Following poor local election results, both major parties in the UK are under pressure to reach a compromise on Brexit. In its talks with the government, the Labour Party is demanding a permanent customs union as part of the future relationship with the EU. In this article, we look at the prospects for a deal and in particular, whether a customs union is likely to provide a satisfactory basis for the future relationship.
Is a customs union enough?
As we have pointed out previously, if the objective is to preserve current levels of frictionless trade in goods with the EU, then a customs union is unlikely to be sufficient on its own. This is because a customs union only removes border "red tape" relating to tariffs and rules of origin; it would not remove the need for paperwork and a certain level of regulatory checks relating to compliance with product standards. These requirements can only be removed by entering into some form of regulatory union with the EU, alongside a customs union.
As Karen Wheeler, head of HMRC's Border Delivery Group, recently put it: "[w]hat you need is, at the very least, something that looks like a customs union, plus something that looks like a single market, which has no customs or tariffs or regulatory standards or controls, if you are going to have completely free movement of goods across the border." She added that: "[t]here is no technology solution which would mean that you could do customs controls and processes and not have a hard border" (see this article).
Of course, a customs union coupled with close regulatory alignment would significantly constrain the UK's ability to pursue an independent trade policy in relation to goods; but if that objective is to take precedence, then the UK will have to accept a significant deterioration in the level of frictionless trade in goods with the EU. For more detail, see our Q&A on customs arrangements and our webinar "Is your supply chain Brexit-ready?".
What about services?
Services make up almost 80% of the UK economy as a whole and account for almost half of total UK exports. As recently pointed out by the UK Trade Policy Observatory, the share of the UK economy accounted for by services is significantly higher than in most other developed countries. The same article also points out that, according to a recent OECD report, service providers outside the Single Market face trade barriers which are four times higher than those for suppliers based inside the EEA.
Even if the government and the Labour Party reached an agreement on a customs union accompanied by a high degree of regulatory alignment (effectively equivalent to Single Market membership for goods), this would do little for services. Yet despite this, both main parties appear to be focussing on goods trade in their attempts to resolve the Brexit impasse.
In their defence, it could be argued that, as the UK has a highly competitive services sector which trades internationally (not just within the EU), it is better placed than the goods sector to withstand a deterioration in trading terms with the EU. It may also be that both parties take the view that, in order to negotiate an end to free movement of people with the EU whilst retaining the benefits of Single Market membership for goods, the UK will have to agree to "take a hit" on services. Indeed, the loss of free movement of people is itself likely to involve a significant "hit" to the services sector. For example, after Brexit, a software business based in the UK could continue to sell into the EU based on WTO terms – but if it regularly sends UK-based staff to client sites in the EU to help with installation or training, this would be more problematic after Brexit and might well require the business to engage more contractors locally (it is far from clear that a comprehensive trade agreement with the EU would improve the position substantially).
Another case of kicking the can down the road?
It will be apparent from the above that a customs union on its own is unlikely to provide a satisfactory basis for a future relationship with the EU. However, at this point, both Labour and the government may be more worried about persuading enough of their own MPs to vote for the draft Withdrawal Agreement to enable Brexit to take place – and if a commitment to a customs union achieves that objective, then it may be felt that it is worth pursuing, despite its flaws. Negotiations on the future relationship might well lead to a recognition that it was in the UK's interest to go further than a customs union and sign up to a regulatory union as well, at least in relation to goods. To that extent, the current focus on a customs union could be seen as a further case of "kicking the can down the road" and putting off the difficult, long term choices until a later date (whilst being somewhat disingenuous about the pros and cons of what is being proposed).
What are the prospects of a successful outcome to the talks?
It is widely reported that the Labour Party is concerned about a future Conservative government under a new leader abandoning a commitment to a customs union and seeking to negotiate a much more distant future relationship with the EU. Labour would then be vulnerable to the accusation that, far from securing concessions, it had in fact facilitated a much "harder" Brexit than originally envisaged when its MPs voted through the draft Withdrawal Agreement. Unless this concern can be addressed, the political incentives for Labour to reach a deal with the government would appear to be weak.
Press reports also suggest that, in the short term at least, the prospects of the talks reaching a positive outcome are low. Indeed, the government has already signalled that it does not expect to be able to secure ratification of the draft Withdrawal Agreement by 22 May, as would be required if it wishes to exit with a deal but avoid holding elections to the European Parliament on 23 May (see this article).
What if the talks fail?
The government's target for having ratified the draft Withdrawal Agreement now appears to have shifted to the beginning of July (as we pointed out last week, this is when the new session of the European Parliament is due to begin). For the time being, it plans to continue discussions with Labour. However, if the talks fail, the idea of a customs union may resurface in some form as part of a renewed attempt by the government to put various options in front of MPs in the hope of getting the draft Withdrawal Agreement approved.
Competition and Commercial
Travers Smith LLP
+44 (0)20 7295 3471