Analysis

During the UK referendum campaign the alternatives to the United Kingdom's EU membership, at least as far as trading relations were concerned, were portrayed as a choice between:

• the European Economic Area (EEA) arrangement;
• the Swiss package of bilateral trade deals;
• an FTA with the EU; and
• access to the EU market under WTO rules.

The possibility that the United Kingdom might leave the EU without any trade deal agreed was not considered (see UNITED KINGDOM: 'Brexit' vote will weaken EU - June 24, 2016). Much of the debate turned on whether the United Kingdom could retain access to the single market, as allowed for under the EEA and Swiss options.

In a recent interview, Malmstrom suggested that the United Kingdom would first have to negotiate its exit from the EU under Article 50 and only then negotiate a trade deal with the EU.

This statement implies that from the moment the United Kingdom leaves the EU to the entry into force of any subsequent EU-UK trade deal, commerce between the EU and the United Kingdom would be governed by WTO rules.

Since it took the EU eight years to negotiate an FTA with Canada, in circumstances less fraught than those facing the United Kingdom today, UK businesses should expect a long period under which WTO rules govern EU-UK trade.

EU tariffs

If the United Kingdom leaves the EU two years after invoking Article 50, many UK exporters will face EU tariffs.

Such tariffs vary across products. They currently stand at over 10% for a few goods, for each of which the United Kingdom exported over 100 million pounds' (131 million dollars') worth to the EU in 2015:

• motor vehicles and parts;
• sports footwear;
• food preparations;
• men's trousers;
• women's and girls' dresses;
• men's shirts;
• women's blouses; and
• T-shirts.

Of these products, motor vehicles and parts are the most commercially significant. Under current obligations, 27.2% of products enter the EU without paying tariffs (see INTERNATIONAL: Trade protectionism hurts global growth - January 14, 2015).

The affected firms have at least two years to prepare for higher tariffs.

Regulatory divergence

Exiting the single market will have other implications, especially for firms where UK regulations and associated regulatory decisions have until now been recognised by other EU members.

Once the United Kingdom leaves the EU, the potential for regulatory divergence arises, requiring firms to expand resources to meet regulatory standards in every jurisdiction where it wishes to supply goods or services.

On top of this, there is the loss of 'passporting' rights for financial services, which is likely to result in larger financial institutions shifting some functions and staff to the remaining EU states.

UK strategies

Rather than face years of EU-UK trade being governed by WTO rules, a UK government could demand that trade talks with the EU occur in tandem with the Article 50 negotiations.

This raises the possibility that, irrespective of the line taken by European Commission, there will be 'talks about talks' about the negotiating agenda once Article 50 is invoked.

The United Kingdom's largest bargaining chip at that stage will be when to invoke that article, the EU making it clear they want invocation as quickly as possible. On the timing issue, the EU is the demandeur.

A consideration that will influence the UK position is its lack of negotiating expertise on trade. The former permanent secretary at the UK Foreign Office, Sir Simon Fraser, has been reported as stating that there are 20 expert trade negotiators in the UK civil service.

This may not be truthful. In the services sector, there is a lack of UK civil servants who can read current WTO legal obligations, let alone negotiate them.

Over the years, the negotiating expertise at the UK business ministry has been run down. Such realities may temper the United Kingdom's desire to negotiate before leaving the EU.

This provides companies with trade policy experts on their staff an opportunity to shape the UK negotiating position. To strengthen the United Kingdom's hand in these talks about talks, and after Article 50 is invoked, the temptation will grow for London to take diplomatic action.

Such action could include limiting free movement rights immediately on the pretext of avoiding a further immigration surge and ending the primacy of EU court rulings in certain high-profile areas, such as deportations.

A UK cabinet minister associated with the 'leave' campaign has suggested this in a recent interview. With such additional bargaining chips, the United Kingdom may be able to start trade negotiations in parallel to the exit talks.

UK demands

Before any UK-EU trade negotiations begin, London will have to identify its key demands. A central consideration is the mismatch between denying free movement of people and access to the single market.

The EU has made it clear to the United Kingdom, and to the Swiss government whose people voted in 2014 to limit immigration, that allowing the former is a prerequisite for the latter.

As it is unlikely that the EU will compromise, should UK ministers feel that the referendum result requires them to limit free movement, the only option that goes beyond WTO rules is an FTA with the EU.

'Only' refers to the options, not to the scope of FTAs which, as the EU-Canada deal shows, can be comprehensive in coverage.

Given the time it would take to negotiate such an accord, UK businesses should expect access to the EU market to proceed in three phases.

Current market access is sustained until two years after the United Kingdom invokes Article 50; then WTO rules determine access to the EU for several years; this is followed upon entry into force of a UK-EU FTA by improved market access, compared to WTO rules, in non-excluded sectors.