Trade deals with third countries

What is the current situation?

The EU is a customs union: EU members have a common trade policy, a common external tariff, and no internal border controls for goods. The EU is therefore represented by the EU Commission in all international trade negotiations and member states cannot negotiate their own trade deals with third countries. The EU has trade deals with a large number of countries, including Canada, South Korea, and Mexico, although not with the US, India, China, or Australia. However, membership of the single market does not in itself preclude making trade deals with third countries: the non-EU members of the EEA and Switzerland do so, which in turn means border controls are required between those countries and the EU.

What has the British government indicated it wants?

The May government has repeatedly stated that after Brexit, the UK should become an independent player, free to seek its own trade deals with the rest of the world. It follows that the UK will have to leave the EU customs union. However, the government has also said that it wishes to negotiate a time-limited transition during which customs arrangements would continue as now. During this period, the UK would be free to negotiate trade agreements with third countries, but such agreements would not be implemented until after the transition.

A long list of countries have been mooted as possible candidates for free trade deals with the UK, in particular the US, China, India, and the rest of the CANZUK countries (Canada, Australia, and New Zealand). The size of the US economy and the “special” ties that exist between the US and the UK mean that the US is likely to be the first priority.

What are the possible outcomes?

Although there have been preliminary discussions with a number of the countries listed above, it is close to impossible for substantive talks to begin. It is as yet unclear when the UK will have the legal authority to begin negotiations; when the UK will leave the EU customs union; and what the trade arrangements between the UK and the EU will be after that point. It is difficult to see how third countries could engage seriously with the UK until these decisions have been taken. In addition, there are significant obstacles to meaningful trade deals with most of the countries listed above:

• The shape of US trade policy under Trump remains unclear, but may be significantly more protectionist. In any case, the US is likely to seek concessions which may be politically unpalatable in the UK (e.g. “chlorinated chicken”);
• India has made clear it will not engage in substantive discussions until the UK is prepared to liberalise policy on visas for students and skilled workers;
• China is unlikely to give the UK significant concessions on market access;
• The EU already has a deal with Canada – the priority is likely to be simply ensuring that the benefits of this are mirrored in a future UK-Canada deal;
• Deals with Australia and New Zealand are more likely (although even here there will be obstacles), but both are very minor trading partners with the UK.

Nevertheless, the freedom to determine its own negotiating position should mean that the UK can be faster and more flexible than the EU as a whole, particularly since it would no longer be constrained by protectionist interests in other EU countries. Whether this will outweigh the loss of leverage from no longer being part of a very large negotiating bloc is very difficult to predict ex ante.

A further uncertainty is what will happen to the 34 trade agreements among 60 countries that the EU has negotiated on behalf of the UK. After Brexit, the UK would cease to be a part of these trade agreements, reducing trade and raising prices. Avoiding this will require the consent of these trade partners and the resolution of some tricky issues, such as re-defining local content requirements that are specified at the EU level.

What are the potential consequences of these outcomes?

Free trade agreements (FTAs) are associated with increases in bilateral trade: so, while it would obviously depend on the terms of specific deals, it is probable that UK trade deals with third countries would increase UK trade. However, since tariff rates are already low, there is limited potential for tariff reductions to increase trade flows – tariffs between the US and the EU average about 1.6%. Non-tariff barriers (NTBs), such as regulatory differences, are much more important. The estimated cost of NTBs on goods is 12.9% to 13.7% between the EU and the US, and on services (which make up 80% of the UK economy), sectors such as business services and financial services face NTBs worth on average around 30% in trade costs.

There are some simple solutions to reducing these costs, such as through mutual recognition of technical standards and expanded labelling for food products. However, many of these costs reflect regulations arising from differences in preferences. For example, if UK citizens do not wish to have chlorinated chicken or genetically modified food in the country, then there is not much expansion in trade that can be expected without seriously undermining the wishes of the public.

But even the most ambitious set of FTAs is unlikely to replace the trade lost as a result of leaving the EU. For example, the National Institute of Economic and Social Research (NIESR) estimate that concluding FTAs with all of the above countries, and more, would only boost UK total trade by about 5%, while Brexit will reduce it by more than 20%.

What is the potential timeline for this?

The UK government has neither the administrative capacity, nor the legal authority to begin negotiating third country FTAs now. It is possible that such negotiations could begin during the “transition” period after Brexit (March 2019), but it is uncertain how much progress could be made before the UK has resolved the terms of its subsequent relationship with the EU. Negotiating substantive FTAs will take a long time – the EU-Canada one took seven years – although the UK might be able to make faster progress on its own,particularly with “easier” countries like Australia and New Zealand. However, it is difficult to see any new FTAs being implemented before the early 2020s at the earliest.

Further readings:
• Datta and Dhingra (2017), What next for US-Europe Trade Policy, in Economics and Policy in the Age of Trump, ed. Chad Bown.
• Dhingra and Datta (2017), London Review of Books (forthcoming).

To download a PDF of this factsheet click here.

Disclaimer:
The views expressed in this explainer are those of the authors and not necessarily those of the UK in a Changing Europe initiative.

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