Bordering on a Customs Union

Container Port

Since the start of this year, the UK political consensus has moved towards a customs union for goods, including agricultural trade, in the final UK-European Union (EU) free trade agreement. This is largely the result of the EU’s rejection of the UK’s alternative proposals to solve the Irish border issue and the Labour party making maintenance of the customs union an explicit objective of Brexit policy. But why is a customs union a better economic option than a regular free trade agreement and why should investors care?

Since the beginning of the Brexit negotiations, the UK government has opposed a customs union with the EU because, it said, this would significantly restrict the UK’s ability to negotiate trade agreements with other countries. Furthermore, it would have the potential to restrict UK domestic policy on state aid, industrial emissions and social and employment laws. In the circumstances, how could a customs union possibly be a good thing?

Fundamentally, Brexit represents a decision about how much to increase trade barriers with the EU going forward. EU membership confers unprecedented free trade in goods and services between members by reducing import tariffs and harmonising regulation; anything other than full membership will be a step down in free trade access to the European single market.

A customs union is a group of countries that agrees to apply the same tariffs to goods from outside the union and often to allow freer trade within the union. In the EU, this tariff is called the common external tariff (CET). Staying in or building a new customs union with the EU would mean that goods could continue to be traded almost as freely as they were pre-Brexit. This is not a perfect solution, given the importance of services for the UK economy – full access for services would require single market membership – but it would provide benefits for the UK economy.

The principal advantage is that it would limit the impact of the UK leaving the EU for firms that export goods. Membership of the EU has massively reduced the administration costs and supply chain delays that border checks impose upon trading nations. This is because members trust the customs processes of fellow members to comply with rules of origin – which is just how customs authorities classify where exported goods have come from.

The costs of compliance and administration could range from 4% to 15% of the value of the good being traded.

Hard border checks

However, in the absence of a customs union agreement, hard border checks would be necessary to check where goods have come from. This would be costly; the UK government’s trade and investment review has estimated that the costs of the costs of compliance and administration could range from 4% to 15% of the value of the good being traded. On top of that, supply chain delays would result in less efficient transport, and this would also increase costs.

The implications of a “hard” Brexit without a customs union agreement would be felt most keenly at the United Kingdom’s only land border – the border between Northern Ireland and the Republic Ireland. There are 275 border crossings on the 310-mile border, none of which are currently customs controlled. Without customs union membership at a minimum, the small roads and fields that mark the border could not be easily monitored and this would encourage smuggling.

Customs checks did exist between North and South from 1972 onwards, with 17 HM Customs and Excise boundary posts at points in the border. Although there were over two hundred more possible crossings, they were not approved for vehicular travel. However, on 1 January 1993, systematic customs checks were abolished between EU member countries. Returning to the previous state of affairs would be highly costly – both in terms of financing and time. In addition, the checks would bring back painful memories of the Troubles.

A number of farms, businesses and even communities straddle the border. Without a customs union – and in the absence the previously hoped for ‘fudge’ solution – the normal functioning and political stability in these places risks being significantly altered. It is also important to note that regulatory alignment on the island of Ireland is likely necessary to really reduce these risks; something not yet properly addressed by the UK government.

The challenge for the UK government is how to make the best economically of a political decision; finding the balance between implementing Brexit and minimising its costs. Customs union is no panacea – but it does provide tangible benefits to exporting firms and the UK government by reducing the costs associated with putting in place and monitoring the border in Ireland and at Calais.

The article above was previously published on Aberdeen Standard Investments’ ‘Thinking Aloud’ blog on 18th June 2018