"Examine the argument that the UK economy will be better off by remaining inside the European Union Customs Union. Use diagrammatic analysis to support your answer." (25 Marks)
Contextual background (not part of the answer)
The EU accounted for 46% of UK exports of goods and services and 53% of imports in 2018. The UK had a trade deficit with the EU of £64 billion in 2018 and a trade surplus of £33 billion with non-EU countries. In June 2016, the United Kingdom voted in a referendum to leave the European Union. Some economists argue that the economic performance of the UK economy in the long run would be better served by an agreement to remain inside the EU customs union.
KAA Point 1: Keeping trade frictions low
Customs Union (CU) involves free trade between members & a common external tariff on imports from non-member countries. One argument for remaining is that EU is UK’s biggest trade partner – lots of cross-border trade e.g. component parts. Inside CU makes it less costly for TNCs to invest & produce in the UK and then export to EU. Extra trade friction costs outside CU lead to higher consumer prices & lower real incomes.
EVAL Point 1: Trade with faster-growing economies
Staying outside the Customs Union means that the UK can negotiate new preferential / free trade agreements outside the EU with faster-growing countries such as China, India, Australia, Vietnam and South Korea. Although the EU is the UK’s biggest trade partner, the % of trade in goods and services with the EU has been falling and other parts of the world economy are growing more strongly.
KAA Point 2: Economic costs from EU tariffs
If the UK leaves the Customs Union (and in the absence of a trade deal with the EU) then import tariffs would apply to UK exports. The average EU import tariff is 4.8%. The EU CET ranges from 0% on pharmaceutical products and 11% on footwear to 45% on tobacco. Higher tariffs can damage consumer welfare and lead to regressive effects on the distribution of income along with higher inflation and interest rates.
EVAL Point 2: Average tariffs have been falling
Staying inside the EU customs union would mean that the UK would be obliged to follow changes in EU trade agreements without any say in how they were negotiated. And whilst there would be some additional tariffs initially, a UK-EU trade agreement is likely. Average import tariffs have fallen in recent years which might help mitigate the macroeconomic effects of leaving the EU Customs Union agreement.
FINAL CONCLUSION
Overall, continued membership of the customs union in my opinion is likely to be best for the UK. The gravity theory of trade suggests strongly that we trade more with countries in close proximity and this is unlikely to change fundamentally in the years ahead. The EU has more than sixty five free trade and preferential agreements with over countries including Canada, South Korea and Australia and there is no guarantee that the UK will be able to achieve better deals with these countries on their own. In a globalized world, keeping trade frictions low is vital to continue to attract inward investment. Nissan has a UK workforce of 6,700 and exported around 250,000 cars to the EU in 2015, around half of its output. Those exports would face a tariff of up to 10 per cent outside the customs union unless a free trade deal could be negotiated. Honda has already announced that it will be closing their Swindon plant in 2021. These are important sources of jobs and incomes for regions outside of London, and provide evidence that the UK should continue to stay inside the CU for the foreseeable future.
