As Theresa May triggers the start of the Brexit process with the notification of Article 50, many have become startlingly complacent about the alternative to crashing out of the EU in two years.
This alternative appears to be some variation of “falling back” on the UK’s commitments at the World Trade Organization (WTO). But this is much more complicated that it appears.
Worse still, for firms that have become used to operating within the comfortable confines of the EU and more than 58 different existing free trade agreements and different preference programs, potentially none of these schemes will apply as soon as May 2019. Instead, UK firms will “revert” to WTO schedules which are considerably less favorable than existing terms.
The UK was one of the original members of the General Agreement on Tariffs and Trade (GATT) in 1948. The GATT eventually became the WTO in 1995. The UK’s independent membership was merged with the EU over the same time period.
The European Union has a unique structure within the WTO. It consists of 29 “members:” 28 member states plus the EU itself. They all share the “rights” and “obligations” of the organization. All EU member states participate at the WTO, even if as they are bundled together as a collective.
This shared structure extends to every level of their rights and obligations—effectively they share each and every commitment evenly as well. This is what makes it so challenging to just sever the UK from the EU.
Essentially, the UK (and, to a certain extent, the EU) will have to negotiate new terms at the WTO. This is a very complicated and challenging task as any newly acceded member can attest.
Because the WTO operates by consensus, any single member can torpedo negotiations. The UK will have to painstakingly negotiate terms of its commitments in goods and services and any other country-specific obligations with each and every one of the 164 other members.
The UK is already a member, so it is not quite engaging in a new accession process to the WTO. But, practically speaking, the experience of creating new schedules and commitments will end up being quite similar to joining the organization for the first time. Each obligation will have to be negotiated with all other WTO member states.
One solution that has been proposed has been for the UK to really practice free trade by unilaterally dropping all tariffs to zero. The country would essentially follow the footsteps of Singapore and Hong Kong.
This would certainly be a bold step. It could be deeply problematic to some domestic sectors in the UK, as offering up duty-free trade would provide tariff free concessions to all 164 other members (including the EU) to the UK market.
Do note that there is no reciprocal obligation for any other WTO member to make similarly bold commitments. The WTO does not operate like bilateral free trade agreements—when a country makes a pledge to set a tariff level within the organization, it is offering to extend this tariff level to every single WTO member. The rest of the membership would not offer up zero tariffs in return since it would mean granting tariff free coverage to all other WTO members and not just to the UK.
Hence a second, slightly more realistic option might be for the UK to just accept the tariff schedules automatically of the EU at the WTO. Note that the UK cannot offer duties higher than EU rates, as these would be rejected by other members.
So how might this work? As an example, the existing EU WTO tariff for sports shoes (like tennis shoes, running shoes, basketball shoes and the like) is 16.9 percent. The UK could simply copy this tariff rate and grant its own Most Favored Nation (MFN) rate of 16.9% to all other WTO partners.
Doing so would avoid a potential problem of having some members at the WTO argue that new UK commitments undermine current levels of access.
But getting 16.9% for sports shoes requires that all WTO members accept the UK offer of this tariff rate. If any of the existing WTO member baulk, the UK may have to negotiate a different rate for this tariff line.
The existing schedule for the EU is partly the result of a complex set of interconnected compromises across thousands of lines of commitments. Just transferring the existing EU commitments over to the UK may not work.
For example, the UK market for sports shoes is likely to be quite lucrative. A WTO member like Vietnam might prefer to have better access than 16.9% and could be willing to hold up the negotiations with the UK across the entire package just for improved access to this one tariff line. Granted, members might not do so, but a happy, quick outcome for the UK is certainly not guaranteed.
Turns out, negotiating tariffs is some of the easy stuff. Working on other aspects of WTO pledges will be even harder. The most challenging elements are likely to be found in the intermingled UK/EU agricultural commitments.
Two aspects are particularly problematic: domestic subsidies (aggregate measures of support or AMS) and tariff rate quotas (TRQs). Both get rather technical, but both issues have some significant implications for agricultural trade for the UK and the EU.
In short, the EU has specific commitments in the WTO for each. The very tricky part is determining how much, if any, of the allocated amounts granted to the EU for subsidies and quotas should reside with the UK?
This is much more challenging that it might first appear. In both cases, the EU negotiated commitments back in 2004 when the Union had only 15 member states. The specific allocation of benefits across the member states today is not known (or is not publicly known).
In each case—for every subsidy and every quota—the EU has a strong incentive to keep the full amount for reallocation among the remaining 27 members. And, it might be remembered, if the two year time horizon for Article 50 negotiations passes without resolution and is not extended by the EU, the bargaining between the EU and UK ceases. Presumably, the WTO allocations would automatically revert to the EU in this situation.
If the UK is not granted a legacy “share” of quotas and subsidies, it will likely be harder to set up new quotas or subsidies in the WTO as an independent state. These have to be negotiated with all WTO members.
The UK could decide to just walk away entirely from both practices: no more domestic agricultural subsidies and no more quotas. This may be easier for the UK to negotiate within the WTO, but could be quite hard to manage at home.
[It could also, it should be noted, make the parallel WTO negotiations for the EU more challenging, as many WTO members would surely press the EU to either reduce or eliminate their own subsidies and quotas. And, if the UK is granted “legacy” rights to either quotas or subsidies, EU amounts should similarly be reduced in any case. Note that many WTO members have been waiting for decades for a good opportunity to revisit both these issues, irrespective of what happens to the EU/UK.]
While other WTO commitments may be less problematic for the UK to negotiate than agriculture, these will also not be easy. For instance, the last time WTO members made commitments in services was in the mid-1990s. Now that the UK will be setting up its own schedule, other WTO members are likely to expect a higher level of national treatment and market access commitments in more sectors than the original EU schedules.
A similar upward pressure on services commitments can be seen in the schedules of other recently acceded members like Vietnam and China.
Once all the WTO commitments are sorted for the UK, it does not replace the market access or treatment that UK firms currently receive as part of the EU. Many of the EU’s current 58 trade arrangements build upon WTO rules as well. Most of these bilateral and regional trade deals will also have to be adjusted or even renegotiated in the wake of Brexit.
None of these, however, can start until the WTO issues have been sorted. Hence it is urgent to get the UK/EU internal discussions underway immediately on how to divide up WTO commitments and start the painstaking process of scheduling independent commitments for the UK.
It may go smoothly and quickly. But it may not. And companies would be well advised to pay careful attention to what happens in Geneva—these apparently arcane discussions about schedules and commitments could become the rules that govern trade for UK businesses for a long time to come.
***This Special Edition of Talking Trade was written by Dr. Deborah Elms, Executive Director, Asian Trade Centre, Singapore***