Christopher Ritson is an Emeritus Professor at the Centre for Rural Economy. This blog was developed from a briefing paper he wrote for the Mid-Northumberland University of the Third Age Brexit Discussion Group.

Image credit: bbc.co.uk

Go back three years and I doubt whether many of us had heard the term “Customs Union”, never mind knew what one was. I did, because on my first visit to Cyprus to advise the Government there on their agricultural policy relative to trade with the (then) EEC, I was confronted with the statement “We want to establish a Customs Union with the EEC”; and the question “Does this mean we will have to adopt the Common Agricultural Policy?” I was vaguely aware that somewhere in the Treaty of Rome (Article 9 as it happens) it says “The Community shall be based upon a Customs Union” and that (Article 38) “The Community shall extent to agriculture and trade in agricultural products”, but I had to find out what that really meant.

I lay out my findings here, in an attempt to help demystify the current political situation we find ourselves in. As far as I am aware, the idea of presenting these alternatives as:

A HIERARCHY OF FORMS OF ECONOMIC AND POLITICAL INTEGRATION

is my own, although probably others have done likewise. The reason is that each “level” absorbs those that precede it. Here goes.

Level 1 TRADE AGREEMENT

An agreement between two countries, or one country and a bloc of countries, which regulates trade between them. This would usually involve the reduction or elimination of tariffs (taxes) and quotas (quantitative restrictions) on imports from each other on a list of products specified in the Agreement. Sometimes there will be tariff quotas – that is, the tariff reduction will apply only up to a specified quantity, often based on historic trade flows. For some agricultural products there are also tariff calendars, where the tariff reduction applies only during the out of season period for domestic production (e.g. EU citrus fruit).

Level 2 FREE TRADE AREA

What it says on the tin. The member states of the Area eliminate tariffs and quotas on trade between them. The best known is EFTA- the European Free Trade Association, known originally as the “Outer Seven” (as the countries involved, including the UK, more or less surrounded the six original Common Market countries). Another example is NAFTA-the North American Free Trade Agreement, which Trump has recently had his knife into.

Level 3 A CUSTOMS UNION

In a Customs Union, the member states agree, in addition to free trade between them, to impose the same tariff on imports from outside the Union (called in the EU the CET– the Common External Tariff, or in official EU documents the CCT – the Common Customs Tariff). This means that once a product has been imported from a non-member country, it can move about within the Union without restriction – known as Free Circulation. In contrast, in a Free Trade Area, individual member states have their own arrangements for treatment of imports from outside the Area. In that case it is still necessary to monitor trade within the Area; otherwise if country A has a zero import tariff on apples, and country B imposes a tariff of 50%, then all imports of apples destined for country B would flow first through country A. This can become complicated; Rules of Origin have to be set, whereby for processed products there will be a maximum proportion of the product (say 10%) that can originate from outside the Union. With the apples, country B will allow free trade for apples grown in country A, but impose a 50% tariff on any apples originally imported by country A from a non-member country.

       The Irish Border

This distinction between a Customs Union and a Free Trade Area is at the heart of the problem of the Irish Border. If the UK continues to belong to the EU Customs Union, then it will continue to impose the CET (or anyway a tariff which is the same as the CET) on imports from non-EU member states. So Australian apples can continue to be imported into the UK and then move freely into the EU. However, in this hypothetical example, if the UK “does a deal” with Australia which includes free trade in apples, then Australian apples would be subject to an import tariff if they move across the Irish Border.

Level 4 THE SINGLE (COMMON or INTERNAL) MARKET

The Single Market seeks to extend the free movement of goods to encompass free movement of Capital, Services, and Labour, and to eliminate member state regulations, which, either by accident or design, discriminate against imports (known as non-tariff barriers). The intention is to create equal conditions of competition – “a level playing field.” The main method of avoiding discrimination has been that member states are obliged to recognise goods which can be legally marketed in another member state, unless they can show some good reason (e.g. consumer safety) for not doing so. This followed a famous ruling by the European Court of Justice, known as the Cassis de Dijon case (finding against Germany that then had a law which said that fruit spirits must have a minimum alcohol content of 25%- all German made fruit spirits of course did have, but Cassis was around 15-20%). The alternative is harmonisation of product standards – which originally was mainly applied in the case of health and safety (e.g. food labelling law), but now covers approximately 50% of products traded within the Single Market.

Another important feature of the Single Market is the control of State Aids aimed at advantaging domestic producers. Where state aids have been widespread and agreed to be required, then a Common Policy is introduced – e.g. the Common Agricultural Policy. From its onset, the CAP has been based on three Principles consistent with a Common Market: Free intra-Community trade in agricultural products, Common Financial Responsibility, and “Community Preference” –member states give preference to agricultural products produced within the Common Market. Until quite recently, something like three-quarters of the entire EU budget was expenditure under the CAP, although it is now closer to 40%.

       The EEA (European Economic Area)

This is a separate treaty. The EEA member states are all the EU states, plus three of the four current EFTA countries –Iceland, Norway and Liechtenstein, and when a country joins the EU, it does not automatically join the EEA, but has to apply. However, in practice what the EEA amounts to is a mechanism that allows Iceland, Norway and Liechtenstein to belong to the Single Market, in return for an annual fee, but excuses them from participating in the Common Agricultural and Fisheries Policies. (The fourth EFTA member, Switzerland, has a separate treaty which provides a similar arrangement.) So when the UK leaves the EU, if it nevertheless remained in the EEA, this would be the so-called “Norway Option”. (The “Canada Plus” option is a trade agreement with an ambitious coverage of goods and some services.)

          The WTO (World Trade Organisation)

The WTO is the successor organisation to the GATT (The General Agreement on Tariffs and Trade) one of the many international organisations established after 1945. Its objective is to reduce tariffs and other restrictions on international trade. It works on the basis of “Rounds” in which the participating countries, and county blocs, negotiate down tariffs on a reciprocal basis.

In its early years the GATT was quite successful in bringing about reciprocal reductions in import tariffs for manufactured products, but singularly unsuccessful with agricultural trade, for which many other forms of trade distorting policies were common (e.g. subsidies under the Common Agricultural Policy). To deal with this problem the GATT (which was in the process of changing its name to the WTO) introduced the concept of tariffication in which the participating countries had to express their various state aids to agricultural in the form of the tariff that would provide the equivalent benefit to domestic farming.  This produced some very high “tariff equivalents” for agricultural products. The negotiation then involved reciprocal reductions in these, which are then “bound” in the Agreement. There are variously coloured “boxes” which dictate the extent to which agricultural supports have to be incorporated into the measure of support, which forms the basis for reciprocal tariff reduction. But with Brexit, the important point is that it is these bound tariffs which would confront UK exports. This is what is implied by “operating under WTO Rules.”

A problem that would confront the UK operating under “WTO Rules” is what is known as the Most Favoured Nation Clause. This says that a country which offers a lower or zero import tariff for a product to one country, must do so for all WTO participating countries, unless the reduced tariff is part of a Trade Agreement. Thus the logical thing for the UK to do without a Brexit Agreement, would be to adopt the same import controls as under the CET, which it could then offer reductions on in Trade Agreements (which are, however, notoriously lengthy to negotiate).

(The following complete the hierarchy:)

Level 5 ECONOMIC AND MONETARY UNION

Here, responsibility for macro-economic policy (e.g. money supply, interest rates, exchange rates) passes from member state Governments to the supra-national authority. The most important element in this is probably the adoption of a common currency.

Level 6 POLITICAL UNION

At some point the degree of control exercised by the central authority (and its elected parliament) is such that the “Union” of member states begins to be thought of as a country, – the United States of – – -, or the United Kingdom of – – -. This can of course subsequently go backwards (Devolution).