Will there be a Brexit deal? After months of difficult negotiations, the deal depends more decisively on one issue than any others: how to ensure that future regulatory changes between Britain and the EU do not undermine fair competition between them.
To be clear, this is not about Britain having to follow future EU rules indefinitely. Both sides already agree that there should be no obligation to follow the other with respect to future regulations. They also agree that neither should diverge from the present domestic rules on environment, labour and social standards; a pledge described as 'non-regression' in the trade lexicon. But the toughest hurdle is about what happens in the future. What if one side raises these standards but the other doesn’t? Can the offended party impose tariffs to remedy being undercut by the firms competing on lower rules? And, how is “being undercut” determined anyway?
The EU has suggested that it wants to be able to impose tariffs unilaterally if it deems that the single market is being threatened by lower standards. Britain, on the other hand, believes that unilaterally imposing punitive tariffs for refusing to comply with future EU rules is unconscionable vassalage.
This is a large gap to bridge. However, rather than getting overwhelmed by this seemingly irreconcilable philosophical difference, the way forward is to focus on finding a clear process for when and how any tariffs might be used in future. Last week, I set out a possible way forward on Twitter. In this piece I explain this solution further.
The key to compromise is finding common ground on three core principles: (i) the principle of symmetry (that both sides should be entitled to take retaliatory measures); (ii) the trade distortion test (that any retaliatory measures, such as tariffs, are justified only after showing an effect on trade, which can be challenged before arbitration); and, lastly, (iii) that there is a clear process to follow before imposing tariffs, which should be used as an option of last resort.
Taken together, these three principles guarantee that both sides can act unilaterally to prevent unfair competition, but that any unilateral action is subject to a clear and robust process and, ultimately, review by independent arbitration. The risks of abuse for political reasons are, therefore, eliminated.
How might this process look like in practice? There are five main steps in the process, from the point of identifying potential risk to competition, to eventually imposing tariffs.
1. Regulatory divergence and risk of trade distortion
If either side, the UK or the EU, raises its domestic standards above the common baseline, and if it believes that the other side’s lower standards threaten to undermine the equal conditions of competition, it should first raise this issue with the other party at the Future Relationship Joint Committee.
In the first instance, there should be every effort to resolve the issue through consultation at the Joint Committee. Consultations are common in most EU trade agreements before dispute settlement and there should be no difference here.
Through the consultation process, the UK and the EU may decide on the higher rules to be their 'common floor', from which they cannot lower domestic standards in the future. An agreement would be amended accordingly through a mutual decision taken at the Joint Committee.
3. Rebalancing measures (subject to the trade distortion test and review by arbitration)
If, following the consultation, the offended party deemed there to be a risk of trade imbalance as a result of lower standards, it would be entitled to request "rebalancing measures" to remedy any potential harm. Rebalancing measures can take the form of financial compensation, or an imposition of temporary tariffs, which should be proportionate to the trade imbalance.
The key, though, is that the offended party would need to justify its decision to request rebalancing measures and to demonstrate, on the basis of evidence, that lower standards have a material effect on trade between the UK and the EU. This is important because if, for example, lower standards did not have an effect on trade with Britain, the parties wouldn’t be entitled to taking those protective measures.
Establishing the existence of potential harm is not straightforward in practice. The agreement should set out clear criteria for what constitutes an “effect on trade”. This would allow for an arbitration review: if the other party does not agree with its (lower) standards creating trade-distorting effects, it may request independent arbitration to consider the issue and, therefore, whether the offended party is entitled to take rebalancing measures.
4. Unilateral remedial measures (as an option of last resort)
If the two sides do not agree on the rebalancing measures, and after the offended side has justifiably demonstrated the effect of lower standards on trade, the option of last resort is imposing proportionate remedial measures - such as tariffs.
Remedial measures could include imposing a tariff to the value of distortion or suspending other concessions under the FTA. The key condition on any remedial measures, however, is that they are proportionate to the nature of trade distortion.
5. Proportionality challenge before arbitration
To prevent disproportionate tariffs being imposed, their proportionality could be challenged before arbitration. If the arbitration panel ruled that the tariffs were disproportionate, they would need to be withdrawn or readjusted according to the panel’s ruling.
Agreeing to such a process, along with criteria for when lower standards might constitute trade distortion, offers a reasonable compromise. It gives the EU the ability to protect the single market when faced with the threat to competition from outside the single market – subject to a clear process – while preserving Britain’s regulatory sovereignty. And, crucially, both sides could use this process, allowing Britain to raise any concerns too.
One drawback is that this process can take some time. Time limits could be imposed for different stages, and an accelerated arbitration process could be used to speed up any review that might be necessary.
The negotiators may not agree on this exact variant for managing divergence. But this, I hope, demonstrates that there is a narrow but viable path to finding agreement.