Mendez-Parra, M. 2016. A simple and targeted trade policy for developing countries after Brexit. GREAT Insights Magazine - Volume 5, Issue 6. December 2016/January 2017.
Although the UK may have achieved the same outcomes working within the European Union, Brexit constitutes an opportunity to improve trade policy towards developing countries, making it simple and skewing its benefits towards the poorest countries.
For the UK, Brexit implies one of the most important recent policy designing exercises. The definition of a new trade policy will be at the core of it and will represent its most visible element. This policy will affect the trade relationships between the UK and the rest of the world. Given the historical and economic links between the UK and many developing countries, Brexit implies a major challenge for their trade (Mendez-Parra et al, 2016). But also it may represent an opportunity to reshape and improve the existing policies affecting their trade with the UK.
The type of relationship between the UK and the European Union (EU) that will emerge after Brexit will influence UK trade policies towards developing countries. If the UK is part of a customs union with the EU, the policy tools available will be limited to a set similar to the one currently available. The UK will not be in position to define new tariffs, preferences or free trade agreements (FTAs). But also other typical deep integration provisions, such as the harmonisation of standards and regulatory procedures that may or may not be part of the agreement between the UK and the EU, may affect the operation of value chains involving the UK, the EU and developing countries.
Although the debate in the UK about participating in both the customs union and the EU single market is very active, the discussion is primarily limited to the effects on the UK. This includes the possibility of defining an autonomous trade policy (i.e. FTAs), the financial services passport and immigration controls. Very little is mentioned about how the new trade policy tools can be designed to help developing countries trade more, contributing to their development. Some principles and specific tools need to be outlined considered in the definition of the trade policy, specifically towards developing countries.
Simplicity must rule the definition of each of the elements of trade policy (Winters, 2016). A policy including numerous special regimes and provisions to attend particular situations is costly to administer. This is especially when the policy tries to provide benefits to everyone, without acknowledging the need of defining priorities. The EU trade policy on agricultural products, for example, contains provisions for domestic producers (i.e. high tariffs), developing countries (i.e. preferences) and large exporters (i.e. quotas).
With respect to the definition of its Most Favourable Nation (MFN) tariff (i.e. the default tariff applied to any World Trade Organization (WTO) member), the UK should aim to eliminate the existing tariff peaks and escalation currently applied (Figure 1). Ideally, a uniform, ad-valorem and low tariff applied across the universe of products allows the collection of some revenue and provides some bargaining power in the negotiation of future FTAs. However, assuming that the UK inherits the EU WTO schedules (Bartels, 2016), this sort of tariff structure will be impossible to apply. In more than 1,200 tariff lines, the EU has bound its tariffs at zero (WTO, 2016). To modify this, the UK will have to negotiate the inherited schedule with all the WTO members. Consequently, the new MFN tariff will need to be defined, in the short run, within the limits of the existing schedules. This, however, does not prevent the reduction of the existing tariff peaks in agriculture, food and textile products.
Figure 1. EU’s tariff structure by TDC section 2014 (in %)
Note: Based on 10 digit tariff data. Ad-valorem equivalent tariffs as generated by TRAINS, using UNCTAD method 2. Names of TDC sections were modified for editing purposes.
Source: Own elaboration based on TRAINS using EU Common Nomenclature at 10 digits.
Preferences for developing countries should be based on a simple two-tier system: for least developed countries (LDCs) and some non-LDCs.
For LDCs, it is likely that the UK will put a similar regime to the existing EU Everything but Arms (EBA) with duty free and quota free (DFQF) access to all LDCs in all products. However, the UK should not miss the opportunity to improve the EBA. Common rules of origin with low domestic content thresholds and flexible cumulation rules with other developing countries and UK FTA partners should be part of the system.
Under the Generalised System of Preferences (GSP) the UK, through the EU, provides preferences to many non-LDCs. The UK must replace the existing two-tier system (GSP and GSP+) with a single offer of preferences. However, as preferences for everyone means preferences for no one, the system for non-LDCs must be less generous than the one for LDCs. The offer should not include many key products for LDCs such as coffee, tea, sugar, cotton, tropical fruits and its processed products. Other products intensive in the use of labour, such as some textiles, could also be excluded. Consequently, it should aim to exclude between 10% and 20% of tariff lines to improve the offer for LDCs. Moreover, for the benefit of both LDCs and the small non-LDCs, a simple and transparent general (i.e. not based on products) criterion should be applied to exclude large and competitive developing countries.
The membership or access to the EU single market will have implications beyond the UK. Compliance of EU standards is assumed for any product originating in any of the member states. Moreover, any imported product that meets EU standards can travel freely within the EU (Holmes, 2016). Flowers imported from Ethiopia into Holland, for example, can be distributed to UK retailers without any additional certification. This helps the seamless operation of the value chain involving UK retailers, Dutch traders and Ethiopian producers. The customs union secures that products can be traded within it without proving its origin.
If as part of the agreement with the EU, there is no standard harmonisation, nothing will prevent UK standards drifting away from EU ones. In this scenario producers in developing countries supplying both the UK and the EU will have to meet multiple standards; increasing production costs and reducing economies of scale. In principle, this is unlikely as even British producers, for which the EU is the largest export market, will be affected too. Moreover, the ‘great repeal act’ would convert all EU regulations in British law on the day of Brexit (DexEU, 2016). Consequently, UK standards are likely to, if not be harmonised, mimic the EU’s ones.
However, even when standards may be similar, double certification costs would not be avoided when the products are exported to both the EU and the UK. In the new EU-UK trade agreement, it will be desirable that the mutual recognition of conformity assessment is extended to the products originated from developing countries.
As part of the EU, the UK is a member of FTAs with developing countries, including Vietnam, Central America and the Economic Partnership Agreements (EPAs) with some African, Caribbean and Pacific countries. Some of these countries, especially some members of EPAs, have the UK as a major destination of their exports of goods (i.e. Kenya) or services (i.e. the Caribbean). Although they include LDCs as well, they are expected to have DFQF under the preferential regime for LDCs.
Based on the territoriality clause of the EPAs, these FTAs apply exclusively to the EU territory. Consequently, many non-LDCs covered by these agreements will find market access restricted into the UK after Brexit. Although the UK may have interest in renegotiating these FTAs, they will not be in a high position in the priority list of partners to negotiate with, particularly in a moment where the negotiation resources will be extremely busy (Lydgate et al, 2016). This suggests that a sort of transitional arrangement may be needed to avoid the disruption (Rollo, 2016). This will be complicated when the UK will be in the process of accommodating its position at the WTO. A WTO waiver may be complicated and it will take time. This means that the transitional provisions will need to depend more on diplomacy to prevent challenges by other WTO members, rather than an agreement.
Thinking ahead, FTAs with developing countries need to be thought of as additional trade policy tools towards non-LDCs. They should be available to any non-LDC wishing to improve their access with respect to the non-LDC preferential regime explained above or that want to introduce deep integration elements in their relationship with the UK. This agreement should be based on the non-full reciprocity of preferences (i.e. the UK should bear most of the effort to make the agreement WTO compatible). They should include common rules of origin with cumulation with LDCs, developing countries and other UK FTA partners. In this regard, the UK should aim for a single model of rules of origin in all its preferential regimes and FTAs.
Among the UK’s priorities is the negotiation of FTAs with other developed countries and emerging economies such as China, India and Brazil. They are expected to be negotiated under more reciprocal principles. However, they may affect trade from LDCs (and other developing countries) due to the additional competition (i.e. preference erosion) that they may exert in the UK market on the products also exported by LDCs. The magnitude of the effect depends on how similar the structure of the exports to the UK by the LDCs and emerging economies is and on the preference margin offered by the UK (Rollo et al, 2013). An FTA with India, for example, may have important effects on Bangladesh and Cambodia, as their exports to the UK are similar in around 20% of the products (Figure 2).
Figure 2. Overlapping of LDCs and possible UK FTA partners exports to the UK (2015) (in %)
Note: Finger-Kreinin Index on the UK imports from these pair of partners at HS 6 digits.
Source: Own elaboration based on Comtrade using TradeSift.
The UK may need to exclude from liberalisation in the FTAs with emerging countries products that clash with the imports from LDCs and where the preference margin offered is high. Moreover, rules of origin in these FTAs should favour the integration of inputs from LDCs. Additionally, if mutual recognition of certification bodies is agreed, it should be extended to the products originated in LDCs. This may favour the creation of value chains involving the UK, its FTA partners and LDCs.
Exports of services have grown faster than exports of goods in developing countries in the last two decades (Balchin et al, 2016). Nevertheless, they are limited primarily to cross-border or regional trade. Although capacity constraints in the provision of services apply in many LDCs, market access issues prevent them from exporting services to far away distances, particularly to developed countries. Restrictions on certain services or certain provision modes (i.e. mode 4 on presence of natural persons) under the General Agreement on Trade in Services (GATS) constitute a major constraint to expand this trade from LDCs.
UK preferences on services, which could be put in place from the very same day of Brexit, should follow the same principles as preferences for goods. They must be simple and provide full coverage. There is no point in offering preferences on services with limited provision capacity from LDCs (i.e. aircraft ground handling), or that exclude key provision modes (notably Mode 4) or that may benefit only a limited number of providers (i.e. artistic performers). The UK should refrain from using trade-related policies to address other domestic objectives (i.e. curving immigration). These objectives should be addressed using other policy instruments, in a non-discriminatory and fair way.
Although procedures are simple and times at customs tend to be short, exports to the UK may be costly for small producers in LDCs. For example, de minimis thresholds for customs are very low. Every import above €150 must pay duties. In addition, imports of more than €22 incur VAT (Pope et al, 2014). Moreover, such low values are also inefficient from the tax collection point of view (Hintsa et al, 2014).
The UK may find it beneficial for LDCs, as well as from the tax efficiency point of view, to raise these thresholds from the very same day of Brexit. To avoid an important loss of revenue and/or unfair competition to domestic suppliers, it should limit these benefits to imports from LDCs, on a strictly business-to-consumer basis, and only for consignments of single or small amounts of units. VAT on these sorts of transactions could also be forfeited. These benefits will help current producers in LDCs but could also develop logistics and packaging activities in LDCs.
Constraints of a different nature affect policy making, with second and third-best solutions being the typical outcome. Brexit is in itself, far from being an ideal outcome and the UK could have continued working inside the EU to reform it. However, within this context, there is scope for some policy instruments to reduce the damage and, in some areas, to actually improve policy and outcomes.
Trade policy will be at the core of Brexit, operating in the relationship with developing countries. There are a series of guiding principles that should define the UK trade policy, especially towards developing countries. Trade policy must be simple with its results skewed towards LDCs. The principle of preferences for everyone means preferences for no one should apply, even when this may imply some costs for other developing countries. The UK may need to use Aid for Trade to compensate those countries affected by these policy changes. Full coverage and simplicity should also apply in the definition of preferences for services. LDCs’ key products should be excluded from the FTAs with certain emerging economies and additional LDC-friendly provisions should be introduced. Finally, there are certain elements that can be introduced on the very same day of Brexit.
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About the author
Dr Max Mendez-Parra is a Senior Research Fellow at the Overseas Development Institute.
Photo: Brexit leave logo Credits: Rareclass, via Flickr.
This article was published in GREAT Insights Volume 5, Issue 6 (December 2016/January 2017).