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The UK and the EU Customs Union: Issues & Questions

Introduction

An important part of the UK’s membership of the European Union (EU) is that we are members (and have been since we joined in 1973), along with the other Member States, of the EU’s Customs Union.  As a consequence of this, we enjoy tariff free trade with the EU.  In addition, we share a Common External Tariff on goods imported from outside the Customs Union, as well as jointly agreed quotas on some goods and other mutually beneficial aspects of customs regulation.  We jointly enforce measures against third countries that we believe are unfairly dumping goods below market price in the EU; and we negotiate trade agreements with third countries on a common basis.  All this is negotiated and administered by the European Commission acting on the approval of the European Council.

Since the referendum in June 2016, it has been suggested that the UK might either remain in the Customs Union after leaving the EU or establish a new customs union with the EU, perhaps along the lines of the EU-Turkey Customs Union which has existed since 1995.  In her Lancaster House speech in January 2017, the Prime Minister stated that the UK would not wish to be bound by the EU’s trade policy (known as the Common Commercial Policy) or by its Common External Tariff.  But the Prime Minister went on to say that “I do want us to have a customs agreement with the EU”; she continued:

Whether that means we must reach a completely new customs agreement, become an associate member of the Customs Union in some way, or remain a signatory to some elements of it, I hold no preconceived position. I have an open mind on how we do it. It is not the means that matter, but the ends.1

This paper looks at the way such customs unions work; how they are regulated, including as part of the world trade system; and whether either remaining in the EU Customs Union or some other customs arrangement akin to it would be a desirable option for the UK after leaving the EU.

 

How customs unions work

Under the World Trade Organisation (WTO), formerly the rules of the General Agreement on Tariffs and Trade (GATT), WTO members must set the same tariffs against all other WTO members under what is known as the ‘most favoured nation’ principle (MFN), with one major exception.  Two or more countries may establish free trade among themselves in the form of either a free trade agreement (FTA) or a customs union (CU), but on one vital condition.  Paragraph 8(b) of Article XXIV of the GATT requires that such agreements should cover “substantially all the trade” between them.  “Substantially all the trade” is open to interpretation and as a result both free trade agreements and customs unions vary in scope and depth.2  The EU’s Customs Union with Turkey, for example, covers all industrial goods but not agriculture or services, and many FTAs have exclusions of, for example, agricultural products.  However, customs unions or FTAs covering a limited number of industrial sectors, such as automotive, aerospace or pharmaceuticals, would on the face of it not be compatible with Article XXIV.3

In an FTA, participating countries reduce or eliminate tariffs and quotas among themselves but can determine their own tariffs against the rest of the world and negotiate their own free trade agreements.  In a CU, in addition to free trade among themselves, participating countries have a common external tariff.  In the EU, the European Commission is responsible for conducting such negotiations (under a mandate from the European Council) in what is known as the Common Commercial Policy.

The purpose of a customs union is to liberalise trade between two or more countries and by doing so to generate greater wealth for them while applying a set of import duties on imports from third countries.  There are quite a number of such unions in the world today and they have been in use since the nineteenth century.  Before free trade agreements between countries became more common after 1945, customs unions were the preferred arrangement for increasing trade between countries, or a group of countries.  In addition to the EU, other customs unions include the Central American Common Market, the Caribbean Community (CARICOM) and the East African Community.4

Customs unions cover trade in goods and not services, on which duties are not normally levied and to which the barriers to trade are usually non-tariff ones, such as requirements for professional qualifications and establishment.  It is increasingly the case that trade in services is integral to the sale of goods, making arrangements to liberalise trade in both goods and services (the concept embedded in the EU’s Single Market) more important.  For example, it is now common place for railway rolling stock to be purchased alongside an agreement for the manufacturer to provide servicing for the vehicles for a number of years.  The more limited WTO agreement on services does not provide the same level of market access for services as does the EU’s Single Market.

 

The EU Customs Union

The main elements of the EU customs union are:

  • common tariffs on imported goods;
  • common anti-dumping rules or quotas for some imported goods;
  • no tariffs on goods traded within the customs union;
  • common product standards for goods, with which imports must comply;
  • common rules of origin, to determine where a product originated and what customs duties should be collected; and
  • the sharing of customs duty revenue by which 80 per cent of duties collected go automatically towards the EU’s budget.

In addition, the EU Member States have abolished customs controls between them.  This means that luggage and vehicles (and people), lorries, trains and aircraft are no longer routinely subject to searches at internal EU borders.5

The EU’s Customs Union, which was established first, is now an integral part of the Single Market.  The product standards, for example, that are adopted at EU level and which help to make the Customs Union work smoothly, are part of the Single Market regulatory system and not just the Customs Union.  Those product standards are enforced by EU agencies and Member States’ own regulatory bodies and ultimately come under the jurisdiction of the European Court of Justice.6

 

The EU-Turkey Customs Union

The EU has had a customs union with Turkey since 1995 which covers all industrial goods and processed agricultural goods.  In return for this arrangement, Turkey has adopted a large part of the EU’s Single Market rules system (the acquis communautaire), applies the Common External Tariff to goods from third countries, is required to have trade arrangements with third countries that are compatible with EU trade agreements with those countries (i.e. they must have the same tariffs etc.), and hands the income from the duties it collects to the EU.  Furthermore, Turkey is not involved in the setting of EU customs tariffs (although it must collect them).  Where the EU has free trade agreements (in whose negotiation Turkey has no say) with third countries, Turkey must accept imports from those countries on FTA terms, although Turkish goods may require separate negotiations to be able to enter those markets on similar terms.7  Turkey is not however subject to the jurisdiction of the European Court of Justice and it was not granted free movement of people when the customs union agreement negotiated.  Since the possible direction of migration at the time would have been from Turkey into the EU, this was not accepted by the EU despite free movement having been negotiated at the time of the EU-Turkey Association Agreement in 1963.8

 

Pros & Cons of Remaining in the EU Customs Union

Remaining in the EU’s Customs Union has certain advantages for the UK economy:

  • no tariffs on goods exported to, or imported from, the EU;
  • no customs checks or rules of origin checks on UK exports to the EU;
  • the possibility of continuing preferential access for goods to 53 countries with which the EU has trade agreements;9
  • a high degree of business certainty and consumer confidence because of the EU law framework; and
  • no need for a customs border between Ireland and Northern Ireland.

The cost of leaving the Customs Union has been estimated by Open Europe to be 1-1.2 per cent of GDP, on a permanent basis.  If the UK were to leave the EU without a wide-ranging free trade agreement, Open Europe estimated the cost to be -1.197 per cent of GDP, or -£32.526 billion, by 2030 or the smaller cost of -0.94 per cent of GDP (-£25.63 billion) over the same timescale if the UK were successful in negotiating a free trade agreement with the EU.10

Open Europe explain why leaving the Customs Union would impose such a high cost:

There is a clear advantage to being part of the customs union for quick and easy movement of trade across borders. It is a fundamental and lasting cost which is difficult to reduce. Over time it has dynamic effects as it impacts import and export decisions. Importantly, unlike tariffs […] this is a deadweight cost rather than a transfer and therefore is lost from the global economy completely.11

The largest part of the cost from leaving the Customs Union would be the imposition of rules of origin.  These can be complex, especially where goods have been made from imported components.  There are no rules of origin for goods manufactured in the Customs Union.12

Tariffs do impose costs too and the tendency of goods to be made in the EU from components imported from another country and then re-exported means that the burden of tariffs could be quite high for UK businesses if we are outside the Customs Union.  This point was made by the Japanese Government in its comments on the UK and Brexit when it said that its first priority for Japanese businesses investing in the UK was “maintenance of the current tariffs rates and customs clearance procedures”.  It went on to point out that if the UK left the Customs Union, tariffs would be “imposed twice, once for auto parts imported from the EU and again for the final products assembled in the UK to be exported to the EU, which would have [a] significant impact on their businesses”.13  The Government has stated that, in order to minimise disruption to trade, it will adopt tariff schedules at the WTO when the UK leaves the EU that “replicate as far as possible our current obligations”.14

The advantages for goods trade do not necessarily apply to services however.  Services are not usually directly affected by customs unions as it is non-tariff barriers to trade (such as regulatory requirements on establishment, the need for recognised professional qualifications etc.) that restrict cross border trade in services.  If the UK stayed in the Customs Union, but left the Single Market, it would have to comply with the terms of EU free trade agreements in goods but these would not compensate for the loss of access for services (the largest sector of the UK economy).  Outside the Customs Union, the UK could potentially use access to its goods market as a lever with third countries to persuade them to allow better access to their markets for UK goods than is usually available to the EU and to allow access to their domestic services markets for UK services.15

 

Sectoral access or other customs arrangements

Some UK Ministers have hinted that the UK might try to stay in the EU Customs Union for some particular goods or sectors.  The Prime Minister suggested in November 2016 that membership of the EU Customs Union was “not just a binary decision” and she enlarged on this point in her Lancaster House speech (quoted above) where she said that she wanted a customs agreement with the EU but without the UK being bound by the EU’s Common External Tariff or it being part of the EU’s Common Commercial Policy.16

Suggestions of a partial or sectoral customs arrangements may be a reference to the EU’s customs union with Turkey (although it does cover all industrial goods) but that arrangement reflects Turkey’s status as a developing economy under WTO rules, a status which the UK could not claim.  These suggestions might also have been a reference to the EU’s arrangements with Switzerland, under which that country enforces EU product standards on goods exported to the EU (through a mutual recognition agreement).  But tariffs are still payable and Switzerland has had to accept free movement of people and the payment of a contribution into the EU budget to achieve its bilateral agreements with the EU.17

As has been mentioned, the rules of the WTO are designed to prevent preferential sector-specific agreements between countries.  It has been suggested, for example, that the UK might seek a sector-specific deal with the EU for the automotive sector but academics who have examined the idea say that it is incompatible with WTO rules.18

The Prime Minister has made clear the UK’s desire to continue to benefit from a customs agreement with the EU but left open how this might be done.  As there are no obvious precedents, other than the EU’s Customs Union agreements with Andorra, San Marino and Turkey, which for different reasons are unlikely to be appropriate in this case, this will be a matter for negotiation between the UK and the EU.

 

Conclusion

The possibility of the UK maintaining a customs relationship with the EU is now officially part of the UK’s negotiation objectives.  But as this paper has explained there are difficulties in the UK remaining in the EU Customs Union, including the lack of preferential access to the EU for services; the need to be bound by third country agreements negotiated by the EU without having any say in their negotiation; the restrictive effect on the UK’s ability to negotiate trade agreements with third countries; and the need to make payments into the EU budget.  As the Prime Minister has said that these latter requirements are an obstacle to the UK remaining in the EU Customs Union, the UK will aim to negotiate arrangements acceptable to it and to the remaining 27 Member States and which are compatible with the UK’s obligations as a member of the WTO.

  1.  HM Government, ‘The government’s negotiating objectives for exiting the EU: PM speech’, 17 January 2017
  2. For an overview of the EU customs union and the EU-Turkey customs union, see House of Lords European Union Committee, 5th Report of Session 2016-17: Brexit: the options for trade, HL 72, 13 December 2016, pp. 28-29
  3.  The General Agreement on Tariffs and Trade, 1947, as amended, p. 41
  4. See Soamiely Andriamananjara, ‘Customs Unions’ in Jean-Pierre Chauffour & Jean-Christophe Maur (eds.), Preferential Trade Agreement Policies for Development: A Handbook (Washington, D.C.: World Bank, 2011), pp.111-120
  5. There are temporary restrictions in the Schengen Area at the time of writing because of the refugee crisis and concerns about terrorism which may lead to vehicles being searched.
  6. See John Springford, ‘Customs union membership is no way out of the Brexit trap’, Centre for European Reform, 16 December 2016
  7.  Ibid. and House of Lords European Union Committee, supra n. 2
  8. Agreement establishing an Association between the European Economic Community and Turkey (signed at Ankara, 12 September 1963), 1977 OJ L 361/1, art. 12
  9. This would depend on the agreement the UK negotiated with the EU and possibly on agreements with the 53 countries.
  10. Stephen Booth et al., What If? The Consequences, challenges & opportunities facing Britain outside the EU, Open Europe, 23 March 2015, p. 80
  11. Ibid.
  12. House of Lords European Union Committee, supra n. 2
  13. Ibid., p. 31
  14. Dr Liam Fox, Secretary of State for International Trade and President of the Board of Trade: HC Deb 5 December 2016, vol 618, col 316WS
  15. John Springford makes this point in relation to services, supra n. 6
  16. ‘Theresa May faces growing anger over Brexit secrecy as Boris Johnson appears to leak key detail’, Rob Merrick, The Independent, 16 November 2016
  17. John Springford, supra n. 6
  18. Michael Gasiorek, Peter Holmes & Jim Rollo, UK-EU trade relations post-Brexit: Too many red lines?, UK Trade Policy Observatory, University of Sussex, 14 November 2016, p. 5