Squaring the Circle in U.K./EU Trade Relations … With a Triangle?

A shorter version of this blog appeared on Borderlex.

Prime Minister Theresa May’s January 16 speech laid out her vision for the United Kingdom’s relationship with the European Union after the U.K. leaves the EU, probably in April 2019, making clear she does not see the U.K. participating in the European common market. Ironically, it could prove that Donald Trump’s curious embrace of Brexit and the much-maligned but yet to be concluded U.S.-EU Transatlantic Trade and Investment Partnership (TTIP) could provide a solution, thus squaring the Brexit circle with a triangle.

A Need for the Clarity of First Principles

The terms “soft” and “hard,” however, muddle the debate (and indeed the thinking[1]) on this.  Even trade “experts”[2] mean different things with these words, and no one else has any clue what they are talking about. We should drop the terms.

A U.K. withdrawal from the EU has enormous consequences. Every citizen, on both sides of the Channel, needs to be able to understand these, even if they’re not experts. Those engaged in the debate need to spell out the assumptions underlying their thinking to help the general public understand their screeds, and the consequences of different approaches to redefining the trade and investment relations between the U.K. and the EU.

It is worth repeating, frequently, the fundamental basis for economic relations. Every country has the right to set standards governing any product and service sold there; it also establishes the laws governing how companies operate in its territory. When it comes to trade, all imports must meet the importing country’s laws; foreign investments too must obey the environmental, labor, and other laws of the land. A country may establish these laws for itself independently of others, but its exporters need to produce goods and services to the standards that apply in importing countries if they want to tap markets outside its borders, and create jobs.[3]

The EU and the U.K.

The six countries that established the European Economic Community from the ashes of World War II exactly sixty years ago decided to make the rules governing goods and services sold in their territories together, both to facilitate trade and the growth trade brings among them and, behind that, to end the threat of war by binding their countries’ economies closer together. As part of this, these countries created a “customs union” so that all imports to them would be subject to the same conditions.

This novel endeavor was such a success that other countries wanted to join in. The U.K. joined in the second wave with Ireland and Denmark in 1973. Six subsequent expansions led to today’s 28-country European Union, which as a whole represented the world’s largest economy in 2015, and which by now has made laws setting safety and other standards for virtually all products, and many services, sold in these 28 countries. The U.K. has been an active, and many would say among the most effective, advocates for these laws, and indeed for the entire “Single Market” approach — which is one reason why 45 percent of all U.K. exports go to the rest of the EU.

The U.K. Without the EU

After the U.K. leaves the EU, it will have “taken back control”: the other 27 EU members will no longer have a say in the laws governing products and services in the UK, or the operation of companies in its territory. Fine. But neither will the U.K. have a say in the making of EU laws.

In this sense, no matter what arrangements the U.K. and the EU eventually agree, the U.K. will have joined what one U.S. Ambassador to the EU[4] called “The Coalition of the Excluded” — a coalition that includes ALL other countries that choose to export to or invest in the EU, whether they belong to the EU Customs Union like Turkey; are members of the European Economic Area (EEA) like Norway; have a special relationship with some 200 sectoral agreements like Switzerland; conclude even an “ambitious” free trade agreement, like Canada (the Comprehensive Economic and Trade Agreement, CETA, which has not been ratified); or are just a “normal” country benefiting from the World Trade Organization’s “Most Favored Nation” (MFN) rules.

In every case, anyone who wants to sell to the EU must ensure its products or services meet EU rules, and all their investors are subject to EU laws. Period. Norway and to a lesser extent Switzerland, have an even less advantageous position, as they have essentially agreed that they will adopt EU rules, even if they have no say in them. (Indeed, Oslo and Bern argued the UK should stay in the EU to help ensure the EU laws they have to accept are not unduly onerous.)

Ms. May’s starting point in her speech should be to acknowledge that the U.K. decision to regain its “sovereignty” means accepting that it in turn has no say in the EU’s sovereign decisions, and that those decisions will affect U.K. exports to, imports from and investments in the EU.

The Prospective New Arrangements

The Customs Union, EEA, Swiss, CETA, WTO or any other model by definition will not be as good, economically, for the UK-EU trade and investment relationship as the existing arrangement. Ms. May should acknowledge that, even as she argues that UK should be better off in other ways -- less EU “red tape” and the right to conclude trade agreements with other countries on its own.[5]

Those arguments, however, immediately invalidate the Customs Union and EEA models[6] as Turkey is not allowed to negotiate free trade agreements with countries that do not first have FTAs with the EU, and EEA countries must accept EU regulatory decisions. If the Customs Union and EEA models are seen as “softer” then the U.K. is in for a “hard” Brexit.

This should not be over-dramatized: even as the U.K. joins the Coalition of the Excluded, it can still sell to and invest in the EU. This is true even with the “hardest” approach — the WTO model. U.K. producers would of course face new costs and significant administrative hurdles. They would need to pay the EU’s general customs and value-added taxes (the duties are generally low, but there are peaks, especially in the agro-foods and light industries sectors) and may require certifications showing they comply with EU rules (heretofore assumed), but lots of companies in the United States, Japan, China, Brazil and elsewhere manage these same difficulties.

Moreover, U.K. producers would do so from a more “favorable” position — right now, laws regulating the products and services sold in the U.K. are the same as those that apply in the EU. May has said the U.K. will initially retain the substance of all these EU laws, so firms in the U.K. need not face any immediate regulatory barriers to products they export to the EU, or vice versa. Even for services, while U.K. providers would lose their “passport” to export freely to all EU countries, EU law allows for such service imports when the provider is under “equivalent” regulation, which U.K. firms would be; having such equivalence determinations for the U.K., even in financial services, should be doable even during the two-year Brexit negotiation process. In this sense, the much talked about “transition period” for Brexit isn’t immediately needed from a regulatory perspective.

The obvious answer for Her Majesty’s government and indeed for the EU is to negotiate a very deep and very comprehensive free trade agreement that eliminates duties, minimizes, as much as possible, the administrative burdens of a trading rather than domestic-selling arrangement, retains open government procurement, provides protections to investors (and helps them resolve disputes not through the European Court of Justice but with the EU’s new Investment Court System), and, on the regulatory front, establishes sectoral mutual recognition and equivalence agreements between the U.K. and EU regulatory agencies that have been working closely together for decades. Such arrangements do not stop either party from regulating as they see fit, but they would help minimize and mitigate the divergences that are sure to develop over the years.

The rub: achieving this in two years will be difficult, at best, especially as the initial focus in U.K.–EU talks will be on settling their existing arrangements rather than developing new ones. Which is where the U.S. part of the triangle might come in.

The Trump Factor and Brexit

President-elect Trump’s seeming embrace of Brexit is at odds with U.S. policy since World War II, which promoted European integration in the political and geo-strategic belief that a more closely united Europe would minimize the chance of yet another devastating war in the Continent. One would have thought this would have been more of a factor in the U.K.’s Brexit debate as well.

Instead, Trump seems to want to facilitate the U.K.’s departure; he and others in Washington (and in London) have talked seriously about concluding a U.S.-U.K. free trade agreement as soon as possible, intimating that this should be ready the day the U.K. leaves the EU.

There is an enormous political, and economic, difficulty with this: As long as the U.K. is a member of the EU, it is illegal for it to negotiate a separate trade agreement with anyone. If it flaunts that rule (which it can), the EU negotiators on the other side of the Brexit table will make any “transition” away from the U.K.’s largest market considerably more difficult.

And the Possible TTIP Triangle

At the same time, the EU (including the U.K.) and the United States are in their third year of negotiating the “comprehensive and ambitious” Transatlantic Trade and Investment Partnership, covering all the market access issues noted above, significant regulatory cooperation with separate annexes covering individual agreements between U.S. and EU regulatory agencies, and rules on such things as customs facilitation, investment, “sustainable development” labor, and environmental protections. The two sides were unable to conclude the talks during Mr. Obama’s term due in part to considerable political opposition in Europe, and in part to differences in the negotiations that, while likely bridgeable, fell afoul of different negotiating tactics and styles. And of course the Brexit referendum threw another wrench into the works, for it is difficult for the United States and EU to negotiate certain things (agricultural quotas) knowing that a huge part of the EU market — and the largest member state trader with the United States — might be leaving.

While Mr. Trump is not anti-trade per se,[7] and never spoke against TTIP, those negotiations are now, at best, on hold until the new administration is in place. And many think they may well be dead, as the new Administration is likely to promote more Buy American requirements in its new infrastructure program, and will have little use for the sustainable development provisions that are politically important for the Democratic Party and in Europe.

But could a revived TTIP help square the Brexit circle?

At some point, the U.K. will be out of the EU. It will need to leave all existing EU trade agreements and replace them with new bilaterals, or the EU and the other countries will need to revise them to include the U.K. as a separate third party. A triangle.

This is true of TTIP as well. But TTIP is under negotiation today, AND it is significantly more ambitious than any other trade agreement the EU (or U.K.) has negotiated. Whether explicitly or implicitly, the United States and the EU could re-enter the talks under a Trump administration assuming the U.K. eventually would be a third party to TTIP.

The European Commission could not allow a member state to be formally at the TTIP negotiating table,[8] but it also doesn’t want a Trojan Horse sitting there when it briefs the member states on the status of the talks. London and Brussels could agree that the U.K. would voluntarily absent itself from the EU briefings, in exchange for an understanding that Washington would be doing the (detailed) “briefing” instead.

The Brits, knowing they would eventually become parties to the deal, would become the bridge they are so often portrayed to be, pushing on both sides to adopt the most favorable terms — from which it as a party would also benefit. This could happen, for instance, by arguing in Washington to allowing “fair” European (and U.K.) firms to bid on U.S. government contracts on a non-discriminatory basis, and ensuring that the EU would give it and the United States as open access as possible in return. Or by helping Washington understand the importance of “geographical indications” for agricultural products in Europe — and the U.K. — while pressing in Europe for more agricultural market access.

This would effectively allow the TTIP structure (market access, regulatory cooperation with individual sectoral agreements, rules) to be used to simultaneously craft what would also be a U.K.-EU FTA and a U.S.-U.K. one. As in the Trans-Pacific Partnership agreement, many of the individual tariff phase outs, quotas and specific sectoral regulatory arrangements would be done bilaterally, U.S.–EU27, U.S.–U.K. and U.K.–EU27 (agreed during the Brexit talks), with all those triangular deals being ready for inclusion in a final legal agreement. If TTIP is finished before Brexit, the specific U.K. provisions could be built in, with the other bits added immediately upon formal completion of a Brexit deal. Brexit would mean the U.K. leaving the U.S.–EU agreement as such (as with all trade agreements), but in the TTIP case to be immediately brought back in.

Can It Work?

The choreography for such an approach is complicated, but so is everything else about Brexit. And this would arguably resolve some key problems. It would defuse the huge problems a U.S.–U.K. deal would cause the Brexit talks. It would allow the U.K. to have more weight in its negotiations with Washington, and yet also give a major geopolitical reason for both the United States and the EU to reach a truly ambitious agreement. And it would help address some of the political concerns TTIP has raised by placing the concerns some in Europe have about the United States in a broader political perspective.

There is little good that comes with Brexit. But perhaps some of the downsides of squaring that circle can be mitigated with a triangle that keeps the U.K., EU and United States closer together.