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.

The BoJo manoeuvre

It is May 2018 and the Prime Minister is in reflective mood, relaxing in 10 Downing Street with a drink. Fortes fortuna luvat was the phrase that sprang to his mind, or “fortune favours the brave” for those not lucky enough to enjoy his classical education. He was thinking of the book he would later write describing how he had emerged not only as the man who saved both the United Kingdom and the European Union, but, more importantly, how he had succeeded where his long-time rival, Dave, had so conspicuously failed. History, he was confident, would be kind to him.

Perhaps brave was not really the best word to describe the fairly straightforward political calculation that, whatever happened in the referendum, as the most prominent Conservative to stand on the Leave side of the debate, he was the obvious choice for Conservative activists to vote for as the leader to follow Dave. The fact that he didn’t himself really believe that Britain should leave the EU had been hidden away in a distant corner of his brain for the duration of the campaign.

There had definitely been a strong element of fortune though. The 50.3% victory for Leave was clearly affected by the torrential rainstorms that hit the UK in the late afternoon of June 23, 2016. The pensioners had been able to vote to Leave in bright sunshine in the morning, but a combination of storms and England playing in the European football championships in the early evening meant a much lower turnout amongst the younger generations, who polls showed were much more inclined to vote Remain.

Though Dave had initially wanted to stay on as Prime Minister, the backbench Conservative MPs quickly made it very clear that his time was up and he announced his resignation the weekend after the referendum. He felt it inappropriate to invoke Article 50 of the Treaty of Rome and start the clock on the two year timetable that would lead to Britain’s exit from the EU, saying that was a decision that should be taken by his successor.

Boris became Conservative Party leader, and Prime Minister, in September at the Party Conference, but the British public had already begun to experience doubts about the wisdom of its referendum decision in the intervening three months. Stock markets, not only in the UK but also in Europe had fallen sharply and a surprisingly large number of businesses announced their intentions to move their European headquarters to somewhere inside the EU – investment intentions and economic confidence had been hit very hard following the vote.

Not surprisingly the global banks such as J P Morgan, Goldman Sachs and Deutsche Bank clearly had well-developed contingency plans and were quick to announce their intention to move jobs from the City to Frankfurt and Paris from 2017 onwards. However what had taken many by surprise were similar announcements from key global manufacturing companies such as Siemens, Toyota and Pfizer and the withdrawal of EdF from the Hinckley power project, on advice from the French government, had left the UK’s long term energy policy in tatters. The number of announced lost jobs directly attributable to the referendum decision was much greater than even the Remain proponents would have dared to suggest in the campaign.

With Donald Trump, the Republican candidate in the November Presidential election, telling everyone how unhappy he was over the his treatment by the Scots over his dream golf course and saying that the UK had no chance of a trade deal if he was President, the UK economy was moving rapidly into recession amid massive uncertainty.

Given this backdrop, Boris also chose not to invoke Article 50, arguing initially that it made more sense to await the outcomes first of the US elections, and then the French and German elections in 2017 – after all there was no point in beginning negotiations with the EU when the two leading nations would not want to agree anything until their domestic political situations were clarified.

The European nations were also surprised by the drop in confidence in their stock markets as investment intentions declined further. The ECB were at the very edge of what was possible in terms of negative interest rates and QE, and fiscal policy remained constrained by German orthodoxy. What Europe had not expected though was the loss of respect from both the US and China, with many very rude comments about their irrelevance in the world without the UK coming from Trump and leading Chinese politicians. The continuing refugee crisis also tested to the limit the desire to maintain the Schengen area freedoms.

The critical factor had however come from Putin, who sensing Europe’s weakness has invaded and occupied Eastern Ukraine and was openly considering its annexation as he had done with Crimea. With the US consumed by its election it was left to Europe to take the lead in responding and they realised they needed to have the active and committed support of the UK.

Both the UK and Europe thus found themselves staring into an abyss in the months following the first referendum and were very frightened by what they saw.

Europe remembered that the initial vision for the EU had been to end war within Europe, and to that end the full-hearted involvement of the UK was now key. Compared with that even the free movement of labour, so beloved by the former Eastern European nations, could be seen as secondary.

So Boris had found it fairly straightforward, once the new German government had come to power, to seize the opportunity and come to a new reform agreement with the EU, which allowed the UK to control which EU residents could stay in the country, and allowed the UK much greater freedom not to implement bureaucratic EU directives. This dealt clearly and satisfactorily with the issues of immigration and sovereignty that had led many in the UK to vote to leave in the first referendum. The second referendum saw a Remain vote of 65%.

He had achieved a rare unity – the English were pleased with him, the Scots were pleased with him and even the Europeans were pleased with him. His place in history was now assured and, best of all, future historians would be able to compare directly the two referenda and prime ministerial performances, one dismal failure under Dave, one major triumph under himself.