Trading places

I spent this evening at a seminar organised by the National Institute of Economic and Social Economic Research (NIESR) at which they outlined their latest economic view and some of the associated research topics. One of the presentations, by Monique Ebell, looked at NIESR's ongoing research into Free Trade Agreements and how the UK is likely to fare post-Brexit.

The worrying conclusion was that leaving the European Single Market (ESM) is going to impose significant costs, irrespective of whatever deal the UK signs with other countries. This is due to the fact that the ESM is a deep and comprehensive trade agreement which is designed to reduce non-tariff barriers, whereas conventional FTAs do little to tackle this problem. And because they are generally aimed at trade in goods, they do little to stimulate services trade which is an important issue for the UK.

NIESR used conventional gravity models to estimate the impact of post-Brexit trade flows. Such models approximate bilateral trade flows between two countries by employing the ‘gravity equation’, derived from Newton’s theory of gravitation. The idea is that just as planets are attracted to each other in proportion to their sizes and proximity, so too are countries. Relative size is determined by GDP, and economic proximity is determined by trade costs – the more economically ‘distant’ the greater the trade costs. Gravity models suggest that relative economic size attracts countries to trade with each other while greater distances weaken the attractiveness.

The empirical results suggest that if the UK were to leave the ESM and impose WTO rules, as Theresa May has threatened, this would lead to a long-term reduction of around 60% in UK trade with the EU compared to what would otherwise take place. Swapping ESM rules for an FTA used by the EU in trade with third party countries would produce a smaller, but still significant, reduction of 45% in UK-EU trade. There would be a modest offset if the UK could replace WTO rules with some form of FTA with the BRICS or Anglophone countries, but it would in no way be enough to fully compensate for the losses.

As it currently stands, leaving the ESM will make the UK significantly less well off. Indeed, NIESR's calculations indicate that swapping the current EU trading arrangements for WTO rules will cut GDP by around 2.3% over the longer term (5-10 years). This is rather smaller than the numbers suggested by the Treasury prior to the referendum, but it is likely there would be significant second round effects which I reckon could produce a long-term decline somewhere in the region of 5%.

We should, of course, be careful of the spurious precision attached to such estimates. But they support the view that leaving the safety of the ESM, which is one of the most integrated international trading markets in the world, will leave the UK poorer than it needs to be. And it is for this reason I continue to believe that the gamble taken by David Cameron in holding the referendum in the first place, and the comments made by Theresa May in her speech two weeks ago, represent steps which are not in the UK's national interest.

If conventional FTAs suggest that the gains from trade with third countries will be outweighed by the losses resulting from a loss of access to the ESM, might it be possible to devise ways to narrow the losses? Obviously, one way would be to replicate the features of the ESM which make it so successful, by reducing non-tariff barriers. But this would involve efforts to improve economic integration in any new trade deals, which in turn would require greater regulatory harmonisation, though this is precisely one of the things which the electorate (narrowly) rejected last June.

Ironically, on a day when the proportion of MPs voting in favour of the Article 50 bill (81.4%) was greater than the proportion of the electorate voting for Brexit (51.9%), the government has still given us no indication that it understands the risks which it is taking with the UK's economic future. Moreover, the fact that the EU is expected to present the UK with a significant exit bill, likely to be in the region of £40-60 bn, suggests that it will take at least five years to recover from the initial financial hit (so much for saving money by leaving, eh Nigel?). Thus, even if Brexit does not cause the damage that is feared, in order to come out ahead the new arrangements would require the UK to get a bigger growth boost than the current arrangements can deliver. Let's just say I am not hopeful.