Archives for August 2017

The 5 errors of the Free Trade Brexiteers

For many of the proponents of Brexit in the referendum debate (Messrs. Gove,
Fox and Johnson in particular), free trade was a crucial part of their argument
on two grounds.

First, they argued that Britain would be able to agree a satisfactory trade deal with the EU following Brexit because the rest of the EU ran a sizeable trade surplus with Britain. Secondly, they argued that, outside the constraints of the Customs Union, Britain would be able to agree advantageous trade deals with other countries around the world (US, China, India) that the EU had not been able, or prepared, to do.

Some fourteen months on, these pre-referendum theoretical arguments have
come in to contact with real world, and five key errors can now be seen in their
arguments.

1. Their argument was based on the absolute size of the EU’s trade surplus:

Whilst almost half of the UK’s exports go to other EU nations, less than 10% of their exports come to the UK. Though the UK runs a deficit in trade with the EU in absolute money terms, relative to the size of the total EU economy their surplus is not very meaningful. Thus, if political considerations were deemed to be important (which events since the referendum have shown to be the case), it would be quite conceivable that some modest economic loss would be acceptable in exchange for other, more political gains.

2. Their arguments were based on an old economic, and now irrelevant,
theory that tariffs are the only thing that matter in international trade:

Two hundred years ago, Ricardo developed an economic theory demonstrating the advantages of untaxed international trade in boosting the economic well-being of all countries. The UK, with its Empire, large navy and entrepreneurial flair benefitted enormously from conducting trade all over the world. Thus, the UK’s history and attachment to the concept of free trade and drive to reduce or eliminate tariffs imposed on the import of physical goods into a country. This has been supported by a clear consensus of conventional, neoliberal economists through the decades since.

Today, tariffs on goods passing across borders are either zero or fairly close to it. There are specific areas where this is not so, principally agricultural products and cars coming in to the EU Customs Union. For goods, free trade is pretty much the norm and there is limited scope to achieve economic benefits from signing more free trade agreements.

3. Their arguments ignore the crucial role played by regulation as the
protectionist policy of choice today:

However, the key protectionist tool used by governments today is regulation. In general, this is used in service industries and is most prevalent in financial services, where protection of the major local banks insurance companies is typically deemed a political necessity, and pharmaceuticals, where the political need to control healthcare costs often impacts on purchases of specific drugs and treatments. These two industries are very important sources of UK export revenues.

Within the EU, the single market operates on the principle that if a product or service has regulatory approval in one EU nation, then it can be sold anywhere else in the EU, subject to EU-level control on what constitutes acceptable regulation. By leaving the EU, the UK will lose these advantages and will have no say on future regulatory change, but UK businesses will have to adapt to any such change.

The investment management industry is an example of an industry that looks like being particularly disadvantaged by Brexit. A substantial part of the industry’s revenues arise from managing the assets of other EU customers under MIFID regulation for investments in funds or under delegation regulation for segregated accounts. Last month, ESMA (the European Markets and Supervision Authority) published an opinion that, post-Brexit, would force more EU investment management activity to be conducted within the EU.

4. Other countries will expect us to make (politically unpalatable)
concessions in order to agree on new trade deals:

Though the US under Trump has indicated its desire to strike a free trade agreement with the UK, they have particular areas such as the food and
healthcare industries, where they would seek a change in UK regulation, before agreeing to such a deal. These are politically difficult for the UK
government.

Both Australia and India have indicated they would be very open to post-Brexit UK trade agreements but their price would be greater access to the UK for their own people, which would make even more difficult the UK’s ability to control and reduce immigration.

5. They over-estimated the attractiveness of the UK as a free trade partner:

They argued that as the 6th largest economy in the world, Britain was exceptionally attractive as a partner in a trade agreement. However, in practice the larger trading partners are (i) China with 1.3bn emerging consumers, (ii) the EU with 500m mostly wealthy consumers and the US with 300m wealthy consumers are many times more attractive as trading partners compared with the 60m wealthy consumers the UK has. In this global perspective the UK has less than 1% of the world’s population. A trade deal with the UK is a “nice-to-have” rather than a “must-have”.

The likely outcome for the UK is now a life outside the EU, accepting their
regulation of any product or service that we wish to sell to them, whilst losing
any say in that regulation or the key political developments in our most
important trading partner. In financial services in particular it is likely that the
UK will dilute its dominant market position within Europe, as regulations
benefit EU members. The UK will be forced to make greater concessions with
other countries in trade matters than the EU would have done in order to
secure trade agreements with these countries.
The voters believed the marketing hype of the free trade Brexiteers, sadly the reality of their delivered product will not match that hype.