Mutual recognition should be the EU’s guiding principle for regulation and trade

By
Pieter Cleppe
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Things seem to moving on the Brexit front, following the inauguration of Rishi Sunak as new British Prime Minister. According to the Sunday Times, senior UK ministers would have been preparing to propose a Swiss-style relationship between the UK and the European Union, without free movement.

Senior conservatives, including Rishi Sunak, have denied all of this, but something is clearly afoot. Only last week, UK Chancellor Jeremy Hunt stated that he would seek to “remove the vast majority of the trade barriers that exist between us and the EU”.

The Swiss-style relationship the Sunday Times reported about would involve scrapping 80% of the checks between Great Britain and Northern Ireland and open up access to the single market, in return for the UK aligning with a number of EU regulations and paying into the EU budget.

Regulatory competition

To recap, Switzerland does not have the same deal as Norway, Liechtenstein and Iceland, who all enjoy full access to the EU’s single market in return for taking over all relevant EU legislation. Unlike those three countries, Switzerland is not part of the “European Economic Area” and only enjoys partial access to the single market, while taking over only part of the EU’s regulations, something which is negotiated on a sector-by-sector basis in more than 100 bilateral deals.

For a long time, the EU has been resenting this “pick and choose” arrangement the Swiss were able to negotiate in the 1990s, after rejecting the Norwegian “fax democracy” arrangement in a referendum. The EU has been trying to convince the Swiss to accept abandoning the bilateral approach and instead agree one overarching agreement, including the principle of “dynamic alignment” of EU rules – which means that the Swiss would be forced to automatically take over updates of EU rules, as opposed to today, where they are able to opt not to take over EU rules, at the price of losing market access for the relevant sector. The Swiss refused this and last year, they declared negotiations to have failed. One particular point of contention was also that the EU was trying to impose its own top court, the European Court of Justice, as the arbiter in case of disputes. No judicial arbiter has been foreseen in EU-Swiss relations so far.

In sum, a Swiss-style relationship is hard to negotiate. For the UK, it would also mean sacrificing sovereignty as compared to the deal Boris Johnson agreed with the EU. Fundamentally, in order to refuel trade between the EU and the UK, it may be sensible to pick and choose sectors where that is feasible over keeping market access to the current restricted level. However, the obvious method to open up trade is that both the EU and the UK simply recognize each other’s regulations as of sufficient quality. After all, most of the UK regulations are still the same as the EU’s, and trade is ultimately about trust.

Such an arrangement would also not reduce regulatory competition, unlike a Swiss-style arrangement. Regulatory competition is something really important. Particularly when it comes to regulating new economic sectors, like the digital sector, it enables jurisdictions to learn from each other on how to cope with new phenomena.

The EU’s protectionist new “Corporate Sustainability Due Diligence” directive

The EU is unfortunately deeply hostile to regulatory competition. It does not only try to impose its regulatory framework to the UK or the Switzerland, but also to the rest of the world.

It can succeed in this sometimes by simply imposing regulations on its own territory. This is called the “Brussels effect”. A good example is the common charging standard the EU imposes for electronic devices by 2024. It now looks like Apple will not only introduce the common charging standard USB-C on its mobile phone devices in the EU, but also in the rest of the world.

The EU also tries other methods to affect regulation globally. In trade deals, it increasingly attempts to introduce all kinds of social and environmental standards, which makes it even harder to agree trade deals.

The EU is becoming ever more creative in trying to find ways to affect rule making in other parts of the globe. A new EU regulatory initiative in this regard is the European Commission’s proposal for a “Corporate Sustainability Due Diligence” directive. This would require certain companies to:

  • undertake due diligence across their value chains to identify the adverse impacts of their business;
  • implement processes to mitigate those impacts; and
  • integrate sustainability and human rights considerations into their corporate governance and management systems.

The proposal is still in its early stage, but it raises many questions. Is it fair for businesses to be held responsible for all kinds of things that go wrong in their supply chains? How can they figure out what their suppliers are doing wrong? Is it even legal to impose drastic obligations on actors to account for the misdeeds of others?

The obligations will be imposed on big companies, with a turnover of more than 150 million euro, but also on companies of a smaller size, with a turnover between 40 and 150 million euro, if they are active in “high-risk sectors”.

The European Commission defines these sectors as follows:

“The following sectors should be regarded as high-impact for the purposes of this Directive:

the manufacture of textiles, leather and related products (including footwear), and the wholesale trade of textiles, clothing and footwear; agriculture, forestry, fisheries (including aquaculture), the manufacture of food products, and the wholesale trade of agricultural raw materials, live animals, wood, food, and beverages; the extraction of mineral resources regardless of where they are extracted from (including crude petroleum, natural gas, coal, lignite, metals and metal ores, as well as all other, non-metallic minerals and quarry products), the manufacture of basic metal products, other non-metallic mineral products and fabricated metal products (except machinery and equipment), and the wholesale trade of mineral resources, basic and intermediate mineral products (including metals and metal ores, construction materials, fuels, chemicals and other intermediate products).”

Clearly, this goes way beyond merely rooting out forced labour in supply chains – which is a sensible thing to do. It also imposes a whole range of specific regulatory choices under the label of “sustainability”, thereby affecting companies importing palm oil, soy and coffee, and threatens to burden them with a whole new set of disproportionate obligations, turning those companies into the EU’s regulatory supervisors. Ultimately, this will obviously translate in higher consumer prices for EU consumers that already facing sky-high inflation.

Also from a free trade perspective, these new obligations would truly represent another non-tariff barrier. Products and commodities linked to deforestation are a major target of the new legislation, despite the fact that producers like Indonesia and Malaysia have made great progress here. Risk analysis has concluded that deforestation due to palm oil in these countries has fallen to its lowest level since 2017. Banning palm oil altogether, which is what many of the pressure groups behind the EU’s regulatory initiative are keen to do, may worsen deforestation, given how it would force greater use of alternatives that require more land use, like sunflower or rapeseed oils, a study by University of Bath researchers published in Nature has found.

The EU Commission does not seem to take any of this into account, and instead, with this new proposed directive, basically threatens emerging economies with new non-tariff barriers.

The UK’s alternative regulatory approach

It really is quite unfortunate that the European Commission has opted for this path, especially when the UK has chosen a different, more optimal, approach, in order to obtain the desired outcome. The UK basically requires products to be in line with the local regulations, thereby effectively applying the principle of mutual recognition.

With regards to a commodity considered to be linked to the risk of deforestation, UK legislation foresees:

“A regulated person in relation to a forest risk commodity must not use that commodity in their UK commercial activities unless relevant local laws were complied with in relation to that commodity.”

The UK’s approach is not only preferable from a free market perspective. It is also a lot more practical. Defining what is “sustainable” is tricky enough. Imposing it on trading partners – which is what turning companies into regulatory supervisors amounts to – only makes it more complex. Certain labour or environmental standards may not be considered acceptable in Europe, but they may be considered acceptable in emerging economies, where the alternative would be poverty, which is bound to also have a negative impact on social and environmental conditions.

Conclusion

Whether talking about opening up trade within the EU, between the EU and non-EU economies in Europe or between the EU and the rest of the world, applying the principle of mutual recognition as a guiding principle should be the way to go forward. Trade, after all, is about trust. Those keen to preserve the benefits of it should hammer this message home at the Berlaymont building in Brussels.

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