Brexit: According to custom(s)

Discontent with the Brexit process has gathered momentum in recent weeks as the EU Withdrawal Bill is debated in the House of Lords. There are two key areas where the Lords disagree with the government’s vision of a post-Brexit Britain, having voted against that part of the bill which seeks to withdraw the UK from the customs union and also against the legislation which peers believe will result in an erosion of workers’ rights. None of this means that the government will necessarily water down its position, since the role of the Lords is primarily to scrutinise legislation and challenge anything proposed in the House of Commons and it cannot block legislation indefinitely. But it may embolden MPs in the lower house to rethink their position on many elements of the Withdrawal Bill.

The customs union issue is particularly important and has proven to be an area where Brexit protagonists have demonstrated that they do not fully understand the implications of their actions. A customs union implies the abolition of customs duties between member states and the imposition of common tariffs against those not in the union. That is not the same thing as the free movement of goods which is enshrined within the EU single market. For one thing, a customs union may not necessarily cover the full range of goods. For example, Turkey is part of a customs union with the EU but the deal does not cover food or agriculture, services or government procurement.

But failure to secure some kind of customs arrangement with the EU will almost certainly mean significant border delays. Those claiming that the Swiss and Norwegian examples show how a customs union can proceed without any such frictions are wrong. Switzerland and Norway are in the Schengen Area (chart) which allows individuals to move easily across borders, but neither are in the customs union so there can be significant delays as goods are transported across the border into the EU.

Moreover, most of the empirical work which utilises trade gravity models to look at trade flows draws the conclusion that leaving the single market or customs union will lead to a reduction in trade between the UK and EU. Such models explicitly incorporate the zero-tariff option, which can be  controlled for in simulations designed to show the counterfactual where tariff barriers exist. A customs union would, of course, be a second best solution compared to what the UK enjoys now. But it is better than no deal at all, and would go a long way towards resolving the Irish border problem.

What is particularly ironic is that the customs union has only become an issue following the referendum. It has been seized upon by those leavers who believe that it is an obstacle to signing trade deals with third countries, but was barely mentioned during the referendum campaign and was certainly not on the ballot paper. There is a sense that some in government are beginning to understand the difficulties involved in the customs union discussion with rumours earlier this week that the prime minister would seek to back away from her previous position (which were denied, of course). This would be the sensible economic decision, although so closely is Theresa May identified with this policy that it would likely spell the end of her tenure in Downing Street. But her departure may be a small price to pay to secure the national interest.

Looking at the issue from outside the UK, financial services remain an area of contention. Two senior EU officials this week rejected the UK’s case for continued post-Brexit access to EU financial markets under something approximating current rules. The EU’s chief Brexit negotiator, Michel Barnier, argued that since the UK would no longer be within the EU’s single market, it would not be covered by its regulations and oversight – a view reiterated separately by Valdis Dombrovskis, the European Commission’s finance chief. This may all be part of the normal poker playing during negotiations, but it highlights that despite the late-March optimism that we may be close to an agreement on a transition period, there are still plenty of areas of disagreement.

Indeed, the Bank of England recently concluded that the transition period would allow non-UK financial institutions operating in the UK to conduct business until the end of the proposed transition period (end-2020) without any change in their regulatory status. But there has been no reciprocal arrangement from the ECB, so firms licensed in the UK are not guaranteed to be able to conduct business in the EU under the current passporting arrangements after March 2019. If ever we needed a reminder that nothing is agreed until everything is agreed, this is it.