The release of the UK’s draft text for a future UK-EU Free Trade Agreement last week confirms that the UK and EU remain far apart on the issue of a ‘level playing field.’
The key question now is whether the two sides will be able to bridge the gap in a way that facilitates continued negotiation and, ultimately, a free trade deal.
What are ‘level playing field’ commitments, and why are they so important to the EU?
Broadly, a level playing field is a set of domestic policies – for example, foods standards, environmental policies, and labour market laws – that create conditions of market competition that are ‘fair’ to both foreign and domestic firms.
There are two distinct areas – trade and investment – where an unlevel playing field can induce shifts in economic activity across borders, creating a loss relative to the initial expectations of a group (of firms, industrial sectors, or workers) in a country that signs a trade agreement.
In the trade realm, if a tariff reduction in one country is accompanied by domestic policies (such as a relaxation of domestic regulations, or tax cuts) that reduce the production costs of domestic firms, then these domestic firms might be able to pass-through the cost reductions into lower prices and crowd out potential imports.
In this way, the benefit of the tariff reduction to foreign exporters is effectively unwound and eliminated.
Similarly, if one country eliminates a tariff, anticipating a modest increase in imports, but the second country then introduces a domestic policy that benefits exporting firms, such as an industrial subsidy, then the tariff-reducing country might feel aggrieved due to an unexpected contraction in the industry that must compete with foreign goods that enter duty-free, and receive the foreign industrial subsidy.
In both examples, changes to domestic policies influence trade flows in ways that were not anticipated by both parties to the trade agreement at the time they sealed the deal.
In the investment realm, countries are concerned that foreign direct investment – particularly large outlays to build or expand manufacturing plants – will be directed toward areas with lower taxes and less regulation.
A particular concern of the EU is that, if the UK is given duty-free access to the EU with no additional commitments on domestic policy, the UK will provide incentives, either financial or regulatory, for foreign multinational enterprises to set up shop in the UK rather than the EU.
“Without a level playing field on environment, labour, taxation and state aid, you cannot have high quality access to the world’s largest single market. The more divergence there is, the more distant the partnership has to be.”
This suggested, even before negotiations began, that the EU would require the UK to align some policies with EU norms to some degree in order to get complete duty-free access to the EU market.
Tellingly, the EU’s draft treaty text contains an entire section titled ‘Level Playing Field and Sustainability’, that closely follows the language in the Political Declaration accompanying the Withdrawal Agreement.
The main, and crucially important difference, is that the EU’s draft treaty goes beyond the Political Declaration to carefully lay out procedures to settle disagreements over level playing field obligations, with detailed plans for sanctions and interim measures to enforce compliance.
In sharp contrast, the UK’s draft treaty follows the broad outline of the Comprehensive Economic and Trade Agreement (CETA) – the free trade agreement between the EU and Canada.
In essence, the UK’s proposal takes a giant step away from the Political Declaration and suggests rebuilding the EU-UK relationship on the model of the more distant relationship of the CETA.
While the CETA includes a brief nod to a level playing field in the areas of subsidies/state aid, competition policy, labour, and the environment, no commitment on taxation is included.
In line with the CETA, the UK’s draft treaty includes modest level playing field commitments in subsides, competition policy, labour and the environment.
The general approach taken is to express support for or reaffirm an existing multilateral agreement, such as International Labour Organisation standards.
However, it explicitly rejects the use of binding, enforceable dispute settlement in all four areas. For competition policy, it simply rejects dispute settlement under any UK-EU agreement. In the area of subsidies, it directs parties to resolve disputes at the WTO.
On labour and environment issues, it follows the CETA model of consultation and establishment of a panel of experts to advise on dispute resolution.
On the issue of taxation, the UK draft treaty affirms a commitment to following OCED principles of fair taxation and rejects any dispute settlement.
The EU takes this further to obligate parties to policies that prevent tax avoidance.
While the idea of cooperation to prevent problems of destructive tax competition may be sensible, it comes off as hypocritical given the fact that some EU member states have already been identified as tax havens, suggesting existing EU rules are not particularly effective with member states.
In sum, at this point in the negotiations, with only a month left to decide if an extension is needed, the two sides appear far apart. Without a bit of give and take between the parties over at least some level playing field issues, it seems unlikely that a deal will be made.