Counting the early costs

It is almost four weeks since the UK’s post-EU trading arrangements kicked in and on balance the experience so far has not been good. Admittedly Nissan announced that the trade deal agreed between the UK and EU gave it a competitive advantage vis-à-vis other UK producers. But a lot of evidence has come to light over recent weeks to suggest that the new arrangements imply a significant increase in trade frictions – as many of us warned all along would happen.

Good news from Nissan. But is it Brexit-related?

Let us, however, start with the good news following Nissan’s announcement last week that it will continue production at its Sunderland operations in north east England. A trade deal was vital for the auto industry, which exports around 40% of its output to the EU. Under the terms of the UK-EU trade agreement, so long as cars meet local content rules they will avoid the 10% import tariff levied by the EU. Nissan currently makes about 30,000 Leaf electric cars per year in Sunderland, most of which are powered by a locally-sourced 40 kWh battery and as a consequence they will remain tariff-free. More powerful versions of the vehicle use an imported 62kWh battery which Nissan has decided to produce locally so that they will also remain tariff-free, and will likely create additional jobs into the bargain. But Nissan’s decision may be less Brexit related and more to do with its troubled relationship with Renault. Following the fracturing of the alliance between the two carmakers in the wake of Carlos Ghosn’s well-documented difficulties, industry sources suggest that Nissan is keen to put some distance between itself and Renault and is seeking an alternative to French production locations. If true, this makes the company’s decision less to do with Brexit and more to do with company-specific issues.

Looking across the car industry more widely, Honda announced in 2019 that it would shut its Swindon plant in summer 2021 and investment in the sector has fallen by 71% since the 2016 referendum compared with the period 2011-2016. Recent difficulties in sourcing parts, thanks to delays at ports, has posed problems for a sector that has relied heavily on just-in-time inventory management.  The more we look at the bigger picture, the more difficult it becomes to link Nissan’s decision to the trade deal, welcome though it is.

Fishing: A metaphor for all that has gone wrong

Elsewhere there are mounting recriminations regarding the impact of the new rules on cross-border trade flows. Nowhere is this more evident than in fishing – the totemic issue at the heart of Brexit. The pro-Brexit Daily Express carried a story at the weekend citing a former Brexit Party MEP who claimed that the deal "sold UK fishermen down the drain." Quelle surprise. After all, the government has form in selling out the interests of minority stakeholders in order to secure an overall deal. Moreover, fishing was never realistically going to be allowed to scupper the prospect of a trade deal given its relative unimportance to the UK economy. So much obfuscation took place during negotiations that it is important to be aware of the full facts. For one thing the UK is a net importer of fish, exporting much of its catch to the EU (France is the largest market) whilst much of the fish consumed in the UK is imported from countries as diverse as China, Germany and Iceland (the three largest sources of imports). The fishing industry was naïve to believe that it could block EU access to British waters whilst continuing to have access to EU markets, and the government was extremely cynical in pandering to these demands knowing it could never deliver.

Under the terms of the UK-EU trade deal, it is still possible for UK fishermen to export to the EU but the administrative burden of doing so has risen enormously. With fish sales to the EU falling sharply in the run-up to 31 December, prices collapsed thus reducing the incentive to put to sea. The higher administrative burden further increases the cost pressures on fishermen, making it uneconomic for many of them to remain in business. The fishing lobby has turned its anger on the government but the increase in red tape was always foreseeable given the relatively hard Brexit that the government ultimately delivered. The FT ran a piece on the travails of the fishing industry at the weekend. It is notable that the reader comments (always worth a read on FT articles) were scathing of the greed of the fishing industry, with many pointing out that they pushed for Brexit merely to serve their own purposes without a thought for other sectors which are highly dependent on EU trade.

Where are the sunny uplands?

But trade frictions are impacting much more widely. Sky News reported last week that truck traffic between the UK and EU in the first three weeks of the year was 29% below year-ago levels (chart 1). This may not all be Brexit-related given that the Covid pandemic is leaving its mark on trade flows. However more damning evidence is that the cost of moving goods from France to the UK has risen by 47% in early 2021 compared with the same period a year ago, while the rejection rate (the extent to which hauliers across the continent are turning down cross-Channel work) has jumped by 168%. Trade across the Irish border has also been impacted whilst the trade border between Northern Ireland and Britain, which runs down the middle of the Irish Sea, acts as a disincentive for producers on the mainland to deliver into Ireland.

These trade frictions raise the cost of doing cross-border business and increase delays, whilst ultimately reducing consumer choice in Britain. Those UK businesses which source items from outside the EU and sell them on to EU-based customers now have to pay duties due to the fact they no longer meet local content rules. Similarly, UK consumers buying from EU suppliers also face higher charges. Naturally, this eats into profit margins, which is a particular problem for small businesses which do not have the capacity to cope with the enhanced administrative burden. This led to the bizarre news story last weekend that advisers working for the Department for International Trade are encouraging British firms exporting to the EU to set up facilities in continental Europe. This will, of course, come at the cost of domestically-based jobs.

To some extent what we have witnessed in the last four weeks represent teething troubles, some of which will be ironed out as businesses adjust. There is no doubt that businesses were unprepared for many of the changes, largely because they did not know until Christmas Eve what sort of regulations they were transitioning towards. But the wider point is that this is a new normal to which we will have to adapt. The claims by many Brexit supporters that leaving the EU would lead to a reduction in red tape were highly disingenuous. In his speech on 24 December, Boris Johnson claimed that “in the context of this giant free trade zone that we’re jointly creating … there will be no non-tariff barriers to trade.” This is manifestly not true (nor is the notion of a giant trading zone – the UK and EU are more separated than at any time since 1972).

It is now four years since Theresa May’s infamous Lancaster House speech in which she announced the UK would leave the single market. I have always maintained that this is an act of economic self-harm because it is impossible to envisage any circumstances in which the perceived benefits of increased sovereignty will outweigh the economic costs. According to Thomas Sampson of the LSE (p106 of this report) the deal concluded in December could reduce trade flows by 13% after 10 years compared with the alternative of staying in the EU and reduce per capita incomes by 6% (chart 2). In the near-term, the dramatic costs of Covid will overshadow Brexit costs. But we should be under no illusions that the trade deal represents the sort of hard Brexit we were warning about in late-2018 – the deal served only to prevent a disorderly outcome, and delivered instead a disruptive one. I have noted previously that the only way to demonstrate to people that Brexit comes with costs attached is to implement it. It could be a very costly experiment.

Frost in Brussels

I am far from sure whether yesterday’s keynote speech in Brussels by David Frost, Boris Johnson’s policy adviser on Europe, was an opening gambit in what is likely to be a long and bitter negotiation between the UK and EU or was really the statement of intent it was made out to be. It was provocative, as might be expected from one who is a self-confessed supporter of Brexit as he made it clear that the UK will not accept supervision from the EU as part of a post-Brexit free trade deal. Worse still, Frost airily dismissed the economics with an “it will be all right in the end” attitude, without putting forward any evidence to support his claims. Perhaps it’s all an act or maybe he really has no idea what he is talking about. But if this is to be the tone of the British government’s approach to Brexit throughout 2020, it is going to be a long, hard year.

Frost’s attempt to rationalise Brexit

Frost’s justification for Brexit leaned heavily on the work of Edmund Burke who, despite being “one of my country’s great political philosophers”, was born and raised in Dublin where he spent the first 21 years of his life. Burke was a student of the French Revolution and one of his most famous works, Reflections on the Revolution in France, argued that the revolution would end in failure because its foundation on the abstract notion of rationality ignored the complexities of human nature and the institutions which were built around it. Academics struggle to interpret this work. This paper by David Armitage notes that there is ongoing debate about whether Burke “was a realist or an idealist, a Rationalist or a Revolutionist.” Frost chooses to interpret him as a realist by invoking the premise that the formation of the EU constitutes a revolution in European governance which overrides national institutions serving the people of individual countries. But whilst Frost’s view of a monolithic EU has some foundation, his interpretation is not one I recognise.

He argues that “if you can’t change policies by voting, as you increasingly can’t in this situation –  then opposition becomes expressed as opposition to the system itself.” But this is to ignore the fact that whilst EU laws are drafted by the Commission, they are passed into law by the European Parliament – comprised of the MEPs we vote for. And whilst it may be true that “the key [EU] texts are as hard to read for the average citizen as the Latin Bible was at the time of Charles the Bold” I can attest that British laws are equally hard to understand for non-lawyers such as myself. After all, I have (tried to) read a lot more British law in the last two years than is good for me.

Where Frost does have a point is that European institutions are, in British eyes, “more abstract, they were more technocratic.” There is not the drama associated with the European Parliament that is associated with Westminster, but as the lessons of the last twelve months have shown that is not necessarily a bad thing. Where I do not agree is the coda to the sentence in which he states European institutions “were more disconnected from or indeed actively hostile to national feeling.” They were perceived as hostile to national interests, it is true, but that is largely thanks to the disinformation (or lies, if you will) pumped out by journalists like Boris Johnson during his time in Brussels.

Nor am I convinced by Frost’s simplistic argument that “Brexit was surely above all a revolt against a system” where “the system” was the EU. “I don’t think it is right to dismiss this just as a reaction to austerity or economic problems” may be his view but not one necessarily backed up by the evidence. The Leave campaign made all sorts of promises that they could not deliver about the benefits of Brexit and the issues were simply too complex to be boiled down into a “yes/no” question, as even my Leave-supporting friends admit. Frost makes the mistake of drawing inferences about the 2016 vote which were not evident at the time. For an eminently clever man, Frost’s arguments were little more than a weak post-hoc justification. And if I can see that, you can bet that the smart people in the EU Commission will come to a similar conclusion. But if the justification for Brexit was weak, wait until you hear his economic arguments.

Trying to justify the economics

Frankly, the economics did not even rate a D+. His opening gambit was to dismiss the work done by the UK Government and the BoE thus: “I would question some of the specifics of all those studies. This probably isn’t the moment to go into the detail … But, in brief, all these studies exaggerate – in my view – the impact of non-tariff barriers.” Try that in an undergraduate essay and see how far you get. To apply the Farage tactic (“I could be more specific about my objections but now is not the time”) is not good enough. Economists are not interested in his view – they want the evidence that contradicts their own. Indeed, the evidence suggests that non-tariff barriers can be more restrictive for trade than actual tariffs. Simple things like technical barriers to trade (regulations on the content of products) or inspections and other formalities that require goods are checked for various reasons are pretty hard to get around. Indeed, there is a well-established literature on the empirical costs of border effects[1].

He went on to note that “many Brexit studies seem very keen to ignore or minimise any of the upsides, whether these be connected to expanded trade with the rest of the world or regulatory change.” There is a reason for that: With the exception of Patrick Minford, whose “analysis” is not worth the time of day, I struggle to think of any study which points to a net economic benefit from Brexit. Similarly, “there is obviously a one-off cost from the introduction of friction at a customs and regulatory border, but I am simply not convinced it is on anything like the scale or with the effects these studies suggest.” But that’s the sort of reasoning used by those who believe the Earth is flat: “Because I cannot see the curvature I am simply not convinced it is anything but flat.”

Ultimately, this speech contained nothing to convince any of us who believe the economic costs of Brexit are non-trivial that the government can be trusted to look after the interests of the economy. Frost made it clear that “we are ready to trade on Australia-style terms if we can’t agree a Canada type FTA”. Since Australia has not yet signed a trade deal with the EU he means the UK is prepared to trade on WTO terms at a time when the WTO has ceased to function properly. But it gets worse. “We understand the trade-offs involved – people sometimes say we don’t but we do … Much of the debate about will Britain diverge from the EU I think misses this point. … But it is perfectly possible to have high standards, and indeed similar or better standards to those prevailing in the EU, without our laws and regulations necessarily doing exactly the same thing … I struggle to see why this is so controversial.” That last line sums it up. The British government either does not understand the EU’s position or chooses not to do so. If you want to have access to the club, you simply have to abide by the rules. This is not a matter for debate.

The galling thing about the whole speech is that it echoes the tone of Theresa May at her worst. It was similarly content-light, promoted a revisionist version of history and made promises which will be undeliverable if the EU refuses to bend. Johnson will run into the same problem as his predecessor. Obviously both sides have to sound tough at the start of negotiations but it really does not have to be like this. What concerns me most is that if this really does represent the UK government’s position, we are headed for a major clash before the year is out. And despite what anyone else may say to the contrary, a hard Brexit is most emphatically not what people voted for in 2016. It’s going to be a rough ride. 

---

[1] Anderson, J.E., E. van Wincoop (2003) ‘Gravity with gravitas: a solution to the border puzzle’, The American Economic Review 93 (1), 170–192

More sabre rattling

In recent weeks I have posed a number of economic questions of Brexit. My issues are never addressed head-on. Instead, the usual response is for supporters of the policy to meet my question with another question which is irrelevant to the issue at hand. I probably shouldn’t be surprised: This has been the modus operandi of Leavers throughout the past four years who have never been able to successfully answer any questions on the economic benefits of Brexit. But we cannot run away from the issues forever, and the latest salvo from Chancellor Sajid Javid in an interview with the FT suggesting there will be no post-Brexit regulatory alignment with the EU raises questions that need to be answered.

To quote directly, “there will not be alignment, we will not be a ruletaker, we will not be in the single market and we will not be in the customs union - and we will do this by the end of the year.” He justifies this stance by arguing that companies have had three years to prepare for a new economic relationship. But they haven’t really. Theresa May’s administration was concerned to minimise trade frictions with the EU and it has never been clear what regulatory arrangement the government was aiming for. It is even less clear today. The fact that the government has postponed EU exit three times in the last ten months means the business community is increasingly unsure which deadlines it has to meet, which has added to the confusion. Following the government’s cancellation of regular meetings with industry groups there appears to be a widening gulf between the needs of business and the government. No wonder that business investment has barely risen in the past three years.

Digging deeper only reveals the flaws in Javid’s thinking. His suggestion that “Japan sells cars to the EU but they don’t follow EU rules” is to ignore the fact that Japan has invested heavily in the UK precisely in order to have production facilities which allow it to comply with EU regulations. His hope to boost annual GDP growth to “between 2.7% and 2.8%” a year also sounds like a big stretch when you consider that the slowdown in population growth appears to have reduced the potential growth rate to something closer to 1.5%. His belief that “Once we’ve got this agreement in place with our European friends, we will continue to be one of the most successful economies on Earth,” was pure hubris. How an economy which neither grows particularly quickly nor has exceptionally high incomes per head, let alone one with a debt-to-GDP ratio close to 90%, can be considered “one of the most successful economies on Earth” strains credulity. The economic situation is not terrible but his is not a description of the UK economy I recognise.

As I can attest from my own experience, just because Javid has worked in a trading environment does not mean he necessarily knows anything about economics and I have no idea whether the man entrusted to looking after the nation’s finances believes this nonsense. I rather suspect he does not, as this gem taken from his Brexit referendum literature in 2016 confirms (see graphic above). Consequently, his comments can simply be seen as a bargaining ploy to get the EU to take seriously the UK’s threat to walk away with no deal at the end of 2020. However, I maintain that such an approach is counterproductive. Nobody doubts that a no-deal Brexit will cause some hardship for the EU but it will only have a problem with one trading partner whilst the UK will have a problem with 27. This type of posturing was tiresome three years ago – today it appears deluded.

There is a clear sense that the government is trying to reboot the economic model, in much the same way as the Thatcher government did 40 years ago. The difference is that the economic failures of the 1970s justified trying out new policies. By the early 1980s, the old industries on which the UK had depended for the better part of a century were no longer globally competitive. One of the ways the UK moved forward was to focus on new sectors, particularly in services, and new markets, particularly the nascent EU single market. The case for such a radical economic change is absent today (though you can argue about the need for political change). If the UK is, as Javid believes, “one of the most successful economies on Earth” what is the argument for such a radical structural change?

Over the last four years, many Brexit supporters have consistently failed to acknowledge the importance of regulatory harmonisation for trade. Industries with cross-border supply chains, for example, do not have to worry whether their products meet local requirements if they are sanctioned for use within the single market. Industries such as pharmaceuticals have to meet stringent requirements before their product is certified for use by the general public. Having the same set of rules across different markets makes it easier to sell across borders, and ultimately reduces costs from which the consumer benefits. Regulatory harmonisation is even more important in service industries where it is so much easier to impose little obstacles that can derail trade. Sajid Javid might believe the UK is no longer going to be a rule taker in international trade rules but he is wrong. Trade rules are what underpin the system and if you want access to the Chinese, Indian or American market you have to abide by the rules in those markets.

I have been upfront about my concerns regarding leaving the EU over the years. Even though I was on the wrong side of the Brexit decision, I can live with the referendum result so long as the economic disruption can be minimised. But I remain opposed to the decision to leave the single market, not only because it was not on the ballot paper in June 2016 but primarily because it threatens to impose higher costs which will lead to a reduction in economic welfare. The Brits do have legitimate concerns about the extent to which the UK may be forced to adhere to future changes to EU law on issues such as the environment, and I will deal with this problem in a subsequent post. Indeed, this may be one of the motivating factors behind Javid’s comments. Nonetheless, for too long politicians have been allowed to get away with economically illiterate arguments to support their political case. This is another such example, and there is a serious risk that one day the EU will call the UK’s bluff.

No permanent friends, only permanent interests

We do not hear as much these days about the prospect of the UK falling back on WTO rules in the event that a trade deal with the EU cannot be concluded. This is partly because such an outcome is unlikely to happen in the near-term since the UK will enter into a transition agreement with the EU from February. But it also probably reflects the fact that the WTO has been severely damaged by the actions of Donald Trump which in turn has reduced its usefulness as a body overseeing international trade rules.

The problem is that Trump has consistently blocked appointments to the WTO’s Appellate Body – the high court of international trade – as the terms of sitting judges expire. The Appellate Body (AB) was established in 1995 and is comprised of seven judges who rule on trade disputes between WTO member countries. Each judge is appointed for a four year term, which can be renewed only once, and the Body requires a quorum of three in order that its rulings are accepted as valid. Following Trump’s tactic of blocking the reappointment of existing members, the AB was reduced to the minimum number of three in 2019 and with the terms of two of them expiring in December, it can no longer command a quorum. In theory, the AB can continue to hear pending appeals because members are able to rule on existing cases even after their mandate expires, but it is no longer able to hear new cases. As a consequence, a country which loses a dispute can file an appeal knowing that it will not be heard, and as a result can continue to act as before.

How have we got into this position? Quite simply, the Trump administration believes that the WTO is biased against the US. It is true that compared to the pre-1995 period the US is less able to throw its considerable weight around on international trade issues. Under the old GATT system, there was no settlement mechanism in place to hold countries to account for trade violations and in the 1980s and early-1990s the US exploited this to introduce a series of unilateral tariffs, ostensibly to force countries to open up their domestic markets. This policy, dubbed “aggressive unilateralism” by US-based trade economist Jagdish Bhagwati, served only to anger major trading blocs such as the EU and in any case its rate of success was limited. To assuage these concerns, the Uruguay Round of GATT began in 1986 which eventually led to the formation of the WTO in 1995, including the Appellate Body.

On a global basis, the WTO has been a great success in as much it has reduced the extent to which trade disputes spiral out of control. But it does constrain the US to work within the rules. However, the US wins around 85% of the cases that it brings before the AB – hardly evidence of bias against it. As long ago as 2007, the US Council on Foreign Relations suggested that “the dispute settlement system reflects a delicate balance between toughness and respect for sovereignty; rather than criticizing the result, U.S. policymakers and legislators should invest more energy in defending it.” Furthermore, the dispute settlement mechanism “curbs the protectionist instincts of U.S. trade policymakers and so underpins prosperity” by acting as a counterweight to the intense domestic lobbying by politically influential, but inefficient, domestic industries.

Ironically, the US is today reported to have reached out to Japan and the EU for support to introduce tougher WTO regulations on government subsidies in a bid to further increase the pressure on China, where the US believes state support is distorting competition. To the extent that this may be a way to bring the US back into the WTO fold, it has found support from the EU. But it comes just a day before the US and China are supposed to sign their phase one trade agreement, in which China will agree to buy at least $200 bn of US exports over the next two years whilst the US will commit to rolling back some of the tariffs it has levied on China (though by no means all).

One of the concerns ahead of the publication of the deal is the extent to which the phase one agreement will fall foul of WTO rules. If, for example, it requires China to import a specified amount of US produce, this would amount to managed trade and thus violate WTO rules. There is also a concern that China may simply import less from other WTO members whilst raising its imports from the US. All this goes to reinforce the views expressed by nineteenth century British prime minister Lord Palmerston that “nations have no permanent friends or allies, they only have permanent interests.” China is very much in the sights of the US but the EU fears that it, too, could fall foul of the Trump administration’s trade policy. Meanwhile, China may well be prepared to acquiesce to US demands for now but at the expense of trade with other nations. And who is going to do anything about it? Not the WTO, which has been hobbled by the US!

At the current juncture, it does look as though we are going back to an era of power politics on trade issues, with the US and China increasingly operating in their own interests. I did point out last August that this was not the right time for the UK to go it alone on trade policy and I maintain – as I have done for the last three years – that the decision to leave the European single market is a dumb and short-sighted policy. As I noted in my last post, it is imperative that the UK strikes the best possible trade deal with the EU for it cannot rely on the kindness of strangers in what looks to be an increasingly hostile trade environment.

End the politics, bring on the economics

It is a sad indictment of our times that the passage of the Withdrawal Agreement Bill through the UK parliament was relegated to the inside pages of the newspapers by the manufactured furore of Harry and Meghan’s “withdrawal” from the Royal Family. Having spent the last twelve months trying to get the WAB across the line, MPs yesterday voted by 330 to 231 to pass the legislation that will enable the UK to leave the EU on 31 January. Whilst it has yet to be ratified by the Lords, this is merely a formality. Transition phase, here we come. 

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?

The NHS and a US trade deal

It may or may not be the case that in order to facilitate a post-Brexit trade deal between the US and UK that will deliver “two and even three times what we’re doing now … everything will be on the table – the NHS, everything.” What is beyond dispute is that Donald Trump said it. Even though Trump appeared to backtrack from this position in a subsequent TV interview, he nonetheless articulated the reality of the UK’s post-Brexit choices. Without the heft that comes from being part of a larger economic bloc, the UK is going to look pretty puny in comparison to the likes of the US and China whose economies are respectively 7.3 and 4.8 times larger than the UK. Brexit supporters still cling to the fiction that the UK will be able to negotiate better deals with third countries than it currently enjoys as a member of the EU. Those with experience of conducting trade negotiations know this to be false. When it comes to opening up new markets, might is right.

This is going to put many of the contenders for the Tory leadership in an invidious position. Those who argue that the UK must leave the EU on 31 October, come what may, are in effect saying that they don’t care about the economic consequences and that the politics matters above all else. Boris Johnson has argued that the Conservatives face “potential extinction” if they cannot deliver Brexit. What he fails to point out is that they will face much the same fate if they get Brexit wrong. And risking the NHS, which is one of the few national institutions which the electorate continues to trust, would be one of the touchstone issues that could undermine them, allowing them to be outflanked by Labour. Indeed, a survey conducted by the Kings Fund found that a higher proportion of respondents thought leaving the EU would be bad for the NHS than those who believed it would be a good thing,

In what ways might a US trade deal put the NHS at risk? The most obvious concern is that US health service providers may be granted preferential access to the British market. This would imply the outsourcing of services currently provided by the state to the private sector – in other words, privatisation of large parts of the health service. As it happens, the NHS does already pay private contractors to run parts of the service. In fiscal 2017-18, almost 11% of NHS England’s outlays went to non-NHS organisations, with 2/3 of that figure going to private health providers (around 7.6% of total outlays). But figures compiled for the FT suggest that spending on non-NHS provided care has remained flat in real terms in recent years.

In the face of this evidence, why do people believe that NHS privatisation is rampant? John Appleby, chief economist of the Nuffield Trust, has suggested that one of the reasons for this is that many of the frontline services which people regularly come into contact with, such as community nursing and health visiting, already have a significant private sector presence. Nonetheless, the public would not regard further outsourcing of public services very favourably since there is a deeply entrenched view that the private sector should not make money out of the suffering of others. In addition, there is a commonly held view on this side of the Atlantic that the US health system fails to adequately look after the less well-off members of society and there is horror in some policy circles at the Trump Administration’s efforts to repeal Obamacare.

Another potential issue is that of opening up the UK market to American pharma companies, with all the attendant consequences for drug pricing. The National Institute for Health and Care Excellence (NICE) measures NHS expenditure to assess the relative cost effectiveness of various treatments against the next best treatment that is currently in use. As a result, the NHS pays significantly less for medicines from American companies than US healthcare providers. The concern is that any trade deal would be used as an excuse to ramp up the prices charged to the NHS. This fear is not unjustified. Alex Azar, Trump’s secretary of health, declared last year that the US would use trade negotiations to demand that “socialised” healthcare systems pay more since they currently pay “unfairly low fees to US companies.” This would allow a reduction in drug costs for US consumers. We should not kid ourselves that Trump’s America First policy will take an altruistic view of healthcare provision to foreign citizens – even those which supposedly enjoy a “special relationship.”

Some prominent Brexit supporters do not have a problem with the outsourcing of NHS services. Nigel Farage has recently been criticised for suggesting that those who can afford private health care should pay for it, as it would "relieve some of the burden on the National Health Service for everyone else." This is not a new position: He was recorded in 2012 suggesting that the NHS should move towards an insurance-based system run by private companies. Another hardline Brexiteer, Daniel Hannan MEP, remarked in 2009 that he “wouldn't wish it [the NHS] on anybody." It’s not exactly man-of-the-people stuff that Brexit supporters are likely to go for.

As it happens, there is a good case to be made for a grown-up debate about how to fund the NHS. But if Brexit is all about taking back control, this debate should be conducted in a cross-party manner and take into account the views of the general public. It should not be forced on the UK government as the result of a trade deal that would benefit the US far more than it would the UK.

Jacob's adventures in Wonderland

The Economists for Free Trade (EFT) group (formerly Economists for Brexit) today released their latest unfortunately-named  publication  “A World Trade Deal – The Complete Guide” which is not much of a guide and is in no way complete. Moreover “A World Trade Deal” is no deal – it is the default option in the event that the UK is unable to agree an arrangement with the EU. Given this starting point, expectations for the rest of the publication were pretty low and it more than lived down to them. But let’s focus on some of the details.

Trading under WTO rules implies imposing tariffs on EU trade where there are currently none. This is in no way a “deal” as EFT would have us believe: The WTO represents nothing more than a lowest common denominator set of rules to reduce trade frictions. EFT also believe that the UK can simply continue trading on the basis of these rules as soon as it exits the EU. There are one or two issues to iron out, such as agreeing on the division of quotas for goods which have already been agreed at the EU level (the US, Australia and NZ have already objected to the proposed divvying up of agricultural quotas). Incidentally, EFT believe this “should not cause great difficulties … the EU and the UK have been working harmoniously in this regard for some time” although The Guardian reported in the spring that “in recent months the united EU and UK front has splintered.”

EFT then poses the question “Does the WTO require physical customs checks, meaning lengthy delays at our ports and borders?” and in their view the answer is negative. But the delays come when other countries impose customs checks on goods entering foreign markets, and then some! According to the WTO, “high levels of bureaucracy and unnecessary costs” result from document requirements that lack transparency and involve duplication; a lack of cooperation between traders and customs agencies and lack of automatic data submission with the result that “at some border crossings, cargo can take up to 30 days to be cleared.”

Against this backdrop, EFT continue to argue that the economic gains to Brexit outweigh the costs. “Those who have modelled a Clean Brexit properly report long-term gains from free trade alone of 2%-4% of GDP.” You have to laugh at the chutzpah. Those who have modelled Brexit “properly” certainly do not include EFT. “The long-term negative outcomes claimed by the Treasury and the January Cross Departmental Brexit Analysis were produced by assuming implausibly high (and illegal) frictional UK-EU border costs.” Yet the bulk of the academic evidence finds that border costs are far higher than often supposed. It is not tariffs that are the problem; rather the costs associated with transacting across borders (legal, contract enforcement, transport and distribution expenses). Indeed, they are generally larger than the marginal costs of production[1].

Then EFT simply descend into fantasy. They reckon that in addition to the positive effects of free trade, the UK will save “approximately £12 billion a year” by cutting payments to the EU. Finally, “because we will be doing all this without the encumbrances and constraints of the Withdrawal Agreement … we can … withhold most or all of the estimated £39 billion divorce payment.” The upshot will be a “long-term gain to GDP of …  about 7% over the next decade and a half” which will “allow enhanced spending on public services and tax cuts by the early 2020s, further boosting the economy.” To sum this up, EFT reckon that a system of imposing additional tariffs on EU trade is going to somehow boost GDP and find a Brexit  dividend that the OBR says does not exist. As the kids would say, LMAO.

And we’re not done yet. EFT argue that “the economically optimal trade strategy in most circumstances for the UK would be to eliminate all tariff and non-tariff barriers unilaterally with respect to all our trading partners.” The elimination of all non-tariff barriers implies the complete deregulation of all product standards. And since non-tariff barriers exist primarily due to differing regulations between trading partners, unless we suddenly converge on a set of global standards (e.g. China and the US adopt the same standards), it will be impossible for the UK to eliminate non-tariff barriers on all imports. Moreover, there is no reason why the rest of the world should reciprocate, particularly if the UK is a relatively small export market (which it is for most countries).

There are numerous other dodgy assertions but I will reserve some final flak for the idea that losing access to the EU market will not damage the financial  services industry. Without going through it point-by-point, I would question the assertion (provided without a reference) that “only 9% of the City’s revenues are vulnerable to the loss of passporting.” More than half the revenue generated by the City is generated from the rest of the EU according to TheCityUK, and initial estimates suggest that 20% of London revenues could be at stake. Moreover, some of the solutions proposed by EFT such as “setting up small entities in the EU that trade with EU customers and those entities entering into mirror, or “back-to-back” trades with the UK parent” would run fall foul of the ECB, which has ruled out boiler plate operations. Anyone who believes that Brexit will not have adverse consequences for financial services would do themselves a favour by talking to people in the industry who are already making their post-Brexit arrangements.

Eurosceptic MPs, operating under the guise of the European Research Group, promised earlier this month to produce an alternative to the Chequers plan but backed down when it became clear that some of the proposals were of “dubious quality.”  Given that Jacob Rees-Mogg lent his support to the EFT proposals but was not prepared to back the ERG plans, you really do have to wonder how bad they were. As trade expert David Henig tweeted this afternoon, the EFT analysis “isn't in any way a serious document. Media should treat the report, and any MPs citing it approvingly, as having nothing useful to say on the subject of post-Brexit trade.” As a drowning man clutches at straws, so the Brexiteers continue to hang their hat on sub-standard analysis such as this. They’re losing the argument because they haven’t got one.

---

[1] Anderson, J. E. and E. van Wincoop (2004) “Trade Costs” Journal of Economic Literature (42), pp. 691-751