The end of January is nigh. Some three and a half years after the UK’s electorate voted – by a narrow 52-48 margin – to leave the European Union, it formally happens at midnight (Brussels time) on January 31st. The UK will be out of the world’s largest and richest trade bloc, something that it has been a part of since 1973.
What are the implications for the automotive industry?
Go deeper with GlobalData
The first thing to say is that although the UK is formally outside of the EU from tomorrow, much will be unchanged under what is known as a ‘transition’ period that lasts for the rest of the year. Citizens’ of the UK and EU can move between the two territories freely and as if the UK was still in the EU. Similarly, traded goods can be shipped unhindered – no additional tariffs or checks at the border. That is obviously good news for the automotive sector, with its elongated and complex pan-European supply chains. It’s business as usual for all those UK-EU shipments in both directions, components and finished vehicles.
The transition period was designed to give a bit of breathing space for businesses and avoid the so-called ‘cliff-edge’ to new standards and arrangements that could be very disruptive. But it is far from the end of the story. The two sides – UK government on one side, EU27 on the other, represented by the European Commission’s negotiating team – are supposed to use this year of transition to hammer out a comprehensive agreement for a permanent relationship between the UK and EU. This would embrace all aspects of relations between the UK and EU – citizens’ rights, movement of people, security cooperation, trade arrangements, fisheries, financial services and so on. It is quite a long list and the general idea is that everything should be in place for 1st January 2021.
Will it be straightforward to get that comprehensive agreement signed off and ready to go before the year is out? That is a big question. Some parts will be easier than others. A big question for the automotive sector is, of course, the shape of permanent trade arrangements. There is a wide spectrum of potential outcomes. Is it difficult to negotiate a free trade agreement between two sides who start from a position of trading completely freely, with fully shared standards and with zero friction at borders. In theory, what could be easier? In practice, just hang on a second. Yes, it is kind of upside down, but we are talking about a negotiating process that will involve considerable horse trading (‘I’ll trade you fisheries for financial services’). On the EU side, the agreement with the UK needs to protect the integrity of the EU’s single market and customs union. That will be the first principle and it means the UK cannot just carry on with current frictionless arrangements on UK-EU trade. There have to be additional checks on rules of origin, even if tariffs are avoided, particularly if the UK leaves the EU’s customs union – which it will do if it seeks to strike new trade deals around the world. What checks, what is measured and how will those checks take place? Many questions are yet to be posed and answered.
We probably won’t know for another ten years how it has finally played out, net Brexit winners and losers.
From an EU standpoint, there is also the ‘free rider’ aspect to consider. If the UK gets too many single market access concessions or benefits akin to EU membership, that will be seen as unfair given that it is no longer an EU member or paying into the EU budget. But EU businesses also want to continue to have good access to the UK market. It is a tricky balance to be struck. We probably won’t know for another ten years how it has finally played out, net Brexit winners and losers. My guess (hope) is that it will be a tough question to answer definitively by then and that other questions will be far more pertinent to our economic well-being – in both UK and EU – anyway.
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By GlobalDataAt this stage, both sides seem keen to get a free trade agreement that avoids new tariffs, but it’s the non-tariff arrangements for trade that will be more tricky to nail down. The usual approach is to define ‘origin’ eg what is a genuinely ‘UK produced’ good by the level of local content of the good – whatever it is. Otherwise, you will potentially have products sourced outside the two FTA signatories’ territories and with low (or zero) local content (screwdriver assembly maybe) avoiding tariffs to the customs union. It’s an open back-door into the customs area. If UK produced cars have to have, say, a 60% UK content level to qualify as British and therefore avoid tariffs under a UK-EU free trade deal, that sets the bar very high indeed for UK exports to the EU to avoid tariffs, even under an FTA.
Some good work has been done to raise UK parts sourcing at many UK car plants, but it gets very difficult to get to a high level if major components are imported. Good luck with building missing engine and transmissions plants ready to go by next January (and in the long-run, where is the supply chain for EVs and parts, battery cells, going to be?). That won’t happen, so there is perhaps an argument for a creative solution (might be seen as a ‘concession’) of some sort that treats EU content on UK-made cars differently to non-EU content and therefore somehow avoids tariffs. But we are then potentially into the detail and semantics of the WTO’s rules on international trade that are built around a set of lowest common denominator principles. The UK can’t easily have a set of special treatments drawn up. And that example illustrates the difficulties inherent in the details of a free trade agreement, sector by sector, industry by industry, line by line. And there are lots of lines as well as lobbyists with special interests seeing opportunities. If 10% tariffs applied to UK car exports to the EU, would there be winners as well as losers? Of course there would. Not everyone wants business as usual or as close to it as we can get. A compromise future trade agreement that works for the EU and also for the UK can’t be just struck easily, unless the UK were to somehow stay in the single market and/or customs union from outside of the EU – a Norway kind of solution, that yields benefits, but comes with zero say in EU affairs. Norway also has plenty of cash in the bank and can happily pay into the EU budget in return for its single market privileges. That Norway option has been ruled out by Britain, thus far.
So, the trade aspects to the permanent deal will take some serious negotiating skills. On the UK side, there is a balance to be struck between wanting to adhere to current/future EU standards and also have room to manoeuvre when negotiating deals with non-EU countries, such as the US and China. Some sectors of the UK economy – such as automotive – lean more towards wanting a continued very close relationship with the EU, than others.
Expect to hear the word ‘equivalence’ banded about this year by UK politicians. It is a word that perhaps avoids ‘rule taker’ criticism and can be used to say that current high standards (EU-based) will still apply, but that the UK chooses them, or alternatively, chooses to diverge. And this brings us to another tricky area – future trade agreements with non-EU countries. The UK could opt to stay aligned with EU standards in some areas – like homologation and type approval for automotive products – but some third parties might argue that the EU standards (say in agriculture) are not appropriate and discriminate against the sale of their products into the UK under an FTA that is still being negotiated. They might well push for more UK divergence from EU rules in their bilateral negotiations with the UK. However, the more the UK diverges from EU standards, the greater the need for border checks, seen from an EU perspective. If cheap chlorine-washed chicken (the example everyone loves) turned up in Britain, there would undoubtedly be border checks to prevent it circulating in the EU. So, the UK trade experts and negotiators have to take a lot into account. Another issue is with third party countries who have preferential trade agreements with the EU in place and which the UK might want to rollover in convenient default fashion – it might not be that straightforward in practice, the third parties naturally interested in exploring improving their terms. Copy and paste, job done in a jiffy, let’s go down the pub and celebrate, it probably ain’t.
Finally, let’s consider the UK and EU’s political backdrop. For Britain, Brexit has been a convoluted and uncomfortable process, to say the least. The country is still deeply divided on EU membership, but there is a general sense of relief that we are finally moving on. The British government, now with a large majority in the UK’s parliament, understandably wants to take some momentum and positive spirit into the upcoming negotiations. The size of the majority in parliament also means it might be better able to make compromises, the government not beholden to small rebel groups as it was during much of last year.
The EU side also has some positives. The UK’s Brexit vote of 2016 hasn’t opened the floodgates to more member countries wanting to leave the bloc. If anything, the UK’s political difficulties and the incessant wrangling of the last few years have probably left the EU – on the surface – more politically united. And all through the negotiations for the UK’s withdrawal agreement, the EU maintained a united front on maintaining the integrity of its single market. The benefits of being inside the club haven’t unravelled.
But the EU is still facing serious strategic questions and difficulties as it considers future economic and political integration. The anti-globalisation sentiment (‘protest vote’) and populist sentiment that created the conditions for Brexit after the last recession hasn’t entirely gone away across Europe. The undoubted strains for the single currency could create more instability, the pressures of containing diverse economies within a single monetary union exposed again, along with political ramifications if severe austerity fixes re-emerge. Many inside the EU would like to see it reformed and there is no great consensus on how deep integration should ultimately go. The UK’s experience surely illustrates that there are dangers in going too far to suppress the role of nation states in the creation of a more federal European entity.
Will the EU change over the next decade? Will there be a two-speed structure, or even three-speed? And if there were, say, three-speeds, could the UK eventually find itself closely aligned to a new third speed (perhaps a loose coalition of EFTA-style free trading countries)? There’s also the broader global economic context and international trade framework that will be highly relevant, too. Protectionist trade blocs for regions across the globe might well become, overall, much less important as the digital economy and AI really take off. There are huge challenges and opportunities for the whole world ahead, not just the EU.
The UK will continue to have a close relationship with the countries next door, but it will be slightly different from next year. The complex negotiations this year are about the degree of difference from today. I don’t believe a ‘no-deal’ outcome is at all likely, but it probably suits everyone in the negotiations to keep the spectre of that unhappy scenario alive and in the room. There will be tough talking for a while yet, from both sides, but no-one wants the degree of difference to end up being all that large. Striking the compromise that works for all won’t be easy, but it is the most likely outcome…eventually. Ah, the transition timetable to next year. Of course, it will all be sorted out and signed off by then won’t it? You never know, there may be a way to fudge it.
