The EU is not a free trade area but a customs union: until we understand the difference, the debate about our membership is meaningless

An excellent piece by Daniel Hannan, reproduced in full.

 Here’s your starter for ten: what’s the difference between a free trade area and a customs union? It might sound like a technical question, but it goes to the heart of our relationship with the EU. And it’s becoming increasingly clear that lots of people, including economics correspondents, don’t really know the answer, which makes it hard to have a meaningful debate about our options.

A free trade area is a group of states which have eliminated most or all tariffs and quotas on their trade. Sometimes, their agreement covers only manufactured goods and commodities. Sometimes it applies to services, too. In a few cases, it incorporates free movement of labour. Examples of free trade areas are Nafta (Canada, the United States and Mexico) and ASEAN (ten South East Asian states).

A customs union involves internal free trade, but also a common external tariff. Its members surrender their separate commercial policies, and give up the right to sign trade agreements. Instead, trade negotiations are conducted, and treaties signed, by the bloc as a whole. Customs unions often exist where one state administers another, or where a tiny nation contracts out its trade policy to a larger neighbour: Swaziland and Lesotho are in a customs union with South Africa, Liechtenstein with Switzerland, Israel with the Palestinian territories. Other than the EU, the two chief customs unions on the planet are Mercosur and the Andean Community. (Though Brussels was so heavily involved in launching these two blocs that they might almost be considered creatures of the EU).

One way to think of the difference is this: Nafta could accept Britain while allowing it to enjoy free trade with the EU; but the reverse is not true.

The two models coexist in Europe. EFTA is a free trade area. Its members buy and sell unrestrictedly with each other and with the EU. They can also sign commercial accords with non-European countries. Switzerland, for example, has signed a free trade agreement with Canada, and is negotiating one with China.

Britain, despite its historical links to Canada, can’t sign such an accord. Nor can it press home the advantage of its growing exports to China (up 40 per cent in two years, as the PM delightedly told his party conference). In both cases, it must wait for the EU to negotiate on its behalf.

We suffer disproportionately from the EU’s common commercial policy because we conduct an exceptionally high percentage of our trade outside Europe. In 2011, non-EU markets accounted for 57 per cent of our exports; the equivalent figure for Belgium was 22 per cent. The EU’s Common External Tariff averages between five and nine per cent – higher than Britain had in the 1920s.

The optimum deal for the United Kingdom is surely to be in a European free trade area but not in a customs union. Again and again, we have been forced to sign less liberal accords than we would have negotiated bilaterally in order to accommodate some protectionist interest on the Continent.

And, of course, membership of the customs union has sundered us from our hinterland. Among the countries with which the EU has negotiated no trade deals at all, beyond the WTO minimum, are the United States, Australia and New Zealand (it is lumberingly getting around to talking to Canada, long after Norway and Switzerland signed their own treaties there).

This is, oddly enough, more of a disadvantage now than it was 40 years ago, because the Commonwealth has grown much faster than the EU, and is forecast to grow at an astonishing 7.3 per cent annually for the next five years. We have purchased membership of a stagnant customs union at the expense of free trade with growing global markets.

Why isn’t this a bigger talking point? Why don’t we hear the statistics more often? Precisely because trade policy ceased to be an issue when we handed it over to Brussels in 1973. In other countries, commercial accords are the major component of foreign policy. Legislators debate them all the time. Journalists take sides. Academics publish detailed papers. Here, as in other EU states, trade has more or less disappeared from public discourse.

Consider, for example, the exchange I had on Twitter a couple of days ago with Evan Davis, the able and impressive BBC presenter:

ED: But among get-outers, what % d’yu think have favoured customs union & single-market as opposed to complete & total withdrawal?

DH: Please understand that the customs union and the single market are two very different things

ED: Indeed fair point. The two are very different. So we have three options. a) Into SEM and Customs union; b) Into customs union, out of Single mkt, and c) out of both.

DH: Er, no. d) IN a free trade area but OUT of the customs union, free to sign an FTA with China.

ED: OK, I won’t argue. Let’s assume others will allow us (d).Then how do sceptics divide between (a) to (d)? Roughly

DH: d) is what Switzerland does and is the preferred choice of most people I talk to.

ED: But I’m right in thinking CH adopts the single market regs? I thought some UKIP folk were against that, no?

Not really, Evan. Switzerland applies some single market measures as a result of its bilateral free trade accords with the EU. It does so as a sovereign country, through domestic legislation, rather than through the direct applicability which pertains on EU territory. But the percentage is lower than in Norway, and immensely lower than Britain. Switzerland has implemented fewer than 2,000 single market directives since 1992; the United Kingdom more than 30,000.

To put it another way, although Swiss exporters must meet EU standards when selling to the EU – just as they must meet Japanese standards when selling to Japan – they are not usually obliged to apply those rules to their domestic sales. In consequence, Switzerland enjoys a competitive advantage with no depreciation of its exports to the EU. In 2011, Switzerland’s sales to the EU were, in per capita terms, four-and-a-half times as much as Britain’s.

Evan Davis is an economics journalist, and a good one. He knows all about this sort of thing. If even he is so far from understanding what Eurosceptics want, we plainly have a great deal of work to do.

I realise that this has already been a very long post, but it’s important, in advance of any referendum, to define our terms. Politicians and pundits often use labels like ‘renegotiation’ and ‘complete withdrawal’ without being clear about what they mean.

Could Britain withdraw from the Common Commercial Policy while still calling itself a member of the EU? Probably not, but even here possibilities exist. The most protected element of the EU’s economy is agriculture. Recent reforms have seen a shift in the CAP away from guaranteed prices toward direct subsidies, paid at national level. Having come this far, it is much more feasible for a county to opt out altogether, which would mean, in practice, withdrawal from the largest element of Euro-tariffs.

When it comes to services, the rules are still being developed. There are growing areas of the economy where, in practice, no external tariff applies.

And, of course, as the WTO lowers tariffs on all goods worldwide, the issue becomes easier to resolve.

We need to be clear about what is in our national interest. We are a trading nation, with few natural resources, dependent on what we buy and sell. The central economic fact of this century is the embourgeoisement of what we still think of as developing countries. In the last three months for which we have figures, our exports to the EU fell by 7.3 per cent while our exports to the rest of the world rose by 13.2 per cent. We need to familiarise ourselves with these statistics; it may not be long before, in a referendum campaign, we are deploying them in anger.


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