Keeping a level head about Brexit’s level playing field

Normal Trade Secrets service returns next Monday, but today we’re interrupting the seasonal break to offer some thoughts on the Brexit deal that was sealed on Christmas Eve.

Hilariously, the UK parliament gets a single day on Thursday to debate the UK-EU “trade and co-operation agreement” (TCA). Readers may remember one argument for Brexit was to restore the sovereignty of parliament. The government is currently treating the House of Commons’ sovereignty as Boris Johnson does the actual sovereign, the Queen: rock up occasionally with a short briefing about what it’s up to, take a couple of questions and then go about its business.

When MPs vote on the TCA, they might be concerned that some provisions will keep the UK in the EU’s regulatory gravity field. Below we explain why we think that’s overdone.

Brussels tests a new enforcement model on the UK

In the end the agreement was pretty much what you’d expect. Few favours for the UK beyond a standard EU bilateral. A basic deal on services, no special access for financial services, no automatic mutual recognition of professional qualifications, few preferential rules of origin to preserve manufacturing supply chains. Something on fish that fishing industries on both sides are unhappy with, as is their wont.

The Brexit gurus have come out with their initial reactions, which seem pretty accurate to us. This is essentially a deal written by the EU in response to the UK’s red lines of leaving the customs union and single market, and it leaves out so much of interest to the UK economy that an indefinite series of disputes and negotiations will follow.

We’d like to focus on an innovation in the deal that almost derailed the talks and has got a lot of attention. Brussels insisted on “level playing field” (LPF) rules deterring the UK from cutting labour, environmental or climate protection standards or spraying around trade-distorting subsidies to business.

The subsidy provisions at least were heavily cut back from the initial EU demand that the UK remain subject to EU law and the European Court of Justice: they now give companies standing in each other’s courts. But the LPF rules still have sharp (and innovative) enforcement teeth. If one side says the other is cutting standards or handing out illicit state aid, they can unilaterally apply “rebalancing” tariffs to correct the distortion, with its notice of intention to do so appellable to a fast-acting arbitration tribunal.

So, is the EU giving itself supreme power to rein the UK in if it dares to exercise its newfound regulatory sovereignty? Is this the chain by which the dastardly ringmasters of Brussels will continue to leash the proud British lion?

We’re going to stick our neck out a long way here and boldly predict that in practice these rules won’t get used very much or constrain the UK from the large bulk of anything it really wants to do.

Let’s leave aside the question of whether the UK would even want to diverge a lot, which seems doubtful: its labour markets are already pretty deregulated, British public opinion is generally quite environmentally friendly and the country has always been a parsimonious user of state aid.

First, let’s recall these rules apply only to labour, environmental and climate standards and to state subsidies. The UK can muck about with product or professional standards all it likes: children’s toys made of solid lead painted with arsenic, doctors allowed to practise with degrees bought off the internet, car safety checked by test drivers who’ve been drinking all day. But those goods and services won’t be acceptable in the EU single market, or indeed probably anywhere else.

Second, there’s an important condition applied to the LPF conditions: divergences must have “material impacts” on trade and investment before either government can apply rebalancing tariffs. This is going to be hard to prove. Suppose the UK makes it easier to fire workers, or increases permissible pollutant limits in industrial wastewater. An EU industry complaining about UK competitors is going to have to show that it is being seriously hurt by that one issue out of the dozens of factors that make up companies’ business costs — and even the rebalancing tariffs have to be strictly proportionate to the harm incurred.

We know this is hard to do because the US, which (thanks to the fierce lobbying of labour unions) has had similar-ish enforceable labour provisions in its trade deals for years. They have failed to have much effect. There was a test case with Guatemala (whose labour standards are, let’s face it, a touch worse than even Boris Johnson’s Britain) where the US failed to win precisely because it could not show the economic damage caused.

There’s more potential for EU-UK conflict over subsidies, where the rules go far further than in other EU bilaterals and where distortive impacts might be more obvious. But even here there’s a test of having to show a significant negative effect on trade or investment before retaliating. Simon Lester of the Cato Institute sagely points out that, to withstand arbitration, governments will probably establish some kind of agency or quasi-judicial mechanism to assess those effects, which will moderate, slow down and depoliticise the process.

Also, let’s remember the provisions are symmetrical. The EU’s going to want to be very careful about trying to expand the definition or measurement of distortion in case it becomes vulnerable to counter-litigation from the UK.

James Webber of the law firm Shearman & Sterling, Trade Secrets’ go-to guy for articulating the positive side of Brexit on such matters, says the new state aid provisions are a huge loosening of the leash: “The new subsidy rules mean that state aid can be spent without prior approval, require companies to bring cases to initiate complaints and need evidence of serious damage done before tariffs or other actions are triggered. These add up to a massive deregulatory change for Great Britain.” (Remember here that Northern Ireland remains subject to EU state aid rules, which could create some fun in future.)

If anything, the really interesting implication of the LPF is what it means for EU and global trade enforcement more generally. Brussels has traditionally shied away from enforcing the labour and environmental provisions in its bilaterals with sanctions, with the old guard in the trade directorate arguing it won’t actually change behaviour in trading partners. But pressure for change has been growing, especially in the European Parliament. So has a desire for enforcement weapons that let Brussels hit back at what it says are trade-distorting actions in partner countries without waiting months and years for a WTO ruling.

In the UK deal, the EU has created a model that should develop precedent and practice and can be tweaked or expanded in future. It’s going to be watched with interest from the US, where some lobby groups are always keen to expand America’s trade defence measures. The EU’s experiments with expanding enforceable labour and environment provisions are unlikely to stop with the UK, and possibly not with the EU itself.

Source: Economy - ft.com