On Monday, Downing Street confirmed its intention for the UK to leave the Customs Union (or the Common External Tariff, CET) when we leave the EU.
It has been striking that, over the past week, so many politicians and business leaders have repeatedly claimed that this would be very damaging to the UK economy.
More than 18 months after the Brexit referendum, so many people still don’t “get it” with regard to the economic benefits of being outside the CET. There’s a need to revisit the economics of customs unions 101.
People are aware of the benefits of leaving the CET in terms of being able to negotiate our own free trade agreements independently.
They’re probably also aware that Project Fear claims about Britain not having enough clout in negotiations as a single country (always an assertion, never a fact), are more than offset by not having to keep 27 other EU countries onboard to reach a deal.
The ability to negotiate free trade agreements is crucially important to the success of Brexit, but it’s only the starter, and entirely misses the main course. The fundamental benefit of leaving the CET doesn’t lend itself to a sound bite or easy explanation on the evening news, but it is based on an iron law of economics – David Ricardo’s Law of Comparative Advantage.
At present, a large protectionist tariff wall surrounds the EU, with goods imported into the EU from outside subject to varying levels of tariff – 10 per cent on cars, and 20-30 per cent on certain food products. This is a tax on consumers, and the extra money paid out is money that could have been retained and saved, or spent on other goods and services.
Leaving the CET would provide an immediate windfall for consumers (and intermediate producers of goods requiring imported components). It would also provide an immediate windfall for the government, which would have delivered voters an effective big tax cut and could expect a bounce in the polls in return.
Of even greater importance than these immediate short-term benefits, however, is the fact that exiting the CET would generate very significant dynamic long-term advantages for the UK economy.
First, it would increase competition, thereby driving up productivity in the UK economy. Second, it would improve resource allocation in the economy towards its most productive use.
These benefits are compelling. If combined with regulatory liberalisation, it is estimated that we could boost the economy by up to seven per cent of GDP if the UK pursued genuine free-trade, with zero tariff barriers on all imported goods.
They’re a favourable tsunami, which would swamp the purported threat to the UK economy from the imposition of tariffs on British goods exported to the EU, in the event that there was no UK-EU free trade agreement. This is an absolutely fundamental point.
Those opposed to genuine free trade argue that overall average CET tariff levels across all goods (not just the cars and food products examples above) are less than four per cent, and so the dynamic trade gains would be minimal. The obvious immediate response is to say that, if the tariff wall is so low, what’s all the fuss about?
However, the focus on tariff levels alone is misleading. Average overall tariff levels are relatively low, but the difference between UK and world prices for goods is high, owing to the influence of non-tariff barriers.
Moving to genuine free trade and trading at world prices – which different datasets suggest could be up to 20 per cent lower than UK prices – is where the real dynamic gains from leaving the CET are to be found.
In short, all the economic evidence points towards leaving the EU’s Customs Union, not sacrificing control to stay within it.