What’s not fake news on the motor industry?

Rules of Origin problems….and how EFTA may solve them

Amid the news blackout that seems to surround the trade talks at present, Brexit Twitter sprang to life this week as ex-Remainers and ex-Leavers got another chance to trade barbs. The future of Nissan’s Sunderland plant was the political Twitterball. The question regurgitating its way to the surface was whether its potential closure was merely Remainer Project Fear or whether its now proven closure is another Brexitastrophe becoming reality.

Schadenfreude denied

The firm denied the story in the German media that the plant’s closure is imminent. But while reports of its demise may be greatly exaggerated – the notion that Nissan is on the brink of saying Auf Wiedersehen Pet to the North East languishing for now in the bucket marked Fake News and Remainers denied their moment of Schadenfreude – one of the issues that could have led to that point is still very much in the “to be resolved” bucket.

Rules of Origin

Rules of Origin (RoO) are the least sexy political topic imaginable this side of Jacob Rees Mogg’s choice of socks. However, they show why Britain needs a deep trading relationship with the EU. Moreover, they show the deficiencies of the Canada-style distant Free Trade Agreement (FTA) that the UK claims to want.

RoO are irrelevant to the UK’s trade with members of the EU Customs Union (EUCU) as long as the UK is a member of the EUCU. The EUCU includes the EU plus Turkey (for some sectors), Andorra, San Marino, and Monaco. Once a good has entered the territory of one member of the EUCU, it is an EUCU product. RoO have not mattered since 1973 but will matter at the end of the transition, when the UK leaves the EUCU.

FTAs always specify the provisions for RoO. But what are they? Simply, they are rules that ensure that only goods that should qualify for tariff-free export do qualify. If the FTA now under negotiation for trade between Britain and the EU after the end of transition removes tariffs on British exports to the EU, it must clarify what “British goods” are. A product assembled in Britain consisting of materials from abroad is a grey area. For that reason, a certain percentage – likely to be 55% – of the value must be “domestic”. To qualify for tariff-free export from Britain, it must arise in Britain.

Get ready for the tricky stuff…

There are, however, exceptions to this. Within that 55%, the parties to an FTA usually say that each party can count value added in the other’s territory as “domestic”. For British producers, then, the likely new rule is that 55% of the value must be added in Britain or in the EU to qualify for relief from EU tariffs. This is called bilateral cumulation, and is commonplace in FTAs.

(We say “Britain” rather than “the UK” because we must count Northern Ireland as effectively part of the EU’s Single Market. According to the Northern Ireland Protocol to the Withdrawal Agreement, it will implement the EU’s Union Customs Code).

For Britain’s trade agreement with the EU, the UK government wanted to add more countries. It wanted British producers to be able to count value added in certain non-EU foreign countries as domestic. The UK itself has precedent for this “extended cumulation”. It converted – “rolled over” – its participation in the EU’s FTA with South Korea to its own bilateral agreement with the Koreans. Producers in both countries can count value added in the EU as “domestic”. Specifically, in the case of its putative FTA with the EU, the UK wanted to add Japan and Turkey, whose automotive products are important inputs to the value chain in the British automotive sector.

Mais non, messieurs

Michel Barnier, however, said “non” to this some weeks ago. Negotiators have continued their efforts to reverse this. However, if there is one issue that makes the Nissan story credible, it is RoO cumulation. The car industry is fuming. Remainers engage in another “I told you so”. Yet interestingly, smart Leavers may also point to the prescience of one of their own prognoses: the continental car industry attempting to swoop in to save the trade status quo because of Britain’s importance to it.

Consistent, too, with arguments made by “clean break” advocates, is that the EU is being inconsistent. At least in a limited and specific way. It refused extended cumulation for Britain covering Japan even though extended cumulation is in the EU’s own FTA with Japan. Why? Let’s read Barnier’s logic:

Pourquoi, Monsieur?

“British proposals on rules of origin would help the UK to develop its role as an assembly hub for the EU!”

What does this mean? It means that while even the continental automotive industry perceives a narrow self-interest in acquiescing to the UK’s request, Barnier sees a greater strategic imperative in preventing the UK from giving manufacturers a spot to work on the EU’s borders where they would have many of the same benefits of being in the EU.

Barriers…

Of course, “many of” does not mean all. Outside of the Single Market and Customs Union, even with an FTA, there are all sorts of non-tariff barriers (NTBs) in the way of trade with countries inside. So, what is Barnier worried about? Why would firms want to serve the EU market from Britain rather than from inside the EU?

…But advantages

From the rest of the keynote speech in which he stated his objections to the UK’s RoO requests, the answer is regulatory competition. His concern is that producers in Britain will have an advantage from lighter regulation. He does not want to grant Britain what Japan – a distant country – has on RoO, because this would remove an obstacle to Britain – a neighbouring country – attracting business and investment away from the EU by undercutting the EU on regulations.

Spill Over

This is a classic example of “spill-over”. RoO and the regulatory Level Playing Field (LPF) are in theory separate issues. However, the UK will not commit to a regulatory LPF between Britain and the EU. Therefore, it does not get its way on RoO either. The connection between the regulatory LPF and other issues is also clear in the only off-the-shelf solution.

The Answer

That is the Pan Euro-Mediterranean (PEM) convention on Rules of Origin. It provides for diagonal cumulation (are we having fun yet?), in which any party can include value added in the territory of any signatory as domestic for the purposes of its exports to any other signatory. It includes the EU and many of its neighbouring countries in Europe, the Middle East, and North Africa. Significantly, it includes Turkey, an important origin country for the UK automotive sector. 

If it were to join PEM, producers in Britain could then include inputs from Turkey in their “domestic” quotient in goods exported to the EU. They would have a better chance of qualifying for zero tariffs. The UK’s position on PEM is unclear: it appeared to have rejected it in favour of extended cumulation. However, the latest information says that the UK’s relationship with it is “yet to be determined”.

RoO are essentially a customs issue. They are about whether a good can be exempt from tariffs (“customs duties”). The EFTA countries are not in the EU’s Customs Union. They do have tariff-free access to the EU. However, they don’t apply the Common External Tariff or the rest of the Union Customs Code. In some cases, they apply different tariffs from those that the EU applies for goods from the same third country. For customs, they are not part of the same unit. Yet, because of their integrated trading relationship with the EU – including Single Market rules – the EU is fine with their inclusion in the PEM convention.

The Deal we need

This is where the government’s whole theory of a trading arrangement for Britain with the EU falls down. It claims to want a bespoke deal based on principles found in EU FTAs with distant countries. No neighbouring country with deep trading arrangements with the EU has the regulatory autonomy that the government seeks for Britain. But Britain also presents more of a threat to be contained than do distant countries. Therefore, under an ideological pursuit of regulatory autonomy, “bespoke” will mean worse than distant countries’ deals, not better. The ready-made EFTA solution is clearly superior.

Of course, the UK is not really asking for a Canada-style deal (for Britain). It is asking for bespoke special treatment: Norwegian benefits with Canadian obligations. It wants the enhanced EU market access of neighbouring countries like Norway that follow Single Market rules, without committing to continue to follow those rules. The EU will obviously never agree to this, leading to the impasse.

The roadblock

Yet we should also ask why regulatory autonomy is such a sacred cow. Johnson says – even promises – that he will not use it to undercut the EU. Yet he also – and this is the “Canadian obligations” part – does not want the regulatory LPF included in dispute resolution.

If he does not intend to change any regulations, and regulatory autonomy is doing so much damage on RoO, on the Great Britain – Northern Ireland border, and on the overall probability of even having a Deal, is it really worth holding on to?

The solution

I mean, I get it. Autonomy is symbolic. That’s why I proposed an interim period during which status quo ante referendum holds on regulatory border checks and regulatory NTBs unless the UK exercises regulatory autonomy for Britain to do something the EU dislikes. Britain would have autonomy; frictionless trade would depend on how the government uses it. The government can use the time to demonstrate examples of regulatory divergence that are worth the costs. I am open to these finally being found, so the sunset proposal in itself does not call for any particular post-sunset arrangement.

But at the end of it, my default assumption is that Norwegian benefits with Norwegian obligations – alongside Norway in EFTA , EFTA’s agreements with the other PEM countries, and the PEM itself –  will end up being the most straightforward model.