The current Conservative Party election process has sparked much debate on what a “no deal” Brexit in fact means. This is because a number of the candidates, including the frontrunner Boris Johnson, have stated that if they are elected they will leave the EU on October 31st. with or without a deal with the EU-27.
There is some debate as to what “without a deal” means, but we can be certain that it means that the current draft Withdrawal Agreement (“WA”) will not be in place.
If the UK withdraws from the EU-27 without an agreement with the EU-27, then, in principle, the trading relationship between the EU-27 and UK reverts to so-called WTO status, relinquishing the Single Market position the UK and EU-27 currently enjoy.
As noted previously, WTO trading terms are not, in themselves, disadvantageous for business and for example, cover substantially all trade between the EU and the US. The issue is the gap between the current Single Market position, and the WTO position, which is likely to be significant. As one example of the gap, the EU-27 and UK would have to reintroduce border checks on trade between them, and where relevant impose tariffs. In some areas, such as agriculture, these tariffs will be substantial.
This requirement to revert to “WTO status” and re-impose certain trade restrictions stems from the fundamental Most Favoured Nation (“MFN”) principle and so it is worthwhile looking at what MFN requires.
MFN requires all WTO Contracting Parties (“CPs”) to treat all other CPs in a non-discriminatory fashion. So if the EU offers any advantage to Country A, then it has to offer that advantage to all other WTO CPs. So, if the UK decides, unilaterally, to remove certain or all tariffs on imports from the EU-27 after it leaves the EU, the UK then has to offer that same duty-free treatment to all other WTO CPs, including for example the US, China and India. While this “duty-free” position is not disastrous (for example Hong Kong and Singapore operate on this basis), it will be a significant short-term shock to the UK economy as it will lose tariff protection against all WTO Members, and some third country investors may not see the UK as a good place to invest when it has no external tariff protection. This idea has been mooted by the UK (see here).
In order to allow groups of CPs to form into trading blocs that eliminate trade restrictions between them, but without having to offer the same advantages to all other CPs, there needs to be some form of exemption from the MFN principle. In relation to goods trade, this exemption is Article XXIV of the GATT, and the services equivalent is Article V of the GATS.
Article XXIV is complex, but in principle allows groups of CPs to eliminate duties and other restrictions on commerce through either a free trade agreement or customs union, provided that this elimination of duties and other restrictions on commerce applies to “substantially all” trade in goods between the CPs. If the CPs agree to that, they do not need to offer that tariff free treatment to CPs who are not part of the group.
Article XXIV(5) allows CPs to enter into an interim agreement for the removal of tariffs and other restrictions on trade pending the finalization of a full agreement. This interim agreement “shall include a plan and schedule for the formation of such a customs union or of such a free-trade area within a reasonable length of time.” As a matter of practice, an interim agreement may be in force for a period of up to 10 years to allow for the process of negotiating a full FTA to be completed.
Therefore, if the UK and EU-27 agree to enter into an interim free trade agreement or customs union, then this interim agreement can result in elimination of duties and other restrictions on commerce with immediate effect.
There are a number of points to note.
First, it is clearly the case that any interim agreement has to be agreed between the UK and EU-27. It is important to quash any suggestion that the UK could unilaterally impose any such arrangement on the EU-27, or any other WTO CP. The EU-27 and UK have agreed the Withdrawal Agreement (“WA”), which is, in effect, an interim agreement under Article XXIV. The EU-27 appears to be committed fully to the WA, and so is unlikely to accept a new and different interim agreement, particularly one which is likely to be much less detailed than the WA. Of course one can speculate under what conditions the EU-27 would abandon the WA, but it will not do so willingly.
Second, even if the EU-27 was prepared to drop the WA as the interim agreement with the UK, it seems clear that the most or all of the issues that caused the defeat of the WA in the UK Parliament, in particular the Northern Ireland backstop, will be treated as a key negotiating item by the EU-27 in any new interim agreement, and so it is unlikely that any new agreement would be concluded quickly or easily.
Third, there is a timing\detail issue. Even if we assume that the EU-27 is prepared to drop the WA, and not require the Northern Ireland backstop, there is little or no time to negotiate any new interim agreement by October 31st. As has been noted, Parliament and the European institutions will be taking summer vacations, including for the UK side, extending the summer recess into the “conference season”, leaving little or no time for the new Prime Minister to engage with the EU-27. Therefore, the timing may require the UK and EU-27 to agree a further extension to Brexit.
Fourth, other WTO CPs retain the right to consider and potentially object to any such interim agreement. While prior practice is complicated, there is no direct analogy to Brexit, and we know that WTO CPs have been interested in, and in a number of cases, objected to aspects of Brexit that may discriminate against those CPs. Therefore, we cannot rule out a challenge to any “short form” interim agreement agreed between the UK and EU-27. Some CPs, such as Japan or the US, that have businesses operating in the UK that would be affected by Brexit may take the view that it is not in the Japanese interest to complain, but there are many CPs who may simply want to challenge the interim agreement because of MFN. As to grounds for the challenge, clearly if the interim agreement did not cover substantially all trade between the UK and EU-27, then that would be an issue. It is also the case, noted above, that the interim agreement “shall include a plan and schedule for the formation of such a customs union or of such a free-trade area within a reasonable length of time.” it is clear that the WA does, but until any alternative is drafted, it is not clear that that alternative would be beyond challenge.
So where does this leave us? If the UK leaves the EU-27 without the agreeing WA, then unless the EU-27 changes its position dramatically and agrees some other form of interim agreement, the UK and EU-27 will have to impose tariffs and other trade barriers on trade between them. Is it likely that the EU-27 will agree an interim agreement that is not the WA? And will any interim agreement that is not the WA pass muster at the WTO? That is the multi-billion dollar question.