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The EU is terrified of a WTO Brexit – the UK should seize its chance to force a good deal

free trade agreement
Written by Harry Western

Harry Western argues that a smart UK government would take advantage of the current vulnerability of the EU economy to a WTO Brexit to negotiate a good free trade deal – instead of desperately assisting the EU in its attempt to force the UK into a customs union.The

  •  A WTO-based Brexit as it would probably lead to large scale diversion of UK trade away from the EU
  • This risk is particularly acute at present because the Eurozone economy is facing a severe slowdown and possible recession, with manufacturing output in freefall in Germany
  • The possible threat of auto tariffs on EU producers by the US makes the EU even more vulnerable; tariffs on EU cars by the UK and US would be a body blow to the industry
  • EU fears of the trade impact of a WTO Brexit explain why the EU has tried to construct a withdrawal agreement which ties the UK into the EU customs union and regulatory system in perpetuity

EU is terrified of a WTO-based Brexit. And with good reason. Currently, UK membership of the EU customs union and single market makes the UK a massive and lucrative captive market for EU producers – the EU’s goods trade surplus with the UK is £95 billion. Under a WTO Brexit, that would be likely to change rapidly.

The ‘no deal’ tariff schedule the UK government recently published would be likely to see a considerable diversion of UK trade away from EU producers, as EU firms lose their preferential access to UK consumers:

  • Double-digit UK tariffs on EU agricultural products will prompt large shifts of UK demand away from EU products such as meat and dairy products and towards UK and third-country producers (many of whom will face lower tariffs, as the UK’s new agricultural tariffs will be lower than those currently levied by the EU).
  • UK tariffs of 10% on finished cars could see EU auto exports to the UK fall by 20-30%, based on standard trade elasticities.
  • Southern European textile producers will also face double-digit tariffs, which in a low-margin business could be devastating.
  • The UK’s abolition of tariffs on the great bulk of industrial products will make third country exports to the UK of thousands of manufactured goods more competitive than now, which would be likely to erode EU producers’ share in the UK market.
  • As the UK starts to sign new free trade deals with third countries, third country producers will gain significant tariff preferences over EU producers in some sectors such as agriculture and autos.
  • As the UK moves to dismantle some EU non-tariff barriers to trade which currently disadvantage third country producers, EU market share in the UK will drop even more.
  • Freed of the more burdensome EU regulations, UK exporters will also be more competitive in third country markets, reducing EU market share there.

Taking all these factors into account, it is quite plausible that EU exports to the UK could fall by 15-20% in total over a few years, a fall amounting to around 0.6% of EU GDP, with additional export losses in other markets. And in some sectors and for some EU countries the drop would be much bigger.

Trade losses of this scale are manageable in the long-term but would be extremely painful in the short term, because the EU economy is currently entering a severe slowdown that could easily morph into a recession. Italian GDP is already shrinking and Germany is on the brink of recession, with manufacturing output in freefall – German industrial orders are falling at their fastest pace since the global financial crisis.

Moreover, another sword of Damocles is hanging over the EU economy in the form of the threat by the US to impose tariffs of up to 25% on EU automobile exports to the US. Again, using standard trade elasticities, this could mean EU exports of autos to the US falling by 60% or more.

The impact on the EU auto industry of high tariffs imposed by both the UK and US could be cataclysmic. In 2018, these two markets were the two largest for German car makers, accounting for over a quarter of total car exports. The loss of up to a half of this market could push some producers towards bankruptcy and would have a huge negative impact on EU firms all the way down the complex supply chains that support auto makers.

And there is a further risk to the EU economy from the financial side. An EU recession prompted by US and UK trade losses could reignite concerns about Italian banks and the long-term solvency of the more indebted Eurozone member states. The result could be a sharp rise in government bond yields in the weaker Eurozone countries, adding to downward pressure on growth.

These economic risks explain why the EU has been so keen to construct a UK withdrawal agreement that locks the UK into the EU customs union and regulatory system indefinitely. What is so puzzling is that the UK authorities have been so keen to go along with this.

A smart UK government would now be using the massive threat posed to the EU economy by a WTO Brexit plus US protectionism to push for a good free trade deal. But the UK authorities appear not to understand the basics of the trade situation, the principles of negotiation or their own long-term economic interests.

 

Harry Western is the pen-name for a senior private sector economists who prefers to remain anonymous for career reasons

 

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Harry Western