Brexit, the digital sector and the problem of regulation
- Summary:
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A panel this week discussed how a smooth Brexit will mean focusing on regulation, not tariffs.
On the day of the launch techUK also held a panel, on which there were two economists discussing the impact of Brexit on the digital sector. The discussion was broad ranging and complex, but there was one point in particular that stuck out.
Both economists agreed that as the UK begins to exit the European Union - and beings to negotiate itself a new trading deal, as it becomes clear that we will be leaving the single market - the primary concern to the digital sector should not be tariffs, but rather regulation.
For example, techUK’s report, written by Frontier Economics, explains that the digital sector is primarily a services based industry. Some 96 percent of sector output and 91 percent of sector exports are spread across service activities. And tariffs on digital goods/services are generally low and bound by WTO rules - thus, not much of a concern.
The primary trade related risks for the digital sector from Brexit will be through non-tariff barriers, i.e. the regulation of services activities. techUK states that this is particularly true for audio-visual and media services, financial services, and data flows.
For example, these service operate on some variation of the country of origin principle. That means when a company’s HQ is in an EU member state and has demonstrated compliance with regulatory requirements of that jurisdiction, it generally doesn’t have to worry about regulatory requirements in other EU member states.
The report notes, that losing eligibility to “qualify as ‘European’ could reduce the attractiveness of the UK as a location” for digital service providers. As we know, the UK is often used as a jumping board for further EU operations.
Possible, but unlikely
It is possible that the UK could negotiate these commitments for the digital sector under a free trade agreement between the UK and the EU. However, this would mean the EU negotiating on things that have traditionally been off limits to countries outside the European Economic Area. For example, audio-visual and media services are specifically excluded from the EU’s free trade agreements. This was true of the recently completed Canada-EU deal.
There’s a bunch of other regulations that are going to cause problems for the digital sector. And to make matters worse, ‘digital’ is quite hard to define, as it is so inextricably linked to most industries.
Amar Breckenridge, manager at Frontier Economics, the authors of the report, commented on this point during the panel and said:There’s the importance of regulation for these sectors. The reason that this is important is that when you are trying to negotiate on regulatory barriers and regulatory measures, those are inherently more complex than tariffs.
Tariffs have numbers attached to them so they’re fairly easy to quantify, regulation doesn’t. And regulation also responds to a whole variety of concerns, not just trade. There are a whole number of trade offs that need to me made.
In the past the UK had a direct conduit into the European Union via its participation in European institutions. The question is, how much of that can be preserved in the future architecture of the negotiations? What the report really reinforced is dealing with these regulatory measures and their importance to the digital sectors, given the exposure of these digital sectors to trade.
Agreeing with Breckenridge, was Vicky Pryce, leading economist and board member at the Centre for Economics and Business Research, who said that digital “could be one of the sectors that is worse affected”. She added that as Europe integrates more tightly on the services front, the UK risks being left behind. Pryce:
Businesses have been saying very clearly in all sectors that they want to stay in the single market. Well, that has certainly not been listened to. I think we are in the process of having some difficulty in terms of what may happen in Europe next. There has been a serious push to get the service sector to integrate, because as we know, this is one of the areas where the single market hasn’t functioned particularly well.
The services directive is being properly implemented and then loads of areas are being pushed, including digital. There are a number of areas where Europe is so different still, it has to sort out issues such as e-commerce, e-payment, e-procurement, transport, the postal service. As they move towards that type of integration, the question is whether or not we are left behind because we haven’t been part of it. So if we are not part of the single market, there could be a serious issue.
And to add salt to the wound, Pryce said that if the government attempts to negotiate beneficial deals for certain sectors, then digital could be further impacted, as it is so closely tied to many industries. She said:
There is this sector by sector customs union discussion, which may take place and is what the Prime Minister announced. In reality what we have seen is that the digital sector services them all.
So where will it be left if there is a motor manufacturing agreement, but actually you still have to worry hugely about content and proof of origin for all sorts of other areas that the digital sector supports?
Sectors are so related and interconnected. We need to watch that vary carefully. Any FTA that favours some sectors, is going to lead a seriously suboptimal situation for the digital sector.
Walk away
Prime Minister Theresa May has also indicated that if the UK can’t negotiate a good free trade agreement, it would be more beneficial for the UK to walk away from the EU trading block. The mindset being that no deal is better than a bad deal.
However, the economists on the panel again argued that this could adversely impact the services sector. Breckenridge said:
The walkaway option probably is not a major issue for goods. The main issue will be in services. Firstly, multi-lateral commitments in services, which I guess form the baseline, are very old. They were negotiated between 1994 and 1997, and changed very little. There is a lack of security there in services. It also means that that process of further liberalisation within Europe proceeds, the UK under a hard option would remain removed from that. That’s problematic. In services, you don’t have multiple applicable disciplines on regulation like you do on goods. So what can you do to mitigate that?
In some sectors there are already legislation, such as financial services, with provisions that allow non-EU members to interact with that regulation and have access. The difficulty is that the UK can’t negotiate bespoke agreements in sectors within the European Union, because that’s not permitted by trade law. Trade law in both goods and services require that countries signing bi-lateral trade agreements liberalise their trade substantially across all sectors. A hard exit would be very problematic.
There is some talk about limiting this by signing FTAs with the rest of the world. But that only goes so far. Trade doesn’t work in the manner of rearranging furniture. It doesn’t work like that. There may be some mitigation by signing trade agreements with other countries, but those also take a lot of time to negotiate and implement.
Finally, the report notes the importance of maintaining conformity with EU data protection/privacy
regulation for the provision of digital services. If they don’t, they would face additional compliance costs and uncertainties. The report states that “the cost of divergence could be significant”.This was a point that Pryce highlighted. She said:
There is a data protection directive and a privacy directive coming through, where the individual from 2018 is going to be responsible for their own data that’s out there, making it much more difficult for the data to transfer across. Certainly making it hugely difficult for any of it to be processed.
If we in the UK send something to an Irish firm, or they send something to us, it’s EU data that’s exiting the EU that won’t be acceptable anymore. So we mustn't underestimate some of the issues there on the data side. I think that’s going to be a very big issue, I would say it’s the number one priority.
My take
This is hard. And it’s complex. Step one is for the government to recognise the importance of the digital sector, a sector that is far harder to define than more traditional sectors. Secondly it requires an understanding that the UK can’t limit itself when exporting digital services - and getting the regulation right will be key to that. Will this be taken into account amongst all the other chaos? It’s too soon to tell.