Media  Global Economy  2018.12.12

For those who want to understand Brexit - A simple explanation on why the UK's exit from the EU is getting so messy

The article was originally posted on Webronza on November 28, 2018

The withdrawal of the United Kingdom from the European Union or Brexit, a portmanteau of "British exit," has been covered by Japanese TV and newspapers as well. We know well that British politics is in great disarray. This is highlighted by the fact that even some members of the governing Conservative Party are opposed to the withdrawal agreement that has recently been reached between British Prime Minister Theresa May and other EU leaders. Most of us, however, may be puzzled as to why the withdrawal agreement is opposed by so many and how that will affect withdrawal process.

I, for one, could not understand exactly what was at issue from Japanese media reports. On November 25, I watched an evening news report by the Japan Broadcasting Corporation (NHK) that EU leaders had approved the withdrawal agreement. I was expecting that NHK would convey this news in such a manner that the viewers could easily understand. The news coverage however seemed to have failed to provide adequate explanations on the key question: what is at issue?

To begin with, a mere withdrawal from the EU must be a simple story: The UK will simply secede from the EU. This must have been what almost all citizens and policymakers in the UK thought when a withdrawal from the EU was put to a national referendum.

However, a special situation in the UK has turned this simple question into a labyrinth.

It was until I read commentaries by the British Broadcasting Corporation (BBC) that I came to a thorough understanding of the issue. However, I suspect that these commentaries may be rather difficult for ordinary Japanese citizens.

For one thing, understanding the commentaries requires special knowledge about the EU and the UK. For another, Japanese news reports may be far from lucid. In fact, I am increasingly concerned that Japanese reporters may not be trying to accurately understand and convey such knowledge.

As a person who worked for the Japanese Mission to the European Union for 3 years since 1996 to 1998, an equivalent to the Japanese embassy in the EU, I may be obliged to convey such knowledge to the Japanese people.

This short article will provide some basic knowledge needed to understand Brexit. I hope that this article will help the reader better understand news reports on Brexit.

What is a customs union?

First and foremost, understanding Brexit requires some knowledge about the EU (the term "EU" is used here for the sake of consistency, although the community had long been referred to as the "EC" until recently). The keywords here are "customs union" and "single market."

The EU was launched in 1958 as the European Economic Community (EEC), made up of Germany, France, Italy, and the Benelux countries (Belgium, Netherlands, and Luxembourg). Behind the launch was the strong political determination of Germany and France--which helped to trigger the two world wars--not to do so again. The UK, on the other hand, distanced itself from the developments in continental Europe.

Since its launch, the EU increased its membership gradually. Now, the EU consists of 28 countries, including the UK, which joined in 1973.

By 1968, the EU consummated a customs union (CU) and a common agricultural policy. This customs union was designed to remove internal tariffs and other trade barriers among the six countries and apply common tariffs to non-member states. In the customs union, no tariff is imposed on goods traded within the EU. For example, when a person in Spain buys a car from a manufacturer in Germany, he or she need not pay any tariff. By contrast, a flat tariff of 10 percent is levied on automobiles that Japan exports to France, Sweden, the UK, or any other of the 28 member states of the EU.

"Customs union" or CU may be an unfamiliar term to many Japanese.

Speaking of trade liberalization, the Japanese media has so far covered bilateral free trade agreements (FTAs) such as the one between Japan and Thailand as well as multilateral FTAs such as the TPP. CUs and FTAs have one thing in common: Trade among CU members or FTA parties is entitled to tariffs lower than those agreed to and bounded under GATT/WTO. This arrangement, which provides preferential treatment to CU members or FTA parties, constitutes a significant exception or derogation to the basic GATT/WTO principle of most-favored-nation treatment that all countries should be treated equally.

However, an FTA differs from a CU in one important aspect: Tariffs for non-FTA parties are not unified; they differ from country to country. For countries not party to an FTA, for example, Country A and Country B, both parties to that FTA, may levy a beef tariff of 100 percent and one percent, respectively. Country A wants to protect its domestic beef industry, while Country B does not need to do so because the beef industry is non-existent there. Since no beef tariff is levied on trade among the FTA parties, beef produced in Country C, a non-FTA party, can be imported to Country A with a tariff of one percent if the product is imported via Country B. In that case, Country A is unable to protect its domestic beef industry. To prevent such import, Country B needs to prove that the beef originates from it if it wants to export the product tariff-free to Country A. This is known as "the rule of origin."

Things are simple as far as primary commodities such as beef are concerned. However, if Country B imports a primary commodity from a non-FTA party and processes it--or imports parts from such countries and fabricates automobiles or TV sets from them--for export to Country A, it is necessary to judge whether such a product can be regarded as truly produced in Country B. Take, for example, autos whose bodies are made in Country B but everything inside which are made in other countries. It is clear that such vehicles cannot be recognized as truly produced in Country B. However, for a product to be recognized as such, to what extent should value be added to that product in Country B? Such a criterion is always a major bone of contention at FTA negotiations.

In fact, the rules of origin for autos were the biggest issue at the negotiations to revamp NAFTA in 2018.

The rules of origin, which are determined by such criteria as the change of tariff heading, the amount of working or processing, and the value added, are said to differ from FTA to FTA. Customs authorities will have to judge whether imports truly originate from a FTA party or a non-FTA party from documentation in order to determine the tariff.

This will paradoxically increase the cost of trade. This is what Jagdish Bhagwati, a renowned scholar of international economics, calls "spaghetti bowl effect."

By contrast, a CU does not require the rules of origin as it imposes common tariffs on imports from non-CU members. In terms of trade liberalization, a CU is more advanced than an FTA, with more close ties among the member countries.

What is a single market?

At the outset, the EU was viewed as an economic marriage between France's agriculture and Germany's industry. After World War II, the German industrial sector wanted the formation of a customs union so that it could dominate the European market, while France, an agricultural country, desired the establishment of a strong agricultural policy in the region.

However, there was a special situation with agriculture. Each country in the region adopted its own protective policy for the industry. Any attempt to liberalize trade in the region while leaving such protective policies intact meant that farmers in a highly protected country would gain a competitive advantage over those in a less protected country. That would be unequal. The playing field should be levelled.

For this reason, different national agricultural policies were unified into the Common Agricultural Policy (CAP), which revolved around the single price support policy within the community. (In this policy, when the market price of an agricultural product fell below the specified support price, that product was bought in the market to increase its price.) Member governments were prohibited from taking any policy that would change competitive conditions. In a sense, it was logical that the launch of the CU in 1968 was in parallel with the establishment of the CAP, which was built on a common single market arising from the unification of the internal market.

In 1992, the EU established a unified single market centering around the free movement of people, goods, capital, and services, although the process significantly lagged behind the developments in the agricultural sector.

Even within the single market, as the member governments were required to address a wider range of sectors such as the environment, some feared that different policies in such sectors could distort corporate competitive conditions among the member states. Others demanded that such differences be eliminated to level the playing field and to facilitate economic activity. There were increasing calls to harmonize legislation among the member governments and even unify policies and regulations for the EU in such sectors as the standardization of food and industrial products, the environment, and competition law, as in the case of the CAP.

In the 1990s onward, the EU thus faced a major challenge of not only increasing its membership, but also unifying and "consolidating" policies and institutions for a single market.

The biggest issue in terms of consolidating the EU was to establish a common currency called the "euro." Yet deeper integration also meant the process of ceding part of the sovereignty of the member states to the EU.

Irish border issue

What is the special situation in the UK?

First of all, there have been deep-seated concerns in the UK that as the EU expands its policy domains and deepens its integration, the country's sovereignty might be violated or the country's fate might be determined by Brussels, the site of EU headquarters, rather than London. This is why the UK refrained from joining the euro and has been reluctant to play an active role in deepening the EU.

As evidenced by the fact that the 2016 national referendum over whether the UK should remain in or leave the EU was not the first of its kind, pro-Brexit views have been repeatedly expressed since the UK joined the EU and strengthened in line with the deepening integration of the EU. Waves of immigrants coming to the EU from the Middle East and Africa from 2015 exacerbated animosities toward the EU, which seemed ready to accept immigrants. This constituted a major factor for the approval of Brexit at the national referendum.

At the outset, everyone thought a divorce from the EU would be easy. Standing in the way, however, was the border issue between Ireland and Northern Ireland, which is a part of the UK.

While Ireland is traditionally a Catholic country, the population in Northern Ireland has been dominated by Protestants as in the case of the Great Britain. Catholics in the region were long discriminated against.

Religious antagonism can be so fierce that most Japanese could not imagine it. Catholics who immigrated to America from Ireland in the past faced discrimination in their new land as Jews did. In the US, Catholic Irish immigrants are called "Green Irish," while Protestant Irish immigrants are called "Orange Irish." Being Green Irish, JFK was vilified for being Catholic in his presidential election.

In the past, Northern Ireland was plagued by terrorist bloodshed in a feud between Protestant residents who wanted the region to remain as part of the UK, and Catholic residents who wanted the region to be united with Ireland. The conflict over Northern Ireland died down after the UK and Ireland joined the EU, which in turn resulted in the abolition of border checks between Ireland and Northern Ireland and the free movement of people and goods under the EU single market. The conflict between the two religious populations came to an end when a peace agreement was reached in 1998.

With this historical background, Brexit will mean the revival of strict border controls between Ireland and Northern Ireland. Checkpoints will be set up, and the movement of people and goods will be restricted. These are the natural consequences of the UK leaving the EU, that is, the customs union and the single market. In other words, a wall will suddenly be set up that will block the free movement of people and goods between the UK and Ireland, a situation the UK will be able to continue enjoying if it remains within the EU.

It would be a nightmare if the peace was broken and bloodshed was repeated. According to the BBC, the UK and the EU have agreed that such a nightmarish scenario must be avoided. However, the goal of leaving the customs union and the single market is incompatible with the goal of doing without border controls.

The EU proposed that the UK detach Northern Ireland from the Great Britain and allow the region to remain in the customs union and the single market in order to do without the strict border controls. In that case, however, EU regulations on food, industrial products, the environment and others would remain in place for Northern Ireland under the single market principle, meaning that this region and Great Britain would be treated differently. The application of the same EU laws and regulations to Northern Ireland and Ireland would make the former virtually independent of Great Britain.

British Prime Minister Theresa May rejected the EU proposal, saying that it would endanger the constitutional unity of the UK. She said that a border must not be drawn in the Irish Sea, situated between Great Britain and Northern Ireland.

The attempt to recover sovereign rights will paradoxically limit them

What agreement has been reached as to how this issue will be addressed?

It has been agreed that although the UK will leave the EU in March 2019, the whole country will remain in the EU's customs union and single market during the transition period that will end on December 31, 2020. (The period can be extended only once, up to a maximum of two years). Arrangements after the transition period are subject to future negotiations. If such negotiations fail to reach an agreement, what they call the "backstop" arrangement, to be discussed later, will be applied.

The draft political declaration on future negotiations that was agreed on along with the legally-binding withdrawal agreement allows for mechanisms to maintain free movement with technical solutions other than checkpoints with regard to border controls until the transition period ends. However, such a mechanism has not been applied anywhere in the world.

Unless such a mechanism is found, a "single EU-UK customs territory" (meaning a temporary customs union) will be established from the end of the transition period. Yet the UK will be subject to "level playing field conditions," so that it cannot gain a competitive advantage over the EU countries while remaining in the same customs territory. Northern Ireland will be in a deeper customs relationship with the EU than Great Britain; it will also remain subject to the rules and regulations of the EU's single market such as standards on food and industrial products. In other words, even after the transition period, the UK consisting of Northern Ireland and Great Britain will remain in the EU's customs union, and while Northern Ireland will be subject to the rules and regulations of the EU's single market, Great Britain will be subject to the rules and regulations that are harmonized with them. This arrangement is called the "backstop," meaning a safety net.

In short, the treatment of the border issue came before the withdrawal from the EU. But this will backfire. During the transition period, EU standards and regulations will apply to the entire UK since the country will remain in the customs union and the single market. After this period, they will continue to apply to Northern Ireland, while Great Britain will effectively remain bound by them because its own standards and regulations must be harmonized with them.

To make matters worse, the UK government will have no say in the process of introducing and amending EU standards and regulations during the transition period and thereafter because the UK will have legally withdrawn from the EU in March 2019. In short, the UK's attempt to recover its sovereign rights by leaving the EU is bound to paradoxically limit or derogate such rights further.

Under the backstop arrangement, food standards, for example, will be different between Northern Ireland and Great Britain. Accordingly, Great Britain will need to make its food products compatible with EU standards if it wants to distribute them in Northern Ireland, and vice versa. For this to happen, food products will need to be checked whether they meet the required standards in much the same way as border controls.

In brief, Northern Ireland and Great Britain constitute different markets, not a single market. In terms of the movement of goods, Northern Ireland will remain part of the EU area just as Ireland is; it will become an entity independent from Great Britain. A de-facto border will be drawn in the Irish Sea.

Furthermore, forming a single customs territory with the EU means that the UK will have no authority to change tariffs. The UK will be unable to conclude an FTA aimed at reducing or abolishing tariffs with other countries. In relation to Japan, the UK will join the Japan-EU FTA; it will not be able to conclude or bring into effect an FTA of its own with Japan or join the TPP 11. Nor it will be able to sign a FTA with the US.

Finally, there is no guaranteed exit from the backstop unless the EU agrees.

This constitutes a major reason why many people in the UK oppose the withdrawal agreement. It is the UK that wants Brexit. It is the UK that faces the Irish borderissue. Brussels may be thinking that the rest is up to London to decide.

Industry will not oppose the withdrawal agreement. No tariffs or customs procedures for internal trade mean no barrier for the Japanese auto industry to procure parts from continental Europe for production in the UK. The worst-case scenario for industry would be that the UK will leave the EU without an agreement, resulting in the revival of tariffs and strict border controls.

It seems to me that the UK have only two options left: either rescind Brexit and maintain a border that allows for the free movement of people and goods (i.e., maintaining economic prosperity with the EU) or leaving the EU altogether and imposing strict border controls (i.e., recovering political sovereignty from the EU).

As the Rolling Stones sing, "You can't always get what you want. You can't always get what you want. You can't always get what you want. But if you try sometimes you just might find. You get what you need"

(This article was translated from the Japanese transcript of Dr. Yamashita's column in "Webronza" on November 28, 2018.)