Newspaper Article

Costs of leaving customs union will inevitably outweigh the benefits

Date: 30 April 2018
Publisher: The IFS
Published in: Times

It is said that a little knowledge is a dangerous thing. Lack of it can be more dangerous still. That is nowhere better demonstrated than in the debate about the merits or otherwise of remaining in the customs union.

The arguments for leaving appear to have considerable force. Within it, we are unable to make our own trade policy and suffer the effects of high tariffs; outside it, we will be able to forge our own agreements, reduce tariffs and benefit British consumers.

With average World Trade Organisation tariffs on clothing at about 10 per cent, on food around 20 per cent and much agricultural produce at higher levels still, the opportunities look substantial. The impression given at least implicitly, and often explicitly, is that our cost of living could come down by these sorts of amounts if only we could escape from behind the European Union’s protectionist walls.

This is where just a minuscule knowledge about the structure of our economy, about trade and about what we actually spend our money on would go a remarkably long way. A world with lower tariffs would be a better world, but they simply are not a big enough deal to offset the costs of leaving the customs union.

Start with the fact that ours is a services-dominated economy — and the knowledge that tariffs do not apply to services. One way or the other, about three quarters of what we spend goes on services. In part, that is because even when we are buying trainers or baked beans or washing machines, a large fraction of what we spend is not on what they cost as they came out the factory gate, or arrived at Felixstowe. We are paying for their transport, the wages of shop assistants, the retailer’s profits, the costs of advertising. All are services whose costs are domestically determined just as surely as the costs of haircuts and cinema tickets. Abolishing a 10 per cent tariff on baked beans would not cut the price of a tin of beans by anything like 10 per cent.

One upside of this is that we are rather better insulated from the vagaries of international markets than one might have thought. It is why a fall in the value of the pound since the referendum that raised the sterling cost of imports by almost 9 per cent is estimated to have pushed up prices by a bit less than 2 per cent.

That’s one reason that the potential impact of tariff reductions on retail prices is relatively limited. The other is that while some tariffs remain high, most are not. The average WTO tariffs that the EU applies to the goods that Britain imports are less than 5 per cent. Taking account of the various trade agreements that the EU has with other countries, the average tariff is rather less than 3 per cent. The EU’s average tariffs are less than those imposed by other big economies, such as the United States. Even ignoring present trade agreements, abolishing all tariffs could reduce consumer prices only by around 1 per cent overall — less than that when existing agreements are accounted for. Worth having, but still offsetting no more than half of the price rise resulting from the post-referendum fall in the value of sterling.

That average tariffs are as low as they are is testament to the (often painfully slow) progress made by international negotiators over many decades. While lower tariffs would be good, a sense of scale is important. The possible benefits are limited. In any case, it is politically most unlikely that any government would simply abolish all these tariffs unilaterally. The immediate costs to those domestic industries, notably agriculture, that would be most exposed to such a policy would be substantial. That’s why some have mooted the idea that, on exiting the customs union, instead of abolishing tariffs across the board we should do so only where there is little in the way of domestic industry to disrupt. We don’t produce many olives and oranges in the UK, so getting rid of tariffs on them would be a win-win. But even taking a fairly broad view of where Britain has no domestic industry to disrupt, abolishing all such easy-win tariffs could reduce prices overall by much less than half a per cent.

Again, a sense of scale is vital. Yes, there are some gains to be made, but they are small. In any case, if we are looking to make trade agreements with other countries, we wouldn’t help our negotiating position by abolishing these tariffs up front. Any reductions are likely to be hammered out bit-by-bit over time.

Even small gains are worth having if they don’t cost anything. The trouble is that leaving the customs union has the potential to be very costly. The EU is by far and away our biggest trading partner, accounting for half of all our trade in goods. Were we to leave the customs union, customs and rules of origin checks would be imposed. These would cause delays and disruptions to companies’ supply chains. The evidence that these costs disrupt trade and reduce welfare is compelling. Moreover, the impact would be out of our hands. However slick and efficient we were to make the process on our side of the border, we would have no control over the behaviour and efficiency of the French, Dutch and Belgian customs officials. Any regulatory divergence between the UK and the EU would further increase these costs.

The idea of having our own trade policy, of cutting tariffs, of signing shiny new trade agreements sounds terribly enticing. The reality, though, is boring. Get a sense of scale, throw in some simple arithmetic and sprinkle a basic understanding of trade and it is obvious that the economic costs of leaving the customs union must outweigh the benefits.

This article was first published by The Times and is reproduced here in full with permission. Paul Johnson is director of the Institute for Fiscal Studies. Follow him on @PJTheEconomist.