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7 February 2019

To explain a no-deal Brexit, we should call it “the Venezuela option”

It’s ironic that those who say a Labour government will lead to us “becoming like Venezuela” are often the same people who want us to have a Venezuela-style trade relationship with the EU.

By Steven Toft

The various options for the UK’s future relationship with Europe are often described using the names of countries which have similar arrangements. We have the Norway Option for remaining in the single market, Norway Plus for single market plus customs union, the Swiss Option for a series of bilateral deals, the Turkey Option for a customs union and the Canada Option for a free trade agreement outside both customs union or single market. Michel Barnier even illustrated the various options with a series of flags on his now famous slide.

But what about leaving the EU with no deal, the WTO model promoted by hardline Brexiters? Does any other country have a similar relationship with the EU? Despite claims that the UK does much of its trade under WTO terms alone, it’s not quite true. The EU has some form of trade agreement with most countries, even those with whom it doesn’t have full free trade deals. As the Institute for Government explained:

“In 2016, of the top 10 trading partners with the EU by total trade, the US, China, Russia, Japan and India have a substantial number of bilateral agreements that go well beyond the terms of WTO trade. Of the top 20, there are no countries that trade on WTO rules alone with no bilateral agreements and no free trade deals.

“If the UK left the EU with no agreements of any kind, then technically its relationship with the EU would be weaker than any of the EU’s main trading partners.”

For the last four decades, almost all of the UK’s commercial agreements with other countries have been negotiated through the EU. Around two-thirds of UK exports in 2017 went either to the EU or to countries with EU free trade agreements. According to the Financial Times, there are 759 agreements with 168 countries that will need to be renegotiated if the UK is to maintain its current trading relationships after Brexit.

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As things stand at the moment, unless something is agreed very soon, overnight on 29 March, the UK’s relationship with its largest trading partner will transform from the best it could be to worse than that of most other countries. On ceasing to be a member of the EU, most of the UK’s current commercial agreements will disappear.

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In terms of its relationship with the EU, only one country comes close to where the UK would be after a no-deal Brexit. Apart from those countries not under some sort of EU sanctions, the only one which has no trading agreements with the EU is Venezuela.

Furthermore, having severed its relationships with the Andean Community and Mercosur, it has acrimonious relationships with its near neighbours, which is what the UK would have with the EU in the event of leaving without a withdrawal agreement. As former Australian government trade negotiator Dmitry Grozoubinski pointed out:

“A threat in a No-Deal Scenario is that a huge volume of the UK’s trade with the EU which currently treats moving from Dover to Calais like moving from London to Oxford will have to be treated like Dover to Venezuela. That’s a logistical and administrative nightmare and a huge shock.

“I maintain the WTO Only/No Deal model should be named the ‘Venezuela Model’ after the country whose trading relations with the EU it will most closely replicate.

“All the other models are named after a country with that relationship to the EU (Norway, Canada.) Venezuela is the closest proxy for No Deal.”

In other words, then, in the event of a no-deal Brexit, UK goods will have the same status in the EU and its trading partners as goods from Venezuela.

The consequences of the Venezuela Option would be severe. The Institute for Government warned in its recent paper that the government and businesses are nowhere near ready to cope with a change on this scale:

“A customs and regulatory border would be introduced between the UK and the EU under no deal. The legal basis for free movement of goods would disappear –tariffs, paperwork and checks on standards would be required by law.

“The EU has said it will apply checks to UK goods as required under EU law. That will put major demands on traders. The Government – particularly HM Revenue and Customs – has begun to communicate with businesses about the new processes they will need to comply with, but not all businesses are aware of the changes they will face.”

Economies evolve based on assumptions and expectations. The single market has been in place for a quarter of a century. Many companies that trade with the EU have no experience of anything else.

Some advocates of no deal argue that the UK managed perfectly will before it joined the EU. That may be true, but that was a very different economy with different expectations and different people working in it. The 1960s economy also managed without an extensive motorway network but if all the motorways were closed indefinitely next month there would be chaos. People have built businesses on the assumption that the motorways are there. The same is true of the EU’s single market and customs union.

As former UK government trade negotiator David Henig says, never mind the speculation, the things we can be certain about in a no-deal scenario will be bad enough. Among the consequences he lists are:

  • UK products will face tariffs if sold into the EU – for example cars at 10 per cent and shoes at 8 per cent. Some UK producers will become uncompetitive when facing these tariffs, especially compared to EU producers, and will therefore cease production;
  • UK products which require testing to be placed on the EU market will need a test carried out within the EU, a UK test will not be sufficient. This will add costs to production;
  • There will be no customs cooperation between the UK and EU, thus for example no mutual recognition of the Authorised Economic Operator scheme. Products are therefore likely to take more time to go through customs checks;
  • The tariffs on goods, and restrictions on services, will also apply to countries with who the EU has a current trade agreement that the UK fails to replicate – for example there is likely to be no agreement with Turkey;
  • Over 50 per cent of UK trade will be affected by these changes. Less than 10 per cent of EU trade will be affected by these changes. UK costs will rise, EU costs are unlikely to do so. This will be a major change to the terms of trade between us.

That last point is important. Much is made of the fact “they sell more to us than we sell to them” – but relative to the size of the EU, that’s still not a large percentage of its trade, whereas it is a considerable part of the UK’s.

Exports to the EU are a much larger slice of the UK economy than exports to the UK are for most EU member countries. This is simply a function of size. With the possible exception of Ireland, no country faces as much risk to its export market from a no-deal Brexit as the UK.

Much of this trade is integrated within EU supply chains. According to the Bank of England, around 30 per cent of the entire value of UK exports, goods and services, is made up of inputs to products that are finished in the EU. As Mark Carney remarked:

“The proportion of UK exports that are intermediate components of EU value chains has increased from about 1/5th of exports in 1995 to about 1/3rd in 2014. Increasingly the UK doesn’t so much export to Europe as through Europe; it is a supplier of components to final goods that are exported beyond the continent.”

The level of interdependence between EU economies has increased because of the single market. The assumption of frictionless trade has seen the development of EU-wide production lines.

UK business is more dependent on inputs from the EU than vice versa, as this chart by the Institute for Fiscal Studies shows:

Image: Institute for Fiscal Studies.

Again, this is a function of size. The disruption to these supply chains will be less of a problem for firms based in the EU, which can, if necessary, re-source supplies from other EU countries, than for UK firms dependent on EU suppliers. The EU will also still have all its existing trade agreements in place on 30 March. So, while a no-deal Brexit would be inconvenient for the EU it would be nowhere near as damaging as it would be for the UK.

None of this is to say that the UK economy would sink to Venezuelan levels of growth and inflation after Brexit: Venezuela’s economic problems go way beyond its trade relationships. It is ironic, though, that the people who threaten us with “becoming like Venezuela” if we vote for a Labour government are the same people who want us to have a Venezuela-style trade relationship with the EU.

Those who casually advocate ripping up four decades worth of trade arrangements are threatening to set the country on a very dangerous path. The idea of flipping from being a major pillar of the world trade order to a borderline pariah state overnight ought to be unthinkable. Instead, it is being promoted by many of our elected representatives. Let’s stop calling it by the respectable-sounding WTO Rules, and give it a name that befits the chaos and misery it would bring: the Venezuela Option.