Dr Peter Holmes—Supplementary written evidence (ETG0011)

The Customs Union vs A Customs Union: possibilities for the UK and the EU[1]

Many commentators have suggested that the UK might continue to be in the EU Customs Union whilst outside the EU.

This note tries to elucidate the implications of this. It suggests that remaining within the EU Customs Union for more than a short transition period is hard to envisage and what is in principle available is to have a Customs Union with the EU Customs Union.

The example of this is Turkey and this note argues that such an arrangement would be highly unsatisfactory. It is in principle possible to imagine a Customs Union arrangement including the EU and the UK that was closer to the status quo than to the Turkey arrangement.

What is the EU Customs Union?

The EU’s Customs Union encompasses its member states plus Monaco and the Isle of Man. Strictly speaking Andorra, San Marino and the Vatican City are not part of the Customs Union, but San Marino is treated as part of Italy’s Customs territory. [2] 

The Rome Treaty stated that the EU (then EEC) member states would form a Customs Union. The Customs Union is not a separate entity that EEC member states all happen to belong to.

But the primary non- EU territory linked to the EU in a customs union relationship is Turkey. Turkey is not part of the EU CU. Rather it has a Customs Union agreement with the EU that differs sharply from the EU Customs Union itself.

If the UK left the EU, it is extremely hard to see how it could be part of the EU CU, except as part of a transition process. Actual EU Customs Union membership requires full application of the EU’s common external tariff, including preferences and services. (The EU does permit national variations in services however where individual national variations are possible in GATS schedules).  Within the Customs Union all EU originating goods and imports that have paid duty have the right of free circulation, so there are no rules of origin within the EU. There is no possibility of anti-dumping duties etc. Since the EU is also a “Regulatory Union” there is no scope for goods being stopped for technical inspections: the direct effect of EU law means that EU technical norms must be applied in the production process of goods.   And Customs revenues on goods from third countries must be handed over to the Commission.  The EU Customs Union is defined in the Treaties as being made up of members of the EU. Of course it is imaginable to think of a relationship which replicates the obligations of members of the EU without having any of their rights. It is a little hard to see why this would be desirable. 

As long as we stayed in the Customs Union or in an equivalent relationship we would have to follow all changes in trade rules set by the EU. Applying these conditions would constitute de facto continuing membership of the EU. Before 1993 the member states of the EU had a Customs Union with a common commercial policy(CCP)[3] but continued to have customs borders.  The borders ended when the single market rules came into force. Logically it is possible to have a Customs Union with a CCP and no tariffs on internal trade but to retain technical inspections at the border. In the EU the two types of union have been merged.

The Turkey EU Customs Union

Turkey however is not part of the EU Customs Union, but has a Customs Union with the EU. This Customs Union is very different from the EU’s own CU. It excludes agriculture. This alone means that there have to customs posts at the border. It includes a great a great many general exceptions to the principles of a customs union. It also excludes services and free movement of labour. There is no sharing of customs revenue.[4]

The rules of the Customs Union are set out in a 1995 document that lists the rights and obligations of both parties.[5] It removes all tariffs  between the parties and also provides for harmonisation of external trade rules.

It provides in Art 12 :

“From the date of entry into force of this Decision, Turkey shall, in relation to countries which are not members of the Community, apply provisions and implementing measures which are substantially similar to those of the Community's commercial policy”

“Substantially similar” means there can be exceptions.

Andre Sapir recently observed: “As a result, the EU-Turkey customs union is in fact a hybrid between a genuine Customs Union and an FTA. This is demonstrated by the fact that Turkey has adopted the EU’s common external tariff for most, but not all, industrial products and only for some agricultural products; it applies additional customs duties for some textile products from countries outside the EU and the EU’s FTA partners; it applies trade defence instruments, such as anti-dumping and countervailing duties, in a totally different manner (for different products and countries) than the EU; and it has not concluded FTAs with some EU FTA partners (including Mexico, South Africa and Ukraine).” http://bruegel.org/2016/08/should-the-uk-pull-out-of-the-eu-customs-union/

Anti-dumping duties are important. According to a recent World Bank study [6]

for the European Commission, only about 15% of Turkish and EU AD investigations were on the same product (para 74) in the period 1995-2011.

The EU in 2014 had AD duties in place or proposed on $500m worth of Turkish exports to the EU and Turkey had actual or proposed AD duties on $1bn of EU exports. Over the period 1995-2011 the World Bank found that of “219 different products that Turkey investigated under its antidumping policy during 1995-2011, just seven (three percent) targeted exports from the EU. Approximately nine percent of the total number of products that the EU targeted with antidumping investigations over 1995- 2011 were aimed at Turkey. “World Bank para 75.

Article 16 of the Customs Union text states that Turkey “will” sign FTAs with countries that have signed agreements with the EU, but this does not require third countries to sign such agreements, and as Sapir notes there are several important exceptions. In the case of Korea, the Turkey Korea agreement was signed several years after the EU-Korea deal. There is no obligation on a third country partner to sign an FTA.

Where the EU has signed an FTA but Turkey has not, there is a risk of Trade Deflection. Goods may be imported into duty free the EU and sent on duty free into Turkey. According to the World Bank:  “For those countries with which the EU has agreed an FTA but Turkey has not, imports can also enter Turkey duty-free via trade deflection. But for those imports arriving directly at Turkish ports, import tariffs are charged”, (Fn 16 p. 24)[7].Obviously this would induce third countries to send goods in transit via the EU. Mexico has apparently refused to sign an FTA with Turkey. The World Bank reports (para 74)  that  in this case as in several others Turkey has been able to invoke a little known exemption clause Article 16(3) which allows Turkey to put import surcharges on third country goods in such circumstances.

The EU can introduce measures against third country goods coming via Turkey. This led to a very important WTO dispute settlement case brought by India against Turkey[8]. After the Customs Union Turkey under EU pressure had introduced quotas on textiles from India to come into line with the EU’s MultiFibre Arrangement quotas. India brought a case at the WTO. India won with the Appellate Body in effect saying the EU Turkey Customs Union had so many barriers that if the EU wanted to stop trade deflection via Turkey it had many border controls at its disposal. In effect it implied the EU-Turkey Customs Union was not a true Customs Union in WTO terms.

The EU-Turkey Customs Union is not a “Regulatory Union”

The 1995 agreement abolished customs duties but not technical barriers. The Customs Union agreement did not create a Regulatory Union as did the EEA agreement. Turkey was required to harmonise technical regulations with the EU, but the EU did not automatically recognise Turkish compliance and grant exemption from controls. A series of Mutual Recognition Agreements on conformity assessment starting in 2006 has gradually allowed more Turkish goods to enter the EU without further technical inspections, but an excellent survey by Togan notes that these agreements facilitate entry only where the EU has harmonised its rules internally. Where separate national rules are applied by member states, the customs authorities can insist on the right to inspect Turkish goods[9].

Clearly for the UK, at the point of Brexit, all our standards would still be aligned with the EU, but new EU rules would not automatically be incorporated into UK law and on exit the EU’s compliance would cease to be supra-nationally enforced without an arrangement such as the EEA’s EFTA court. For Turkey compliance is enforced by Turkish courts and the threat of trade sanctions.

The contrast with the EEA.

The EEA is a regulatory union but not a customs union, so that there are customs duties on third country goods and any goods whose import content does not meet the rules of origin. So at the borders with Norway Iceland and Liechtenstein goods are checked for origin but not for compliance with EU technical rules, because membership of the EEA implies full legal compliance with all EU rules.

By being a Free Trade area not a Customs union the non-EU EEA members have the right which Turkey does not have to sign whatever Free Trade Agreements they wish. But this only applies to tariffs. As we have seen, regulatory measures are extremely important and a UK in the EEA but not the EU could not sign any agreement that lowered technical barriers to trade with the EU. A recent Bruegel paper  notes :

“What would be the consequences for the EU of China signing an FTA with the UK while the UK maintains at least an FTA with the rest of Europe, if not full participation in the single market? This ‘status quo’ scenario should raise concerns for the EU about whether Chinese exports could use the UK ‘back door’ to enter the EU market without China signing a bilateral FTA with the EU.” [10]

This would not be allowed by the EU. Norway is thus restricted in its ability to sign “deep” trade agreements with third countries that include relaxation of technical barriers and so too would the UK be. .

What are the overall Implications for the UK?

Being part of the EU Customs Union but not in the EU makes no sense. It is logically possible to have an arrangement with the EU that mimics the effects of the current situation whilst denying the UK any rights as a member. This is imaginable as a transition arrangement but would clearly need to be negotiated as such an arrangement does not exist so far.

In principle the UK could sign a customs union agreement with the EU as Turkey has done, but I would argue that this is wholly unsatisfactory from a trade perspective. The Turkey Customs Union is not really a full CU. It does not allow fully free trade in both directions. It takes away the right to have an independent trade policy with third countries, but allows third countries that have signed an FTA with the EU to enter the Turkish market unless special derogation provisions are used. This would surely be unacceptable to the UK.

A closer customs union arrangement between the UK and the EU is not unimaginable

By contrast the EEA agreement offers market access to the EU free of technical barriers, but duty free access only for goods meeting origin rules. It necessarily means full supranational implementation of EU acquis, as well as free movement of labour. The EEA appears to allow more freedom to sign FTAs with third countries but this is only partially true as respect for EEA regulatory rules means only tariff barriers can be negotiated with third countries.

October 2016