A year ago things were very different. Having ended 2018 with the government being held in contempt of parliament and surviving a Conservative leadership challenge, Theresa May began 2019 with the most heavy defeat ever inflicted on a sitting government as her Brexit deal was rejected by MPs. She then had to face down a parliamentary vote of confidence. And it never got better for her, as her battered credibility meant that she could never deliver what she promised. Having sown the seeds of her own demise, May was eventually replaced by Boris Johnson who promised to “get Brexit done” and won an overwhelming election victory as a result. How did he do it? Quite simply, he took a direct approach and the defeats he suffered along the way, on issues such as proroguing parliament, eventually played to his advantage because they demonstrated that he was prepared to do whatever it took to fulfil the wishes of the electorate (as I noted here).
But whilst Johnson has won the political battles hands down, the economics poses much more difficult challenges – a view which has always been at the heart of my opposition to Brexit. The visit to London of the new European Commission President, Ursula von der Leyen, acted as a reminder that this is a process which will be driven by the EU, and the UK has flexibility only in as much as it can choose its degree of compliance with the EU’s demands. Von der Leyen reminded her audience that there are trade-offs – something that British politicians have failed to be honest about over the past four years – and the more the UK wishes to deviate from the rules governing the single market, the less access it will have. She also expressed her doubts that the UK will be able to negotiate a full future-relationship deal and have it ratified by the end of this year (it is, in her words, “basically impossible”). But how do we square this with the Johnson government’s stated intention not to extend the transition period beyond end-2020?
One way is that the UK simply does not attempt to replicate the full and comprehensive relationship with the EU that it has now. Under these circumstances the UK will aim for a lowest common denominator trade deal which will allow Johnson to claim that he has fulfilled his mandate to take the UK out of the EU without extending the transition period. It is pretty likely that this will focus only on goods trade, which has been the focus of the government’s attention up to now, whilst services continue to be ignored. On the assumption that some form of trade deal is agreed, at issue is the extent to which the UK is prepared to abide by EU standards. The greater the degree of divergence, the higher will be the barriers to EU trade which will make UK manufacturing even more uncompetitive vis-à-vis other EU economies.
This, of course, is the economic calculation. The political calculation is that voters do indeed want to “get Brexit done” and Johnson’s behaviour so far suggests he will do whatever it takes to deliver this, even if there is collateral damage along the way. Indeed, it has been reported from inside government that this approach is expected to play well with those traditional Labour voters who lent their support to the Conservatives at last month’s election.
But this does not mean it is economically sensible. Whilst it is unreasonable to expect most Brexit supporters to understand the economics – this is after all a matter of the heart for many – there remains a wilful misunderstanding of trade issues amongst the better educated supporters of this policy. I was told just recently that Brexit will allow the UK to unshackle itself from a moribund EU. This is a good thing, I was told, because the share of the EU in world GDP continues to fall so it makes sense to leave and strike trade deals with faster growing regions. I intend to look at the UK’s external trade position in more detail another time, but let’s deal with these points which I thought we had put to rest years ago (clearly not).
It is true that the EU’s share of world GDP has fallen – on my estimates using data in real terms, which allows us to abstract from exchange rate swings, I reckon that the EU’s share (ex UK) has fallen from about 23% in 1980 to around 14% today. But the US share has also fallen, from 19% to 15% over the same period and the share of what I call “consuming countries” (Europe, North America and Australasia) has declined from 45% to 30%. What does this tell us? Simply that if one country grows more slowly than another, its share of GDP must decline as a matter of simple arithmetic. Moreover, the fastest growing economies have been enabled in their quest for growth because they are exporting countries. The UK might have a chance of boosting exports if growth in these countries is based on domestic demand, but it isn’t. The flip side of this is that the UK’s imports from the world's fastest growing economies have been growing more rapidly than exports. As a result the UK’s trade deficit with China has increased more rapidly than that with the EU over the past 20 years (by a factor of 10 versus 8 for the EU).
We also have to account for pesky details such as incomes per capita. All of the world’s most rapidly growing economies have incomes per head which are lower than the EU. Chinese GDP per head, for example, is around a quarter of the EU average in USD terms (chart). And we can forget about the artificial construct of PPP comparisons – it is the absolute level of income which will determine whether China can afford to buy what the rich world wants to export to it (at a price that makes it worthwhile for European economies). And China is a lot further away, implying higher transport costs. It is for this reason that the analysis of trade issues based on gravity models continues to support the view that economies that are situated close to each other and which have similar levels of income tend to trade more with each other.
Anyone believing that leaving the European single market will allow the UK to tap into more rapidly growing export markets is wrong. Doubtless there will be those who will tell me that that the Brexit issue is settled and we should all get behind making it a success. But the best way to make it an economic success is not to rush into making a shoddy trade deal by adhering to an artificial deadline to satisfy political ends. Unlike last year, when there appeared to be some grown-ups in government able to understand these issues, I fear they are fewer and further between today. But that’s what we voted for, right?
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