Level playing field
The Political Declaration pledged a level playing field (LPF) to ensure open and fair competition. The EU had set the LPF provisions as a pre-condition for the Free Trade Agreement (FTA), because the UK is a close neighbour and a large economy with deep trade connections. Although LPF terms appear in other EU FTAs, they are less important to the EU for more distant countries like Canada or Japan.
Principally, the EU wanted and still wants to prevent the UK from deregulating or increasing state financial support to give British industry an unfair competitive advantage over EU rivals. The UK sought reciprocal undertakings to avoid unfair EU competitive advantage over UK firms.
The objectives of the LPF safeguards were to:
- ensure open and fair competition based on commitments across the economic partnership;
- prevent distortions of trade and unfair competitive advantages;
- address cross-border UK-EU pollution;
- address global sustainability and climate change challenges by continuing close cooperation.
The LPF provisions relate to several areas as well as regulatory and technical standards. The main LPF areas are:
- state aid (i.e. government subsidies)
- competition
- social and employment standards
- environment and climate change
- relevant tax matters
State aid and standards
State aid
On state aid, the UK wanted to be free to set its own rules and to have maximum access to the EU market of 450 million consumers. The EU wanted to make sure that the UK does not gain unfair competitive advantage through state aid. The UK and EU need to agree to a common framework for subsidy rules. These will involve the UK committing to a robust regime that will prevent unfair subsidies that allow UK firms to undercut their EU competitors. The PD commits to mechanisms for domestic enforcement and for dispute settlement. As a start point, the EU asked the UK to commit to preserving EU state aid rules.
The UK does not spend much on subsidies compared to most EU counterparts (see Figure 14.3). The UK government currently provides about £8 billion a year in approved state aid, mainly to support environmental goals. This is only 0.4% of GDP and less than a third of what Germany spends (1.5% of GDP). So, from a helicopter view, UK state aid should not be a major issue for either the UK or the EU.
Figure 14.3: State aid as % of GDP (2018)
To secure a UK-EU FTA, a UK state-aid policy was essential. Experts say it was crucial to give confidence to EU negotiators that Britain will not compete unfairly with EU firms. A clear state-aid policy also has benefits for the UK itself. The Institute for Government made a strong case for effective control of subsidies post Brexit.
So far, the government has announced that the UK would follow WTO subsidy rules after the end of the transition period. It also said it would publish clear guidance on WTO rules before the end of 2020 for public authorities and devolved administrations. In addition, business would be able to comment on the UK’s own proposed domestic regime in 2021. However, due to lack of effective enforcement, a WTO approach would mean weak control, which is unlikely to satisfy the EU.
State-aid rules appear in other trade deals. For example, the UK-Japan FTA copies restrictions on subsidies in the EU-Japan deal. These prohibit both governments from, for example, giving indefinite guarantees to struggling companies, or providing a bailout without a restructuring plan. As a result of its Japan deal, the UK will need to put laws in place to ensure that British public bodies meet the restrictions.
Under WTO rules, when a country believes another is giving unfair subsidies to a domestic producer, it can respond with ‘countervailing duties’. This means tariffs on goods that might have nothing to do with the subsidised sector. For example, the US responded to what it saw as unfair subsidies to Airbus with higher tariffs on aircraft, Scotch whisky and other products.
Standards
On standards, the EU proposed (and the UK agreed) that the minimum protections for environment and labour should be those that apply today. If the UK goes below the minimum and this affects trade or investment, the EU would be entitled to levy tariff sanctions (subject to arbitration) to level up the playing field. The main issue will be how to deal with future divergence. As standards evolve, the two parties may agree new higher minimum levels.
Sources:
UK Trade Policy Observatory, UK-EU trade relations: A checklist of 10 key issues
European Commission, DG Competition, State Aid Scoreboard 2019
HMG, Government sets out plans for new approach to subsidy control, September 2020
Institute for Government, Beyond state aid, September 2020
Financial Times, Japan trade deal commits UK to stricter state aid curbs than in EU talks, 13 September 2020
Free Trade Agreement
The UK government’s principal aims for trade were:
- Zero tariffs and quotas on UK-EU goods trade;
- Ability to diverge from EU regulations and rules.
It framed its aims in terms of a “Canada-style agreement” (a Comprehensive Economic and Trade Agreement) or an “Australia-style agreement” (‘no deal’). All reputable economists agree that no-deal terms (aka a WTO Brexit) would be disastrous for UK trade and the economy. For example, NIESR estimated that UK-EU trade would fall by 59% to 65% and overall trade by 24% to 26%. See the section on impact assessment for details.
Compared to WTO terms, Canada++ might have sounded impressive, but it would have still been a big step-down from EU membership. Even with an FTA, friction-free trade in the Single Market would be gone for UK-based companies, who would find it more difficult and more expensive to trade with EU customers and suppliers. For example, rules of origin checks would apply. Also, British companies which trade with Northern Ireland would face new checks and controls.
However, the tariff and quota terms of Johnson’s basic FTA should have been relatively simple to negotiate. Fish was the main exception.
Cost of divergence
As the UK wanted to diverge from EU rules, the EU will treat the UK as if it will diverge, whether it does or not. EU trade controls will apply to UK exports irrespective of whether the UK’s rules and regulations are the same as the EU’s – the same as any other FTA partner.
This means the full spectrum of EU checks and controls will apply, for example:
- Exporters will need an EU-established entity to be legally responsible for ensuring the product complies with EU rules and for placing it on the EU market. This could be the EU-based importer or a legal representative. UK exporters of low-risk products will be able to self-certify that they meet EU requirements. However, they will no longer be able to place them directly on the EU market.
- Exports of animals and animal-origin products will face new regulatory controls at the border. These will involve new paperwork (such as export health certificates signed by a vet) and new physical inspections). This will happen irrespective of whether the UK applies the same food hygiene standards as the EU.
Continued alignment (‘dynamic alignment’ to accommodate changes to EU rules) will benefit UK-based businesses serving the UK and the EU. Alignment avoids having to produce to different rules when selling to both markets. However, it will only remove regulatory barriers to trade, where the EU grants the UK equivalence (see below).
The UK’s freedom to diverge comes with large additional costs. However, when the UK decides to diverge, for example, by adopting US production methods. the UK would not face new barriers with the EU – they would already exist. Avoiding extra costs because you are already paying them is a false benefit. Indeed. the government’s own analysis found that the benefits of regulatory divergence are likely to be small.
European product standards are recognised globally. As a result, UK exporters are likely to follow them. The UK will have to choose between keeping the benefits of not diverging by following EU rules; or pursuing Brexit ideology about sovereignty over the UK’s wider economic interests.
Source: Centre for European Reform, Flexibility does not come free, Sam Lowe, January 2020
Equivalence and adequacy
There are some areas where unilateral alignment with EU rules could lead to greater market access. Two important examples are:
- Financial services and the areas covered by the EU’s financial equivalence regime. Here, the EU could allow certain financial services activity, focused on the EU-27, to continue to take place in the UK. In these areas, historically, the UK has often gold-plated EU rules for financial services – known as ‘super-equivalence’. However, it is important to note that, even with equivalence granted, there would still be a large gap compared to membership of the Single Market.
- Data protection. Here, unilateral alignment would mean the EU is more likely to grant the UK an adequacy ruling. Adequacy would mean that companies would be able to continue storing the personal data of EU citizens in UK data centres. This is important because exchanges of personal data are at the core of law enforcement and judicial cooperation, as well as commercial trade with the EU.
Equivalence and adequacy rulings are unilateral. This means that they are in the EU’s gift and are not subject to negotiation. The EU can withdraw them at short notice, which gives the EU significant leverage. For example, the EU recently withdrew permission for EU stocks to trade on Swiss exchanges to put pressure on Switzerland to sign up to an unrelated agreement. Of course, the UK may also grant equivalence to the EU in certain areas to facilitate EU27 access to the UK market.
Rules of origin
Rules of origin drive one of the new customs checks that will affect UK-EU trade. The purpose of the rules is to find out where something was made in order to decide whether the product is tariff free or a tariff should apply. As the UK has left the EU Customs Union, UK exporters to the EU have to prove the origin of their products. This is standard practice for parties to an FTA.
To determine origin, exporters must analyse the content of their products between local content and that from other countries. To do this, there are different rules for different sectors and goods classifications. For a manufactured product in a global supply chain, the rules might measure each country’s economic contribution to the product. For example, for a car to qualify for zero tariffs under the EU’s FTA with South Korea, 55% of its value must have been created in the EU.
All FTAs define their particular rules of origin. For example, the trade agreement between the EU and South Africa allows components from both to count towards ‘local content’. However, for the UK, South African components are excluded from EU local content. The multiplicity of trade agreements involved in an international manufacturing process can make it difficult to apply the rules.
The upshot is that rules-of-origin checks cost UK exporters money and time. As a result, the rules make post-Brexit exporting to the EU less competitive, less attractive and less profitable compared to EU membership.