First posted on:
Bruegel blog post, 12 January 2021
On 1 January 2021, the United Kingdom left both the European Customs Union and the Single Market. Its trade relationship with the European Union is now governed by a Trade and Cooperation Agreement (TCA), which establishes a free-trade area in goods and services broadly comparable to recent trade deals between the EU and major, advanced non-European countries such as Canada and Japan.
To appreciate fully the significance of this new chapter in the EU-UK trade relationship – and the ironies it brings with it – it is useful to examine how that relationship has evolved over the past 60-plus years. The UK is now outside structures it helped create and that, indeed, were fundamental to UK efforts over six decades to avoid being economically disadvantaged in Europe. It should be noted that what follows focuses solely on trade, which is the core of the TCA. This article does not delve into areas such as monetary integration or the EU budget, which were important when the UK belonged to the EU but are marginal for the TCA.
During the 1950s, most European countries traded with one another (and with many countries outside Europe) on purely General Agreements for Tariffs and Trade (GATT, created in 1947) terms, applying the same non-discriminatory most-favoured nation (MFN) tariff to imports from all sources. This meant, for instance, that the United Kingdom applied the same tariff on imports from France, Sweden and any other GATT country, and that Germany applied the same tariff on imports from France, the UK or any other GATT member.
This situation changed in 1958 with the creation of the European Economic Community (EEC) by the original six members, and the gradual introduction of the Customs Union, entailing the abolition of duties and quotas between member states and the establishment of a common external tariff vis-à-vis third countries. Automatically, third countries found themselves at a disadvantage on the EEC market, with its members now applying the common external tariff on imports from the UK or from any other GATT member, but gradually imposing no tariff on imports from their EEC partners.
To gain an idea of the magnitude of the disadvantage caused by the EEC for third countries, one needs an estimate of two factors: the size of the EEC market compared to other markets, and how high its external tariff was. Both were relatively large. In 1958, the EEC accounted for nearly two thirds of the GDP of Europe (excluding Soviet bloc countries, Yugoslavia and Albania), and the average tariff of the original six members was 13% for non-agricultural goods and much higher for agricultural products. The loss for European producers located outside the EEC was thus significant.
In response, the UK and six other European countries established in 1960 the European Free Trade Association (EFTA). Like the EEC’s Customs Union, this free-trade agreement (FTA) involved the abolition of duties and quotas between its members, but, like all other FTAs, it did not adopt a common external tariff. Instead, each EFTA country continued to apply its own MFN schedule to imports from third countries.
By itself, the creation of EFTA did not eliminate the disadvantage that, for example, UK exports faced on the German market compared to French exports after the creation of the EEC. But it partly compensated for this loss through better market access to other EFTA markets, such as Sweden. But the ultimate objective of the EFTA governments was to use EFTA as a bargaining chip to negotiate duty- and quota-free access to the EEC market in exchange for reciprocal access to the EFTA market (in 1960 the combined GDP of the EFTA members amounted to nearly 50% of the EEC’s GDP, making agreement not unrealistic). This attempt failed initially and, like producers in other countries in Europe and elsewhere, UK and other EFTA producers had to continue trading with the EEC on relatively disadvantageous GATT terms (Table 1, column 1).
Table 1 Trade regime within the EU and between the EU and other European countries
Notes: Countries in red are the seven original EFTA members: Austria, Denmark, Norway, Portugal, Sweden, Switzerland and the United Kingdom; CU: customs union; FTA: free-trade area in goods; FTA+: free-trade area in goods and services; SM: single market. EU6*: the six original EEC members: Belgium, France, Germany, Italy, Luxembourg, and the Netherlands. EU13*: the 13 countries that have joined the EU since 2004: Cyprus, Czech R., Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, Slovenia (2004); Bulgaria and Romania (2007); and Croatia (2014). GATT*: Ireland only joined GATT in 1967. GATT**: only five EU13 countries had joined GATT by 1972: Cyprus (1963); Yugoslavia (1966), to which Croatia and Slovenia belonged; Poland (1967); and Romania (1971). GATT***: a sixth EU13 country joined GATT during this period: Hungary (1973). GATT****: three more EU13 countries joined GATT during this period: Czech R. (1993), Slovakia (1993), and Slovenia (1994). GATT°: Iceland only joined GATT in 1968; Liechtenstein only became a formal GATT member in 1994. GATT°°: Switzerland only joined GATT in 1966. SM*: Switzerland does not fully belong to the single market.
For the UK, the EEC’s initial refusal to create a free-trade area with EFTA was more problematic than for any other EFTA member. As the largest EFTA country (about 60% of EFTA GDP), EFTA membership offered little compensation to UK exporters for the loss of access to traditional markets now inside the EEC. In a context of relatively poor domestic economic performance, this situation prompted the UK government to submit a first application to join the EEC in 1961. It was rejected in 1963, triggering a second UK application in 1967 that was again rejected. Finally, the UK joined the EU in 1973 after the departure from office of the main stumbling block, French President de Gaulle.
This marked the beginning of the second chapter in the relationship between the EEC and the UK. The UK’s accession to the EEC had two ripple effects for other EFTA members and for Ireland, all of which were highly dependent on access to the UK market. The first consequence was the accession, also in 1973, of Denmark and Ireland to the EEC (Norway voted on it but decided against). The second was the creation of a free-trade area between the EEC’s customs union and the remaining EFTA members, which now also included Iceland. Since the EEC had already established FTAs with Greece, Spain and Turkey, it meant that, by 1973, EEC trade with European countries (excluding socialist countries) was mostly duty- and quota-free (Table 1, column 2). The accession of Greece to the EEC in 1981 barely changed the situation (Table 1, column 3).
The third chapter in the UK-EEC relationship opened in 1985 and closed in 2004. The EEC – joined by Portugal and Spain in 1986 (Table 1, column 4) – and its custom union had been highly successful in abolishing tariffs and quotas among its members. But it had done nothing to remove non-border measures, such as product conformity procedures, that continued to hamper trade in goods. Nor had it removed barriers to trade in services or the free circulation of capital and labour. This task fell to the Delors Commission and one of its two British members, Lord Cockfield, sent to Brussels by Prime Minister Margaret Thatcher to eliminate bureaucratic barriers to trade within the EEC. Cockfield’s 1985 White Paper on “Completing the Internal Market” and the accompanying 1986 Single European Act formed the foundations of the Single Market, as the Common Market was then renamed.
The central role of Thatcher and Cockfield in the creation of the Single Market is well known. Martin Sandbu has even suggested in the Financial Times (30 December 2020) that “Thatcher was the political force behind a genuinely unified European market for goods, services, labour and capital; Arthur Cockfield …was its intellectual architect and bureaucratic engineer”. The creation of the Single Market in 1993 didn’t just boost trade and growth for the 12 EEC members (Table 1, column 5). As argued by Baldwin (1995) and verified statistically by Sapir (2001), the Single Market programme also produced a ‘domino effect’ for EEC neighbours, whose access to the EEC market was threatened by its closer integration.
In the space of three years, five EFTA countries requested EEC accession: Austria (1989), Sweden (1991), and Finland, Norway and Switzerland (1992). Austria, Finland and Sweden ultimately joined in 1995 the European Union, the successor of the EEC founded in 1993. Meanwhile, Norway (whose citizens had rejected EU membership), Iceland and Liechtenstein joined the newly formed European Economic Area (EEA), giving them access to the EU’s Single Market on terms equal to those of EU members. Switzerland, whose citizens rejected accession to both the EU and the EEA, also gained access to the EU’s Single Market, though on less equal terms than EEA members. Turkey, which had applied for EEC membership in 1987 but was only declared eligible to join the EU in 1997, upgraded its FTA with the EU to a customs union in 1995. Finally, the former socialist countries of central and eastern Europe established FTAs with the EU.
By 1995, the EU counted 15 members. Nearly all other European countries had close economic ties with the EU, trading with it on better than WTO (the successor to GATT, established in 1995) terms, a situation partly linked to the UK’s decisions to join the EEC in 1973 and to help create the single market two decades later (Table 1, column 6).
The fourth chapter in the UK-EU trade relationship came with the EU accession of eleven former socialist countries of central and eastern Europe, plus Cyprus and Malta (two former British colonies), starting in 2004. This fourth wave of EU enlargement, which was strongly supported by the UK, created the biggest customs union and single market in the world, made up of the 28 EU members, the only countries belonging to both the European Customs Union and Single Market. Turkey also belonged to the Customs Union, but not to the Single Market; three of the EFTA members (Iceland, Liechtenstein, and Norway) belonged to the Single Market, but not the Customs Union; and the fourth EFTA member, Switzerland, belonged to large parts of the Single Market, but not the Customs Union (Table 1, column 7).
This situation has now been modified profoundly by the decision of the UK to leave the EU and to leave both the European Customs Union and the Single Market. The UK-EU trade relationship is now governed by the TCA, which is fairly similar to the FTAs between the EU and major, advanced non-European countries, such as Canada (the Comprehensive Trade and Economic Agreement, CETA) and Japan (the EU-Japan Economic Partnership Agreement, EUJEPA). These agreements also provide preferential access for trade in goods, though not completely duty- and quota-free as the TCA does – a difference which, together with the difference in geographical proximity, explains why only the TCA includes level-playing-field conditions. Like the TCA, the agreements with Canada and Japan also provide some preferential access for trade in services and the removal of some non-border barriers to trade in goods and services, but considerably less so than within the single market.
Hence, the UK now finds itself in a trade relationship with the EU on terms that are far less favourable than those enjoyed by EU members or other EU neighbours like Norway or Switzerland, which enjoy duty- and quota-free access to the EU market for goods, and full or significant access to the EU single market for goods, services, capital and labour. The TCA’s terms are also less favourable than those of Turkey for trade in goods (since rules of origin are absent in the customs union but not in the TCA), though they are better for services (since the EU-Turkey customs union does not cover services; Table 1, column 8).
The UK’s decision to leave the European Customs Union and Single Market is doubly ironic.
The first irony is that this decision is indirectly related to the Single Market programme and the fourth enlargement, two EU policies spearheaded by successive UK governments. The Single Market birthed the single currency, in which the UK refused to participate and which left it frustrated at being excluded from important decisions, especially during the euro area sovereign debt crisis, as Ivan Rogers, a former UK ambassador to the EU has vividly explained. Moreover, the Single Market in conjunction with the eastern enlargement brought large inflows of foreign workers to the UK who were initially welcomed but eventually generated a backlash because of perceived pressure on certain public services.
The second irony is that the decision runs completely counter to the UK’s efforts during the past 60 years to avoid being economically disadvantaged in Europe, starting with its decision to create EFTA in 1960. Today, the UK finds itself outside the EU and with less favourable access to its market than any other European country. All its former EFTA companions have either joined the EU or remain outside the EU but inside the European Single Market. True, by staying outside the EU, the UK will be free to set its own rules, but it will have to continue to adhere to EU rules in order to retain access to the EU market, which combines size and geographical proximity like no other market in the world. The future will tell whether this fifth chapter in the UK-EU trade relationship is temporary or lasting, and what the short-, medium- and long-term consequences will be.