Forget Norway-minus, or Canada-plus, or even Canada-plus-plus-plus. If the UK wants jobs, trade and living standards to prosper after Brexit, it should aim for Melilla-max. Without it, British business could topple over the dreaded cliff edge, not in 2021, but on 30 March 2019.
Melilla? Let me explain. In some places, the edges of the European Union are blurred. Liechtenstein, Andorra and San Marino are the small change from some of the more exotic episodes in Europe’s history. They are not fully in the EU or fully out. Melilla, and nearby Ceuta, belong to the list. They are Spanish enclaves on the Moroccan coast. Madrid considers them part of Spain: they elect their own members of Spain’s parliament.
However, they have a special economic status in the EU. The common agricultural policy does not apply to them. Nor do VAT rules or fishing quotas. Crucially, Ceuta and Melilla do not belong to the customs union – but enjoy the same trading rights as if they did.
This is roughly what the ministers advocating a soft Brexit say they want, at least for the two-year transition phase and, in some cases, permanently. The UK would still be able to export to, and import from, the EU and the rest of the world, exactly as we do now. Among other advantages, continued trading on customs union rules would allow Irish border to remain open.
The problem is this. Even if Theresa May’s Cabinet agreed on this objective, and even if the rest of the EU agreed with it too, a UK-EU deal along these lines will not be enough. On the day the UK leaves the EU, it will leave the customs union, because EU membership is a formal condition of customs union membership. These are the rules. Maybe one day an EU treaty will change those rules. But that’s a long and tortuous process. The current rules can’t simply be waived or modified in a negotiation between David Davis and Michel Barnier, or even between Theresa May and Donald Tusk.
That is why we now hear talk not of Britain staying in “the” customs union but “a” customs union: something that walks like a duck and quacks like a duck but isn’t legally “the” duck. The problem is not trade between UK and the EU. Subject to squaring the arrangement with the World Trade Organisation, we may continue to have regional friction-free arrangements to sell whisky to Germany and buy Prosecco from Italy. But the customs union does not just facilitate trade within Europe. Importantly, it also sets the rules for trade with the rest of the world.
This is where Ceuta and Melilla enter the picture. The EU is perfectly happy with tariff-free trade between the two Spanish enclaves and the rest of Europe. The tricky bit is their ability to trade with the rest of the world. It is not enough for Brussels to approve the trading status of the two enclaves. The EU’s trading partners in the rest of the world must approve it, too.
That is precisely what has happened in the EU’s trade deals with Canada (page 583, since you ask) and Korea (page 1,353). Canada and Korea accept that Ceuta and Melilla, though not part of the EU customs union, can be treated as if they were. The point is not that this was a bone of contention: the governments in Ottawa and Seoul are unlikely to have felt threatened by the economic clout of the 170,000 residents of the two enclaves. The point, rather, is that, legally, Ceuta and Melilla would not have been allowed to trade on customs union terms without explicit approval from Canada and Korea.
As far as the UK is concerned, the precedent is clear. On 30 March next year, if Brexit takes place on schedule, the UK will find itself outside the customs union. It will not be able to apply customs union rules to trade with the rest of the world. Thus the 80 countries such as Canada and Korea with which the EU has trade agreements or pending agreements (such as Japan) will have to change the way they trade with the UK – unless each of them goes through the formal, legal process of amending their agreements.
That is bad enough, but it gets worse. One of the main elements of any trade deal are the “rules of origin”. The EU-Korea trade deal is typical. Korean cars have duty-free access to the EU market, and vice versa. But what exactly is a “Korean” car? Most contain Chinese components, as well as steel imported from elsewhere. At what point does a “Korean” car cease to be Korean? The “rules of origin” determine which products are eligible for preferential trade treatment. Thus the EU-Korea agreement stipulates that at least 55 per cent of the value of cars must originate in Korea (to sell duty free to us) or in the EU (to sell duty free to them).
Now consider what will happen after Brexit. European car-making is an integrated business, with components crossing internal EU borders at will. Imagine a car assembled in the UK with components entering the UK from other EU countries. Suppose 30 per cent of the value is generated in the UK, and another 40 per cent in the rest of the EU. At the moment, the total EU value-added is 70 per cent. It passes the 55 per cent rules-of-origin hurdle.
After Brexit that will cease to apply. Only 40 per cent of the car will be “EU”. The car will not be able to enter Korea duty free. In order to meet the “rules of origin”, the European car-maker will have to cut back or close its UK operation, and transfer much or all of its work to the remaining members of the EU.
That is not all. The problem will arise immediately, not at the end of two years of transition. Moreover, this issue alone would be enough to scupper hopes of the Irish border continuing to remain completely open, for the “rules of origin” system is one reason for customs checks between EU and non-EU countries. (For example, Norway has a single market arrangement with the EU, but remains outside the customs union. That is why there continue to be border-checks on the Norway-Sweden border.)
What if the UK agrees “a” customs union agreement with the EU, like Turkey? This will not solve the Irish border problem. The border between Turkey and its EU neighbour, Bulgaria, is far from open. It has customs checks and a three-metre fence topped with razor wire. Nor does the arrangement give Turkey unfettered access to markets in countries such as Canada, Korea and, prospectively, Japan. Indeed, the relationship is asymmetrical. Turkey’s agreement with the EU requires it to accept EU-wide tariffs and free trade rules for importing goods from the rest of the world – but as it does not belong to “the” customs union, the rest of the world is free to impose WTO tariffs on goods their citizens import from Turkey.
Imagine a post-Brexit future in which the UK had a similar agreement: forced to allow Korean and Japanese cars into Britain duty free, but facing the competitive disadvantage of a tariff wall when trying to sell British cars to the Far East.
Here’s the rub. To have a no-change transition, let alone a bright long-term future for British jobs and investment, we need not just “a” customs union agreement with the EU. We – together with the EU – need to amend every agreement between the EU and other countries such as Canada, Korea and Japan. This process will entail around 80 triangular negotiations, requiring approval in each case by the UK, the EU and the country in question – and all within the next few months.
This is why the Ceuta and Melilla precedent matters. They are not members of the EU’s customs union, but they have “a” customs union-like arrangement with the EU. In this respect their position is identical to the one that some UK ministers say they want, at least during the transition phase. But, unlike Turkey, the two enclaves can enjoy the benefits of free trade with Canada, Korea and the other countries only because those third countries have explicitly agreed to vary the rules.
What, then, are the UK’s options – apart from abandoning Brexit altogether? A rational answer depends on turning conventional wisdom about transition on its head. The normal argument is that it is relatively simple to keep things as they are for two years or so; and that this buys the time to solve the more complex problems of our long-term relations with the outside world.
The opposite is nearer the truth. The big challenge is to do all the deals with the rest of the world before Brexit, not afterwards. And given that we will rely on the EU to do these deals, we shall need agreements with the other 27 EU member states before these external negotiations can begin. This could be quite a challenge. (Other countries may be relaxed about competition from Ceuta and Melilla, but they might want to look hard at their relationship with post-Brexit Britain.)
There is an alternative. Instead of seeking a transitional deal, the UK could apply for an extension of EU membership for two more years. This is permitted under Article 50, although it needs need the unanimous agreement of the rest of the EU. Then the short-term problems of our relationship with the customs union and the Single Market would melt away. And there would be more time to sort out suitable long-term arrangement, with Melilla-max a far better model for British business (and the aim of an open Irish border) than Norway-minus or Canada-plus.
Politically, of course, that is anathema to Brexiteers. They would suspect that one extension of membership would lead to another, and then another – until we decide that Brexit is a bad idea after all. Better to go ahead with Brexit next year and then deal with the consequences. But economically, those consequences could be even worse, and hit the UK even earlier, than ministers say or, perhaps, even realise.