WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

By Mahdi Ghodsi.

• With the first round of talks out of the way, attention is now turning to negotiation between the UK and EU27 over their future trading relationship.
• Most academic and media attention has been focused on the potential impact of tariffs after Brexit. Much less focus has been placed on non-tariff measures (NTMs).
• Research conducted by wiiw has found that the imposition of NTMs have very diverse impacts across sectors.
• The fact that the UK and EU are both developed markets is likely to reduce the trade-distorting effects of tariffs. However, clear distortions are likely to materialise, as a result of a divergence in standards.
• By far the most severe impact is the requirement for the UK to comply with thousands of regulations that are subject to mutual recognition in the EU. This will require border checks (and accompanying infrastructure) and will be a meaningful barrier and cost to trade.

After months of tortuous wrangling on the first phase of Brexit negotiations, the UK eventually caved in to most EU demands on citizens’ rights, the Irish border, and the financial settlement in December. This paved the way for the two sides to move onto the next stage of negotiations, including the future trading arrangement. This was greeted warmly by the UK government, which is aiming for an “ambitious” free trade deal with the EU post-Brexit. However, it is apparent that at least some members of the UK government have not fully appreciated the complexities of the next round. David Davis, the UK’s Brexit Minister, remarked in a TV interview “It’s not that complicated, it comes right back to the alignment point...We start in full alignment, we start in complete convergence so we can work it out from there”. Unfortunately for Mr Davis, the reality is quite different.

There have been several studies in the recent economic literature looking at post-Brexit economic losses for the UK as a result of a new trading relationship with the EU. Many of these studies are comparative analyses focusing on the consequences of the UK leaving the EU single market. These studies compare the UK with an external trading partner of a comparable economic size to the EU, and advanced level of economic development, i.e. with a high-tech industrial structure and knowledge-intensive services. These studies model what would happen if the UK did note have a free trade agreement (FTA) with the EU. Then, despite not having an observable counter-factual evidence to the de facto non-EU UK, these studies indicate that leaving the EU would potentially lead to trade distortions and possible losses, both to the UK and the EU member states with which it currently has a deep trade relationship.

Many Brexit impact studies, however, focus largely on the impact of tariffs. Though highly relevant, in-depth analyses on the consequences of Brexit due to trade frictions caused by non-tariff measures (NTM) are rare. The World Trade Organization (WTO) agreements allow the imposition of NTMs if they are not pursuing a protectionist or discriminative motivation to distort trade. Protection of human health, animal welfare, plant life, security, and environmental vitalities, improving the market efficiencies or consumer’s rights through standards or regulations could be eligible motivations to impose two types of NTMs. Technical barriers to trade (TBT) and sanitary and phytosanitary (SPS) measures are among the most implemented regulatory measures pursuing those motives.

Impacts of NTMs are diverse, however can be significant

However, in line with many other studies on NTMs, a recent study by the wiiw encompassing around 5000 products traded globally during the period 1995-2014 indicates that these NTMs have very diverse impact across industries and importing countries. One important reason could be the differences in standards and regulative frameworks across countries in the world. Advanced economies producing high-quality products can more easily adopt to the regulative measures imposed by another country, leading to trade creation effect. By contrast, exports from least developed countries not meeting those high standards might be prohibited unless they comply with the NTM in force.

In the WTO’s I-TIP database, there were 2,639 notifications by the EU on TBT and SPS measures until 2016. The notifications by single EU member states (including the new member states) covering both types of NTMs amount to 2,256, of which only 62 measures originate from notifications by the UK. These figures point towards a substantial role for mutual recognition across the whole EU, which is a mechanism in addition to the harmonization of standards across the common market. The NTMs imposed by the EU are harmonised, while those imposed by individual member states cannot affect intra-EU trade due to mutual recognition. An NTM imposed by a single EU member state does not necessarily need to be harmonized, while they could be mutually recognised by other member states when intra-EU trade is involved. Mutual recognition implies that a measure regulated by a single member state should not restrict trade from other EU member states, even if the product does not fully comply with that regulation.

Post-Brexit trade distortions are very likely

After Brexit, two scenarios will distort trade between the UK and the EU27 in addition to possible increase in tariffs to either most-favoured nation (MFN) rates or any other preferential tariff rates which might be negotiated. The first is the divergence in standards which are already harmonized across the whole EU (this may not necessarily occur immediately).

The second one is that the UK should comply with those regulations (the remaining 2,194 TBT and SPS measures) which have been previously recognized mutually across the EU. The consequences of this could be much harsher, and materialise much more quickly. It would require immediate border inspections with reallocation of some resources for the tasks on both sides. This could potentially cause further immediate trade friction than that of the already-mentioned comparative studies in the recent literature. The reason is that such trade inspections already exist between the EU and external trading partners, while such a relationship between the EU and UK would need to be initiated and the infrastructure established.

There are some arguments that a so-called “soft” Brexit, including a possible FTA between the UK and the EU27 with provisions on NTMs, might be a solution avoiding any significant post-Brexit regulatory barriers. However, this is not likely to happen. One reason could be the main motivation behind the Brexit vote leading to a policymaking of the UK independent from Brussels. This will not be achieved if the future standards and regulations in the UK are to be still synced, harmonized, and/or rather dictated by the EU. Such independent policymaking would lead to substantial divergences across regulations and standards on products, which would also cause many difficulties with mutual recognition.