexit without WTO agreements

There may well be a transitional period, during which the UK temporarily adopts the EU’s agreements on tariffs and services until it can reach deals of its own. In this case, the tariffs for exporters from the Netherlands or other WTO members would be the same as those applied by the EU (see the WTO tariff-data website for those applicable to particular products).

If the British are unable to adopt the EU agreements, they will probably set their own temporary unilateral import tariffs or market-access restrictions for services. These would remain in place only until trade agreements with the other WTO members are reached. But this move could still meet resistance from those other members, as it is quite conceivable that they would not accept British exporters benefitting from the low import tariffs they have agreed amongst themselves whilst the UK is free to set any tariff it likes. Lowering the tariffs would generate less resistance, but also give British industry less protection and so cause public and political dissatisfaction within the UK.

Whether or not the UK’s individual membership of the WTO is confirmed, British exporters will probably be subject to its other member states’ import tariffs as soon as Brexit occurs[1]. Under the “most-favoured nation” (MFN) principle, the agreed tariffs on goods and access arrangements for services would also apply to British exports.

Box 1: WTO principles

Some 163 countries are members of the World Trade Organisation, which aims to facilitate international trade. It does so by abolishing rules that hinder trade, allowing nations to negotiate reductions in import tariffs and making sure that the same rules apply to all countries. Most of its agreements focus upon reducing trade barriers for physical goods, with fewer addressing services. Since the WTO was founded, tariffs on industrial goods have fallen by an average of 40 per cent.

One of the most important agreements between the WTO member states is that they treat all the other members equally. In other words, no country may favour a particular trading partner by charging lower tariffs on its products or granting better market access for its services. The WTO regulates import tariffs and agreements on services using the “most-favoured nation” (MFM) principle. This leaves countries within the WTO free to agree the levels of import tariffs on particular products between themselves, but then requires them not to charge any other member state a different tariff on the same product. The same applies to market access for services.

As well as agreeing import tariffs, WTO members also negotiate tariff quotas. These are set amounts of products that can be imported at a tariff lower than the standard rate. Such quotas apply only to agricultural products; the EU has 94 in all, for items including rice, sugar, beef and bananas. A tariff quota is sometimes applied only to a specific country, but most of those agreed by the EU can be used by all WTO member states to enjoy lower tariffs until the quota limit is reached (Kamerstuk, 2000).

Source: Rabobank

Footnote
[1] If the UK does manage to reach trade agreements with other countries and/or the EU before this point, they take preference over WTO terms.

EU might also have to renegotiate with WTO

There is a chance that the EU may also have to enter into new negotiations with the WTO after Brexit, because of the changes it brings about. After all, other WTO members struck trade deals with the EU on the assumption that it included the UK. Without having to take British interests into account any more, those agreements might be ripe for revision. If this does happen, however, the process should be somewhat easier than it will be for the UK, since the EU’s established agreements can remain in force until the necessary negotiations are completed.

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