A free-trade area arises when a group of countries come together and agree not to impose tariffs or quotas on trade in goods between them. The arrangement can extend to some liberalization of trade in services, but most free trade areas provide for no free movement of labour or capital.
In a customs union (a more advanced form of free trade area), the members also agree to impose a common tariff on imports coming from the outside world. This is to prevent any one member agreeing a better deal with a non-member, and undercutting the rest of the groups a result, buying and selling across borders is thus even easier than in a free-trade area, since businesses know that if their produce meets standards in their home country it can also be sold elsewhere.
A single, or common, market goes a lot further: as well as tariffs and quotas, it seeks to remove various other barriers to trade. For example, member countries agree to harmonise product standards – on the strength of alcoholic drinks, for instance, or fuel efficiency levels in cars – across their markets; otherwise, these could be used by countries to restrict trade.
The approach also extends to other areas. Again, to prevent one member under-cutting the rest, a common external tariff policy is needed. Next, private barriers to trade could be established by monopolies or cartels, and so a common competition policy has to be agreed in the interests of businesses in all the member countries.
Finally, members may be able to target favourable policies – such as tax breaks, subsidies, or laxer environmental or labour laws – towards their own firms to make production cheaper. Since this has the effect of distorting competition across the single market, policies governing these areas also have to be harmonised.
All these features are present in the European Union’s single market, which is based on four freedoms of movement – of goods, services, labour and capital. As part of belonging to this system, member states get access to – and the ability to influence – the procedures by which its laws are made. They each contribute a member of the European Commission, their MEPs sit in the European Parliament, and their governments are represented on the European Council. Importantly, they also submit to the judgments of the European Court of Justice, which makes sure that the harmonized body of law is correctly implemented. Finally, they give up the freedom to pursue their own independent trade deals – to prevent any one of them negotiating a preferential agreement with a third country and undercutting their fellow members.
What are the alternatives to membership?
The alternatives to full membership of the EU are often described by referring to the countries which currently use each model.
The ‘Norwegian model’ allows Norway to participate in the EU’s single market though the European Economic Area, which entails respecting all the four freedoms (including the free movement of persons). It has independent control over its fisheries and farming policy (which full member states delegate to the EU), and can pursue its own trade deals.
The model requires Norway to implement numerous complementary policies, among them employment, environment or consumer protection, and to pay an annual fee. Overall, Norway is bound by the legislation that the EU adopts in these areas, but it does not participate in EU decision-making. It also has to abide by the decisions of the European Free Trade Area Court, a court similar to the Court of Justice. So this is a ‘half-in’ solution: enjoying the advantages of the single market, but having little ability to influence its laws and being subject to institutional oversight.Switzerland is not a member of the EU, but its model rests on a series of sector-by-sector trade deals. It thus has selective access to the single market, and has agreed to participate in EU research and education programs, and policies on borders (Schengen) and asylum (Dublin).
To obtain these agreements, Switzerland has to accept package deals from the EU, including elements of legislation it was opposed to. The agreements have to be constantly updated to reflect changes in EU law, and every bill presented to the Swiss federal parliament is examined with regard to its compatibility with EU law. This is a ‘piece-by-piece’ solution: there is an enormously complex web of bilateral trade deals in place.
The ‘Turkish model’ gives it tariff-free access to the single market, and its external tariffs (facing the rest of the world) are set by the EU. As with the Norwegian and Swiss models, Turkey has to abide by EU product standards, but has no ability to influence them. This arrangement extends only to trade in goods: attempts to broaden the deal to include services and agriculture have faltered.
Canada has negotiated a tariff-free agreement on trade in goods – but not services. Importantly, although the deal includes the gradual elimination of regulatory barriers, it also includes some features which add costs for Canadian exporters. For example, they will have to demonstrate that the goods they’re selling into the EU were entirely made in Canada – a move designed to prevent exporters from elsewhere in the world gaining access to the single market through the back door. Without this protection in place, a firm from a country which does not have a trade agreement with the EU could set up an outpost in Canada, ship its goods there, and then export into the single market.
The final option is the default position: trading with the EU under the framework of the World Trade Organisation (the ‘WTO model’). This is the approach which guides the EU’s trade with non-members with whom it has no specific agreement. Under WTO rules a country – such as New Zealand – can trade with the EU, but the two parties have to apply the same tariff rates and quotas that they apply to the rest of the world. Both are free to impose regulatory barriers to trade, and the rules do not cover trade in services.
How do these models compare with ‘hard’ and ‘soft’ Brexit?
The models can be roughly mapped onto the two blueprints emerging for Brexit.
The ‘hard’ version sees the UK leaving the single market: no longer having to pay a contribution to the EU’s budget, being able to limit the free movement of people, and not being subject to the ECJ’s rulings. It is hoped that some form of bilateral trade agreement could be achieved (like the ‘Canadian’ or ‘Swiss’ models); failing that, the UK would fall back on trading with the EU under WTO rules.
Either way, there are three sets of difficulties with this. First, selling into the single market would still require British firms to abide by EU laws; but having left the EU, the UK would have no ability to influence how they are made (this is the difficulty Norway and Switzerland currently face). Secondly, negotiating the replacement deal would be enormously time-consuming and complex: the Canadian agreement took seven years to negotiate, and still hasn’t been ratified. Extending from this is the difficulty that the EU would not be able to give the UK terms which were any better than those already agreed with other countries. Third, such a deal would include posting tariffs on exports to the EU, and it is highly unlikely that it would include free trade in services (neither the Canadian FTA nor the standard WTO framework do so). This is a problem for the UK, because it exports vastly more services to the EU than it does goods.
On the other hand, ‘soft Brexit’ looks much more like the Norwegian model. The UK would retain export access to the single market in both goods and services, would accept free movement of people, would continue to pay some ‘access fee’, and would continue to be bound by the ECJ. This would drastically reduce the impact on the UK’s economy, particularly during the transition from membership to exit.
When can we start negotiating our own trade deals?
Until the Article 50 negotiations have been completed (with or without an exit treaty) the UK is a still a member of the EU, and as such, it is not allowed to pursue its own trade deals with other countries.
What it can do is informally sound out current, or prospective, trading partners, and try to establish the rough outline of a future deal. However, there are two areas of difficulty here. First, the EU accounts for around 40% of British exports, but individual member states are not allowed to enter into trade talks and would be unlikely to respond well to informal soundings while Article 50 negotiations are in progress. Second, countries beyond the EU – Commonwealth trading partners, emerging markets, the US, Canada, and so on – are already showing themselves to be reluctant to commit too much effort to pre-negotiations until they have greater clarity on the form of Brexit. They may well find, for example, that after Brexit a trade deal with the EU 27 is far more valuable than one with the UK.
By Dr John Paul Salter, Visiting Lecturer in Public Policy at King’s College London.
The views expressed in this explainer are those of the authors and not necessarily those of the UK in a Changing Europe initiative.