5.1 Trade trends and arrangements

• About 4/5 of global trade is in goods and 1/5 is in services
  • Services trade is growing faster than goods trade

• Recent trends in world trade:
  • In 2022, global trade dipped by 3%
  • Developing countries bore the brunt, but most regions contracted
  • Contraction partly due to trade and geopolitical tensions between large players
  • Prevailing focus on inflation overshadows urgent issues like trade disruptions, climate change and rising inequalities

• Main players in world trade:
  • EU, US and China dominate world trade
  • UK ranks 6th for trade after Germany and France
  • UK ranks 10th for goods exports
  • UK ranks 2nd for services exports

• Preferential trade arrangements reduce tariff and non-tariff trade barriers
  • Non-tariff barriers have much bigger impact than tariffs
  • EU single market and customs union remove the most barriers globally
  • UK’s red lines limited post-Brexit deal to a basic FTA
  • FTA removes tariffs but does little for non-tariff barriers or services

Click here for summary of Brexit FactBase.

Global trade trends

This section describes the context of trends in global trade.

• Global trends
• Impact of Covid-19
• Main players
• Trade share trends
• Trade openness trends

Global trends

International trade has played a critical role in the economic health of developed nations and in growing the prosperity of developing nations. See “Why trade matters” in the section on economic context. However, the paradigm is shifting.

As the United Nations observed: “the asymmetry of gains from the international trading system, apparent in both advanced and developing countries, has been building into a backlash against the rules of global governance and, increasingly, the very idea of free trade. This backlash is prompting policymakers to reassess their strategic prioritization of international trade. A new trade lexicography reflects these shifts, with terms such as “fragmentation”, “deglobalization”, “slowbalization”, “reshoring”, “nearshoring”, “friendshoring”, “de-risking”, “decoupling”, “open strategic autonomy” and “new industrial policy” peppering current discussions around trade policy.”

Global trade dipped 3% to $31 trillion in 2023 after peaking in 2022 (in current prices). The downturn was driven by lower demand in developed economies and weaker trade in East Asia and Latin America. This resulted in a 5% fall in trade in goods. Meanwhile, trade in services bucked the negative trend, growing by 8%. Services growth was fuelled by surge of nearly 40% in tourism and travel-related services. Other points to note:

• Developing countries felt the brunt, experiencing a sharper decline in trade, with their imports and exports falling by 5% and 7%, respectively, compared to a 4% drop in imports and 3% in exports for developed nations.
• Most regions saw negative trade growth in 2023. The exception was a significant increase in intra-regional trade in Africa.
• Electric cars drove trade in environmental goods. Despite the overall decline, 2023 saw a 2% rise in trade for environmental products, driven primarily by soaring electric car sales.
• Trade in electric vehicles grew by 60%, highlighting shifting market demands and preferences.

The UN notes that the prevailing focus on inflation overshadows urgent issues like trade disruptions, climate change and rising inequalities. Although inflation has come down from the highs of late 2022, it has been a slow and halting descent, largely due to the easing of supply-side pressures. Higher interest rates have so far contributed little to ease prices and have come at a steep cost in terms of inequality and damaged investment prospects. Meanwhile, the cost of living and insufficient wage growth continue to squeeze household budgets everywhere. This impacts demand, which impacts global trade.

Sources:
United Nations Conference on Trade and Development, Global Trade Update March 2024
Trade and development report 2023

Goods and services

Merchandise (goods trade) is declining since mid 2022 while services appear more resilient. See Figure 5.1, which shows quarterly world trade, merchandise (in values and volumes) and services (in values) (Index numbers, first quarter of 2015=100)

Figure 5.1: Goods and serevices (Q1 2015 – Q3 2023)

Source: UNCTAD, Trade and development report, 2023

The bulk of international trade is physical goods: $24.2 trillion in 2022 (78% of total), while services accounted for $6.8 trillion (22% of total).  See Figure 5.2

• World trade in goods and services has increased markedly over the last eighteen years, rising from about $13 trillion in 2005 to about $31 trillion in 2022.
  • Trade declined substantially in 2020 due to Covid, before recovering in 2021.
• Trade in services almost trebled between 2005 and 2022 from $2.5 trillion to $6.8 trillion.
  • Growth in services trade has been steadier and less volatile than growth in goods trade.

Figure 5.2: Trends in world trade (2018 – 2022)

Source: WTO, World Trade Statistical Review, 2023

During the last two years, the geographical proximity of international trade has remained relatively constant, showing minimal nearshoring or far-shoring trends. However, since the latter part of 2022, there has been a noticeable rise in the political proximity of trade (see Figure 5.3). This indicates that bilateral trade patterns have been favouring trade between countries with similar geopolitical stances (a pattern generally referred to as friend-shoring). Concurrently, there has been an increasing concentration of global trade to favour major trade relationships, although this trend has softened in the last quarter of 2023.

Figure 5.3: Shifting dynamics in global trade

Source: UNCTAD, Trade and development report, 2023

Impact of COVID-19

The effects of the COVID-19 economic downturn on global trade was remarkably rapid and intense, both in relation to the decline and to the rebound.

In 2020, international trade in goods and services declined by over 10% over 2019 which stood at just under US$ 25 trillion:

• Goods trade declined by 8% and trade in commercial services contracted by 18% compared to 2019.
• Most of the trade downturn occurred during the first half of 2020.

In Q3 2020 the effect of the pandemic on international trade changed course, but only for goods. Buoyed by the trade of COVID-19 related products (personal protective equipment, medical tests, home office equipment etc.), merchandise trade started to rebound and in Q4 2020 the value of global trade in goods was similar to the pre-pandemic levels of 2019.

• All major economies, apart from China, recorded their sharpest drops in Q2 2020. Trade started to recover slowly for most of the major economies during Q3 2020, with a more general and stronger recovery in Q4 2020.
• China’s exports bottomed in Q1 2020. China’s export resilience during the pandemic was exceptional among the major economies. After falling in Q1 2020, Chinese exports were stabilising in Q2 2020, and rebounding from Q3 2020. China’s out-performance continued during 2021. China’s exports of services fully recovered by Q4 2020 and exceeded pre-pandemic levels in all quarters of 2021.
• Trade strongly rebounded during 2021 and increased by nearly US$ 6 trillion, reaching US$ 27.5 trillion, with goods trade exceeding 2019 values. However, trade in services remained below 2019 levels even in 2021, largely due to the fall in demand for tourism, travel and accommodation services.

Sources:
World Trade Organisation, World Trade Statistical Review 2021
UNCTAD, Key statistics and trends in international trade 2021
IMF blog, 2 June 2022

Main players

The EU27, China and the US dominate world trade in goods and services (see Table 5.1 and Figure 5.4) – trade is the sum of exports and imports. In 2022:

• The EU27 had an external trade deficit (€256 billion), the US a deficit (€903 billion) and China a surplus (€806 billion).
• EU27, China, US and 18 other countries accounted for about €41.3 trillion or 83% of the world’s trade of €48.7 trillion.
• EU27’s external trade was €8.0 trillion (excluding intra-EU trade), China €6.8 trillion (excluding Hong Kong) and US €6.6 trillion.
• Due to their dominance, the EU27, the US, and increasingly China, have a major influence over the standards that regulate world trade.

Figure 5.4: Main players in world trade of goods and services (2022 – EUR bn)

​

See Table 5.1 for the detailed rankings:

• UK trade was €1.38 trillion, ranking below Japan and accounting for 4.3% of world trade.
  • If Germany was shown as a separate country,  it would rank above the UK for total trade.
  • In terms of individual countries, the UK ranked:
    • 6th for goods trade after US, China, Japan, South Korea and Germany;
    • 3rd for services trade behind the US and China.

Table 5.1: Main players in world trade of goods and services (2022)

Key goods trade partners

Figure 5.5 shows the first trade partner in 2020 for trade of goods for each country:

• EU27 is the first trade partner for US, China, UK, Russia and about half of Africa.
• US is the first trade partner for the EU27, Mexico, Canada, Central America, Colombia and India.
• China is the first trade partner for Japan, Mongolia, Australasia, Indonesia, Saudi Arabia, Iran, about half of Africa, and most of South America.
• Brazil is the first trade partner for Argentina, Bolivia and Paraguay.

Figure 5.5: First trade partner for trade in goods (2022)

Source: European Commission, DG Trade Statistical Guide, August 2023

Trade share trends

Figure 5.6 shows trends in share of world trade from 2010 to 2020.

• EU27 (excluding intra-EU trade) has had the top share in each year but its share over the last few years has been declining gently and was16.2% in 2022.
• China’s share has grown consistently but declined in 2022 to 13.8%.
• US increased its share between 2012 and 2016, but since then has declined to 13.2%.
• UK’s share was 4.5% in 2012 (below Japan), and followed a similar path to Japan to arrive at 4.1% in 2022.
• Japan gradually declined from a 5.2% share in 2012 to 3.9% in 2022.

Figure 5.6: Trends in share of world trade for EU27, US, China and Japan (2005-2020)

Source: European Commission, DG Trade Statistical Guide, August 2023

Trade openness trends

Most economies depend on trade with other nations. To assess ‘trade openness’ (or ‘trade intensity’) economists use the ratio of trade to GDP. The measure indicates the level of integration of a country with the world economy. Trade openness tends to be higher in developing nations and lower for larger economies.

The global average ratio of trade to GDP for 20202 was 63%.

Figure 5.7 shows the trend in trade openness over the last decade.

• China’s trade openness has declined as its economy has grown and domestic consumption of domestic products has increased.
• In 2022, the EU27’s trade openness accelerated to 50.9%, ahead of the US, Japan and China.
• US has been declining slowly for ome time and was 27.2% in 2022.
• UK trade openness has been more volatile, like Japan. It was 63.8% in 2012, before falling to 57% in 2015. It then rose in 2019 to 64%, and, after a Covid decline, rose to 70.2% in 2022.

Figure 5.7: Trend in trade openness (2012 – 2022)

Sources:
World Bank, Trade as % of GDP
European Commission, DG Trade Statistical Guide, August 2023

Trade arrangements

Overview

This section looks at trade barriers and the different types of trade arrangement that can reduce them, including arrangements with the EU. It covers:

• Trade barriers
• WTO terms
• Customs unions
• Free trade agreements
• Mutual recognition agreements
• Equivalence
• EEA-EFTA
• EU membership
• EU VAT area

Trade barriers

There are two types of trade barrier: tariff barriers and non-tariff barriers.

• Tariffs only apply to goods and may be related to quota thresholds.
• Goods are also subject to non-tariff barriers (for example, customs checks).
• Services carry no tariffs but are usually subject to extensive non-tariff barriers (such as regulatory approval to provide services, restricted mobility of people, requirements for local commercial presence etc.)

Trade liberalisation over second half of the last century has led to low tariffs. For example, the Institute for Fiscal Studies estimates the UK paid an average tariff on goods imports of only 2.8% as an EU member. The average includes the benefit of extensive zero-tariff trade agreements. Tariffs tend to be much higher on agricultural and food products than other goods at an average of, say, around 20% (without a trade agreement).

Non-tariff barriers (NTBs) apply to both goods and services, cost more and impeded trade more than tariffs.

• There are two types of NTB:
  • Customs barriers (such as certificates of origin and rules of origin);
  • Regulatory barriers (technical standards, regulatory standards etc).
• Non-tariff barriers, for most goods, are more expensive than tariffs (for details, please see the section on ‘No deal/end of transition’)
  • UK government estimates that the cost of NTBs is comparable to a tariff ranging from below 5% to over 20% depending on industry sector (source: EU Exit Analysis, Cross-Whitehall Briefing, page 9).
• For goods, EU trade arrangements with third countries often eliminate most tariffs but only partially reduce NTBs.
  • None eliminates tariffs and NTBs to the extent that EU membership does.
• For services, most EU trade agreements with third countries, apart from EEA membership, do little to reduce trade barriers.
  • The Comprehensive Economic and Trade Agreement with Canada is the most advanced EU FTA. However, even it includes limited liberalisation of services trade.
  • Even within the Single Market, the EU recognises that there is further work to do to remove frictions in services trade.

To reduce trade barriers, countries enter into preferential trade arrangement. Figure 5.8 contrasts the level of trade barriers under the main types of trade agreement.

• The most basic trade arrangement is ‘WTO terms’ which means trade barriers are at their highest.
• A Free Trade Agreement (FTA) sounds attractive but it’s a misnomer, because an FTA only removes tariffs and quotas for goods, leaving most NTBs in place.
• The most sophisticated trade arrangement is EU membership, which minimises trade barriers for goods and services. 

Figure 5.8: Trade barriers in trade arrangements

Source: RBAS analysis (updated 4 April 2022)
Institute for Fiscal Studies, The EU Single Market: The Value of Membership versus Access to the UK, August 2016

WTO terms

The World Trade Organisation sets minimal, common-denominator rules among 164 countries in the world accounting for 98% of world trade (25 more countries are applying for membership). All members conduct some of their trade through preferential trade agreements with other members.

Trading under WTO terms with the EU has no preferential features. However, bilateral agreements relating to specific sectors or product standards may enhance trade. For example, the EU has bilateral agreements with the US and China. For a more detailed discussion of UK trade, the WTO and the main Brexit options please see the 2018 briefing for non-experts: UK Trade and the Word Trade Organisation.

The UK is a member of the WTO in its own right, but, as a member state, the EU acted on its behalf.

Each member has its own ‘schedules’, WTO-speak for the list of tariffs and quotas that it applies to imports from other countries. The schedules also include ceilings on agricultural subsidies and commitments on opening markets for services. For some members, there can also be commitments on opening government procurement markets. For a helpful summary of what’s in WTO schedules, please see Peter Ungphakorn’s blog: 12 years on, EU’s certified WTO goods commitments now up to date to 2004.

The UK now has its own schedule for tariffs and quotas to WTO members and a schedule for services.  The scheduled tariffs are called ‘bound tariffs’. These are ceilings on the tariffs that the UK can levy on imports. Applied tariff rates are often lower than the bound rates. In May 2020, the UK published its applied tariffs, the UK Global Tariff (UKGT), which have applied since the transition period finished on 31 January 2020.

WTO members take decisions by consensus, supported by the WTO Secretariat, which has no executive power. For the UK’s proposed schedules to be certified, there had to be no objection by any of the other 163 WTO members. The UK traded under its proposed schedules while the certification process proceeded. 

WTO members do not delegate decision-making power. This means that the WTO processes for negotiating schedules require careful navigation. As an example, on 5th October 2017, the US and other countries, including Argentina, Brazil and New Zealand objected to a proposed deal between the UK and EU to divide agricultural import quotas between themselves.

Customs unions

A customs union is only relevant for trade in goods. Its purpose is to eliminate customs duties in bilateral trade and establish common import tariffs. Although CUs relate only to goods, some countries have parallel economic partnership agreements that cover some services.

All members of a CU apply the same set of tariffs, which vary by sector, to goods imported from outside the union. A common external tariff (CET) means that:

• Imported goods from third countries are subject to the same tariffs irrespective of which member country imports them.
• Once inside the CU, goods move tariff-free between members without costly checks on the origin of goods (this is a major benefit for manufacturing sectors, such as automotive, with integrated supply chains that import components from within the CU).
• Members must have border checks with countries outside the CU. Imports from countries outside the CU are still subject to rules of origin checks – even with an FTA. For example, there are border checks between Canada and the US, and Mexico and the US, even though they are all members of NAFTA.
• Members are usually prevented from pursuing bilateral FTAs with other countries (because these affect tariffs and quotas).
  • As a member of the EU Customs Union, the UK could not negotiate and sign independent trade deals that affect import tariffs.
  • However, the UK would be free to agree bilateral trade deals with third countries that facilitate market access for UK goods and services.

Not all CUs prevent members from conducting individual trade negotiations. For example, although Turkey is in a customs union with the EU it can agree trade deals with other countries for some sectors. This is because the Turkey-EU CU is not as comprehensive as the EU CU. However, Turkey is not consulted on EU trade negotiations.

A CU has a very limited impact on customs controls. It removes a few checks but does not remove the need for checks for compliance with regulatory and technical standards. Other trade agreements are necessary to remove the other trade barriers.

The European Commission published Table 5.2  to demonstrate that a CU with the EU removes just two checks on imports from third countries to the EU. To remove all the other controls at the border requires membership of the Single Market and the EU VAT area.

There are 15 other CUs around the world, including:

• Gulf Cooperation Council (GCC)
• West African Economic and Monetary Union (WAEMU)
• Central American Common Market (CACM)
• Caribbean Community (CARICOM)
• Andean Community (CAN)
• Southern Cone Common Market (Mercosur).

Table 5.2: Limited impact of a customs union on EU customs controls

Sources:
House of Lords, Library Note: Leaving the European Union: Customs Unions—An Introduction, 27 January 2017
Centre for European Reform, Is Labour selling the UK a Turkey?, April 2018
European Commission, 22 May 2018

Free trade agreements

A free trade agreement (FTA) is a reciprocal agreement between at least two parties, which aims to liberalise trade by significantly reducing or eliminating tariffs and quotas on goods trade between its members. WTO rules govern FTAs.

These preferential agreements must be between at least two countries but may involve more – for example regional deals. Unlike a customs union, an FTA does not require its members to set the same tariffs on trade with countries outside the FTA. Modern FTAs try to remove a few NTBs but most remain in place. Modern FTAs may also address some services trade (for example, the FTA between Canada and the EU) but in a limited way.

FTAs that deal only with tariffs, quotas and customs arrangements, are called “shallow” agreements. Those that include rules on other relevant domestic policies that affect trade are referred to as “deep” agreements. These might include policies on, for example, competition, intellectual property rights, investment and movement of capital. Some FTAs go further and cover issues such as environmental laws, labour market regulations and measures on visa and asylum. There is a trend towards deeper FTAs.

Four examples of well-known regional FTAs and their members:

• EFTA FTA – Norway, Iceland, Switzerland and Liechtenstein
• NAFTA – US, Canada, Mexico
• ASEAN FTA – Brunei Darussalam, Indonesia, Malaysia, Philippines, Singapore, Thailand plus Cambodia, Laos, Myanmar, Viet Nam
• Dominican Republic-Central America Free Trade Area (CAFTA-DR) – US, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, Dominican Republic.

Mutual recognition agreements

Mutual recognition agreements (MRAs) are agreements between two trading partners to reduce technical barriers to trade. Without an MRA, local regulatory bodies cannot certify goods for sale in the other country.

Post-Brexit, UK goods for export to the EU have to be made to EU standards. They also need to be tested and certified to show that they comply. Checks might include inspection, testing, certification, and licensing according to technical regulations and standards which are aimed, for example, at preventing safety, environmental and health risks.

There are two main types of MRAs: ‘traditional’ and ‘enhanced’.

A traditional MRA:

• is an agreement limited to the mutual recognition of ‘conformity assessment’ (i.e. recognition of the competence of the partner’s testing bodies to conduct product safety testing);
• means a designated testing body in the export country can perform testing on the basis of technical requirements of the importing country and vice versa. The product can be exported without undergoing further testing;
• may cover a single sector, such as the 2004 EU-US MRA on marine equipment, or several sectors, such as the CETA between Canada and the EU, which has very broad sectoral coverage; and,
• does not require states to harmonise rules (i.e. to create common technical standards and regulations); and,
• does not require that parties to an MRA recognise each other’s requirements as equivalent.

An enhanced MRA:

• automatically recognises the relevant rules of the other country;
• is based on broad and deep regulatory alignment (eg the EU single market, or between Australia and New Zealand) or common international regulatory standards, such as those for marine equipment;
• may relate to services:
  • UK and Swiss authorities signed the “Berne Financial Services Agreement” on 21 December 2023  to provide enhanced market access for UK and Swiss firms to each other’s markets in specific financial services sectors);
  • UK and Swiss authorities also agreed an MRA for professional services in February 2024.

Source: Mutual recognition agreements (MRAs): all you need to know, 18 May 2020, Professor Catherine Barnard

Equivalence

Equivalence is an autonomous, unilateral, non-reciprocal, designation by one country that another country has a sufficiently similar level of regulation for particular activities or services to permit cross-border trading in those specific activities.

In the EU’s case, its laws may allow market access for firms based outside the European Economic Area (EEA). Each such law allows, within its specific area, the European Commission to decide whether the regulatory regime of a country achieves outcomes “equivalent” to its own. To facilitate trade with third countries, the EU has equivalence provisions in many regulations, ranging from financial markets to data adequacy. But these do not cover many other areas, including important sectors such as chemicals.

For example, EU financial services law includes around 40 areas for equivalence decisions. However, these do not cover most core banking and financial activities, like accepting deposits or providing investment services to retail investors. The EU has granted the UK regulatory equivalence in one specific area of financial services: central counterparties. This expires on 30 June 2025, but could be renewed.

For its part, the UK has granted the EEA member states 22 areas of equivalence in financial services. However, in financial services, the EU has granted less equivalence to the UK than it has to the US, Switzerland, and Singapore. The European Commission argues that concerns around the UK’s “possible divergence from EU rules”  justify withholding further equivalence decisions.

The EU has the power to remove its permissions at short notice, within 30 days, which gives it significant leverage that it may use to achieve other trade goals. For example, in 2019, the EU withdrew permission for EU stocks to trade on Swiss exchanges, to put pressure on Switzerland to formalise an overarching trade framework deal.

In 2021, the Commission also adopted two adequacy decisions for the United Kingdom – one under the General Data Protection Regulation (GDPR) and the other for the Law Enforcement Directive. These mean that personal data can now flow freely from the EU to the UK where it benefits from an equivalent level of protection to that guaranteed under EU law. Both adequacy decisions include strong safeguards in case of future divergence such as a ‘sunset clause’, which limits the duration of adequacy to four years (to 30 June 2025).

Source: House of Commons Library,  ‘Equivalence’ with the EU on financial services, Thursday, 19 November, 2020

EEA-EFTA

The European Free Trade Association (EFTA) is an intergovernmental organisation set up for the promotion of free trade and economic integration to the benefit of its four Member States (Iceland, Norway, Liechtenstein and Switzerland). Note that EFTA does not act on behalf of its members like the EU. Instead, the EFTA members themselves negotiate and sign the agreements.

The European Economic Area (EEA) provides for the free movement of persons, goods, services and capital within the Single Market of the EU between its 27 member states, as well as three member states of EFTA: Iceland, Liechtenstein and Norway (see Figure 5.9). The context for the four freedoms for the EFTA states is slightly different than for EU members. The EEA Agreement makes it clear that they are means to achieve trade goals rather than political ends in themselves.

EEA-EFTA members may contribute to the EU programmes in which they choose to participate, but do not contribute to general EU budget.

The EEA agreement is limited compared to EU membership. For example, it does not include:

• EU Customs Union
• EU Common Trade Policy (and EU trade agreements with third countries)
• Common Agricultural Policy
• Common Fisheries Policy.

To ensure unified application of EEA rules, the three EEA-EFTA States established the EFTA Surveillance Authority and the EFTA Court, which mirror the surveillance functions of the European Commission and the competences of the ECJ.

For more detail on EFTA and differences with EEA and EU, see https://www.efta.int

Figure 5.9: EEA and EFTA members (before UK departure from EEA)

EU membership

Economic cooperation between member states is a core objective of the EU.  As a result, one of the major benefits of EU membership is near-frictionless trade of goods and services within the EU. Some barriers, such as transport costs, culture and language remain.

Four EU frameworks remove trade barriers between member states in a powerful combination that eliminates tariffs (border taxes) and customs checks. They also reduce (but do not eliminate) regulatory NTBs, which are particularly important for services trade.

• Single Market
• Union Customs Code
• Customs Union (see above)
• EU VAT area (see below)

Non-members may have preferential trade arrangements with the EU including Mutual Recognition Agreements (MRAs). An MRA recognises the results of one another’s conformity assessments as equivalent (a set of processes that confirm whether a product meets specified legal requirements – these may include testing, inspection, and certification).

Unilaterally, the EU may grant a third country regulatory equivalence (for example on financial services regulation) or adequacy (for example on data protection), where it believes it meets the required EU standard. The EU has the power to remove these at short notice, and it may use its leverage to achieve other trade goals.

Single Market

Membership of the Single Market reduces NTBs for goods and services in a way that no other existing trade deal or free trade area does. It means that goods and many services can be freely traded with other member states. A car manufactured in Madrid or Bavaria can be sold anywhere in the EU.

All non-EU countries have ‘access’ to the EU Single Market as an export destination, so ‘access’ means little.

Union Customs Code

The Union Customs Code sets out the framework for strong customs cooperation between member states. It also defines the formalities for the movement of goods between EU member states and third countries, including:

• Import–export procedures
• Data requirements
• Tariff classifications
• Common risk criteria

Common interpretation of these rules is necessary to avoid, for example, differences in tariffs charged as a result of different tariff classifications of the same goods. The Union Customs Code also mandates greater use of information technology between member states’ customs authorities to allow real-time information sharing. Many of these features are included in the recent WTO Trade Facilitation Agreement.

Preferential trade agreements

Non-members may have preferential trade arrangements with the EU. There are three main types with different purposes:

• Customs unions: eliminate customs duties in bilateral trade and establish common import tariffs (like Turkey);
• Association Agreements, Stabilisation Agreements, Free Trade Agreements and Economic Partnership Agreements: remove or reduce customs tariffs and some NTBs (like Canada or Japan);
• Partnership and Cooperation Agreements: provide a general framework for bilateral economic relations but leave customs tariffs as they are (like Russia). Often partnership and cooperation agreements precede a deeper trade agreement.

See Appendix C for a list of EU trade agreements.

EU VAT area

The EU VAT area is separate from the EU Customs Union and Single Market. It is a key enabler of trade between member states. The UK’s departure from the EU VAT area has had important consequences. Tax is a complex area. Please note that the comments below aim to highlight the main considerations and are not comprehensive.

Pre-Brexit situation

The UK introduced VAT as a condition of joining the EEC in 1973. As a member state, the UK became part of the EU VAT area designed to facilitate trade between its members. When the UK left the EU, it left the EU VAT area.

For EU members, being registered for VAT in one member state is sufficient to trade in all. VAT is generally not charged on the supply of goods, nor certain services, between businesses from another EU country. VAT only becomes chargeable when sold to the final customer.

Under the EU rules, the minimum standard rate of VAT is 15% and the maximum 25%. The current UK standard rate is 20%. Member states cannot levy a rate of VAT higher than their standard rate. There is a prescribed list of goods and services to which EU member states can apply reduced rates of VAT. These are set at a minimum of 5% with only two reduced rates allowed.

The UK enjoyed an opt-out to maintain zero rates on items such as food, children’s shoes, clothes and books. The UK could not create new zero-rated items (for example for tampons or child seats) and, if it moved an item out of the zero-rate band, it could not move it back.

Future developments

The EU had recently issued proposals for more flexible VAT rates, but these still constrained members. The EU was concerned that intra-EU VAT-free trade had become a major source of fraud. This led to a big shortfall in VAT receipts – the so-called ‘VAT gap’. As a result, the EU planned to move to a single EU VAT area.

This results in a fundamental shift to VAT being payable in the country where goods and services are consumed. The seller in the country of origin needs to register, account and pay VAT – unless the customer in the destination country is certified to be a ‘reliable taxpayer’ (allowing deferred VAT accounting to continue).

Impact of leaving EU VAT area

There are serious implications for trade in leaving the EU VAT area. Please see the section on Brexit impact for details.

Sources:
What Brexit means for VAT, Prospect Magazine, April 2018
VAT: Brexit’s hidden border dilemma, Chris Giles, Financial Times, 30 May 2018

UK-EU trade options

Summary of EU trade models

Table 5.3 summarises the five common models for trading with the EU. The UK initially sought a bespoke deal which would be different to the existing models. However, it settled for a basic FTA (model 3).

Without a customs union between the UK and the EU, border controls are required between Great Britain and the EU, including between Northern Ireland and Great Britain. Northern Ireland remains in the EU CU. For a fuller discussion of international trade and trade models, please see the briefing paper: UK trade and the World Trade Organisation.

Table 5.3: EU trade models

Source: RBAS analysis

UK red lines

The UK government’s self-imposed ‘red lines’ restricted the UK’s future trading relationship with the EU. The red lines, which the May government defined after the referendum, were to leave the Single Market, the Customs Union, jurisdiction of the ECJ, and end freedom of movement of people. The red lines were incompatible with invisible borders in Ireland and between GB and Northern Ireland.

Remarkably, Theresa May announced the red lines in her Lancaster House speech in January 2017 without wider consultation, without cabinet discussion and without parliamentary debate. She also announced them before negotiations with the EU had begun.

Within the red lines, there were only two Brexit trade options: an FTA (like Canada or South Korea) or ‘no deal’ (WTO terms) – see Figure 5.10, which the European Commission used to show how the red lines closed down options. The EEA option, which have had the lowest trade barriers, would have required the government to relax its red lines.

Figure 5.10: UK red lines and future EU-UK trading relationship

Source:
European Commission to EU27, published 19 December 2017
Brexit Unfolded, Professor Chris Grey, pp60-63, 2021

Non-trade agreements

In early 2019, the EU’s Treaties database listed 1,261 international agreements to which the EU is party. These are a mixture of bilateral and multilateral treaties. Previous analysis by the FT found that those of interest to the UK relate to 168 countries. By law, the UK was excluded from all bilateral agreements with the EU on 1 January 2021.

However, not all of the treaties required action to maintain continuity following Brexit. The government’s view was that about 1,000 EU treaties were relevant. It said that only 157 would need to be replaced in the event of ‘no deal’, but that the UK would be seeking to replace an unspecified number of additional agreements.  As the FT pointed out, many countries wanted to know the outcome of EU-UK talks before finalising their own commitments.

Non-trade areas that these agreements covered include:

• aviation
• nuclear
• environment
• fisheries
• justice
• political cooperation

The UK remains a party to most mixed multilateral agreements (where it was already a party in its own right) but the UK would not remain party to mixed bilateral agreements. Around a quarter (over 300) of the EU’s international agreements are “mixed” agreements which cover competences shared by the EU and member states.  At the UK’s request, the EU notified other parties to international agreements that the UK was to be treated as a member state during the transition period for the purposes of these agreements.

The UK engaged in agreements for many areas. These included customs co-operation, fisheries, organic equivalence, justice and home affairs and wider political co-operation. Most air services agreements had been concluded, as had nuclear co-operation and safeguards agreements. In March 2019, the government listed 158 international agreements, across different policy areas, that it was seeking to replace should the UK leave the EU without a deal. It also referred to an unspecified number of additional agreements in certain policy areas.

Sources:
HMG, Department for Exiting the EU, International Agreements if the UK leaves without a deal, November 2019 (Withdrawn)
House of Commons Library, UK replacement of the EU’s external agreements after Brexit, May 2019
FT, After Brexit: the UK will need to renegotiate at least 759 treaties 30 May 2017, Paul Mclean

Go to the second trade section – 5.2 Trade.

Last updated on 21st July 2024 by Richard Barfield