Articles, Briefing Notes & Speeches

The Trade Policy Research Centre is concerned with realistic solutions to the UK's trading relationships with other entities, especially the European Union.

Address to Civitas on 2 October 2014


Good afternoon, and thank you very much, David2, for inviting me as your lunchtime speaker today.

Some years ago, studying Russian economic history at Cambridge, I remember being gripped by the story of the Great Debate in the mid-1920s between those who argued that agriculture should be the first priority for Soviet economic development and those who contended that top priority should be given to heavy industry.

Now we have a new great debate here over how, if it ultimately comes to it, the UK should seek to structure its future trade relations with the EU and the rest of the world if we withdrew from full EU membership. I count some seven different approaches apart from ours which are currently under discussion: the so called Norway, Swiss, Turkish, WTO and EEA-lite options and the ideas of a UK-USA free trade agreement or a Commonwealth free trade agreement.

I find myself even more gripped by this new great debate in the UK than I was by the Soviet one in the 1920s because, thanks to the Trade Policy Research Centre's supporters' financial generosity over many years, I find myself trying to contribute to it. Many of our supporters also bring invaluable experience and wisdom to our deliberations, uniquely so in the case of David Heathcoat-Amory, whom we are fortunate to have with us today.

I believe the distinctive features of the TPRC's approach are:

  • First, always remembering that the basis of world trade is the multilateral trading system founded on the World Trade Organization Agreements
  • Second, focussing clearly on the sectoral dimensions of trade as opposed to the macro-economic level
  • Third, always trying to think outside the box of existing models such as the Swiss and Norwegian options. In the long history of world trade no substantial country has ever left a mature customs union like the EU. So we absolutely have to think originally!

I think that no one in the UK now regards the status quo of our EU membership as acceptable. Even in the late 1990s, when it first started to look probable that we would avoid joining the euro, it was reasonable to ask how comfortable our position would be as a non-Eurozone member of the EU.

But now, following two European Court of Justice rulings on short selling and the financial transactions tax earlier this year, our situation is looking extremely uncomfortable. Both rulings look blatantly discriminatory against the UK with its world class financial services industry. And there are no grounds for expecting any more favourable treatment in the near future from the ECJ regarding bankers' bonuses or the European Central Bank's proposal to force clearing houses with large euro-based transactions to move to the Eurozone. And of course we are seeing ever tighter regulatory control of the City by the three European Supervisory Authorities, especially the European Securities Markets Authority.

I think this and the appointment last July of Jean Claude Juncker as President of the European Commission have been concentrating quite a few people's minds. George Osborne's mind already seemed to be concentrated when he told Open Europe's great pan-European conference on EU Reform in January that "proper legal protection for the rights of non-euro members is absolutely necessary—to preserve the single market and make it possible for Britain to remain in the EU". I wonder how he thinks we can hope to get such protection now.

Of course we must do all we can to negotiate an acceptable basis for continuing EU membership, including radical reform, and we must be seen to be doing so. I myself would prefer little more than just a trade-related basis for continuing membership. But it may become clear quite quickly, perhaps within the space of a few months, that our European friends are not going to play ball. So we absolutely must have an alternative in reserve.

Today I'd like to propose a way of leaving the EU, if we ultimately have to, which has not so far been widely considered alongside the usual list of options I mentioned above. Instead of these we are advocating what we call "Staying in Europe for trade" through negotiating a new inter-governmental customs union agreement with the EU with full UK voting participation in customs union policy decisions. I'll come on to discuss this in more detail.

But first I'd like to discuss two important lessons from history. The first, which is still very recent history, is from Alex Salmond's incredibly inept failure to offer a clearly defined option for how Scotland would leave the UK in the event of a YES vote.

As Olli Rehn pointed out at a late stage in the campaign, Salmond's sterlingisation plan for Scotland's currency on leaving the UK would have made it impossible for an independent Scotland to apply to join the EU in its own right, meaning it would have been left in limbo without any preferential trading agreement with any country, including the UK and the EU. Presumably no one had told Alex Salmond how difficult, complex and time consuming it would have been for Scotland to negotiate its own preferential trade agreements from scratch, especially starting with no civil servants who knew the first thing about it!

Second, I'd like to remind you of the dangers of protectionism. When President Hoover signed the infamous Smoot-Hawley Tariff Act of 1930 in the wake of the Wall Street crash US tariffs rose by an average of 20 per cent. Then, in 1932, Britain compounded the crime against the non-English speaking world first by imposing a general tariff of 10 per cent on all imports, then by persuading the main British Empire countries to discriminate against the rest of the world through the new Imperial Preference system they signed up to under the Ottawa Agreements.

World trade went into disastrous decline and certain countries decided they needed to create their own empires, starting with Italy's invasion of Abyssinia in 1935. As was widely said at the time, the road to Addis Ababa began at Ottawa. We know the rest of that story.

The relevance of that for today is the importance of preventing Europe going protectionist. With most of the Eurozone now sinking fast into a vicious deflationary spiral and the rise of populist anti-establishment parties everywhere I see this as a very serious risk.

At present the so called "Northern liberal bloc" of countries on the Council of Ministers, led by Germany and the UK, has 40 per cent of the vote. But without us their voting strength would sink to 31 per cent, well below the 35 per cent blocking minority threshold which will start to apply next month. Correspondingly, the voting strength of the "Club Med" protectionist countries led by France, Italy and Spain would rise from 38 per cent to 43 per cent, giving them a dominant position on the Council of Ministers.

These are uncertain and potentially dangerous times. Who knows how the Eurozone crisis is going to develop? Please do not let us risk the UK catalysing a return to protectionism like we did at Ottawa 82 years ago. Keep the European customs union together, I say! And, I will come on to argue, being in customs union with Europe is actually rather a good place for the UK to be. The EU's average tariff on manufactured goods of just 2.3 per cent is only a small price to pay for free movement of goods.

Back three quarters of a century ago, in 1941 as the war was reaching its most desperate stage, it took the towering vision of Churchill and Roosevelt to agree the Atlantic Charter which, amongst other things, committed them to lowering world trade barriers once peace returned. That led to 23 countries signing up to the original GATT (or General Agreement on Tariffs and Trade) in 1947 and to the eventual establishment of the WTO in 1995.

The WTO and the rules-based multilateral trading system are the very bedrock of global trade. Eight trade rounds since 1947 have brought average developed country industrial tariffs down from the 20-30 per cent range after the war to under 4 per cent now, and the WTO's membership has risen to 159 countries. Trade, in the sense of aggregate exports and imports of goods and services, has grown to well over 50 per cent of most developed countries' GDPs.

Through four major trade rounds—the Dillon Round, the Kennedy Round, the Tokyo Round and the Uruguay Round (which created the WTO 20 years ago) Europe has played a central role in this process, which I see as one of the most amazing achievements of international cooperation in all history. It has underlain the astonishing growth in prosperity the world has seen over the last two thirds of a century.

I've been following the world of trade policy for over 15 years now since I first started to research alternative trading relationships the UK might ultimately negotiate with the EU if we couldn't establish an acceptable basis for continuing membership. That interest has led me to visit the WTO many times in Geneva, and I've also attended its Ministerial Conferences in Seattle, Cancun and Hong Kong.

In particular, I have been following closely the WTO's efforts through the Doha round to make world trade even freer and fairer. If it eventually succeeds, and I remain hopeful, it will achieve dramatic further reductions in the higher ranges of tariff rates and trade-distorting agricultural subsidies. For example EU tariffs for cars will come down from 10 per cent to 4½ per cent whilst average EU duties on food, beverages and tobacco will come down by well over half from their current level of over 20 per cent. In my view, it is not the EU's fault that the Doha round is currently stalled.

Beside the WTO multilateral trading system, free trade agreements are really just icing on the cake, and quite thin icing in most cases. Those of you who have had read the Trade Policy Research Centre's recent UK Trade Statistics Discussion Paper will know that most free trade agreements achieve much less than the term literally suggests. Farm lobbies fight to keep high levels of protection in place through getting key tariff lines excluded from agreements and retaining non-tariff barriers. Protectionism in trade in services is notoriously difficult to tackle through free trade agreements.

Rules of origin, in particular, are a serious impediment to duty-free trade in free trade agreements. They are essentially protectionist devices designed to ensure that duty-free trade only applies to goods which have been made or partly made in the free-trade areas they create. They are technical in language, complex and often difficult for even experts to understand.

Incidentally, the much vaunted Transatlantic Trade and Investment Partnership now looks to have little prospect of success. Only a year ago Kenneth Clarke was claiming the so-called TTIP as a prime justification for the UK staying in the EU. But now the chances of getting any deal through both Congress and the European Parliament are looking increasingly slim. Endless technical problems and regulatory issues have been emerging. Agricultural interests on both sides of the Atlantic are digging in their heels. And, predictably, the profound incompatibility of EU and US-style rules of origin is proving a major problem. 

I used to think that if we ultimately decided to leave the EU we should negotiate a free trade agreement with the EU like Switzerland or Norway. But I have changed my mind. The "Let's be like Switzerland or Norway" default thinking mode of much of the UK's Euro-sceptic movement looks seriously unrealistic when you look in any detail at how those countries' relationships with the EU are working in practise.

Switzerland's relationship with the EU has been built up piecemeal, starting with their original free trade agreement in 1972 and later two rounds of new bilateral agreements. A major problem for the EU is that none of these bilateral agreements contains any effective dispute resolution mechanism. For some time the EU has been trying hard to push Switzerland into some form of supranational surveillance of these agreements. So it seems highly unlikely that the EU would be willing to consider replicating the existing Swiss package for the UK.

Switzerland's referendum vote in February against continuing free movement of persons was of course a seismic shock for both the Swiss Federal Council and the European Commission. Now, inevitably, Brussels is trying to steamroller Switzerland into reversing that democratic vote by threatening that all its twenty or so different bilateral trade agreements with the EU will lapse unless it continues to adhere to the free movement of persons one.

A further problem for Switzerland is that it is surrounded by the EU, which makes it particularly vulnerable to border issues.

For Norway, as is well known, the workings of the European Economic Area Agreement have gradually been depriving it of legislative control of more and more areas of its national life. In the words of Martin Howe QC, "It is blindingly obvious that Norway's relationship with the EU as part of the European Economic Area should be rejected out of hand as any kind of model for the UK. This is because the EEA states are effectively obliged to implement the burdensome regulatory requirements of the EU single market but have no vote on framing them. To leave the EU to escape from its regulatory strictures and then sign up to that sort of arrangement would be entirely irrational."

At the Trade Policy Research Centre we now do not think any free trade agreement the UK could negotiate with the EU would fit the bill.

Instead, as I mentioned earlier we are advocating what we call "Staying in Europe for trade" through negotiating a new inter-governmental customs union agreement with the EU with full UK voting participation in customs union policy decisions. For those unfamiliar with the important technical distinction between customs unions and free-trade areas I have got some one-pagers here.

In essence, customs unions are where a group of countries get together and agree to have unrestricted free movement of goods between them and common external tariffs against imports from other countries. By contrast, countries forming free-trade areas agree to have free trade between them in goods which originate in those countries, but they remain free to set their own tariffs on imports from other countries.

Let me summarise why we argue our "Staying in Europe for trade" approach is the best one:

  • First, it would enable a seamless change from the present basis of UK-EU trade, with continuing free movement of goods, no rules of origin tests and no changes in customs paperwork and other border procedures. I don't think the EU's average tariff of 2.3 per cent on manufactured imports is at all a high price to pay for that.

  • Second, it would give the UK the moral high ground of being able to offer EU exporters continuing unimpaired access to UK markets for all their goods and services exports. How could our EU friends reasonably object when they know that most British voters have no vocation for political union?

  • Third, as I said earlier, it would keep the UK in customs union with the EU as a liberal ally for Germany and the rest of the Northern liberal bloc on the Council of Ministers.

  • Fourth, by retaining the Common External Tariff and free movement of goods it would address the prime concerns about the UK leaving the EU of the higher tariff sectors such as cars, food & beverages and chemicals in both the UK and the rest of the EU.

    These sectors account for nearly 40 per cent of UK-EU merchandise trade, and they are mainly foreign-owned. In my view, they are just too powerful to take on at the same time as the many EU politicians who would be desperate for us not to leave. The rest of the EU is running a £32 billion trade surplus with the UK in cars, food & beverages and chemicals alone, which would ensure the UK an extremely strong negotiating position.

  • Fifth, it would permit the relatively easy adaption of existing EU free trade agreements with third countries such as Switzerland, Norway, South Korea and Singapore to enable the UK to remain party to at least their chapters on trade in goods. If the UK ceased to be in customs union with the EU it would have to negotiate new free trade agreements with all these countries and then ratify them, which could easily take two years or more.

    Leaving aside the now highly uncertain prospects for the TTIP, there is now no realistic near-term prospect of the EU completing any new free trade agreement with any significant third country other than the one it has signed (but not yet ratified) with Canada.

  • Sixth, it would enable the UK to assure the court of world opinion, led by the USA, China, India and Japan as well as the WTO itself, that the UK leaving the EU in this manner

    • would not in any way disrupt world trade, and
    • would enable the UK to continue to work with the EU for the multilateral liberalisation of world trade through the Doha round.
  • Seventh, it would permit the UK to pursue trade disputes with third countries either in its own right or in alliance with the EU or the USA or any other country.

  • Eighth and lastly, it would enable the UK to negotiate in its own right with third countries in areas which are currently EU competences, such as:

    • investment agreements
    • agreements on aspects of trade in services such as commercial rights of presence, movement of persons and mutual recognition of professional qualifications, and
    • protocols on regulatory cooperation

Well, you might say, wouldn't it be much better to break free entirely of the EU's Common Commercial Policy? There can be no doubt the current arrangement leads to higher prices for the consumer in protected sectors such as cars and food. But we would argue that would be a case of letting the unattainable best become the enemy of the attainable good.

The reality is that being in customs union with the EU is actually rather a good place to be:

  • UK goods exports to the rest of the world grew at 6 per cent per annum between 2008 and 2013. That's an increase of 35 per cent. Over the same five year period UK goods exports to the rest of the EU increased by just 9 per cent.
  • UK service exports to the rest of the world grew at 5 per cent per annum between 2008 and 2013. That's an increase of 30 per cent. Over the same five year period UK service exports to the rest of the EU increased by just 5 per cent.
  • On our calculations, if present trends continue, the proportion of UK exports of goods and services going to the rest of the EU will be down to just 37.5 per cent by 2017, the hoped for referendum year! That's after adjusting for the famous Rotterdam-Antwerp effect, which results in UK exports ultimately destined for the rest of the world being registered in the official UK trade statistics as exports to the Netherlands and Belgium.

    It has to be said that the trade case for continuing UK membership of the EU is steadily diminishing.

    You might reasonably ask what we should do if our EU friends refuse to agree to our staying in customs union with them on a new inter-governmental basis. The answer is we have to have the confidence to threaten to withdraw from the EU without any form of preferential trade agreement, with both sides putting up tariffs against each other. But that would be such obvious madness that we could be certain that sanity would eventually prevail. The truth is that being in customs union together suits them at least as well as us.

    So where now? Our future negotiations with the EU will not be without drama. It is vital we are properly prepared. I see a real danger that in our search for a negotiated settlement embracing continuing EU membership we let ourselves be distracted from thorough examination of the best alternative.

    I suggest we should try to avoid duplication of efforts here. What we now urgently need is a serious, transparent, cross party, properly funded and professionally assisted study to try to establish political consensus on the optimum solution for our own country if we are not able to establish an acceptable basis for continuing EU membership. To fail on this would be political irresponsibility of an unforgivable magnitude.

    I believe the TPRC's "Staying in Europe for Trade" approach is by far the best alternative, especially as it would enable the UK, with all its unique set of global connections, to strive in its own name for freer and fairer trade, both within Europe and throughout the rest of the world.

    Thank you!

    Note (1): Certain figures in this speech have been retrospectively changed following the publication on 31st October 2014 of The Pink Book 2014 on the UK Balance of Payments.

    Note (2): Dr David Green, Director, Civitas.