The Great British Trade-Off

I first published this article on the National Institute of Economic and Social Research blog. It is reproduced here with permission. For the non-British readers, the title is a play of words in reference to a famous BBC TV series, the Great British Bake Off.

The British Prime Minister and four of her senior cabinet colleagues will in a series of speeches over the next few days set out a vision for the UK after Brexit. Those speeches will likely reiterate the government’s official goal of ‘free and frictionless’ trade with the EU. Less clear are the concessions that the UK is prepared to make to achieve this objective. In this blog we explore the likely trade-offs from the prism of a simple schematic and focus on three key areas of negotiation - market access, labour movement and budgetary contribution. There is no magic formula and the decision is ultimately political. With that in mind, the PM and her colleagues should spell the priorities on each of these three dimensions in the forthcoming speeches.

The trade arrangements that the European Union has already established with Norway, Switzerland or Canada offer an important insights into the trade-offs that might be required. There are a number of dimensions by which one can define the new relationship. We have distilled these into three key areas: level of market access, budgetary contribution and restrictions on labour movement.

Figure 1 is a visual representation of the trade-off for a handful of relationships between the EU and non-EU countries where the vertices of the triangle correspond to full market access, complete freedom of movement of people and size of the financial contribution (as a percentage of Gross National Income). The largest triangle in black is the situation that the UK currently is in as a member state of the EU: the UK has full access to the EU market in goods and services, allows EU citizens to move freely in and out of the UK, and contributes about 0.5% of GNI to the EU budget, net of what it receives. Norway opted to join the European Economic Area (EEA) to have close to full access to the single market, both in goods and services. The dashed red triangle shows that, to be accepted as a member of the EEA, Norway had to agree to significant financial contributions (“Norway Grants”, amounting to 0.14% of GNI) and freedom of movement of persons. Switzerland’s bilateral agreements with the EU means that it allows freedom of movement of persons, makes a very small net budgetary contribution, but its market access is significantly reduced in the service sector. Finally, the trade deal with Canada (CETA) is less extensive than Switzerland and is essentially restricted to just goods. Canada does not make a budgetary contribution.

To measure the level of access to the EU market, we extended the World Bank database of preferential trade agreement to include the Swiss-EU bilateral agreement and CETA. The database classifies the content of trade agreements into 52 standardized provisions, which include for example reduction in tariffs for industrial goods, reduction in technical barriers to trade and opening up of public procurement contracts. Our metrics is the sum of provisions weighted by a factor 3 if a provision is legally enforceable with a formal dispute settlement mechanism, 2 if a provision is legally enforceable but without a dispute settlement mechanism or 1 if it is not legally enforceable. Having a dispute settlement mechanism in place provides more certainty for companies and therefore it is considered an important factor of the depth of a trading agreement.

Figure 2 shows the level of market access for the most ambitious trade agreements that the EU has signed to date, using our metric of market access. EU-member states get the highest score of 130 and Norway, which is a founding member of the EEA, gets a score of 120 as both are subject to the Court of Justice of the European Union (CJEU). Switzerland has a lower market access than Norway: it faces restrictions in the service sector, and in the financial industry in particular. For the UK, losing “passporting” (the regulatory equivalence in the financial services industry) would be particularly damaging as a lot of business in the City of London relies on it. Despite covering most goods, CETA is even less ambitious than the Swiss-EU agreement because only a handful of service sectors are liberalised (postal, transport and telecommunications sectors).

The EU has negotiated a wide range of trading relationships with non-EU countries and as such there is room for a new relationship with the UK that embodies ‘free and frictionless trade’. But the position of the UK government to end the free movement of persons and the jurisdiction of the CJEU makes that objective more difficult to attain because it will most likely push the UK out of the single market. This means that the new UK triangle in figure 1 will be constrained to be inside the Norway triangle, with a lower market access than currently enjoyed by members of the single market and the UK itself. To maintain a higher market access than Switzerland, which faces restrictions on some services and the financial sector in particular, the UK will probably have to continue contributing to the EU budget and accept some degree of free movement of labour. There should be no more references to magical, self-regenerating cake in the forthcoming speeches. For the negotiations to success the UK now needs to decide which concession it is ready to make.