Media Global Economy 2020.05.01
The United Kingdom and the European Union have started negotiations which will shape and direct the future relationship between the two sides from 2021 onwards. The talks are mainly about a free trade agreement on the trade of goods and services and the protection of investments and include catch quotas for EU member states in Britain's economic waters.
Is British Prime Minister Johnson playing brinkmanship?
The British Government, led by Prime Minister Boris Johnson, intends to bring the negotiations to a conclusion during this year (2020), insisting that it will not request an extension of the transition period until 2022, which has been originally agreed upon by the U.K. and the EU.
This is also a campaign promise made by the Conservative Party at the end of last year, and its objective is provided in the Brexit Law passed by the British Parliament. Should the negotiations fail in 2020, there will be no agreement between the U.K. and the EU in 2021, which means that each side will impose trade tariffs on imports from the other.
Setting the deadline for the negotiation period for the end of 2020 is like the U.K. bluffing the EU, which is recognized in the EU as brinkmanship by Boris Johnson.
Before Brexit was implemented at the end of January 2020, there was a fear that the U.K. might leave the EU with no deal. At that time, Prime Minister Boris Johnson threatened the EU by saying that there might be a no-deal Brexit. However, the no-deal Brexit scenario many were concerned about at that time is not the same as the no-deal situation between the U.K. and the EU which is expected to occur after 2021.
The border issue between Northern Ireland and the Republic of Ireland, over which concerns were raised as to whether the Northern Ireland conflict might be reignited, was settled by the agreement made between the U.K. and the EU in October last year (2019). Following this, "Brexit with a deal" was implemented at the end of January 2020. Even if the Britain-EU talks break down this year, tariffs and customs clearance will be simply applied again between the two parties. What Boris Johnson says is not such a strong bluff.
In addition, brinkmanship, which is often referred to as a strategy adopted by North Korea against the U.S., is usually a way for a weaker party to negotiate with a stronger party. In fact, some of the leaders of EU member states say that the EU, more powerful in economic terms, can overwhelm the U.K. Triumphant voices can also be heard declaring that the U.K. is no match for the EU consisting of 27 countries. Not only the EU member states but also those in the European Commission who are responsible for negotiating with the U.K. seem to think that the U.K. has a weak position in the negotiations.
The U.S.'s argument for a level playing field
This view is most clearly reflected in the level-playing-field argument, which claims that if the U.K. wants to export to the EU market without tariffs and quotas, it will be required to keep complying with EU regulations and policies, including regulations on labor and the environment, and government subsidies (and corporate taxation).
The level playing field is an argument that the U.S. negotiators prefer to use in various trade negotiations. Behind this lies an arrogant and selfish belief that the U.S. industries lose in international competition just because their counterparts use unfair trade tactics, and that otherwise the U.S. could not lose. The U.S. even believes that if the U.S. cannot win in any sports competition, the playing field is not level but skewed to the advantage of its counterparts.
With regard to its relationship with Japan, the U.S. says that while Japanese cars are exported to the U.S., American cars are not sold at all in Japan because American cars are unfairly treated and eliminated from the Japanese market by the regulations of the Japanese government and business practices unique to Japan. This belief is strongly held by some people in the U.S. government and auto industry. I am sometimes surprised and puzzled that even intellectuals hold this kind of opinion.
However, while we see a lot of European cars such as Mercedes, BMW, Volvo, Peugeot, Fiat, and MINI in Japan, we rarely see American cars such as Ford and GM. If Americans want to know why American cars don't sell well in Japan, they have only to come to Japan and ask any Japanese passerby. No one in Japan wants to buy an American car just because of its bad reputation.
The EU's arrogant negotiating style
But the best that can be done even by the U.S. is to insist that other countries should not give their industries a competitive edge over their American counterparts by employing regulations looser than international standards on labor and the environment. If I remember correctly, the U.S. has never required other countries to employ its own regulations or the same level of regulations. The European Commission's demands on the U.K. make us wonder when the EU became more arrogant than the U.S. This may be European chauvinism.
If the EU should adopt a carbon tax or change its emissions trading system regarding the global warming problem, will the U.K. be required to adopt the same policies?
The EU cannot, and will not be able to, demand that sovereign states continue to adopt EU rules and policies. It is unfair for the EU to call on Britain to do what the EU did not demand of Japan and Canada when it reached FTAs with them. Making such a demand is like treating the U.K. as a dependency of the EU.
The basic philosophy for international agreements and treaties is reciprocity, on the basis of which every nation recognizes that they have the same rights and obligations to each other. Therefore, from the viewpoint of reciprocity, the EU is not allowed to ease its restrictions more than the U.K. Is this acceptable to the EU?
The European Commission does not seem to give any thought to it. With that, the EU is doing nothing more than demanding that the U.K. accepts an unequal treaty.
British people reacted against the "backstop" agreement former British Prime Minister Theresa May concluded with the EU because the backstop agreement required Northern Ireland to apply the same regulations and standards as the EU, and Great Britain to apply the equivalents of the EU. The EU's level-playing-field demand looks like the same as the backstop agreement. The U.K. does not accept it at all. This is because Brexit is designed for the U.K. to recover sovereignty from Brussels and to regain the freedom to establish laws and regulations on its own. Emphasis is placed on sovereignty in the documents by the British government. Bureaucrats of the EU member state governments and the European Commission do not seem to pay any attention to the opinions of the British people, who went through the Brexit process. Citizens in the EU member states may well criticize the EU and the European Commission for causing "democratic deficit".
The U.K. is in an advantageous negotiating position on fishing
However, if bureaucrats of the EU member state governments and the European Commission think that the U.K. is easy to negotiate with, they will learn a hard lesson. Actually, Britain's position has an advantage over that of the EU.
Like the trade agreement reached by Japan and the U.S. last year, the Japanese government has followed the demands from the U.S. government without putting up any resistance. This is because Japan feels indebted to the U.S., the military power of which has protected Japan so far. Otherwise, Japan would be able to negotiate with the U.S. equally.
However, there is no such relationship between the U.K and the EU. The U.K. need not feel inferior when negotiating with the EU.
The EU is in a weaker position in this round of the talks. Fishermen from France, the Netherlands, Denmark and other EU member states catch about 40 percent of the total EU catch in Britain's fishing waters (usually referred to as "economic waters" because the U.K. has a sovereign right over underwater mineral resources in addition to fishery resources). So far, EU member states have been given fishing quotas by Brussels under the EU common fishing policy because Britain's fishing waters are part of EU's fishing waters. But after Brexit, the government of the U.K., independent of the EU, has jurisdiction over Britain's fishing waters. The U.K. will allocate quotas to each country every year in light of the resources based on its own judgement.
The U.K. will naturally allocate quotas first to domestic fishermen, who expect this to happen. The rest of resources which are allowable to catch will be allocated to the EU fishermen.
The European Commission, which wants to secure the same catch quotas as before for fishermen in EU member states, is against the way the British government responds to this issue. However, this approach is internationally common. If the EU fails to reach an agreement with the U.K. by the end of 2020, quotas for EU member states may fall to zero in 2021. The EU fishermen will not have legal access to Britain's fishing waters.
It is understandable that the EU wants to demand the same catch quotas as before, but the EU, which is in a weaker position, cannot stand strong against the U.K. When the 200-mile exclusive economic zones were introduced in the late 1970s, Japan, whose fishermen had previously operated freely on the high seas, had to hold negotiations with the Soviet Union and the U.S. on their catches in those countries' waters. Japan, which was suddenly forced into a weaker position, had to face very severe consequences. The situation was similar to that the EU is in now.
Since Japan's catch quotas in Soviet waters were drastically reduced, the Japanese government had to pay compensation to fishermen who had to scrap their fishing boats, which led to a significant reduction in the number of vessels in the northern seas. As a result of negotiations with the U.S., Japanese fishing boats were required not only to pay a fishing fee but also to purchase fish caught by U.S. fishermen at sea in exchange for permission for Japanese fishing boats to operate in the U.S. waters, and eventually Japanese boats were completely driven out of the U.S. waters.
As the Danish Prime Minister said when referring to fishing as the most important issue, fishing, which plays an important role in local economies, is a politically important issue. If the situation Japan was in were to occur, there would be serious political chaos in the EU.
The European Commission insists that if the 2020 negotiations break down and tariffs are raised, the U.K. will not be able to sell to the EU because the EU is Britain's main market even though Britain's own fish catches may increase.
But this is utterly mistaken and droll. Many of the tariffs on fishery products the EU has promised to the World Trade Organization not to raise any further range from 10 to 20 percent except for 22 percent on tuna. It is hard to believe that such tariff levels would affect U.K. exports to the EU.
Rather, foodstuffs such as fishery products are characterized by the fact that demand for such products will hardly decrease even as prices rise (which is referred to as "inelastic" in economic terms). British fishery exports to the EU will not be affected very much because the EU consumers buy them even if tariffs are imposed on British products.
EU consumers will be affected by rising prices. Even with some tariff impact, British fish catches and exports will clearly increase if catch quotas for EU member states in Britain's fishing waters are reduced. It is the EU fishermen and consumers who will suffer damage.
The U.K. is in an advantageous negotiating position on trade and automobiles
It is the EU that is in a weaker position in usual trade negotiations as well. In EU member states, it is a widely held belief that the U.K. will be affected if there is no agreement between the two parties, but this view is groundless.
In goods, the EU had a surplus of £93.5 billion against the U.K. in 2018. The EU's largest export item to the U.K. is automobiles, valued at £46.5 billion, which is 2.6 times larger than Britain's auto exports to the EU at £17.4 billion.
The EU's auto trade surplus of £29.1 billion accounts for 30 percent of its total trade surplus. If the EU reaches an FTA with the U.K., the tariff on automobiles will fall to zero, but if not, a 10 percent tariff will be imposed. It is the EU that wants to maintain free trade with the U.K., and that will be substantially affected if the 2020 negotiations break down.
And that is not all. In 2020, the U.K. is free to hold FTA talks with countries other than the EU, such as Japan and the U.S. In 2021, when the U.K. leaves the EU Customs Union, the U.K. will be able to put these FTAs into effect.
As I have emphasized many times, the essence of FTAs is discrimination against non-participating countries. FTA participating countries have advantages such as expanding access, while non-participating countries have disadvantages.
If the U.K. has no agreement with the EU and reaches an FTA with other countries such as Japan and the U.S., those countries, including Japan, will benefit from the U.K. market owing to the loss incurred by the EU. The United States tried to reach an FTA with Japan because it feared that it might lose its agricultural market share in Japan against TPP-11 member countries including Australia which have gained preferential access to the Japanese agricultural market. The same thing will happen in the EU.
In its trade relationship with Japan, the U.K. has an overall trade deficit of £3 billion. As for automobiles, the export value from Japan to the U.K. is £1.934 billion, while the export value from the U.K. to Japan is £1.298 billion, which means that the U.K. has a deficit of £636 million. In other words, Japan has a trade surplus in automobiles. If the negotiations between the U.K. and the EU break down, and an FTA between the U.K. and Japan comes into effect, the number of automobiles exported from the EU to the U.K. will decrease due to a 10 percent tariff while Japan will be able to export more automobiles without any tariff burden.
A difference of 10 percent is not negligibly small for the automotive industry, which is fighting a fierce price war.
The U.K. is in an advantageous negotiating position on agriculture
The same thing will happen in Britain's trade relationship with agricultural exporters such as the U.S. and Australia. Among the EU's top ten export items to the U.K., vegetables and fruit rank 7th, valued at £6.92 billion, and meat ranks 10th, valued at £5.507 billion.
Usually 10 to 20 percent tariffs are levied on vegetables and fruit. In the Uruguay round of global trade talks, the EU abolished the non-tariff barriers against meat imports by taking into account the gap between domestic and overseas prices at that time and introducing tariffs. The price difference at that time was so huge that the newly introduced tariffs were substantially prohibiting imports. This was called "dirty tariffication."
At that time, the EU, like Japan and the U.S., introduced a special rate tariff free from the influence of exchange rate fluctuations. The EU tariff on beef (per 100 kg) is currently 12.8 % + €176.8. To convert this tariff into the special rate tariff by taking into account the prices of frozen beef imported by Japan (since little beef is exported to the EU from the U.S. and Australia), the rate will be 63 percent, which is far higher than Japan's 38.5 percent tariff on imported beef.
By using the special rate tariff, the EU has blocked beef and other imports from the U.S. and Australia. First of all, what will happen at a stage when the U.K.-EU talks break down? The same tariff (12.8 % + €176.8) will be levied on exports from the EU to the U.K. and exports from the U.S. and Australia to the U.K. Based on the same conditions (the aforementioned level playing field), EU-produced beef products, less competitive in price, cannot beat those imported from the U.S. and Australia on a level playing field. The EU meat industry will lose the U.K. market.
In addition, if an FTA between the U.S. and the U.K. comes into effect, then the tariffs on U.S. exports to the U.K. will be abolished, and higher tariffs will be levied on the EU exports to the U.K. The U.S. will have a stronger advantage over EU for its products.
If the U.K. joins the Trans-Pacific Partnership, Australia will benefit from it. If the U.S. and Australia recognize this fact, these countries will try to reach an FTA with the U.K. as soon as possible (during the year 2020).
It will be agricultural countries in the EU such as France that will suffer damage. The proportion of the budget for agriculture in the total EU budget has been decreasing, but it currently still accounts for 40 percent. Agriculture plays a very important role in EU politics. Agriculture is a cornerstone of the EU. Automobiles may not become a political issue, but agriculture surely will. President Macron will be faced with difficult situations.
Moreover, once an FTA between the U.S. and the U.K. comes into effect, this issue will not be solvable even if the EU reaches an FTA with the U.K. If the U.K. abolishes the tariffs on beef imports from the U.S., Australia and the EU, will the EU with concerns about competitiveness be able to compete with the U.S. and Australia on a level playing field?
The EU needs to change its negotiating style
It's not only about economics. Prime Minister Boris Johnson has a robust political foundation. His party won a sweeping victory at the general election at the end of last year, and the ruling Conservative Party has an overwhelming majority of seats in Parliament against the opposition parties. On top of that, as long as he doesn't intend to dissolve Parliament, his administration will remain stable for five years. In contrast, leaders in EU pivotal countries, like German Chancellor Merkel and French President Macron, have less stable political foundations.
After the first round of EU-U.K. negotiations, EU's chief negotiator Michel Barnier emphasized at a press conference that Britain and the European Union have "very serious" differences. He might have been surprised at Britain's strong position. It is reported that the U.K. will present a draft free trade agreement to the EU in the next round of the talks. The U.K. is in a strong enough negotiating position not to be concerned about a breakdown in the talks if the EU doesn't like Britain's proposal.
The EU will need to reconsider its negotiating position. There is a difference between Britain's pre-Brexit and post-Brexit negotiating position. The U.K. now is not as weak as it was. If the EU wants to avoid a disadvantageous situation, I'm afraid the EU has no other choice but to make concessions with the U.K. and at the same time hold intensive talks with it to reach an agreement in 2020.