Update: Brexit impact on UK trade in goods and in services
Two just-published briefings for MPs look at: the evolving status of the World Trade Organization and post-Brexit trade in goods; and at the future of trade in services from a UK perspective.
The future of trade in goods
The WTO continues has been struggling for over ten years to finalise an update to trade terms. This impasse has led to ‘significant criticism’.
A no-deal Brexit on 31 October – or at the end of any transition period – means the UK resuming WTO membership as a ‘non-EU Member’ state during this time of uncertainty over the very existence and authority of the WTO.
Brexit advocates have argued that WTO rules will form an adequate basis on which to base the future UK trade policy – but this assumption clearly presupposes a ‘functioning’ world trade system.
The UK put in two parallel applications for membership of the WTO to trade under WTO terms – one for ‘commerce’; and the other for ‘services’. Each application was to join the WTO on a ‘preferred nation status’ – broadly similar to the membership status level enjoyed by the UK as a joint-member of the European Union.
Each application process takes a minimum of six months – including three-months allowed for publication of the application to the other 180 WTO members for them to ‘comment’. A significant number of countries objected to UK joining on ‘preferred nation’ status. This would have allowed beneficial trading conditions with other ‘preferred nations’ – including the remaining 27 EU states. The chances are that the UK will have to join on the most ‘basic’ terms – and it could take a further ten years to get back to the global trading conditions enjoyed by the UK today.
The Parliamentary briefing examines: the WTO failure to agree to new multilateral trade agreements under; the compound effect of post-2016 United States ‘protectionism’ – and the impact of US trade policy on both the global trade environment and the WTO; and considers recent proposals that have been made to ‘remedy’ the WTO’s problems.
The Trump administration has been downright hostile towards the existing WTO – including precipitating an existential crisis for the institution by obstructing the appointment of new ‘judges’ to the WTO’s Appellate Body. Brexiteers seem to have missed the adverse impact on the UK under WTO rules coming from ‘regional trade agreements’ – such as the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) – as countries look for alternatives to the WTO in order to liberalise trading conditions.
The future of trade in services
This key sector has received less attention in the public debate than trade in goods. Whilst the ‘offerings’ are intangible, the UK’s exposure to services trade means that businesses in many sectors across the economy will be affected. International trade in services is complex and the UK has proven to be masterful. The market stability of the last 40 years has underpinned the UK’s success at growing this market – but this is all about to change with Brexit.
Services account for nearly 80% of the UK economic output – and for 45% of UK exports – a share that has been growing over time. The UK is the world’s second largest exporter of services by value – and is generally viewed as a world leader in many service activities such as financial services.
The EU is the UK’s largest export market for services, accounting for 41% of all service exports.
The future of services trade has received less attention in the Brexit debate than trade in goods. But the potential change in the terms of trade with the EU will dramatically affect the sector and will impact on many UK businesses and the economy.
Key issues for future UK trade in services include:
- Trade in many sectors depends on the freedom to establish and run businesses abroad;
- Freedom of movement provides access to qualified workers;
- A large proportion of services trade is supported by free flow of data;
- Specific sectors depend on mutual recognition of qualifications or regulatory bodies;
- Businesses and consumer bodies have expressed a wish to have access to effective enforcement of any new terms of trade – at least comparable to what is presently available to them through the EU justice system; and
- The fundamental principles of regulatory alignment will need to be addressed by the UK and EU. Each party will have to determine the extent to which the UK’s standards and regulations for services will be allowed to diverge from the EU’s. The closer aligned the UK and EU remain, the greater the access the UK will have to the single market – but the less freedom the UK will have to change regulations. This trades-off control over a sovereign nation’s rules – such as regulating products and markets – and the degree of access to the other economy’s market.
The services sectors cover a broad range of activities. Professional and business services, combined with financial services, account for a half of UK services exports. However, cross-border services trade also includes: tourism and travel; transportation by road, sea, air and rail; telecoms and IT; broadcasting, film and culture; higher education; construction; and retail.
Trade in services is complex and fundamentally different from trade in physical goods. Services trade across borders in many different ways: online – or through other digital channels); in person – when a consumer travels to the supplier or the supplier to the client; and through subsidiary companies abroad.
Unlike trade in goods, services are not restricted by tariff barriers and border checks. National regulations determine if, when and how foreign providers are allowed to enter a market – covering such areas as: licensing; quotas; professional qualifications; and immigration. These ‘non-tariff barriers’ are complex and hard to assess – and vary widely by sector and by activity. Behind-the-border requirements and regulations add to difficulties in selling services in another country.
Facilitating trade in services means that restrictions have to be removed and/or regulations harmonised country by country. This, in turn, means that countries have to give up their right to regulate – and that can be a politically difficult choice. It is no surprise that liberalisation of trade in services lags behind that of goods.
The UK’s exposure to services trade means that any major change of the terms of cross-border trade will affect businesses in many sectors across the economy, although some will have to adapt more than others. While services imports are very significant both for UK consumers and for businesses that rely on imported services inputs into UK production, the substantial role of services exports in the UK economy tells us that access conditions to foreign markets will be crucial for UK services.
Although many barriers still remain in the EU, the single market is the most integrated area for trade in services in the world. Companies and individuals are free to establish and run a business from anywhere in the single market – including provision of services from their ‘home’ Member State. Consumers can buy services in or from any EU Member State including the one in which they live. Member States have regulatory powers, but their rules generally may not discriminate or prohibit access to their market. Freedom to provide services is supported by free movement of people, cross-cutting as well as sector-specific rules on mutual recognition of professional qualifications, and common rules on data.
Should the UK leaves the EU without a ‘deal’ it will immediately become a ‘third country’ to the EU. Without a deal trade with the EU will be based on the rules of the General Agreement on Trade in Services (GATS) of the World Trade Organisation (WTO). In addition, UK businesses will face rules set by individual EU Member States for services.
WTO trading system provides a broad global framework for continued liberalisation of trade in services rather than setting compulsory rules. GATS prohibits discrimination between members, and mandates ‘national treatment’ of ‘foreign providers’, as well as transparency and objectivity of national regulations. Members commit to opening markets in specific sectors – however, any country can back down on such policies.
The UK and the EU in their ‘Political Declaration’ set out on the future relationship that in relation to services and investment both have an ambition to go well beyond the current commitments under the WTO and existing free trade agreements of the EU with third countries. As the UK leaves the single market for services it has a limited number of options:
- Free trade agreements: countries can make commitments on liberalisation of services. Most recent agreements such as the EU-Canada deal CETA and EU-Japan agreement attempt to go deeper than GATS – but do not provide anywhere near the level of access which is available to EU members in the single market. To establish a relationship on services with the EU which is closer than any existing free trade agreement can offer, the UK would have to seek enhanced regulatory cooperation with the EU on issues such a mutual recognition, free flow of data and business travel. Passporting arrangements would have to be agreed for financial services.
- EEA and a customs union: if the UK were to choose to remain in the European Economic Area (EEA), service providers would retain access to the EU market – but have limited influence on regulation. Free movement of people would probably have to be accepted. A minimalist customs union for goods only is not enough to support services trade with the EU. In addition, the UK would have to seek a solution for the same aspects as under an FTA: negotiate market access, regulatory cooperation and mutual recognition.
Leaving the EU will change the economic relationship between the UK and EU. The nature of the future UK-EU trading relationship will be crucial in determining Brexit’s impact on the UK services sector. The crucial question is thus how much divergence there will be between the UK and EU. The greater the divergence, the higher barriers to trading become and the costlier it will be for UK companies who export to the EU to meet EU rules (and for EU companies trading with the UK). By maintaining a close relationship between UK and EU standards and regulations, the UK would, however, limit its freedom to change its regulatory systems and other areas of economic policy.
A number of studies have attempted to estimate the potential economic impact of Brexit. While it is difficult to measure non-tariff barriers (NTBs) and their impact, economic research generally finds that:
- the closer the future UK-EU trade relationship is, the smaller the increase in trading costs are; and,
- in turn, the smaller the negative impact on trade volumes (exports and imports).
Possible reductions in trade costs with non-EU countries are not expected to make up for the lower trade volumes with the EU – compared with the UK remaining in the EU. For example, a WTO/no-deal scenario is estimated to lead to the UK trading less with other countries than in a scenario where the UK remains in the EEA after Brexit.
Lower trade volumes would be expected to negatively impact economic output. The degree to which this is the case depends on the specific sector in question and how much it relies on trade (in particular trade with the EU). While the results of studies in this area vary, services sectors that appear most vulnerable to negative effects are the wholesale trade sector and the financial services sector.