Recent media reports suggest that there is confusion about the United Kingdom’s (UK) Brexit proposal (“the Chequers proposal”) and President Trump’s thoughts on how the proposal would impact a future UK-USA trade agreement. The underlying issues are not difficult to disentangle, but do require an understanding of the types of trade relations countries can enter into.
On 29 March 2019, the UK will exit the European Union (EU). This is what is called Brexit and will require a rejigging of the current arrangements for trade between the UK and the EU. At the same time, the UK and USA are seeking a trade agreement between the two countries. In general terms, there are different levels of economic integration agreements that countries can enter into. The most basic form of economic integration is a Free Trade Agreement (FTA). This is what the UK and USA are seeking to enter into. A higher, second level of economic integration is a Customs Union (CU), which reflects the current arrangement between the UK and EU. There are also more advanced levels of integration, culminating in full economic union, but for the purposes of Brexit and its impact on UK-USA trade relations, we can focus on FTAs and CUs.
Both FTAs and CUs seek to eliminate tariffs between signatory countries. But there is a crucial distinction between the two. In a FTA, countries maintain their own, individual tariff structures in respect of non-FTA countries. In a CU, countries apply a common tariff structure in respect of non-CU countries. What does this mean? Let us use an example. The minimum number of countries needed to form a FTA or a CU is two. Thus, to keep things simple, we can imagine that there are two countries, A and B, that enter into a FTA. In this instance, Countries A and B have agreed to allow their goods (optionally services too) to be traded without tariffs being imposed on those goods. When it comes to trade from a non-FTA country, say Country C, Countries A and B each maintain an independent right to charge whatever tariffs each country wishes to charge on goods from Country C. In the case of a CU this is different: not only do Country A and B agree not to charge tariffs on each others goods, but they also agree to charge common tariffs on trade from non-CU countries such as Country C.
What is the significance of this, why does it matter whether Country A and B maintain their autonomy in terms of setting tariff rates for non-member countries rather than harmonizing their rates? At first glance, it does not matter. Both FTAs and CUs eliminate tariffs among member countries, which is the principal purpose of these agreements. But if we think this through a bit further, we realize that, in the case of a FTA, there is an inherent problem, which is that the FTA could be used by non-member countries to circumvent higher tariffs. How would this work? Let’s say Country A charges 50% on goods from Country C, whereas Country B charges only 10% on goods from Country C. If you were a trader from Country C you might want to use the FTA between Countries A and B to your advantage by exporting your goods, first to Country B, paying the lower tariff rate, and then to re-export those goods from Country B to Country A without having to pay any tariffs under the FTA. In a CU this problem does not arise because both Country A and Country B would charge the same tariff on goods coming in from outside the CU, i.e. from Country C. In practice, countries in a FTA shield against tariff circumvention by way of re-export by applying something called rules of origin. Rules of origin can be quite complicated, but in essence only goods which can be shown to have originated in Countries A and B will benefit from the zero tariff arrangements, not goods from non-FTA countries.
But if you have to check the origin of goods, you will need a border and also customs enforcement. And this is where the Brexit issue comes in. Currently, as the UK is in a CU with the EU, goods can be shipped freely between the two without any customs enforcement. This is a very convenient arrangement for traders and businesses and the UK would like to maintain it post-Brexit. But the UK would also like to enter into FTAs with third countries, such as the USA. At the moment, since the UK is obliged to maintain common tariffs with the EU, the UK cannot enter into FTAs. If it did, the UK would be undercutting the agreed common tariffs. In fact, one of the perceived benefits of Brexit is the expectation of new, global trade opportunities as a result of being unshackled from common tariffs with the EU. The Chequers proposal put forward the idea that something akin to the existing CU with the EU could be maintained while also allowing for a FTA with the USA. As we saw above, the problem with this type of proposal is that exporters in the USA could export their goods to the UK tariff-free and then re-export them to the EU, thus avoiding the EU’s common tariffs on goods from the USA. The Chequers proposal advances some measures to avoid such circumvention, for instance, by establishing a system of “trusted traders” whereby those trusted traders basically declare whether their goods are heading for the UK or will be re-exported to the EU. If the goods were headed to the UK, there would be no tariff, whereas if they were headed to the EU, the UK would levy the EU-wide common tariff on goods from the USA and pass on the proceeds to the EU.
It has been argued that the Chequers proposal creates incentives for cheating and is essentially unworkable. Chequers poses many challenges, not just tariffs. For instance, the UK currently shares its rules on product standards with the EU. This allows products to circulate freely between the UK and the EU. If a post-Brexit UK were to maintain EU product standards under the current CU, there would be little or no incentive for countries like the USA to enter into a FTA with the UK. If trade between the UK and USA had to abide by EU standards, the USA would be better off dealing with the EU directly. For these and other reasons, there are many legal practitioners who believe that the UK will have to decide whether to maintain a CU with the EU and forgo FTAs with third countries or to leave the CU and enter into FTAs with third countries. In line with this view, President Trump, in an interview with The Sun newspaper on 13 July 2018, suggested that the UK cannot have it both ways. Literally, Trump said that the Chequers proposal would “kill” a future UK-USA trade deal. Later the same day, at a press conference, Trump urged UK Prime Minister Theresa May to negotiate a Brexit agreement that would allow the UK and USA to enter into a free trade agreement – in other words, not the Chequers proposal. Thus, contrary to some media reports, there is no contradiction between Trump’s stated views in The Sun interview and during the press conference with Prime Minister May – although the comments made at the press conference were clearly more diplomatic in tone than those expressed in The Sun interview.
The fundamental distinction between a FTA and a CU mean that the UK will have to choose one path or the other. It is difficult to conceive a path which would allow the UK to have its cake and eat it.