Would an 'independent' UK get a better US trade deal than the EU?

Could the UK sucessfully negotiate a trade deal with the US?

Yesterday MEPs voted on a resolution to back defensive measures to exclude cultural and some agricultural products, such as genetically modified foods from a proposed free trade deal with the US (TTIP).

Understandably US farmers have already taken exception to what they see as EU protectionism. This raises concerns that the potential gain from an EU/US trade deal may be watered down, delayed or even blocked all together by vested interests on both sides of the Atlantic.

As a member of the EU the UK's foreign trade is governed by the EU's common commercial policy and so has to be done via an EU deal. After the EU the US is the UK's most important trading partner. Some involved in the UK-EU debate - particularly Outers - suggest that if the UK left the EU it could negotiate a deal with the US on better terms than it could potentially gain via the EU. But is that the case? Here are some of the factors that could be important.

UK exports to the US in £bn (ONS 2011) are big...

A mismatch in negotiating power. Although the UK exports a lot to the US, as a % of it's total exports, the US sends only 4% to the UK. So although a trade deal should be mutually beneficial, reaching a solution would be disproportionately in the UK's interests. Therefore, there would be an imbalance of negotiating power. For this the EU's weight could help on issues where the UK's interests are aligned with it.

Would the US want to go through the hassle? Given this asymmetry, and the relative small market the UK is for the US, one question is if the US would go through all the political hurdles -  approval in Congress, taking on the unions etc. Indeed, talk to people in Washington and there's some scepticism about this. (However, the US has signed agreements with 23 states, some very small, so perhaps it is more a matter of the terms you would get?)

But US exports to UK (US BEA 2011) are small...

Fewer protectionist hold ups. At the same time, the US and the UK are more compatible economies than are the US and EU. The UK negotiating on its own account would not be hindered by protectionist issues emanating largely from France and MEPs, that could hold up US agreement or require concessions, such as the protection of agriculture, genetically modified foods or geographical indicators. However the UK is still unlikely to wish to see the US allowed to subsidise its agricultural exports, so tough negotiations would still be required.

Access for financial services could be a tough negotiation. The UK negotiating with the US on financial services would come up against a powerful US lobby attempting to protect its banks from what is New York's main rival - London. However, the UK negotiating on its own would arguably have a better chance to strike a deal on 'reciprocity' with US funds, a more generous arrangement than that which currently exists under regulations such as the AIFM Directive or UCITS. Additionally the UK would not bear the burden of having risky eurozone banks getting in on the deal. In recent negotiations with Singapore the US gained a better deal than the EU on financial services, partly because while Singapore was happy with UK banks it was wary of giving access to all eurozone banks (a big untold story in all of this).

If the idea is that an 'independent' UK can automatically join some gigantic Transatlantic free trade zone, in place of its current EU membership, there will be plenty of hurdles and a good deal is by no means guaranteed. Added to that there's also the small matter of negotiating an equivalent free trade deal with the EU....

EEA plus: a model for the future of the UK in Europe?

For all the noise about Europe in the UK, British sceptics (with some exceptions) aren't necessarily great at thinking outside the box. 

We have previously looked at the existing models used by countries that have decided against/been refused EU membership (i.e. Norway's EEA membership, Switzerland's Free Trade Agreements, Turkey's customs union with the EU, or simply the WTO) and concluded that they would all have drawbacks for a country and economy as large and diverse as the UK. In particular, the Norwegian model is pretty much a non-starter.

However, there is another hypothetical model, which we will set out in a forthcoming briefing, that could be more attractive if it could be secured: let's call it 'EEA plus'.

Now, we don't necessarily advocate this particular option and this is only a blogpost, but intellectually and politically, it's far more attractive than anything we've seen so far in terms of a fundamental replacement for the current EU structure. 

Over the last decade, several figures, including Jacques Delors, former EU Commission President, and Valery Giscard d’Estaing, former French President and author of the EU Constitution, have suggested the UK be given ‘associate membership’ or ‘special status’. Neither concepts have been fully fleshed out, but Giscard d’Estaing suggested that a ‘special status’ could allow the UK to opt-out of future EU policies, which could allow it to continue to vote on policies it took part in but not on those it didn’t. Lord Owen has made a similar argument - which he will expand on in a speech today.

From where we sit, there is one absolutely vital element that has to be added if this is going to work for the UK: voting rights. The great weakness of the EEA model at the moment is that a country like Norway, as we have noted repeatedly, is out of the EU but run by the EU. It just wouldn't work for the UK (which is home to 36% of the EU's wholesale finance market, for example).

So what 'EEA plus' would involve is single market access but with votes on all laws which are EEA relevant. For EU geeks, it would be a bit like EEA-EU co-decision over single market laws. There are several ways in which this could work. For example, an "EEA council" already exists with members from both the EU and EEA states. This could be expanded to be the effective decision-making body for the EU as a whole in the fields that apply to both constituencies. Alternatively, a majority could be needed in both the EU Council of Ministers and a comparable EEA body for it to become law in both. A range of other issues, such as an arbitrage mechanism and ECJ jurisdiction, would have to be thought through. Also, it would have to be designed so that only genuine single market measures made it into the agreement - not the add-ons such as employment laws (which Norway has to accept) - whilst the UK may wish to stay inside the EU customs union (which Norway and Switzerland are not part of). The UK may also want to be part of other areas, such as crime and police cooperation (perhaps on a bilateral opt-in basis) and there would also need to be consideration about the merits of retaining its veto over EU foreign policy for example.

But, crucially, such an arrangement would get around the massive drawbacks inherent in the Norwegian model. Another great advantage of this model is that it could provide an institutional wrapping for all those countries that for one reason or another cannot be full EU members, and certainly not eurozone members: the UK, Norway, Switzerland and maybe even Turkey. It would be a new mode of European membership - and, if the UK can get its act together, very much the "economic growth" tier.

If you think this is far-fetched, you might be right, but it's actually not a new idea. In 1989, ahead of the negotiations that would establish the EEA agreement, Delors mooted a “more structured partnership with common decision-making and administrative institutions”, which would have potentially given those countries market access and decision making powers, rather than the limited right of refusal that EEA countries currently have.

In a speech in 1989, discussing the potential approach to those countries who had remained in the European Free Trade Association (EFTA), Delors said:

“There are two options:

(i) we can stick to our present relations, essentially bilateral, with the ultimate aim of creating a free trade area encompassing the Community and EFTA;

(ii) or, alternatively, we can look for a new, more structured partnership with common decision-making and administrative institutions to make our activities more effective and to highlight the political dimension of our cooperation in the economic, social, financial and cultural spheres.

It would be premature to go into the details of this institutional framework. I have my own ideas, but they need to be discussed by the new Commission and then informally, without obligation, with the countries concerned. It should be noted however that the options would change if EFTA were to strengthen its own structures. In that case the framework for cooperation would rest on the two pillars of our organizations. If it did not, we would simply have a system based on Community rules, which could be extended — in specific areas — to interested EFTA countries and then perhaps, at some date in the future, to other European nations.

But if we leave the institutional aspect of such a venture aside for a moment and focus on the substance of this broader-based cooperation, several delicate questions arise. It becomes clear in fact that our EFTA friends are basically attracted, in varying degrees, by the prospect of enjoying the benefits of a frontier-free market. But we all know that the single market forms a whole with its advantages and disadvantages, its possibilities and limitations. Can our EFTA friends be allowed to pick and choose? I have some misgivings here.”

This option could probably qualify as both "in" and "out". For one, it would be very similar to the Single Market plus deal that Boris Johnson has argued for in the past and, could be defined as staying in the EU, although on a radically different basis.

A final sobering thought: the final result of the EEA talks only granted EEA states ‘decision-shaping’ powers through representation on non-legislative committees and consultation with the EU Commission and a right of refusal that is relatively weak becuase it can result in loss of market access – giving an indication that this will be a challenge to achieve.

Going global: Germany is slowly shifting its trade away from the EU (or why German growth alone cannot save the eurozone periphery)

On top of the release of UK trade data, Germany has also put out its latest trade statistics. As this is Germany we're talking about, the figures are interesting on all kinds of levels.

As the graph above shows German trade has recovered since the start of the year, although exports and imports remain well below their March 2012 levels. Exports have recovered slightly quicker allowing for Germany’s significant trade surplus to widen further.

But where is this new demand coming from? The eurozone remains mired in recession, so there is little chance that the turnaround in trade is being driven within the single currency bloc. Looking at the graph below may provide some clue.

As we can see, of Germany’s top trading partners only five on the import side and four on the export side are from within the eurozone. These are from the end of last year, but with growth in the US picking up and Asia still doing relatively well, it’s likely that much of the upswing in German trade was with these countries rather than the eurozone. This is confirmed to some extent by the table below which shows that trade with non-euro EU countries and third countries was either positive or less negative relative to a year ago.

What’s the significance of all this?

• Firstly, it raises interesting questions about Germany’s role in the eurozone and the crisis. Trade with eurozone countries, especially those in the periphery, is becoming less important for Germany on both the export and import side. The knock on conclusion of this is that even if Germany were to boost domestic demand or import more (as many southern European leaders have called for) it’s not clear it would actually have a huge benefit for the struggling country.

• A report by Deutsche Bank in February found that an additional 1% growth in German GDP would only provide a 0.1% boost to the current account of struggling economies. Far from enough to have any material impact on overcoming the crisis.

• The second interesting point, in terms of the UK-EU debate, is that Germany is proving incredibly successful in cultivating trade with countries outside the EU, despite at times a stifling European regulatory environment (including meddlesome EU rules) and the eurozone crisis. This is likely due to its focus on manufacturing and its strong ‘Mittelstand’ (the undervalued euro also helps). In turn, this suggests the choice presented by some - either you trade with the EU or you trade with the rest of the world - is clearly false. Warts and all, you can cultivate trade with the rest of the world from within the EU - what you need is economic assets which appeal to these fast developing economies. And of course, a more, liberal, outward-looking EU would certainly help as well. 

A new angle to UK-EU trade?

The WTO and the OECD yesterday announced the release of a new set of trade data. This data tries to pin down the “value added” from trade rather than just the gross figures. Essentially, this means the data tries to track where the final demand for an exported product/service comes from, thereby netting out trade which simply contributes to the production line of the finished good/service.

The data provides an interesting new contribution to the UK-EU debate on trade. Notably the figures highlight that, under the value added approach, US trade looks more important to the UK than European countries. The Guardian questions whether this could aid the calls for the UK to exit the EU.

Superficially it may, but looking at the data more deeply, we think not. As the WTO/OECD note:

“This suggests that UK exports to other EU countries are at least partly intermediate services and inputs that are then further processed and shipped to other countries (in particular to the US).”

So, although the US is the source for the ‘final demand’ we still have to export our products or services to other countries in the EU for them to take advantage of this demand. Being a member of the EU and the single market plays a big role in allowing us to do this. The real question is, would the UK still be able to access this final demand from the US if it left the EU?

Well, it’s almost impossible to say. One thing that seems certain though, is that, since many of these exports are intermediate ones, there is no guarantee that we would still be able to export them outside the EU even if the final demand remains from the US (this point is hinted at by Ian King in the Times).

A final interesting point is that the increase in value added exports to the US seems to occur for most large EU countries. Why this is, is not entirely clear. To us, it seems that it could be motivated by specialisation within the EU, with EU members producing various component goods and services which are then combined into final exports to the US. If this is the case then this seems a positive result to us, as it surely increases the cost competitiveness of exports from the EU (including the UK).

From the perspective of the UK/EU debate this 'value added' data is another interest metric to add, although at the moment it offers little more conclusive evidence than what we currently have. The bigger benefit comes in broader terms, as the FT notes, providing further support for free trade. With protectionist forces flaring up during the eurozone crisis, countries would do well to keep that in mind as well.

EU Referenda games: staying in, leaving or renegotiation - it's all complicated

With Europe as fluid as ever, talk of some sort of EU referendum is heating up in the UK (well at least in the Westminster bubble).

The always excellent James Forsyth of the Spectator argued in the magazine yesterday that London Mayor Boris Johnson’s support for a referendum and UKIP’s rise taken together “make it highly likely that Britain will have its first vote on Europe since 1975 within the next five years."

He also notes that,

"The popularity of Cameron’s EU veto made his circle realise how much of a political asset Euroscepticism could be, if used in the right way. There is also concern in No. 10 that if the Tories don’t offer the public a vote, Labour will."

He goes on to say that,

"One source intimately involved in Tory electoral strategy told me recently that a referendum in the next manifesto was ‘basically a certainty’...My understanding is that, at the moment, the favoured option is to propose renegotiation, followed by a referendum on the new arrangements within 18 months. During the campaign, the Tories would argue for staying in if new terms could be agreed but leaving if the rest of Europe refused to play ball." 

The equally excellent Paul Goodman over on Conservative Home today echoes Forsyth, listing a range of reasons why a referendum draws nearer.

And Forsyth's colleague Alex Massie also picks up on this on the Speccie's Coffee House blog, looking at all the complications involved in trying to square an EU renegotiation with a referendum (the "on what?" question always looms large). We've looked at the various options for a referendum in detail before, so this is all familiar (if you're interested in the different options, we strongly recommend reading this piece).  Massie makes a good point though. An EU referendum is too often seen in Tory leadership ranks as being about "a matter of party morale, discipline and tactical positioning", not getting something that actually works for the UK.

We agree. The thing is, this is far too complicated an issue to make a matter of mere party management. It will be part of the equation, of course, but making it subject to pure party politics will reduce the discussion to the usual Westminster back-and-forth on vague concepts such as "influence", "isolation" or "sovereignty" - it will be Mandelson land.

But where Massie - and a whole range of other commentators and politicians - get it wrong is when they say that in contrast to the renegotiation option, "an in/out plebiscite at least offers a choice between easily-grasped options."

No it doesn't. Staying in raises a whole range of complicated questions - what does the UK do if the eurozone takes that quantum leap towards further integration? What happens if the EU merely becomes a political extension of the eurozone (which Britain can't join)? In other words, if we want things to stay as they are, things will have to change.

And the "out" option? It sounds easy at a superficial glance, but in a serious discussion, it would raise far more questions than answers. In fact, there's virtually no "out" option (save perhaps one) - all options to withdraw from the EU treaties (which is what 'out' must mean, though it is rarely defined), involves joining something else. Doing a "Norway" would be suicide for UK, i.e. accepting 2/3 of EU laws but with no say over them; a Switzerland would be slightly better but still immensely complicated. A different type of Free Trade Agreement altogether involving business paying hefty fees or facing new admin burdens on exports to the EU, which contain some imported components? A customs union a la Turkey meaning being stuffed on market access on services? Simply falling back on the WTO's Most Favoured Nation (MFN) rules, with a range of costly barriers to trade and movement?

Answers anyone? The truth is that most of the complications that apply to renegotiation, also apply to the "out" option, including the need for some sort of "approval" from other countries for whatever alternative arrangement the UK enters into (apart from the WTO option) possibly. The truth is that all three options: staying in on current terms, renegotiation or withdrawal from the EU treaties are massively complicated. To whet your appetite, we're about to publish a comprehensive report looking at the different options for the UK was it to vote to decide to leave. And trust us, it's complicated.

What we do know is that both Britain and the eurozone will simply have to move. It's therefore right that No 10 is now considering different options.

But again, it should be for the right reasons.

Beijing beating Brussels at its own game?

Last week in Brussels, we organised a very interesting event looking at trade between the EU and Asia - the importance of which can hardly be over-stated given Europe's, shall we say, current economic predicament.

At the event, Conservative MEP Syed Kamall warned against the EU pursuing an “anti-business agenda” in trade talks, including excessive environmental standards, as “we end up with everything but trade.”

Today, we received another reminder of the dangers involved in the EU pursing green protectionism: other trading blocs may do the same.

From PA we learn that the EU, the US and Japan have launched a complaint at the World Trade Organisation, claiming that China is limiting its export of rare earths. This is a pretty bad situation, as these minerals are vital to the production of high-tech goods, such as hybrid cars, weapons, flat-screen TVs, mobile phones, mercury-vapour lights and camera lenses. And as China accounts for more than 90% of global production of 17 rare earth minerals that are used to make this stuff, Europe is pretty dependent on the trade.

But here's the intricate part, China says it's 'only protecting the environment'. The country's Commerce Ministry said in a statement:

"The Chinese policy objective is to achieve sustainable development in order to protect resources and the environment, and this is not a trade-distorting way of protecting domestic industries."

Tricky. Now, we're certainly not siding with China here, but merely making the humble observation that if Europe continues to flirt with Non Trade Barriers of various sorts, including 'green' ones, others may start to play it at its own game.

Perhaps something to keep in mind when certain EU leaders call for a "buy European act." Sooner or later, chickens could come home to roost.