What exactly is a Canada-style deal?

Beth Oppenheim is a researcher at the Centre for European Reform and Charles Grant is director of the Centre for European Reform.

The European Commission believes that the only plausible future economic relationship between the EU and the UK is one modelled on the EU’s free trade agreement with Canada. Michel Barnier made that clear on Friday after the Commission and the UK agreed the broad outlines of our divorce agreement. The British hope to achieve something better than Canada in the next phase of the Brexit talks. David Davis said told the BBC today that he wanted “Canada, plus, plus, plus“. But, if he can’t get any of the pluses, a “Canada Dry” deal would pose problems for the UK economy.

What “Canada” offers

The EU-Canada Comprehensive Economic Trade Agreement (CETA) has been lauded by the EU and Canada as “the gold standard for future trade deals”. It abolishes almost all tariffs on goods, with most eliminated immediately, and some phased out over three to seven years. The agreement also reduces some non-tariff barriers, promising greater cooperation between Canadian and EU regulatory authorities.

The agreement establishes mutual recognition of Conformity Assessment Bodies in some sectors, for instance for machinery and electrical goods, meaning that the EU allows Canada’s assessment bodies to certify that goods made in Canada meet European standards, and vice versa. This is narrow in scope, and does not mean mutual recognition of the standards themselves. Furthermore, these mutual recognition agreements do not cover sectors that are important for the UK, like chemicals, food and drink, so such products would need to be checked at the border.

CETA offers improved access to some services markets, like telecoms, energy and maritime transport, and allows firms to bid for public procurement contracts in the other market.

What “Canada” misses out

But Canada without any pluses would not suit the UK at all well. A CETA-style deal would be a step backwards from the harmonisation of standards and mutual recognition that the UK enjoys as a member of the single market. Some agricultural products are excluded, such as poultry and eggs, while 15 types of fruit and vegetables face tariffs of up to 20%.

The deal also fails to achieve any significant mutual recognition of technical standards. Nothing is established, for instance, on medicines, cars or on the labelling and regulation of agricultural products. Non-tariff barriers in such areas would increase costs for UK exporters and disrupt trade flows.

In some areas, Canada has agreed to abide by EU rules without reciprocation by the EU. Whereas Canada has no say in setting EU rules and standards, all exports into the EU must meet its product regulations, which are more stringent than Canada’s.

CETA has required some legislative changes in Canada, for instance on its Patent Act and its Food and Drug Act, while its businesses are aligning to European standards in many sectors like food, chemicals and electrical equipment. In contrast, the EU has not changed a single technical regulation in response to the agreement. The UK should expect similar asymmetry in any future free trade agreement with the EU: if it wants to minimise the friction of trading with the single market, it will need to maintain European regulations, just like any other non-EU country.

Services: a giant hole

Still more problematic is the narrow scope of CETA’s liberalisation of services. The agreement would be inadequate for a service-driven economy like Britain’s, where services account for 80% of output. The British service sector is heavily reliant on the EU market, with which it enjoys a trade surplus of £14 billion. CETA excludes audio-visual and cultural services, as well as public services like health and education. It offers little on aviation, electricity or, crucially, financial services.

Until now, the City has benefited from the EU’s “passporting” scheme, which allows British financial services companies licensed by the UK to operate throughout the EU without setting up subsidiaries (and vice versa). The EU bought over a quarter of British financial services exports in 2014, worth £22.7 billion. But speaking at a CER conference in Brussels on November 23, Barnier confirmed that passporting would end under a Canada-style agreement.

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CETA’s provisions on financial services do not go much beyond the WTO’s General Agreement on Trade and Services (GATS), of which the EU and Canada are already signatories. CETA provides for trade in financial services by repeating the WTO principles, which include “national treatment”, meaning that financial firms from the other territory must be treated equally to domestic ones.

But GATS has a number of important exclusions, including financial stability rules and consumer protection. GATS does not allow cross-border provision of financial services to consumers, or passporting. So in reality, trade in services under GATS and CETA would offer significantly less market access than EU membership. Such a framework would have serious consequences for the UK’s service industries.

Canada-style would suit EU just fine

A future agreement that was close to CETA would suit the EU much better than the UK. Services exports matter more to the UK than the EU. The UK currently has a trade deficit in goods with the EU of £96 billion a year. Under a CETA-style deal, the EU would continue to export goods to the UK without tariffs. This would benefit British consumers, since the alternative of WTO tariffs would raise prices on imports from the EU, of up to 8% on dairy products and 6% on meat for example.

But while the EU could continue its most important trade, British exporters of services would find access dramatically restricted. A CETA-type deal would only intensify the existing trade imbalance between Britain and the EU.

Losing access to European services markets would hurt the British economy. Treasury analysis conducted before the referendum predicted that the UK would be “permanently poorer” under a negotiated bilateral agreement like Canada’s. The Treasury estimated that by 2030, GDP would have shrunk by 6.2%, trade would fall by up to 19% and foreign investment by up to 20%, compared to what they would otherwise be. Both the figures and the methodology were contested, and branded as scaremongering, but the OECD produced a similar estimate of a loss of 5.1% of GDP by 2030 under a CETA-style agreement. The CBI predicted a more conservative loss of 3.1% of GDP by 2020, and 1.2% by 2030.

A new court, too

CETA also establishes a new investment court system, which has drawn sharp criticism, particularly from trade unions and NGOs. The agreement aims to alleviate barriers to investors entering the other territory’s market. Investors can take a government to the court if they believe that a new domestic law has affected the value of their investment.

Currently, a Swedish energy company is suing the German government for €4.7 billion (£4.1 billion), for allegedly breaching the Energy Charter Treaty – which uses a similar kind of investment court – following Angela Merkel legislating to close Germany’s nuclear power stations.

Critics have expressed concerns that this mechanism could allow foreign investors to de facto shape domestic laws, due to threat of heavy financial penalties. With a CETA-style deal, the British government could find its ability to legislate in the public interest restricted.

The EU will have to accept some tailoring of a Canada-style trade deal to suit the UK, because the structure of its trade is very different to that of Canada. Most of Canada’s top export items (including precious metals and pearls) were duty-free before CETA, and in high demand in Europe. In contrast, many of the UK’s exports are in sectors with high levels of regulatory protection (such as food and chemicals), where mutual recognition would be required to prevent costly compliance checks when goods cross the EU’s border – recognition that the EU has been unwilling to offer in CETA. The UK would also want far more services included, particularly in financial, electricity and aviation markets. But the more bespoke the deal, the more protracted the negotiations will be; CETA took seven years to negotiate.

Ratification

CETA and many of the EU’s FTAs are “mixed agreements”, which means the EU and its member-states exercise shared competence. So if one member-state disliked concessions made to the UK, it could block an FTA. CETA was initially delayed by a rebellion in the Walloon assembly, before being approved by the European Council and European Parliament. It is still undergoing ratification by individual member-states’ parliaments.

A deal that is too generous could risk rebellion – in the European Council guidelines from April 2017, member-states agreed that any FTA “cannot … amount to participation in the Single Market … there can be no cherry picking”. EU leaders care deeply about preserving the integrity of the single market. No other countries participate in it, bar those in the EEA, and they pay a heavy price.

Low politics as well as high principle will influence the EU stance. In services markets such as finance, aviation and audio-visual, some member-states hope to pick up business that may leave the UK – or at least protect home firms from British competition.

This is a shortened version of a report that has already appeared on the CER website. 

Correction: British services sector has a surplus of £14 billion with the EU rather than £24 billion. The article was updated shortly after publication to reflect this.

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Edited by Hugo Dixon