One Step at a Time

To understand how trade agreements, regulations, standards and the real world intersect, let’s break down the journey of a product from being made to being sold into distinct steps.

Phase 1: How Something Is Made

In this phase, all the action is taking place in the exporting country.

There is a factory or some other facility that is manufacturing the product. That factory has to follow its country’s environmental regulations which govern things like:

• Animal welfare;
• How it disposes of its pollution and waste
• How much energy it can use
• How much water it can use
• Whether it pays a carbon tax and/or must capture its carbon emissions

The factory employs workers, whose rights are governed by its country’s labour regulations like:

• Minimum wages;
• Overtime and breaks;
• Insurance and liability;
• Leave and holidays;
• Unionization rights.

The government of the factory might be using some state aid policies to support it, such as:

• Subsidies;
• Tax breaks or incentives;
• Regulatory waivers.

Note: These kind of regulations are specifically those that relate to the process of creation where that process doesn’t impact the safety of the final product. If for example you use lead paint in a toy, that might make it unsafe for kids which is a Phase 2 border regulation, even though it happens on your territory.

The Trade Policy Connection

The environmental, labour and state aid policies of a country are mostly its own business.

For example, if the United Kingdom decides to have stronger or weaker environmental regulations, that’s not really up to the European Union to decide.

However, a disparity in these kind of regulations can provide one country’s exports an advantage in another’s market. If for example a country no longer requires employers to provide overtime for workers, or heavily subsidizes energy, its factories might gain an advantage.

This is what the European Union is talking about when it calls for Level Playing Field provisions. They want the United Kingdom to make commitments on its regulations in these areas so that EU producers aren’t undercut. If they receive this legal guarantee, the EU will feel more comfortable signing away its ability to apply tariffs on UK goods at the border.

Key Point: In trade agreements, provisions around Phase 1 regulations are primarily minimum levels of regulation and enforcement. They are designed to prevent one party exploiting the market access it gains from the trade agreement by using lower levels of regulation to undercut prices.

Phase 2: Entering the Country

At the Border Regulations

When a product arrives at the border of another country, it generally has to demonstrate it meets local regulations. It doesn’t matter what the regulations are in your own country, if you want to sell into my market you have to prove your widget meets my widget rules.

Unlike the regulations in Phase 1, the relevant regulations here aren’t generally about how the product was made, but whether the final product is safe and meets local rules for products of that type.

This could include satisfying it is:

• Appropriately certified as safe for consumption or use;
• Not carrying any communicable diseases;
• Properly packaged and labeled in the local language;

The Trade Policy Connection

These types of regulations are about protecting the public, and so even the most ambitious treaties tend to leave governments a lot of flexibility to regulate in these spaces.

Typically however, trade agreements (including the WTO) require governments to regulate for legitimate reasons and not just to protect their domestic producers by making it harder for foreign stuff to get into the country.

A lot of the discussions you hear about the US-UK FTA, and for example chlorinated chicken, are about this type of regulation. The United States believes the EU ban on hormones in beef and on chlorine washing chicken is actually a Phase 1 regulation dressed up as a Phase 2 one. It argues the EU has no evidence that the final product arriving at their border as a result of chlorine washing is unsafe, and that it’s abusing safety rules because it doesn’t like or want to compete with the US’s animal welfare and farming regulations.

What makes this situation more complicated in the UK-EU context are EU concerns that lower UK regulations on things like chlorinated chicken might pose a risk of such products ending up inside the EU Single Market, which would require more checks and screening at the EU border to prevent.

The World Trade Organization rules also mean that the border is the one place you are allowed to discriminate against foreign products. Once something is inside your territory (and so has passed border checks) you’re supposed to treat it the same way as any other good of that type.

Key Point: In trade agreements, provisions around Phase 2 regulations are primarily about maximum levels of regulation and enforcement. They are designed to prevent one party invalidating the market access it grants to another by using unjustified, unscientific or impossible to prove compliance with regulations to keep their products out of its market.

Tariffs

Tariffs are taxes paid to the local government for bringing goods into their territory. Every trading area has its own tariffs on each product type, ranging from 0% all the way up.

Most Free Trade Agreements are all about eliminating or reducing a significant proportion of the above 0% tariffs between the parties involved, and committing to keeping them that way.

If you’re trying to bring in a product using the lower tariff rate a Free Trade Agreement provides, you may also have to demonstrate to the importing country that you made enough of the product at home to qualify for the lower rate. This is called meeting the Rules of Origin and it’s there to avoid another country shipping an almost completed product through yours to take advantage of a free trade agreement they’re not party to.

Phase 3: Point of Sale

Once a product has entered your territory, it may have to satisfy the private standards of local retailers or customers. These aren’t government mandated regulations, but are instead the private rules firms have established for themselves to govern what they buy.

Examples include:

• Jewelers requiring diamonds be certified by the The Kimberley Process as not being “blood diamonds”;
• Supermarket requirements around fruit and vegetable aesthetics;
• Retailers requiring that products be certified as environmentally friendly.

The Trade Policy Connection

Sometimes, government regulations at the border in Phase 2 will “point to” a well established private standard, at which point it rises to the level of a regulation. This is where trade policy comes in, with a lot of the normal rules that apply in Phase 1.

Regulation in Trade Agreements - Important Terms

A trade agreement like currently in negotiation EU-UK one can commit the two sides to different things on each type of regulation along the Product Journey. To understand what might come out of it, there are some useful terms to know.

Term: Enforcement of Local Laws

This is the bare minimum most trade agreements include on Environment and Labour (both Phase I). The only commitment here is both sides actively enforce their local laws and do not let factories bypass or ignore them to be more competitive as exporters.

It’s almost certain the EU-UK agreement will include this, as both sides are rules based system who enforce their own laws.

Term: Non-Regression

This is  a bolder commitment. It binds both sides not to reduce their Phase 1 and possibly even their Phase 2 regulations below where they are at the time the agreement is signed.

In practice for the EU-UK agreement, this would mean the UK has to maintain the EU’s current standards but would not be obliged to raise its standards in lockstep with the EU going forward. It’s understood the EU might push for this in Environment and Labour (Phase I), but also possibly in areas like food and plant safety rules (Phase II)

Term: Dynamic Alignment

This is what the EU may push for in State Aid (Phase 1) and possibly in Environment and Labour (also both Phase I).

This would commit the United Kingdom to not only keeping its rules at the level they are on Brexit day, but also to keep upgrading them to match those of the European Union if the EU decides to make theirs more stringent.

So for example, if the UK agrees to dynamically align its environmental regulations and the EU introduces a tougher carbon tax, the UK would need to do the same thing or something very similar.

Term: Equivalence

For a business, the at the border (Phase 2) regulatory coin has two sides:

1. What is the rule?
2. How do I prove I meet it?

In a lot of cases, it’s not enough to simply be compliant with regulations, you also have to have the appropriate certificates to prove it.

If a trade agreement grants ‘equivalence’ on a type of regulation, that means both sides acknowledge that the other party’s regulations are good enough, even if they differ. Something produced in Country A according to Country A’s safety standards can therefore enter Country B without additional checks or documentation.

This saves businesses a lot of money and products in transit a lot of time, so it’s pretty desirable. However, granting this to another country is a big deal as you’re effectively trusting their lawmakers to protect your citizens.

Sometimes to make this work, the two sides create processes (like the European Court of Justice) which can examine two different regulations on the same thing and reach a decision about whether they’re functionally equivalent or not.

Term: Conformity Assessment

This is a broad term for the process of proving you meet the regulations of a destination market.

In some cases however, trade agreements grant the regulations and laboratories of another country the right to test and certify against the regulations of the other party.

So for example, a widget made in Country A and destined for Country B can go to a Country A lab which will test it against Country B’s rules. Country B agrees to accept that lab’s certificate, rather than requiring retesting at a Country B lab.

This again, potentially saves businesses a lot of time and money.

Final Word

Brexit means the UK is moving from a place where it had no tariffs and aligned regulations across most of Phase 1 and Phase 2, into… something else.

The Free Trade Agreement negotiations will depend significantly on how many commitments on Phase 1 and possibly Phase 2 alignment the UK is willing to make (or how few the EU is willing to accept) in order to keep tariffs at zero and minimize new costs related to conformity assessment.

The fate of entire sectors may rest on the decisions made.