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Articles for the ‘Economics for Business: Ch 24’ Category

What do trade deals involve?

In the light of the Brexit vote and the government’s position that the UK will leave the single market and customs union, there has been much discussion of the need for the UK to achieve trade deals. Indeed, a UK-US trade deal was one of the key issues on Theresa May’s agenda when she met Donald Trump just a week after his inauguration.

But what forms can a trade deal take? What does achieving one entail? What are likely to be the various effects on different industries – who will be the winners and losers? And what role does comparative advantage play? The articles below examine these questions.

Given that up until Brexit, the UK already has free trade with the rest of the EU, there is a lot to lose if barriers are erected when the UK leaves. In the meantime, it is vital to start negotiating new trade deals, a process that can be extremely difficult and time-consuming.

A far as new trade arrangements with the EU are concerned, these cannot be agreed until after the UK leaves the EU, in approximately two years’ time, although the government is keen that preliminary discussions take place as soon as Article 50 is triggered, which the government plans to do by the end of March.

Articles
Trade deals are difficult to negotiate and Britain lacks the skills for the job The Conversation, Nigel Driffield (27/1/17)
Why a U.S.-U.K. Trade Deal Could be Harder than it Sounds Newsweek, Josh Lowe (26/1/17)
UK-US trade deal will have ‘very small upsides’ for Britain, says former Bank of England economist Independent, Rob Merrick (26/1/17)
Trump says he wants a U.K. trade deal. Don’t hold your breath CNN Money, Alanna Petroff (23/1/16)
Reality Check: Can there be a quick UK-USA trade deal? BBC News, Jonty Bloom (16/1/17)

Questions

  1. What elements would be included in a UK-US trade deal?
  2. Explain the gains from trade that can result from exploiting comparative advantage.
  3. Explain the statement in the article that allowing trade to be determined by comparative advantage is ‘often politically unacceptable, as governments generally look to protect jobs and tax revenues, as well as to protect activities that fund innovation’.
  4. Why is it difficult to work out in advance the likely effects on trade of a trade deal?
  5. What would be the benefits and costs to the UK of allowing all countries’ imports into the UK tariff free?
  6. What are meant by ‘trade creation’ and ‘trade diversion’? What determines the extent to which a trade deal will result in trade creation or trade diversion?
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Hard Brexit

Theresa May has said that the UK will quit the EU single market and seek to negotiate new trade deals, both with the EU and with other countries. As she said, “What I am proposing cannot mean membership of the single market.” It would also mean leaving the customs union, which sets common external tariffs for goods imported into the EU.

The single market guarantees free movement of goods, services, labour and capital between EU members. There are no internal tariffs and common rules and regulations concerning products, production and trade. By leaving the single market, the UK will be able to restrict immigration from EU countries, as it is currently allowed to do from non-EU countries.

A customs union is a free trade area with common external tariffs and uniform methods of handling imports. There are also no, or only minimal, checks and other bureaucracies at borders between members. The EU customs union means that individual EU countries are not permitted to do separate trade deals with non-EU countries.

Once the UK has left the EU, probably in around two years’ time, it will then be able to have different trade arrangements from the EU with countries outside the EU. Leaving the customs union would mean that the UK would face the EU’s common external tariff or around 5% on most goods, and 10% on cars.

Leaving the EU single market and customs union has been dubbed ‘hard Brexit’. Most businesses and many politicians had hoped that elements of the single market could be retained, such as tariff-free trade between the UK and the EU and free movement of capital. However, by leaving the single market, access to it will depend on the outcome of negotiations.

Negotiations will take place once Article 50 – the formal notice of leaving – has been invoked. The government has said that it will do this by the end of March this year. Then, under EU legislation, there will be up to two years of negotiations, at which point the UK will leave the EU.

The articles look at the nature of the EU single market and customs union and at the implications for the UK of leaving them.

Articles
Britain to leave EU market as May sets ‘hard Brexit’ course Reuters, Kylie MacLellan and William James (17/1/17)
Brexit: UK to leave single market, says Theresa May BBC News (17/1/17)
How Does U.K. Want to Trade With EU Post-Brexit?: QuickTake Q&A Bloomberg, Simon Kennedy (17/1/17)
Brexit at-a-glance: What we learned from Theresa May BBC News, Tom Moseley (17/1/17)
Theresa May unveils plan to quit EU single market under Brexit Financial Times, Henry Mance (17/1/17)
Doing Brexit the hard way The Economist (21/1/17)
Theresa May confirms it’ll be a hard Brexit – here’s what that means for trade The Conversation, Billy Melo Araujo (17/1/17)
How to read Theresa May’s Brexit speech The Conversation, Paul James Cardwell (17/1/17)
Theresa May’s hard Brexit hinges on a dated vision of global trade The Conversation, Martin Smith (17/1/17)
Brexit: What is the EU customs union and why should people care that the UK is leaving it? Independent, Ben Chapman (17/1/17)

Questions

  1. Explain the difference between a free-trade area, a customs union, a common market and a single market.
  2. What arrangement does Norway have with the EU?
  3. How would the UK’s future relationship with the EU differ from Norway’s?
  4. Distinguish between trade creation and trade diversion from joining a customs union. Who loses from trade diversion?
  5. Will leaving the EU mean that trade which was diverted can be reversed?
  6. What will determine the net benefits from new trade arrangements compared with the current situation of membership of the EU?
  7. What are the possible implications of hard Brexit for (a) inward investment and (b) companies currently in the UK of relocating to other parts of the EU? Why is the magnitude of such effects extremely hard to predict?
  8. Explain what is meant by ‘passporting rights’ for financial services firms. Why are they unlikely still to have such rights after Brexit?
  9. Discuss the argument put forward in The Conversation article that ‘Theresa May’s hard Brexit hinges on a dated vision of global trade’.
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The lost decade: reflections by Bank of England chiefs

In two recent speeches, the Governor of the Bank of England, Mark Carney, and the Bank’s Chief Economist, Andy Haldane, have reflected on the growing inequality in the UK and other countries. They have also answered criticisms that monetary policy has exacerbated the problem. As, Andy Haldane puts it:

It is clear monetary policy has played a material role in lifting all boats since the financial crisis broke. …[But] even if monetary policy has lifted all boats, and could plausibly do so again if needed, that does not mean it has done so equally. In particular, concerns have been expressed about the potential distributional effects of monetary policy.

Jan Vlieghe [member of the Monetary Policy Committee] has recently looked at how monetary policy may have affected the fortunes of, among others, savers, pension funds and pensioners. The empirical evidence does not suggest these cohorts have been disadvantaged to any significant degree by the monetary policy stance. For most members in each cohort, the boost to their asset portfolios and the improved wages and profits due to a stronger economy more than offset the direct loss of income from lower rates [of interest on savings accounts].

Andy Haldane’s speech focused largely on regional inequality. He argued that productivity has grown much more rapidly in the more prosperous regions, such as London and the South East. This has resulted in rising inequality in wages between different parts of the UK. Policies that focus on raising productivity in the less prosperous regions could play a major role in reducing income inequality.

Mark Carney’s speech echoed a lot of what Andy Haldane was saying. He argued that expansionary monetary policy has, according to Bank of England modelling, “raised the level of GDP by around 8% relative to trend and lowered unemployment by 4 percentage points at their peak”. And the benefits have been felt by virtually everyone. Even savers have generally gained:

That’s in part because, to a large extent, the thrifty saver and the rich asset holder are often one and the same. Just 2% of households have deposit holdings in excess of £5000, few other financial assets and don’t own a home.

But some people still gained more from monetary policy than others – enough to contribute to widening inequality.

Losers from the lost decade
Mark Carney looked beyond monetary policy and argued that the UK has experienced a ‘lost decade’, where real incomes today are little higher than 10 years ago – the first time this has happened for 150 years. This stalling of average real incomes has been accompanied by widening inequality between various groups, where a few have got a lot richer, especially the top 1%, and many have got poorer. Although the Gini coefficient has remained relatively constant in recent years, there has been a widening gap between the generations.

For both income and wealth, some of the most significant shifts have happened across generations. A typical millennial earned £8000 less during their twenties than their predecessors. Since 2007, those over 60 have seen their incomes rise at five times the rate of the population as a whole. Moreover, rising real house prices between the mid-1990s and the late 2000s have created a growing disparity between older home owners and younger renters.

This pattern has been repeated around the developed world and has led to disillusionment with globalisation and a rise in populism. Globalisation has been “associated with low wages, insecure employment, stateless corporations and striking inequalities”. (Click here for a PowerPoint of the chart.)

And populism has been reflected in the crisis in Greece, the Brexit vote, Donald Trump’s election, the rise of the National Front in France, the No vote in the Italian referendum on reforming the constitution and the rise in anti-establishment parties and sentiment generally. Mainstream parties are beginning to realise that concerns over globalisation, inequality and a sense of disempowerment must be addressed.

Solutions to inequality
As far as solutions are concerned, central must be a rise in general productivity that increases potential real income.

Boosting the determinants of long-run prosperity is the job of government’s structural, or supply-side policies. These government policies influence the economy’s investment in education and skills; its capacity for research and development; the quality of its core institutions, such as the rule of law; the effectiveness of its regulatory environment; the flexibility of its labour market; the intensity of competition; and its openness to trade and investment.

But will this supply-side approach be enough to bring both greater prosperity and greater equality? Will an openness to trade be accepted by populist politicians who blame globalisation and the unequal gains from international trade for the plight of the poor? Carney recognises the problem and argues that:

For the societies of free-trading, networked countries to prosper, they must first re-distribute some of the gains from trade and technology, and then re-skill and reconnect all of their citizens. By doing so, they can put individuals back in control.

For free trade to benefit all requires some redistribution. There are limits, of course, because of fiscal constraints at the macro level and the need to maintain incentives at the micro level. Fostering dependency on the state is no way to increase human agency, even though a safety net is needed to cushion shocks and smooth adjustment.

Redistribution and fairness also means turning back the tide of stateless corporations.

… Because technology and trade are constantly evolving and can lead to rapid shifts in production, the commitment to reskilling all workers must be continual.

In a job market subject to frequent, radical changes, people’s prospects depend on direct and creative engagement with global markets. Lifelong learning, ever-greening skills and cooperative training will become more important than ever.

But whether these prescriptions will be accepted by people across the developed world who feel that the capitalist system has failed them and who look to more radical solutions, whether from the left or the right, remains to be seen. And whether they will be adopted by governments is another question!

Webcast
Roscoe Lecture Bank of England on YouTube, Mark Carney (5/12/16)

Speeches
One Car, Two Car, Red Car, Blue Car Bank of England, Andrew Haldane (2/12/16)
The Spectre of Monetarism: Roscoe Lecture, Liverpool John Moores University Bank of England, Mark Carney (5/12/16)

Articles: Andrew Haldane speech
Bank of England chief economist says monetary stimulus stopped ‘left behind’ from drowning Independent, Ben Chu (2/12/16)
BoE’s Andrew Haldane warns of regional growth inequality BBC News (2/12/16)
‘Regions would have faced contraction’ without rate cuts and money printing Belfast Telegraph (2/12/16)
Bank of England chief: UK can be transformed if it copies progress on Teesside Gazette Live, Mike Hughes (2/12/16)

Articles: Mark Carney speech
Governor’s ‘dynamite’ warning on wages and globalisation Sky News, Ed Conway (6/12/16)
Mark Carney warns Britain is suffering first lost decade since 1860 as people across Europe lose trust in globalisation The Telegraph, Szu Ping Chan and Peter Foster (5/12/16)
Mark Carney: we must tackle isolation and detachment caused by globalisation The Guardian, Katie Allen (6/12/16)
Bank of England’s Carney warns of strains from globalization Reuters, William Schomberg and David Milliken (6/12/16)
CARNEY: Britain is in ‘the first lost decade since the 1860s’ Business Insider UK, Oscar Williams-Grut (7/12/16)
Carney warns about popular disillusion with capitalism BBC News (5/12/16)
Some fresh ideas to tackle social insecurity Guardian letters (7/12/16)

Report
Monitoring poverty and social exclusion 2016 (MPSE) Joseph Rowntree Foundation, Adam Tinson, Carla Ayrton, Karen Barker, Theo Barry Born, Hannah Aldridge and Peter Kenway (7/12/16)

Data
OECD Income Distribution Database (IDD): Gini, poverty, income, Methods and Concepts OECD
The effects of taxes and benefits on household income Statistical bulletins ONS

Questions

  1. Has monetary policy aggravated the problem of inequality? Explain.
  2. Comment on Charts 11a and 11b on page 19 of the Haldane speech.
  3. Does the process of globalisation help to reduce inequality or does it make it worse?
  4. If countries specialise in the production of goods in which they have a comparative advantage, does this encourage them to use more or less of relatively cheap factors of production? How does this impact on factor prices? How does this affect income distribution?
  5. How might smaller-scale firms “by-pass big corporates and engage in a form of artisanal globalisation; a revolution that could bring cottage industry full circle”?
  6. Why has regional inequality increased in the UK?
  7. What types of supply-side policy would help to reduce inequality?
  8. Explain the following statement from Mark Carney’s speech: “For free trade to benefit all requires some redistribution. There are limits, of course, because of fiscal constraints at the macro level and the need to maintain incentives at the micro level”.
  9. Mark Carney stated that “redistribution and fairness also means turning back the tide of stateless corporations”. How might this be done?
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Red lines and options on UK trade post Brexit

A paper by three University of Sussex academics has just been published by the university’s UK Trade Policy Observatory (UKTPO). It looks at possible trade relations between the UK and the EU post Brexit. It identifies four key government objectives or constraints – what the authors call ‘red lines’ – and five possible types of trade arrangement with the EU.

The four red lines the authors identify are:

Limitations on the movement of people/labour;
An independent trade policy;
No compulsory budgetary contribution to the EU;
Legal oversight by UK courts only and not by the European Court of Justice.

Just how tight each of these four constraints should be is a matter for debate and political decision. For example, how extensive the limitations on the movement of labour should be and whether or not there should be any ‘voluntary’ budgetary contributions to the EU are issues where there is scope for negotiation.

Alongside these constraints is the objective of continuing to have as much access to and influence over the Single Market as possible.

The five possible types of trade arrangement with the EU identified in the paper are as follows:

1. Full Customs Union (CU) with the EU-27
2. Partial Customs Union with EU (based on EU-Turkey CU)
3. Free Trade Area (FTA) with access to the Single Market (European Economic Area)
4. Free Trade Area without automatic access to Single Market
5. Reversion to World Trade Organisation (WTO) Most Favoured Nation (MFN) terms

To clarify the terminology: a free trade area (FTA) is simply an agreement whereby member countries have no tariff barriers between themselves but individually can choose the tariffs they impose on imports from non-member countries; a customs union is a free trade area where all members impose common tariffs on imports from non-member countries and individual members are thus prevented from negotiating separate trade deals with non-member countries; membership of the European Economic Area requires accepting freedom of movement of labour and compulsory contributions to the EU budget; WTO Most Favoured Nation rules would involve the UK trading with the EU but with tariffs equal to the most favourable ones granted to other countries outside the EU and EEA.

The red lines would rule out the UK being part of the customs union or the EEA. Although WTO membership would not breach any of the red lines, the imposition of tariffs against UK exports would be damaging. So the option that seems most appealing to many ‘Brexiteers’ is to have a free trade area agreement with the EU and negotiate separate trade deals with other countries.

But even if a tariff-free arrangement were negotiated with the EU, there would still be constraints imposed on UK companies exporting to the EU: goods exported to the EU would have to meet various standards. But this would constrain the UK’s ability to negotiate trade deals with other countries, which might demand separate standards.

The paper and The Economist article explore these constraints and policy alternatives and come to the conclusion that there is no easy solution. The option that looks the best “from the UK government’s point of view and given its red lines, would be an FTA with a variety of special sectoral arrangements”.

Article
Brexit means…a lot of complex trade decisions The Economist, Buttonwood’s notebook (15/11/16)

Paper
UK–EU Trade Relations post Brexit: Too Many Red Lines? UK Trade Policy observatory (UKTPO), Briefing Paper No. 5, Michael Gasiorek, Peter Holmes and Jim Rollo (November 2016)

Questions

  1. Explain the difference between a free trade area, a customs union and a single market.
  2. Go through each of the four red lines identified in the paper and consider what flexibility there might be in meeting them.
  3. What problems would there be in operating a free trade agreement with the EU while separately pursuing trade deals with other countries?
  4. What is meant by ‘mutual recognition’ and what is its significance in setting common standards in the Single Market?
  5. What problems are likely to arise in protecting the interests of the UK’s service-sector exports in a post-Brexit environment?
  6. What does the EU mean by ‘cherry picking’ in terms of trade arrangements? How might the EU’s attitudes in this regard constrain UK policy?
  7. Does the paper’s analysis suggest that a ‘hard Brexit’ is inevitable?
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Trump and trade

President-elect Donald Trump has blamed free trade for much of America’s economic problems. He argues that cheap imports from China, partly from an undervalued yuan, have led to a loss of jobs and to large-scale income flows from the USA to China. “They have taken our jobs; they have taken our money; and on top of that they have loaned the money to us and we actually pay them interest now on money,” he claimed to The Economist.

And it’s not just trade with China that he criticises. He sees cheap imports from developing countries generally as undermining US jobs. The solution he advocates is the imposition of tariffs on imports that threaten US jobs and scrapping, or fundamentally renegotiating, trade deals.

He refers to NAFTA – the North American Free Trade Agreement with Canada and Mexico – as the worst trade deal in US history and blames it for the loss of thousands of US manufacturing jobs. He has said that he will demand better terms from Mexico and Canada. If they don’t agree to them, he’d pull the USA out of NAFTA altogether.

A more recent trade agreement is the Trans-Pacific Partnership (TPP) with 11 other Pacific rim countries (but not including China). The agreement was signed on 4 February 2016, but is awaiting ratification from member countries. Amongst other things, the agreement cuts over 18,000 tariffs. Donald Trump has said that he would block the deal, even though it would lead to the elimination of tariffs on most US manufactured and agricultural products exported to the other countries. He argues that it would lead to a large-scale loss of US jobs from cheap imports.

Another major trade deal criticised by Trump is that being negotiated between the USA and the EU – the Transatlantic Trade and Investment Partnership (TTIP). It has already faced fierce opposition in Europe, with many fearing that it would give too much power to US corporations in their operations in Europe. With the opposition from Trump, it looks unlikely that the agreement will be signed, even in an amended form.

So is this more protectionist stance by Donald Trump in America’s interests? The main argument against restricting imports is that people generally in the USA would be poorer. This is the prediction from the law of comparative advantage. Trade allows a country to consume beyond its production possibility curve by specialising in the production of goods with relatively low opportunity costs and importing goods which would have had a higher opportunity cost if they were produced domestically (see, for example, Economics, 9th edition, pages 711–4). By imposing tariffs or other restrictions on cheap imports, consumers would end up paying more for such goods if they now have to be produced domestically. Cheap Chinese t-shirts would be replaced by expensive US ones. Real US incomes would be lower.

Another danger of pursuing protectionist policies is that other countries might retaliate. Trade wars might result, with the world ending up poorer.

Then there is a problem of locating products. It is not a simple question of saying a product is made in the USA or elsewhere. With complex modern supply chains, many products use components and services, such as design and logistics, from many different countries. Imposing restrictions on imports may lead to damage to products which are seen as US products.

An open trade policy, by contrast, not only leads to higher consumption, it stimulates economic growth and the extra competition it creates improves domestic productivity. As the pro-free trade article by Graeme Leach, linked below, argues:

There is overwhelming evidence that free trade improves economic performance by increasing competition in the domestic market. Trade disciplines domestic firms with market power, and simultaneously promotes productivity growth. Research also shows that a 10 per cent increase in trade leads to a 5 per cent increase in per capita income. More open trade policies are associated with higher per capita incomes.

And as the article by Clark Packard argues:

There is no question that America’s middle and lower classes have benefited from our trade liberalization. Through the widely accepted principle of comparative advantage in our trade policies, productivity has surged and prices have declined. Lower prices save the average American family thousands of dollars a year on goods they consume, raising the standard of living through enhanced purchasing power.

Despite these arguments, there is one crucial problem with free trade. Although overall levels of consumption may be higher, trade may make some people poorer. If workers in the US steel or garment industries lose their jobs because of cheap imports, they will certainly feel worse off, especially if there is no prospect of them getting another job elsewhere. They may lack transferable skills or have too many family or personal ties to move elsewhere in the country.

The government could help to ameliorate the problems of those made unemployed by providing retraining or resettlement grants or by investing in infrastructure projects that require relatively low skilled, but local, construction workers. But, as the Forbes article states:

It is in helping displaced workers of all types that US government, as well as the leaders of other rich countries, have largely failed. Little has been done to assist laid-off workers whose industries simply cannot compete in developed countries anymore.

What is more, inequality has been growing in the USA, and in most other developed countries too. International trade and investment and the growing concentration of power in large corporations has meant that most of the gains from trade have gone to the richest people. Many of the poor blame trade for their plight and the argument that they have still made some gains is either not believed or is not enough to appease them.

An interesting insight into why people may have voted for Trump and his policy of protectionism is provided by the Ultimatum Game (see also). As the final article below explains:

The game itself involves two players. The first player receives a sum of money, and gets to propose how to divide it between the two players. The second player can do only one thing: accept or reject the proposal. If the second player accepts, then the money is divided between the two players as proposed. But if the second player rejects the proposal, then neither player gets anything.

It might seem that the rational thing for the second person to do is to accept whatever the first person proposes, however little it gives to the second person providing it is something – after all, even a little is better than nothing. But experiments show that people playing the second person do not behave in that way. They seek a fair distribution. If the proposed distribution is perceived as unfair, they would prefer to reject the proposal, with both players getting nothing.

This may help to explain the psychology of poor blue-collar workers. They would rather punish the rich a lot, and possibly themselves a little, than let the rich continue getting richer while they are stuck on low wages with little prospect for improvement. But, of course, they may also believe Trump’s rhetoric that they will indeed be better off from protectionist policies that help save their jobs.

What precisely Donald Trump will do about trade agreements and protection, we will have to wait and see. Often what is pledged in an election campaign is not carried out in office or is substantially watered down.

Articles
How Donald Trump thinks about trade The Economist (9/11/16)
What President Trump’s victory means for the most important trade deal in the world Independent, James Moore (9/11/16)
Trump and trade: A radical agenda? BBC News, Ben Morris (9/11/16)
Trump could change trade stance, says former Bush adviser BBC News, Tom Espiner (11/11/16)
3 Ways President-Elect Trump May Shake Up Trade Policy NPR, Marilyn Geewax (9/11/16)
Donald Trump Win to Upend Trade Policy Nasdaq, William Mauldin and John Lyons (9/11/16)
Stiglitz Grades Donald Trump an F on Economics Bloomberg, Enda Curran and Angie Lau (19/9/16)
Trump can kill trade deals but he can’t kill globalisation The Conversation, Remy Davison (10/11/16)
Anti-free trader Donald Trump is on a collision course with economic reality City A.M., Graeme Leach (9/11/16)
What Trump And Clinton Both Get Wrong On Trade Forbes, Simon Constable (4/11/16)
The Rabble Understands Trade Pretty Well Huffington Post, Brad Miller (4/11/16)
Contrary to Donald Trump’s claims, free trade benefits the poorest Americans U.S.News, Clark Packard (27/10/16)
The Meaning of Open Trade and Open Borders The New Yorker, Bernard Avishai (17/10/16)
We just saw what voters do when they feel screwed. Here’s the economic theory of why they do it. Quartz, James Allworth (9/11/16)

Questions

  1. Use a simple two-product production possibility diagram to demonstrate the possible consumption gains to a country from trading with another country and specialising in exporting the good in which it has a comparative advantage.
  2. Search Donald Trump’s speeches to identify statements he has made about the trade policies he will pursue as president.
  3. Explain why some people may gain more from free trade than others. Why do the people who have gained the most tend to be the richest people?
  4. What are the arguments for and against the free movement of labour (a) within countries; (b) between countries?
  5. Compare the relative benefits and costs of tariffs and various forms of administrative constraints on trade.
  6. If the second player in the ultimatum game rejects an ‘unfair’ offer, should this behaviour be described as ‘irrational? Explain.
  7. Find out the details of the Trans-Pacific Partnership agreement. In what ways, other than through increased trade, would the agreement benefit the residents of the member countries?
  8. Does free trade threaten employment in the long term? Explain.
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Brexit costs

The Treasury has published a paper analysing the costs of Britain leaving the EU. Its central assumption is that the UK would negotiate a bilateral trade deal with the EU similar to that between Canada and the EU. Under this assumption the Treasury estimates that, by 2030, GDP would be 6.2% lower than if the UK had remained in the EU, meaning that the average household would be £4300 per year worse off than it would otherwise have been. The analysis also finds that there would be a total reduction in tax receipts of £36 billion per year – far greater than any savings from lower contributions to the EU budget.

Not surprisingly the ‘Vote Remain’ campaign for the UK to stay in the EU has welcomed the analysis, seeing it as strong evidence in support of their case. Also, not surprisingly, the Vote Leave campaign has questioned both the analysis and the assumptions on which it is based.

The Treasury analysis looks at three possible scenarios: (a) a Canada-style bilateral arrangement (the central estimate); (b) the UK becoming a member or the European Economic Area – the ‘Norwegian model’ (according to the Treasury, this would reduce GDP by 3.8%); (c) no specific deal with the EU, with the UK simply having the same access to the EU as any other country that is a mamber of the WTO (this would reduce GDP by 7.5%). Thus the Norwegian model would probably result in a smaller reduction in growth, but the UK would still continue to make contributions to the EU budget and have to allow free movement of labour. Only in option (c) would it have total control over migration. Each of the estimates has a margin of error, giving a range for the reduction in GDP across the three scenarios from 3.4% to 9.5%.

The Treasury used a three-stage process to arrive at its conclusions, as explained in the FT article below:

First, it uses gravity models to estimate the effect of different trade relationships on the quantity of trade and foreign direct investment. Gravity models take into account how close countries are to each other geographically, as well as their historical links, rather than assuming that trade flows to wherever the lowest tariffs are.

Second, it uses external academic results to estimate the consequences for productivity – the efficiency of the UK economy – from different levels of trade and foreign direct investment.

Third, it plugs the productivity numbers unto a global economic model run by the National Institute of Economic and Social Research to estimate the long-run differences in national income and prosperity.

Clearly there is large-scale uncertainty over any forecasts 14 years ahead, especially when the relationship with the EU and other countries post-EU exit can only be roughly estimated. The question is whether the assumptions are reasonable and whether there would be substantial costs from Brexit, but not necessarily of £4300 per household.

The following articles look at the analysis and its assumptions. Unlike many newspaper articles, which clearly have an agenda, these articles are relatively unbiased and try to assess the arguments. Of course, it would be difficult to be totally unbiased and it would be a good idea to try to spot any biases in each of the articles.

Articles
Treasury’s Brexit analysis: what it says — and what it doesn’t Financial Times, Chris Giles (18/4/16)
A Treasury analysis suggests the costs of Brexit would be high The Economist (18/4/16)
George Osborne says UK would lose £36bn in tax receipts if it left EU The Guardian, Anushka Asthana and Tom Clark (18/4/16)
Will each UK household be £4,300 worse off if the UK leaves the EU? The Guardian, Larry Elliott (18/4/16)
FactCheck Q&A: can we trust the Treasury on Brexit? Channel 4 News, Patrick Worrall (18/4/16)
Reality Check: Would Brexit cost your family £4,300? BBC News, Anthony Reuben (18/4/16)
Brexit sparks outbreak of agreement among economists Financial Times, Chris Giles (27/4/16)

Treasury analysis
EU referendum: HM Treasury analysis key facts HM Treasury (18/4/16)
HM Treasury analysis: the long-term economic impact of EU membership and the alternatives HM Treasury (18/4/16)

Questions

  1. Would households actually be poorer if the Treasury’s forecasts are correct?
  2. What alternative trade arrangements with the EU would be possible if the UK left the EU?
  3. What are the Treasury model’s main weaknesses?
  4. What considerations are UK voters likely to take into account in the referendum which are not included in the Treasury analysis?
  5. Make out the case for supporting the analysis of the Treasury.
  6. Make out the case for rejecting the analysis of the Treasury.
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Trade wars looming

According to the law of comparative advantage, trade can benefit all countries if they export goods which they can produce at lower opportunity costs than their trading partners. Trade enables all countries to consume beyond their production possibility frontier. What is more, trade can increase competition, which encourages firms to be more efficient.

That trade is beneficial has been generally accepted by governments around the world since the Second World War, with the General Agreement on Tariffs and Trade (GATT) and then the World Trade Organization (WTO) advocating the dismantling of trade barriers. Countries have participated in a series of trade ’rounds’, such as the Uruguay Round (1986–94) and most recently the Doha Round (2001–15). But since the financial crisis of 2008, there has been waning enthusiasm for freer trade and growing calls to protect strategic and/or vulnerable industries. To some extent this mirrors the growth in protection after the Great Depression of the early 1930s as countries sought to boost their own industries.

After some progress in the Doha round talks in Nairobi in December 2015, the talks effectively marked the end of a fourteen-year road for the round (see also). There was a failure to agree on a number of items and chances of resurrecting the talks seem slim.

The classic response to calls for protection is that it can lead to a trade war, with a net loss in global output as less efficient domestic industries are shielded from competition from lower-cost imports. Consumers lose from no longer having access to cheaper imported goods. Trade wars, it is argued, are a negative sum game. Any gains to one country are more than offset by losses elsewhere. In fact, it is likely that all countries will lose.

One argument for protection recognises the efficiency gains from free trade, but argues that current trade is distorted. For example, countries may subsidise the export of products in which they have a comparative disadvantage and dump them on the rest of the world. The WTO recognises this as a legitimate argument for tariffs, if they are used to offset the effect of the subsidies and make import prices more reflective of the cost of production.

But increasingly arguments go beyond this. Industries that are regarded as strategic to a country’s future, such as the steel industry or agriculture, are seen as warranting protection. With protection, investment may flow to such industries, making them more efficient and even gaining a comparative advantage at some point in the future.

Then there is the question of income distribution. Trade with poor countries may help to close the gap somewhat between rich and poor countries. The reason is that poor countries, with an abundance of labour, are likely to have a comparative advantage in labour-intensive products. The demand for exports of such products will help to drive up wages in such countries. However, income distribution within the rich countries may become less equal. Cheap imports from developing countries may depress the wages of unskilled or low-skilled workers in the rich countries.

Another argument concerns the devastation caused to communities by the closure of plants which are major employers. Workers made redundant may find it hard to find alternative employment, especially if their skills are specific to the plant that has closed. At least in the short term, it is argued that such industries warrant protection to allow time for alternative employers to be attracted into the area.

Arguments such as these are being used today in many countries as they struggle with slowing growth in China, a glut of global resources and overcapacity in certain industries.

The steel industry is a case in point. The announcement by Tata Steel that it intends to close the Port Talbot steel works has been met with consternation and calls for protection against subsidised Chinese steel imports. The USA already imposes tariffs of 256% on corrosion-resistant Chinese steel. The EU has proposed raising tariffs on Chinese steel to the full amount of the subsidy, but the UK has blocked this, not wishing to trigger a trade war with China. In the meantime, China has announced the imposition of a tariff of 46% on a particular type of hi-tech steel imported from the EU.

On the other side of the Atlantic, there have been growing protectionist calls from presidential front runners. Donald Trump and Ted Cruz on the Republican side, and Bernie Sanders and now Hilary Clinton on the Democratic side, are opposed to the trade agreement that President Obama has been seeking with the EU – the Transatlantic Trade and Investment Partnership (TTIP). Donald Trump has proposed imposing tariffs of 45% on all Chinese imports.

The following articles look at the growing calls for protection, especially against China, and at the arguments about what should be done to protect the UK and EU steel industry.

Articles
Defiant China slaps steel tariffs on Britain as trade war looms The Telegraph, Ambrose Evans-Pritchard (1/4/16)
China’s soaring steel exports may presage a trade war, The Economist (9/12/15)
Trade, at what price? The Economist (30/3/16)
Free trade in America: Open argument The Economist (2/4/16)
Can the British steel industry be saved? Financial Times (2/4/16)
Steel crisis: UK government plays down China tariff fears BBC News (2/4/16)
The dogmas destroying UK steel also inhibit future economic growth The Observer, WIll Hutton (3/4/16)
UK accused of leading efforts to block limits to Chinese steel dumping The Guardian, Frances Perraudin (1/4/16)
There’s always an excuse to justify suspending free trade – Tata is the latest The Telegraph, Allister Heath (1/4/16)
Can one of the world’s top economies live without making steel? Bloomberg, Thomas Biesheuvel (1/4/16)
Trade policy is no longer just for political nerds: it matters in the UK and US The Guardian, Larry Elliott (27/3/16)
Steel shrivels while Britain’s balance of payments crisis grows The Observer, WIlliam Keegan (3/4/16)
Trump’s tariff plan could boomerang, spark trade wars with China, Mexico Reuters, David Lawder and Roberta Rampton (24/3/16)
Analysis: A Trump trade war could cost the U.S. millions of jobs Daily Herald (Chicago), Jim Tankersley (3/4/16)

Questions

  1. What is meant by the ‘law of comparative advantage’? Does the law imply that countries will always gain from totally free trade?
  2. Demonstrate the gains for each of two countries which choose to trade with each other (see, for example, pages 711–3 in Economics, 9th edition).
  3. What is meant by ‘strategic trade theory’? How would such theory relate to the case of steel production in south Wales?
  4. What are the arguments for and against the EU imposing tariffs on Chinese steel imports equal to the subsidy given by the Chinese government?
  5. Is protectionism always a negative sum game? Explain.
  6. Assess the validity of various arguments for protection.
  7. Why did it prove impossible to complete the Doha round?
  8. What is meant by the ‘Transatlantic Trade and Investment Partnership (TTIP)’? Why is there so much opposition to it?
  9. Are bilateral trade deals, such as the TTIP, the best way of moving forward in reaping the gains from freer trade?
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The outlook for emerging markets

Are emerging markets about to experience a credit crunch? Slowing growth in China and other emerging market economies (EMEs) does not bode well. Nor does the prospect of rising interest rates in the USA and the resulting increase in the costs of servicing the high levels of dollar-denominated debt in many such countries.

According to the Bank for International Settlements (BIS) (see also), the stock of dollar-denominated debt in emerging market economies has doubled since 2009 and this makes them vulnerable to tighter US monetary policy.

Weaker financial market conditions combined with an increased sensitivity to US rates may heighten the risk of negative spillovers to EMEs when US policy is normalised. …

Despite low interest rates, rising debt levels have pushed debt service ratios for households and firms above their long-run averages, particularly since 2013, signalling increased risks of financial crises in EMEs.

But there is another perspective. Many emerging economies are pursuing looser monetary policy and this, combined with tighter US monetary policy, is causing their exchange rates against the dollar to depreciate, thereby increasing their export competitiveness. At the same time, more rapid growth in the USA and some EU countries, should also help to stimulate demand for their exports.

Also, in recent years there has been a large growth in trade between emerging economies – so-called ‘South–South trade’. Exports from developing countries to other developing countries has grown from 38% of developing countries’ exports in 1995 to over 52% in 2015. With technological catch-up taking place in many of these economies and with lower labour and land costs, their prospects look bright for economic growth over the longer term.

These two different perspectives are taken in the following two articles from the Telegraph. The first looks at the BIS’s analysis of growing debt and the possibility of a credit crunch. The second, while acknowledging the current weakness of many emerging economies, looks at the prospects for improving growth over the coming years.

Articles
‘Uneasy’ market calm masks debt timebomb, BIS warns The Telegraph, Szu Ping Chan (6/12/15)
Why emerging markets will rise from gloom to boom The Telegraph, Liam Halligan (5/12/15)

Questions

  1. How does an improving US economy impact on emerging market economies?
  2. Will the impact of US monetary policy on exchange rates be adverse or advantageous for emerging market economies?
  3. What forms does dollar-denominated debt take in emerging economies?
  4. Why has south–south trade grown in recent years? Is it consistent with the law of comparative advantage?
  5. Why is growth likely to be higher in emerging economies than in developed economies in the coming years?
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A major new trade deal – the Trans-Pacific Partnership

Governments of twelve Pacific rim nations, including the USA, Canada, Japan and Australia have just agreed to a trade deal – the Trans-Pacific Partnership (TPP). This represents the most significant trade deal since the completion of the Uruguay Round and the creation of the World Trade Organisation in 1994. Together these countries account for some 40% of global GDP. The deal must still be signed by the leaders of the TPP countries, however, and, more importantly, ratified by their legislatures, where, to put it mildly, agreement is not universal.

The deal is hailed as a move towards freer trade in a number of areas, including agriculture and services. But it also provides greater protection for owners of intellectual property. Proponents of the deal argue that it will to lead large-scale reductions in tariffs and other trade restrictions. As the Economist article states:

For American exporters alone, 18,000 individual tariffs will be reduced to zero. Much the same will be true for firms in the other 11 members. Even agricultural barriers, usually among the most heavily defended, will start to come down. Foreigners will gain a toehold in Canada’s dairy sector and a bigger share of Japan’s beef market, for example.

But despite this being the biggest trade deal for some 20 years, it has been highly criticised by various groups. Freer trade threatens industries that will face competition from other countries in the TPP. This unites both corporations and unions in trying to protect their own specific interests. However, the agreement gives ground to many special industries by retaining protection in a number of areas, at least for several years.

It has also been criticised by environmentalists who worry about the removal of various environmental safeguards. In answer to these concerns, there are several provisions in the agreement that provide some measure of environmental protection so as to slow things such as deforestation, overfishing and carbon emissions. But environmentalists argue that these provisions do not go far enough.

Others are concerned that the agreement will allow corporations to challenge governments and undermine the ability of governments to regulate them.

The articles look at some of the details of the agreement and at the arguments for and against ratifying it. Some of these arguments go to the heart of the age-old free trade versus protection debate.

US, Japan and 10 countries strike Pacific trade deal Financial Times, Shawn Donnan and Demetri Sevastopulo (5/10/15)
What Trade-Deal Critics Are Missing Wall Street Journal, Zachary Karabell (8/10/15)
The Trans-Pacific Partnership: Weighing anchor The Economist (10/10/15)
A trade deal is no excuse to milk taxpayers Globe and Mail (Canada), Yuen Pau Woo (7/10/15)
What Is the Trans-Pacific Partnership Agreement (TPP)? Electronic Frontier Foundation
Wikileaks release of TPP deal text stokes ‘freedom of expression’ fears The Guardian, Sam Thielman (9/10/15)
TPP’s clauses that let Australia be sued are weapons of legal destruction, says lawyer The Guardian, Jess Hill (10/11/15)

Questions

  1. Who are likely to benefit from the TPP?
  2. Why are American republicans generally opposed to the agreement?
  3. What are the objections to the TPP’s provisions for the protection of intellectual property rights?
  4. Would the current twelve members of the TPP gain if China joined?
  5. What are the objections of environmentalists to TPP?
  6. What effect will the TPP on European countries?
  7. Other than a reduction in tariffs, what other types of measures are included in the TPP?
  8. What is the Investor-State Dispute Settlement mechanism and what criticisms have been made of it? Are they justified?
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UK trade: not all doom and gloom

The UK’s balance on trade continues to be sharply in deficit. At the same time, both manufacturing and overall production are still well below their pre-crisis levels. What is more, with a sterling exchange rate that has appreciated substantially over recent months, UK exports are at an increasing price disadvantage. The hoped-for re-balancing of the economy from debt-financed consumption to investment and exports has not occurred. Investment in the UK remains low relative to that in other major economies (see).

But other developments in the global economy are working in the UK’s favour.

Manufacturing globally is becoming more capital intensive, which reduces the comparative advantage of developing countries with low labour costs.

At the same time, the dividing line between manufacturing and services is becoming more blurred. Manufacturers in developing countries may still produce parts, such as chips or engines, but the design, marketing and sales of the products may take place in developed countries, such as the UK. Indeed, as products become more sophisticated, an increasing amount of value added may occur in developed countries.

The UK may be particularly well-placed in this regard. It can provide many high-end services in IT, business support and financial services to international manufacturers. It may have a comparative advantage in idea-intensive production.

Finally with a higher exchange rate, the UK’s terms of trade have been improving. The downside is that it makes UK exports more expensive in foreign currency terms, but it also makes commodity prices cheaper, which have already fallen in dollar terms, and also the prices of imported component parts. This helps offset the effect of the appreciation of the exchange rate on exports.

The following article by Jeremy Warner considers whether, despite its poor performance in traditional manufacturing, the UK might have hit an economic ‘sweet spot’ in its trade position.

Article
Unbalanced but lucky, Britain hits an economic sweet spot The Telegraph, Jeremy Warner (8/9/15)

Data
UK Trade (Excel file) ONS (9/9/15)
(See, for example, Worksheet 1. You can search for longer series using Google advanced search, putting www.ons.gov.uk in the ‘site or domaine’ box and searching for a particular series, using the series identifier found at the top of each column in the Excel file, such as BOKI for balance on trade in goods.)
Exchange rate data Bank of England Statistical Interactive Database

Questions

  1. Explain the difference between the balance on trade, the balance on trade in goods and the balance of payments on current account.
  2. Why has the UK not experienced a re-balancing of the economy as hope for by the Chancellor of the Exchequer, amongst others?
  3. What is meant by the ‘terms of trade’?
  4. What would cause an ‘improvement’ in the terms of trade?
  5. Are the UK’s terms of trade likely to move in the UK’s favour in the coming months? Explain.
  6. What current factors are mitigating against a recovery of UK manufacturing exports?
  7. Is de-industrialisation necessarily a ‘bad thing’?
  8. Does the development of new capital-intensive technologies in manufacturing mean that the UK could become a net exporter of manufactures? Explain why or why not.
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