eBSI Export Academy Wins Global Award for Trade Finance Online Programs!

Challenges for EU Supply Chains upon Brexit Day

Introduction

Brexit is very probably the most divisive issue to dominate international political discourse in the last 50 years.  United Kingdom (UK) manufacturers have been a key link in the supply chains of EU companies for over 40 years now.  Brexit may be about to break that link.  To date UK manufacturers have been able to rely on relatively few regulations, free access to EU markets and tariff free trade with the other 27 EU countries. Manufacturing makes up 45% of UK Exports and of that, 52% gets sent to other EU member states. All this may be about to end if the United Kingdom decides to leave without a deal, an ominous event which may take place as soon as 31 October, 2019.  In order to understand the scale of the problem facing both UK and EU companies it is important to review the nature and level of entanglement now in a modern supply chain.  Simple domestic supply chains from primary resource producer to manufacturer to distributor to end consumer is no longer the norm.  We can’t say that a product was made in Ireland any more -  more and more it’s Made in the EU or Made in the World! 

Example of UK Manufacturer in EU Supply Chain

A very clear example of how deeply integrated UK companies are in EU supply chains can be seen on a report from BBC Newsnight where they looked at EU Supply Chains after Brexit.  The case of an engine block manufacturer, Grainger and Worrall Ltd, established in 1946 in Shropshire, in the United Kingdom. They make engine blocks and prototypes for the automotive industry and for formula one racing.  It has established a reliable supply chain with its partners. Here is the timeline of one of its engine blocks destined to enter the supply chain of a French car manufacturer:

Day 1 – Engine Block is cast in UK and takes 5 days to cure.
Day 5 – Engine block sent to Italy for initial machining of the block which takes 5 days.
Day 10 – Block is sent to Germany for 4 days of coating.
Day 14 – Block set to Italy for final machining and assembly which takes 10 days
Day 24 – Block goes to Germany for 3 days of honing
Day 27 – Returns to UK for final cleaning and inspections taking 2 days
Day 29 – Finished engine block sent to French car manufacturer taking 1 day.
Day 30 – Finished engine block enters French car manufacturer’s production line.

As can be seen from this example, the ramifications of customs checks on the 6 border crossings that are currently required to complete this manufacturing process will imply potentially several days additional time to the supply chain timing which can then imply delays for the final client as well as the EU companies involved in manufacturing stages of the engine block (BBC Newsnight, 2017).

There is a risk that this company’s clients may seek alternative manufacturers in other parts of the EU and develop those EU based manufacturers to produce the inputs currently covered by the UK company. 

What are WTO Rules?

At present, any manufacturer within the EU can export its goods to other EU member states with minimal documentation and no customs checks thanks to the EU Single Market.  This will change if the UK crashes out of the EU as they will no longer be a member of the single market nor the customs union and will be treated as a third party subject to World Trade Organisation rules. 

The World Trade Organisation is the global body governing international trade.   It was born out of the General Agreement on Tariffs and Trade under the Uruguay round of talks. 

The WTO has established a series of rules and principles which every member of the organisation must follow and is the foundation of the multilateral trading system.  These rules state that a WTO member must apply its external tariff regime equally – known as the Most Favoured Nation (MFN) principle (World Trade Organisation, n.d.).  Under this principle, a country cannot discriminate between its trading partners.  If a country grants one country a special tariff reduction, it must be applied to all other WTO members. 

As has been seen, the EU external tariff has been steadily reduced and now stands at only between 1% and 1.5% on average but with some important exceptions as will be seen.

Tariff Implications of a No-Deal Brexit on UK Exports to the EU

Even before the Brexit referendum clear warnings were made about the potential impact of leaving the EU without a trade deal, and while the EU external tariff regime is quite benign as can be seen in the chart below:

 However, while in general terms the tariff is low and in some cases zero even without EU membership or a Free Trade Agreement (FTA), there are some tariff categories that do present significant costs and about 35% of UK goods exports to the EU are in sectors where there are high tariffs such as the car industry, textiles, food and chemicals.  The following table shows the potential ramifications of a no deal Brexit on those sectors:

Adding to this challenge is the fact that in a world of increasingly more complex supply chains it is very possible that a manufactured product could have to cross several borders and even repeatedly during its manufacturing process and each step in that journey that requires a border crossing will imply not only additional documentation but additional cost in terms of tariffs applied if under a no-deal scenario (Booth, et al., 2015).

Costs of Export Under a No-Deal Scenario

We have already seen that if the UK crashes out of the EU it will result in the application of WTO rules which will imply the application of the EU common external tariff on goods entering the European Union from the United Kingdom.  There are other costs that will have to be incurred as a result of no longer being in the Customs Union and Single Market.

For example, until now shipping goods from Manchester to Paris has been as easy as shipping them from Manchester to London.  Now it will imply extra export declarations, more customs documents, time delays in crossing borders, and even non-tariff measures such as standards and conformity assessments, regulatory alignment issues over time, and others.

Leaving without a deal also will mean leaving the single market which will imply there will no longer be mutual recognition of standards and the costs associated with quality checks to prove compliance with EU standards. 

According to Berden et al in 2009, their “research on the costs of non-tariff measures between the US and the EU, in comparison to intra-EU trade suggest these are often significantly higher than existing EU tariffs:

Transport equipment:                         22.1%
Post and telecommunications:          11.7%
Textiles:                      `                       19.2%
Electrical and optical equipment         6.5%
Food, beverages and tobacco:           5.8%”

Source: (Berden, et al., 2009)

UK companies supplying into EU value chains will face similar costs which will be passed on, all or in part, to their EU customers. 

There might be ways of mitigating against some of the border / regulatory costs through electronic documentation procedures, trusted-trade programmes, pseudo customs union arrangements, but additional costs will be hard to avoid especially as EU and UK norms diverge over time.

Impact of Brexit on EU Free Trade Agreements

A Free Trade Agreement is an international Treaty between a country or block of countries which agrees the partial or complete removal of tariffs and other non-tariff barriers between the parties to the agreement.  At present the European Union has over 55 Free Trade Agreements with countries around the world.  Under a Free Trade Agreement, a participating country’s exporter must meet established Rules of Origin in order to be able to avail of the benefits of the Free Trade Agreement. 

Rules of Origin “specify the conditions under which a good becomes eligible for zero tariffs in a Free Trade Agreement” (Krishna, 2005).  According to the World Trade Organisation, “Rules of origin are the criteria needed to determine the national source of a product. Their importance is derived from the fact that duties and restrictions in several cases depend upon the source of imports.

There is wide variation in the practice of governments with regard to the rules of origin. While the requirement of substantial transformation is universally recognized, some governments apply the criterion of change of tariff classification, others the ad valorem percentage criterion and yet others the criterion of manufacturing or processing operation. In a globalizing world it has become even more important that a degree of harmonization is achieved in these practices of Members in implementing such a requirement” (World Trade Organisation, 2019).

According to the World Trade Organisation, “Rules of origin are used:

— to implement measures and instruments of commercial policy such as anti-dumping duties and safeguard measures;
— to determine whether imported products shall receive most-favoured-nation (MFN) treatment or preferential treatment;
— for the purpose of trade statistics;

— for the application of labelling and marking requirements; and
— for government procurement” (World Trade Organisation, 2019).

In the example of the manufacture of the engine block by the UK firm given earlier, the ultimate destination of that product was into the production process of another EU firm.  Under the rules of origin, depending on which Free Trade Agreement you would be looking at, an exporter would need to prove that at least 50% of their inputs or substantial transformation was generated within the European Union in order to avail of the relevant Free Trade benefits.  If in this scenario, the French exporter was selling their good for EUR 100 thousand euro and of that sales price, prior to Brexit, 55% of that value was originated within the European Union with 28 members, and of that, 15 percent was of United Kingdom origin, then on the day after Brexit, that French firm would lose its preferential treatment under the Free Trade Agreement because with the UK becoming a third country, the French manufacturer would only have 40% of its value of EU origin.  This is one of the biggest risks for EU companies who use inputs from the United Kingdom because for some products that tariff could be as high as 25% or even higher depending on the treaty counter party country and their external tariff schedule (Gasiorek, 2017).

Mitigating Risks of Brexit using Blockchain

One of the ideas that has been suggested as a solution to the border problem between the Republic and Northern Ireland is to have a ‘technological solution’ to allow seamless border controls after Brexit.  This is based on the application of Blockchain technologies and while it has been rejected by Ireland and the EU, it does hold some credibility with respect to supply chain mitigation. 

According to Bolton, 2018 “Blockchain – otherwise known as distributed ledger technology – works differently: when two people want to transact, that transaction and its specifications are cryptographically logged into a ‘block’ of data. Once the members of the distributed network have verified it, is added to the blockchain, creating a permanent record of the transaction. The network itself is both the medium of transaction and the means of recording it, as the actual blockchain ‘file’ belongs to all of its members, and each owns a copy of it. The result is a permanent record where each new transaction contains information about previous transactions so that it can be consulted at any time. Additionally, its peer-to-peer system means that information can only be modified if a majority of the members of the network agree to do so, making it secure” (Bolton, 2018).

It should therefore be possible, considering the complex supply chains involved in international trade to create a system based on block chain which would allow users to use blockchain to record all the various transactions and information exchanges between the parties and in a secure fragmented environment. 

Bolton further explains that “using blockchain within a supply-chain would provide a firm with the infrastructure necessary to remove the need to secure each transaction or step in the supply-chain through intermediaries via registration, tracking and certification. Information on any shipment – whether it be a proof of purchase, a clearance form, a bill of lading, insurance – can be made part of a block, a transparent chain of custody, and be accessible to suppliers, transporters, buyers, regulators and auditors. Having all this information in one location would not only lower transaction costs but also decrease auditing and accounting costs as well” (Bolton, 2018).  Given the fact that under a no-deal Brexit non-tariff related transaction costs could increase by up to 10%, then investment in a Blockchain solution makes a lot of sense to mitigate that.

Other Possible Risk Mitigations

It is crucial that manufacturers take a close look at their supply chains and map out them in order to identify potential risks from a no-deal Brexit.  This would involve undertaking an assessment of every actor in the supply chain and identify the potential exposure for each of them, Companies need to create a critical supplier list as part of this process.  Sources need to be identified as whether they are EU or non-EU origin and how their inputs will impact the business.  If the impact is negative, alternative suppliers need to be sourced within the European Union.  It would also be prudent to identify further channels of distribution and to attempt to optimise the supply chain. 

Conclusion

All in all, a Brexit is going to be a messy affair.  It will result in disruption to supply chains both within the EU, in the United Kingdom and in supply chains outside of the two.  There will be no easy exit and it will be important for companies to identify the risks they face and implement appropriate mitigation strategies or alternative supply arrangements or distribution channels as needed. 

Companies in the EU availing of Free Trade Agreements with other countries will need to make a deep analysis of their supply chains and identify where UK origin inputs could adversely affect their preferential rules of origin status and if the impact is detrimental to their own status an alternative supplier will need to be sourced to rebalance the input mix to retain the required rules of origin minimum value.

In the end, Brexit is not an economic decision but a political one and increasingly an emotional one which despite the self-destructive implications seems to be inevitable at this stage no matter the damage done to the UK itself or its partners.  I personally think its lunacy to seek out free trade agreements independently when one is already a member of a customs union and that block has already established Free Trade Agreements with 55 or more other countries – all of which will be lost upon Brexit day, even with a deal with the EU.  It really is a damage limitation exercise for all EU based firms to get through this as best they can and with the least financial impact as possible.

 

BIBLIOGRAPHY

BBC Newsnight, 2017. The missing link? EU supply chains after Brexit. [Online]
Available at: https://www.youtube.com/watch?v=5TZjJMBImsY
[Accessed 10 August 2019].

Berden, K. G. et al., 2009. Non-Tarif Measures in EU-US - Trade and Investment - An Economic Analysis, Rotterdam: ECORYS Nederland BV.

Bolton, N., 2018. Blockchain and trade: Not a fix for Brexit, but could revolutionise global value chains (if governments let it), Brussels: European Centre for International Political Economy (ECIPE).

Booth, S. et al., 2015. What if...? The Consequences, challenges & opportunities facing Britain outside EU, London: Open Europe.

FUSACCHIA,, I., SALVATICI, L. & WINTERS, L. A., 2019. BREXIT AND GLOBAL VALUE CHAINS: ‘NO-DEAL’ IS STILL COSTLY, University of Sussex: UK Trade Policy Observatory.

Gasiorek, M., 2017. BREXIT: Which industries might see an impact if we fall off the cliff edge?. London, InterAnalysis & University of Sussex.

Krishna, K., 2005. UNDERSTANDING RULES OF ORIGIN, Cambridge, MA: NATIONAL BUREAU OF ECONOMIC RESEARCH.

World Trade Organisation, 2019. Technical Information on Rules of Origin. [Online]
Available at: https://www.wto.org/english/tratop_e/roi_e/roi_info_e.htm
[Accessed 10 August 2019].

World Trade Organisation, n.d. Understanding the WTO - Principles of the trading system. [Online]
Available at: https://www.wto.org/english/thewto_e/whatis_e/tif_e/fact2_e.htm
[Accessed 3 August 2019].

Leave a comment

Please note, comments must be approved before they are published