As March 2019 draws closer, the UK government remains divided over the type of trade relationship it wants to achieve in the ongoing negotiations with the EU. Paola Conconi (ULB/LSE) explains why Japanese multinationals may pull out of the UK in case of a hard Brexit, one which would mean there is no kind of customs union with the EU.
Some members of May’s Cabinet are pushing for a “soft” Brexit, which would allow remaining close to the EU’s single market and customs union. Others favour a “hard” Brexit and aim to strike a trade deal similar to CETA, the agreement concluded between the EU and Canada. Multinational corporations with plants in the UK favour a soft Brexit. In a leaked report, the Japanese government points out that 879 Japanese companies, including manufacturing giant Hitachi and carmakers Honda, Nissan and Toyota, employ 142,000 staff in Britain. It calls Mrs May to keep Britain in the EU single market and customs union, warning that Japanese companies may otherwise relocate to continental Europe.
On February 8, Mrs May met with Koji Tsuruoka, Japan’s ambassador to the UK, and representatives of major Japanese companies including carmakers, other manufacturers, and banks. Speaking after the meeting, the Japanese ambassador has reiterated the warning that his country’s firms will leave Britain if Brexit makes it “unprofitable” to stay. “If there is no profitability of continuing operation in the UK, not Japanese only, no private company can continue operations,” Mr Tsuruoka said.
Multinational companies like Honda and Nissan have used the UK as their base to serve the European market. For example, almost 80% of the cars manufactured by Nissan in its plant in Sunderland are currently sold to consumers in the rest of Europe. EU membership guarantees regulatory alignment with the rest of Europe and duty-free treatment. Exit from the single market would imply that UK and EU regulations are no longer automatically aligned. More importantly, exit from the customs union would mean that multinationals may face high tariffs if they want to serve EU customers from the UK.
This may seem surprising, given that in free trade agreements like CETA tariffs on most manufacturing products are slashed to zero. The key difference is that, within a customs union, goods cross borders without any checks at all. By contrast, in a free trade agreement, shipments need to be checked by customs authorities to ensure that they conform with rules of origin (RoO). Only goods that comply with these rules are considered as originating from member countries and are granted preferential tariff treatment. Satisfying origin criteria is straightforward for simple goods like iron-ore but is much more complicated for goods like cars, which are produced in international value chains using components from around the world.
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In a recent study (Conconi et al., 2018), we show that rules of origin in free trade agreements distort global value chains, deterring final good producers from importing inputs from non-member countries. We have constructed a unique dataset of the RoO contained in NAFTA, the world’s largest free trade agreement: for every final good, we can trace all the inputs that are subject to RoO requirements; similarly, we can link every intermediate good to the final goods that impose RoO restrictions on its sourcing. Exploiting cross-product and cross-country variation in treatment over time, we show that NAFTA RoO led to a sizeable reduction in imports of intermediate goods from third countries relative to NAFTA partners. In terms of magnitude, our estimates imply that imports of affected intermediate goods from non-NAFTA countries would have been around 45% higher in the absence of RoO.
Our study can help to explain why Japanese multinationals may pull out of the UK in case of a hard Brexit. Companies like Honda and Nissan rely on global supply chains. For example, key components for the models they produce in the UK are imported from Japan. Right now, they can automatically sell the cars they produce in the UK to the rest of the EU at zero tariffs. In the case of a UK-EU free trade agreement, they would face a tradeoff, if they decide to remain in the UK: stop importing key components from Japan and other non-member countries, to comply with rules of origin and obtain duty free treatment; or keep their global value chains in place, but face a 10% tariff when exporting their cars from the UK to the EU. Relocating to continental Europe would allow them to remain in the customs union, avoiding this tradeoff.
Leaving the customs union would thus be more problematic than envisaged by both voters and politicians at the time of the Brexit vote. It would not only raise the possibility a hard border between Northern Ireland and the Republic, endangering the reconciliation process between them; but it may also lead multinationals to move out of UK, resulting in the loss of thousands of jobs. It is then not surprising that Jeremy Corbyn has called for the UK to be in a permanent customs union with the EU.
If, as it seems likely, the government decides to go for hard Brexit, it should make sure that the rules of origin it negotiates with the EU as part of the new trade deal are as flexible as possible, to minimise the distortion of global supply chains and the risk of relocation of multinationals. The devil is in the detail: what threshold of minimum domestic content is agreed on cars may, for example, decide whether companies like Honda and Nissan remain in the UK or move to France or Germany.
This post represents the views of the author and not those of the Brexit blog, nor of the LSE. It is based on the LSE’s Centre for Economic Performance Discussion Paper No 1525, “From Final Goods to Inputs: The Protectionist Effect of Rules of Origin” by Paola Conconi, Manuel García Santana, Laura Puccio and Roberto Venturini (forthcoming in the American Economic Review).
Paola Conconi is Professor of Economics at the Université libre de Bruxelles (ULB) and Visiting Professor at the London School of Economics. She is the Director of the CEPR Research Network on Global Value Chains, Trade and Development.
Longer paper very interesting. But I was left puzzled by a couple of points.Can RoOs really be called trade barriers? They are an inevitable consequence of an FTA (as opposed to CU)? Intriguingly, most criticisms of how RoOs work imply tight RoOs reduce the degree of preference in the FTA and so are likely to reduce trade diversion, but this work suggests they increase preference margins. One Mexican official said to me if US tightens automotive RoOs, assemblers will stop assembling US components in Mexico and just source and assemble in Asia!
Whilst I do not disagree with the general conclusions that RoO means that production stays within the agreement area I disagree that the UK car industry will move to Germany and France.
Why? Because simply even before Brexit the UK car industry (as well as the EU industry) have been moving suppliers to closer to the factory. They do this because the old model of making stock cars, leaving them in a field and then offering discounts to shift them is unprofitable. The profit is made making customised cars to individual customer spec and supplying them quickly. So having 6 weeks stock sat on a boat costing Nissan 250 million a year is not good. They want the factories that make those products next to the Nissan plant so they can say tomorrow we need x red ones, y blue ones and z green ones. This was/is happening irrespective of brexit.
So as the Manufacturers in the UK have publicly stated they want to accelerate the movement of suppliers to the UK and have asked the Government to put up a 100 million fund to aid this process. Quite the opposite of them moving to France or Germany which would be financially very bad for them. (Ford and Opel have big plants in Germany and can not make a profit).
On a fact checking basis so errors in the article. The article states that Nissan export 80% of production to the EU. They do not, they export 80% of production to 130 countries around the world including Infinitis to USA. Also previously to Sunderland getting the X-Trail, X-Trails were made in Japan, so subject to 10% tarrifs when sold in the EU and this was a successful model in sales and Japan is not a cheap manufacturing location. The flagship model at Honda Swindon is the Civic. The Civics that are sold in the continental EU are made in Turkey, the Civics made at Swindon are exported all over the world including Japan and USA. In fact the top selling by volume Honda in Europe is not even made in the EU, nor in a country until recently made in a county with an FTA with the EU, let alone a customs union, the CRV made in Canada.
Because of these facts I would argue that being in the Customs Union or Single Market is being overblown. It does not seem to be a big issue for the car makers.
On this Nissan point you’re correct that the 81% that exported does not all go to the EU. However even exports not going to the EU will almost certainly be exported under EU FTA’s or other types of EU trade agreements. The UK exports virtually nothing under WTO terms.
Indeed specifically in the case of my business we will be more damaged by the exit from the EU’s FTAs then we will by the loss of the EU Single Market.
It’s also worth remembering that Colin Lawther, Senior Vice President at Nissan has gone on the record to a Parliamentary committee that leaving the customs union will be a disaster for Nissan Sunderland. I’m not an expert on care manufacturing but I believe Nissan. I don’t really see why they would submit detailed, dishonest testimony.
Very interesting! Just moved back to the UK after over ,40 years in Florida. Just learning about the pros and cons of Brexit.
No he has not gone on record as saying leaving the customs union is a disaster. Journalists spun it that way, but that is not to their credit.
He discussed in great deal customs unions, free trade and even gave Nissans preferences (free trade above customs union). He also said disruption to Nissans parts supplies would be a disaster, but that this happens to days, when we are in the customs union (French Unions) and they have a “military Operation” to activate new routes.
The full transcript is here.
http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/international-trade-committee/uk-trade-options-beyond-2019/oral/48155.html
Q627 Chair: So you are quite comfortable outwith the customs union?
Colin Lawther: No, our position is the same as it was before the vote. It would be better to stay in a status quo so that we have surety of business going forward. That would be the best outcome for us at the end of the Brexit process—that we remain in a free trade agreement, we have access to the customs union, and technology is harmonised across Europe. Stay as we are is the ideal solution for Nissan.
It’s diplomatic language but looks like disaster:
Q628 Chair: But if the UK ends up trading with Europe at WTO rates or circumstances, are Nissan happy and comfortable with that?
Colin Lawther: The best business solution is to stay as we are.
Chair: I understand that, but are you happy to be trading at WTO?
Colin Lawther: No, we are better off staying as we are. Anything changing from the WTO changes the business circumstances, so we would have to look at the degrees of change and adjust our business to take into account whatever this new trading platform would be.
Seeing as we have had such angst over £350 million on the side of a bus, it’s not acceptable to say “it is diplomatic language but looks like disaster.”
The last sentence is plain to read. Circumstances change so they will change their business.”
This happens all the time in the business world. Overnight Trump has announced steel tariffs, business will adapt to this change. He is also right to say that the status quo is best for them, they would have preferred to not have the GFC happen or Dieselgate, but they will deal with all of them.
As is also in the transcript the major change that he is worried about is the move to EV platforms. Nothing to do with Brexit.
The truth is no-one really knows the true fallout of leaving the EU and customs union for manufactures like Nissan until it happens. We import more cars than we export,, so there is an argument that UK, manufactures could make more cars for the local market, especially if imported cars become more expensive.
But of course business including the stock market is based on confidence. Being able to predict in several years time, what sales will be like and be able to plan investments in confidence of costs versus sales.
Nissan does not have that.
If it wasn’t for its excellent performance, I believe its future would be less in the balance.