Trade Policy Insights: UK & EU Customs Union – Why in, why out?

Daniela Stratulativ (daniela.stratulativ@ihsmarkit.com), Head of Global Trade Analysis, IHS Markit Maritime & Trade

Key Points:

• If the UK leaves the EU Customs Union, it would be able to negotiate free trade agreements on its own terms with non-EU countries, and the EU. These agreements could take between four and ten years. The EU has 43 free trade agreements (FTAs) in force, with more than 50 countries, and is currently negotiating 12 regional and bilateral trade agreements.
• Until new agreements are concluded, the UK will trade on WTO terms with EU countries and non-EU partners. This translates into higher tariffs, increased costs for intermediate outputs used in UK production and higher prices for consumers. Rules of origin will also translate into higher tariffs and will make UK products that use intermediate outputs less competitive.
• UK imports from non-EU countries in 2017 reached close to 129 million tonnes and over 291 bn USD. UK exports to non-EU partners in 2017 were close to 235 bn USD and reached over 53 million tonnes.
• UK imports from the EU in 2018 reached 120 million tonnes and 364 bn USD. Exports totaled 108 million tonnes and 229 bn USD.
• The Customs Union reduces trade barriers such as custom checks and tariffs.
• If the UK exits the EU Customs Union, airports and seaports have to be prepared for additional customs checks and new administrative procedures. The largest volumes of non-EU imports come through London Heathrow, Manchester Airport, London Stansted, Birmingham Airport, and East Midlands Airport. The busiest seaports are Immingham, Milford, Southampton, Felixstowe, and Liverpool. The UK's highest volumes of exports to non-EU countries leave through Southampton, Felixstowe, London Gateway, Liverpool, and Hound Point Terminal. The airports with the highest volumes of exports to the EU are London Heathrow, London Stansted, East Midlands Airport, Manchester Airport, and Warton Aerodrome.

EU Customs Union and trade agreements

The Customs Union reduces administrative and financial trade barriers such as customs checks and tariffs. Goods cross borders within the EU duty-free and common tariffs are imposed on any goods entering the Customs Union, regardless of which EU country is the importer.

If the UK leaves the Customs Union, it would be able to negotiate free trade deals with non-EU countries.

The EU has 43 FTAs in force, with more than 50 countries, and currently is negotiating 12 regional and bilateral trade agreements.

Exiting the Customs Union means UK products will not benefit from the lower tariffs that the EU has negotiated, since the UK will have to trade under WTO rules. Britain's exporters would face costly tariff increases. The UK would also have to impose tariffs, raising consumer prices.

The UK will have to negotiate new trade agreements with each of the countries that have FTAs with the EU. Even if the UK and the current non-EU partners agree to sign bilateral agreements and keep the terms as in the EU-negotiated FTAs, there is still one significant issue that will affect UK exports: the rules of origin.

For every product included in a trade agreement, the rules of origin are specified: the percentage of that product that has to come from domestic activity in the exporting country, in order for the product to be eligible for duty-free access in the importing country.

Currently, for each UK product, the UK inputs and the EU partners intermediate inputs are cumulated to calculate the percentage of UK content. If the UK does not benefit from EU FTAs with other countries, the intermediate inputs incorporated in UK products will not count as UK content. As a result, many UK products will not qualify for duty-free access. This will make UK products less competitive compared to similar products of EU partners. It is estimated the UK imports $80 billion worth of goods to use in production, excluding precious metals and stones (UK Trade Policy Observatory). The main UK sectors that use intermediate inputs are machinery and mechanical appliances, electrical machinery, and vehicles.

The UK cannot conclude trade agreements until it has left the EU, since it is still bound by the EU's exclusive right to negotiate trade deals.

It could take longer than seven years to negotiate a trade deal with the EU. The Canada - EU trade agreement (CETA) took seven years to negotiate and was relatively simple. The CETA does not include provisions for services and non-tariff barriers, which the UK, as a large provider of professional services, will have to include.

If the UK exits the EU Customs Union, what will be the impact on importers and exporters due to tariffs and rules of origin checks?

UK trade with non-EU countries

UK imports from non-EU countries in 2017 reached close to 129 million tonnes. The main partners are Norway with a 20% share, United States 14%, Russia 10%, China 7%, and Canada 4%. In 2017, the total value of non-EU imports was over 291 bn USD.

The UK's top five imports from non-EU countries by value are precious metals, mineral fuels, machinery and mechanical appliances, electrical machinery, and aircraft.

Source: IHS Markit © 2019 IHS Markit

The largest volumes of UK imports from non-EU countries are mineral fuels, ores, wood, plastering materials, and animal feed. Mineral fuels, ores and animal feed imports increased in 2017 compared to the previous year at 7%, respectively 5%, and 5%, while imports of wood and plastering materials decreased.

Source: IHS Markit © 2019 IHS Markit

The airports and seaports with the highest volumes of UK imports from non-EU countries are presented in the figures below.

Source: IHS Markit © 2019 IHS Markit

Mineral fuels, wood, electrical machinery, plastics, and steel are imported in high volumes across the five seaports. In addition, Southampton is the port of entry for vehicles; both Southampton and Felixstowe receive high volumes of furniture, while Liverpool is the entry for oil seeds, cereals, sugar, and confectionery.

In 2017, the total value of UK exports to non-EU countries was close to 235 bn USD. The main partners by value are the United States with a 25% share, China 9%, Switzerland 8%, Hong Kong and United Arab Emirates each with 4%. UK exports from non-EU countries in 2017 reached over 53 million tonnes.

The UK's top five exports to non-EU countries by value are machinery and mechanical appliances, vehicles, precious metals, pharmaceuticals, and electrical machinery.

Source: IHS Markit © 2019 IHS Markit

The largest volumes of UK exports to non-EU countries are mineral fuels, iron and steel, pulp of wood and scrap paper, vehicles and plastics. Mineral fuels exports increased in 2017 compared to the previous year at 27%, while iron, steel and vehicles volumes increased by 8%.

Source: IHS Markit © 2019 IHS Markit

The airports and seaports with the highest volumes of UK exports to non-EU trade partners are presented in the figures below.

Source: IHS Markit © 2019 IHS Markit

UK trade with EU countries

UK exports to the EU and imports from EU countries will be subject to tariffs and rules of origin checks, according to WTO rules. In 2018, imports reached 120 million tonnes and 364 bn USD. Exports totaled 108 million tonnes and 229 bn USD.

The largest volumes of UK exports and imports to/from the EU are in the energy and mining sector, chemicals, vegetables, metals and wood. Different products are exported and imported in these categories.

Source: IHS Markit © 2019 IHS Markit

Source: IHS Markit © 2019 IHS Markit

This column is based on data from IHS Markit Global Trade Atlas (GTA)andWorld Trade Service (WTS).

Risks, opportunities, impact on supply chains and shipping industry can be identified for any products at 6-digit code level within GTA. Insights can be complemented with bill of lading data fromPIERSand vessel movements via AIS.

We provide The New Intelligence for strategic decision-making to over 50,000 customers in 140 countries - Governments and private sector, including 80% of Global Fortune 500 companies.

Full description of HS codes used in the analysis:

23 Residues And Waste From The Food Industries; Prepared Animal Feed
25 Salt; Sulfur; Earths And Stone; Plastering Materials, Lime And Cement
26 Ores, Slag And Ash
27 Mineral Fuels, Mineral Oils And Products Of Their Distillation; Bituminous Substances; Mineral Waxes
30 Pharmaceutical Products
39 Plastics And Articles Thereof
44 Wood And Articles Of Wood; Wood Charcoal
47 Pulp Of Wood Or Other Fibrous Cellulosic Material; Recovered (Waste And Scrap) Paper And Paperboard
71 Natural Or Cultured Pearls, Precious Or Semiprecious Stones, Precious Metals; Precious Metal Clad Metals, Articles Thereof; Imitation Jewelry; Coin
72 Iron And Steel
84 Nuclear Reactors, Boilers, Machinery And Mechanical Appliances; Parts Thereof
85 Electrical Machinery And Equipment And Parts Thereof; Sound Recorders And Reproducers, Television Recorders And Reproducers, Parts And Accessories
87 Vehicles, Other Than Railway Or Tramway Rolling Stock, And Parts And Accessories Thereof
88 Aircraft, Spacecraft, And Parts Thereof