Customs union

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What is a customs union?

A customs union of countries does two main things: it removes tariffs – duties paid on particular imports or exports – between members and it sets up a common external tariff to non-members. The common external tariff means that, generally, the same tariff is charged wherever a member imports goods from outside the customs union.

There are currently 16 customs unions notified at the World Trade Organization. Each has a common external tariff which covers the majority of trade, but most have exceptions. For example, where the EU’s Customs Union covers all goods, the South American customs union MERCOSUR (which includes Argentina, Brazil and Uruguay) does not cover motor vehicles and sugar and Turkey’s customs union with the EU does not cover primary agricultural goods and coal and steel products.

A customs union on its own is irrelevant to services (services don’t have tariffs).

How does a customs union differ to a free trade agreement?

A free trade agreement (FTA) is an agreement between countries that removes tariffs and other restrictions on goods which are traded between those countries.

The main difference between a customs union and a free trade agreement is that even where zero (or reduced) tariffs are part of an FTA, extra bureaucracy is needed to take advantage of those tariffs. Exporting under an FTA means companies have to comply with a complex set of rules (known as preferential rules of origin) to prove that goods have only come from countries who have signed up to the FTA.

For example, in the EU–South Korea free trade agreement, a car arriving in the EU from South Korea must be 55% ‘made in Korea’ to qualify for tariff-free access. That requires exporters to know and to be able to prove where different inputs have come from in their supply chain. The intention is to ensure that, for example, Chinese parts, which aren’t covered by a trade agreement with the EU, could not enter South Korea at a lower rate and then be counted towards the South Korean contribution when exporting to the EU.

For a customs union, once the common external tariff has been paid for a product then it is in “free circulation” and traders only have to prove the common external tariff has been paid on goods or parts they have used. This is much easier to demonstrate than proving the origin of imported goods. 

Does a customs union create a frictionless border?

A customs union does not, on its own, create frictionless goods trade.

It does not remove the need for customs documentation – including an advance declaration for a security check, a movement certificate, an invoice and transport documents. At the border there are a multitude of checks that authorities can conduct such as regulatory checks, VAT checks and smuggling checks that are not removed by a customs union alone. Being a member of the EU Single Market largely reduces these checks.

The Turkey–Bulgaria border shows that even a customs union with further provisions on regulation is not sufficient for frictionless goods trade. Turkish hauliers routinely suffer traffic congestion at the Turkey–Bulgaria border, partly because their agreement with the EU does not cover transport services. 

What might a UK-EU customs union look like?

There are two examples that could provide some clues as to what a UK-EU customs union might include: the EU-Turkey Customs Union and the Irish border backstop which the UK has already negotiated with the EU.

Turkey has aligned a majority of its technical goods regulation with the EU in order to simplify cross-border trade. It has also adopted some level playing field provisions on state aid and competition. However, the EU-Turkey Customs Union has led to a number of unresolved disputes.

The EU has clearly already sought to ensure that the problems it has had with Turkey – over enforcing the terms of the arrangement and settling disputes – would not be repeated with the UK in the backstop. The backstop outlines a common external tariff with the EU along with strong level playing field commitments in state aid and competition. There are looser non-regression commitments for social and environmental standards that try to lock in the current levels of protection, but do not commit the UK to ongoing alignment. How this is built on and what institutions enforce the level playing field will be an important part of a future UK-EU negotiation.

Ultimately the level of integration beyond the backstop would be up for negotiation. 

What would a customs union with the EU mean for an independent trade policy?

A customs union would limit, but not entirely remove, the scope for the UK to have an independent trade policy.

A customs union would not prevent the UK from regaining control over trade policy issues such as services and visas. The major limitations for the UK would be that it would not have free control over its tariffs – it would not be able to offer lower tariffs to partners the EU had not already lowered them for, nor unilaterally lower tariffs below the EU’s.

The UK would most likely still need to negotiate its own agreement with future EU trade partners to bring its tariff into line with the EU. That is how Tukey’s customs union works. Like Turkey, the UK would continue to apply tariffs to imports from a country with whom the EU had negotiated an FTA. Only when the UK also negotiated a deal would it lower its tariffs in line with the EU.

Circumvention, which is an issue for Turkey, could also affect the UK. In Turkey’s case, for example, this means that while tariffs are still imposed on direct imports from Canada, once goods from Canada – which has an FTA with the EU – are cleared to enter the EU market, they can be shipped into Turkey without tariffs. So this hinders Turkey’s attempts to negotiate deals with Canada – and other countries which already have deals with EU. However, within the EU-Turkey Customs Union, there are provisions to guard against circumvention – they apply a (temporary) levy on Mexican cars that enter Turkey via the EU. However, that would then increase the barriers to trade between Turkey and the EU.

The UK is not necessarily going to face the same issues as Turkey. The UK is a larger, well-regulated market, and a trade deal can cover many issues beyond tariffs. But the UK’s inability to lower tariffs below the EU’s would limit one of the UK’s key bargaining chips for negotiating deals – particularly as the UK is particularly interested in gaining access for UK services, in return for more favourable goods access. 

Will the EU let the UK have a say in its future trade policy?

The UK is unlikely to get an equal say in comparison to the 27 EU member states. It could ask for mechanisms to improve consultation. For example, there could be UK participation in the work of EU trade committees. The UK could also ask the EU to insist that a country which is negotiating with the EU also negotiate equivalent access to UK products. There would be mutual incentive in negotiating in parallel to coordinate the leverage both markets offer.

However, consultation would not amount to the membership rights of a vote – one of the EU’s core negotiating principles is to retain autonomy of decision making. There have been suggestions that a different arrangement, with a degree of co-decision, could be agreed – but so far that has had no traction with member state governments. As a result, the UK would not, under current arrangements be able to be a decision maker on future EU trade policy.

What would the economic impact of a customs union be on the UK?

The economic impact of a customs union largely depends on what is assumed about additional provisions for tackling regulatory barriers to trade. The National Institute Of Economic and Social Research finds that UK gross domestic product (GDP) would be 3% worse off in comparison to remaining in the EU if the UK agreed a customs union. It assumes a broadly similar situation to the backstop, with a different relationship for Northern Ireland, a common external tariff for the UK and no other regulatory provisions.

Another assessment by Rand that compares a customs union to something akin to Switzerland – in other words more alignment and reduction of barriers in goods – suggests there would be a 1.95% decrease in GDP in the long term.

Update date: 
Thursday, May 9, 2019
Authors: Alex Stojanovic