Comment

Freedom to diverge after Brexit will cost UK

Sam Lowe / Jan 2020

Photo: European Union 2020

 

Prime Minister Boris Johnson has indicated he wants the UK to be able to diverge from the European Union rules and regulations after Brexit, with Number 10 saying the future partnership, “must not involve any kind of alignment.” European Commission President Ursula von der Leyen has responded by spelling out the EU’s principle that access to the EU’s market is intrinsically linked to acceptance of the bloc’s rules, institutions and legal obligations. “The more divergence there is, the more distant the partnership has to be,” she said. But in practice the EU’s approach is likely to be even tougher: the moment the UK obtains the right to diverge from EU rules, it will – in most areas – be treated by the EU as if it has already done so. The flexibility to diverge does not come for free, as I explain in my latest analysis for the CER. The UK government claims to have accepted that gaining the freedom to regulate as it sees fit will mean new trade friction. But it is not clear that businesses and the public understand what this means in practice.

Sticking to EU rules after Brexit means British businesses won’t need to produce to two different sets of rules when selling to both markets. But it will not lead to a substantive reduction in regulatory barriers to trade if the UK has secured the ability to diverge. For example, once the UK is outside of the EU’s food hygiene (SPS)  regime, British exports of products of animal origin will face fresh regulatory controls at the EU border such as new paperwork and physical inspections – regardless of whether the UK applies the same food hygiene regime or not. However, if the UK does then diverge, say to accept US production methods, this would not lead to a significant further increase in trading friction with the EU. The additional trade costs associated with choosing to diverge are large, but the relative costs of then actually diverging are smaller.

Similarly, once the UK is outside the EU’s single market, British producers will not be able to place products directly on the European market even if they continue to follow EU standards. They will need an EU-established entity to take on the legal responsibility for ensuring the product meets EU rules. This creates an additional cost for British businesses selling to Europe, no matter what the UK’s domestic regime. But there are no additional barriers to British companies should the UK introduce its own product standards.

There are some exceptions where unilateral alignment with EU rules can lead to greater market access. One is financial services, and particularly the areas which are eligible for consideration under the EU’s financial equivalence regime. Here, unilateral adherence to EU rules could lead to the EU allowing certain financial services activity, focused on the EU-27, to continue to take place in the UK. But equivalence rulings are unilateral – what the EU gives, it can easily take away. It has used this power as a bargaining chip in negotiations. 

There has been some additional confusion about the concept of regulatory divergence in the Brexit debate. In the context of the negotiations on the future EU-UK relationship, the EU will ask the UK to commit to preserving existing environment and labour protections, and to continue adhering to EU state aid rules, as pre-conditions for a tariff and quota-free trade agreement. But it is important to note that the areas in which the EU has asked the UK to make regulatory commitments do not on the whole relate to the standards of products. Rather, the EU is focusing on preventing the UK from deregulating or increasing state financial support to make British industry more competitive than companies based in the EU-27. And compliance will not be rewarded with fewer regulatory hurdles to trade; it is simply a necessary condition to secure an FTA and the removal of tariffs and quotas.

In practice, there are few areas where the UK is likely to diverge significantly. European product standards are recognised globally, beyond just the EU, and there is little to no appetite from businesses to increase their compliance burden by having to certify their products separately for the UK market. The EU is a regulatory superpower, and the UK is in its orbit by virtue of geography. The big question is whether the UK seeks the benefits of convergence by legally binding itself to EU rules, or whether it prioritises the rhetoric of ‘taking back control’ over the economic interests of entire sectors.

The big upfront cost of flexibility does come with one upside. Decisions that currently look politically difficult –such as accepting US food standards to get an FTA with America– might become easier if the UK has already borne the cost of divergence. But gaining flexibility with no intention or plan of using it comes with a significant price tag. 

 

 

Sam Lowe

Sam Lowe

January 2020

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