Tag: free trade

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Brexit and UK exports of food and drink

The effects of the Brexit trade deal are becoming clearer as new data are released. Figures for UK food imports and exports from and to the EU for the first quarter of 2021 have been published by the Food and Drink Federation. These show a 46.6% fall in UK food and drink exports to the EU in Q1 2021 when compared with Q1 2020, and a 55.1% fall when compared with Q1 2019 (before COVID).

The dairy sector has been the hardest hit, with exports of milk and cream to the EU down by more than 90% and exports of cheese down by 67% compared with Q1 2020. Other hard-hit sectors have been soft drinks, fish, potatoes and chicken. (Click here for a PowerPoint of the following chart.)

The Brexit trade deal did not involve the imposition of tariffs on exports and imports. However, with the UK having left the EU single market, there are now many regulatory checks and a considerable amount of paperwork to be completed for each consignment of exports. These frictions are slowing down trade and adding to costs. Although food and drink exports are beginning to recover somewhat, the delays while formalities are completed will have a lasting dampening effect on exports to the EU, especially in the case of perishable goods, such as meat and fish.

Also, farming has been badly affected by labour shortages, with many EU citizens returning to the EU. For example, according to the British Poultry Council (BPC), 10 per cent fewer chickens had been produced since Easter because of worker shortages. Across meat processing generally, similar shortfalls are being recorded because of a lack of labour.

Articles

Questions

  1. Find out how exports to the EU from sectors other than food and drink have fared since January this year.
  2. What are rules of origin? Why are they less likely to apply to food exports to the EU than to manufactured exports?
  3. Would you describe the Brexit trade deal (the EU-UK Trade and Cooperation Agreement) as a ‘free-trade’ deal? Explain.
  4. What are the particular difficulties for the food and drink sector in the Trade and Cooperation Agreement?
  5. Find out which parts of the food and drink sector have been particularly affected by labour shortages.
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UK–Australia trade deal: benefits and costs

The UK and Australia are set to sign a free-trade deal at the G7 summit in Cornwall on 11–13 June. This will eventually give tariff-free access to each other’s markets, with existing tariffs being phased out over a 15-year period. It is the first trade deal not based on an existing EU template. The government hopes that it will be followed by trade deals with other countries, including New Zealand, Canada and, crucially, the USA.

But what are the benefits and costs of such a deal?

Trade and comparative advantage

The classic economic argument is that free trade allows countries to benefit from the law of comparative advantage. According to the law, provided opportunity costs of various goods differ in two countries, both of them can gain from mutual trade if they specialise in producing (and exporting) those goods that have relatively low opportunity costs compared with the other country. In the case of the UK and Australia, the UK has a comparative advantage in products such as financial services and high-tech and specialist manufactured products. Australia has a comparative advantage in agricultural products, such as lamb, beef and wheat and in various ores and minerals. By increasing trade in these products, there can be a net efficiency gain to both sides and hence a higher GDP than before.

There is clearly a benefit to consumers in both countries from cheaper products, but the gains are likely to be very small. The most optimistic estimate is that the gain in UK GDP will be around 0.01% to 0.02%. Part of the reason is the physical distance between the two countries. For products such as meat, grain and raw materials, shipping costs could be relatively high. This might result in no cost advantage over imports from much nearer countries, such as EU member states.

But modern trade deals are less about tariffs, which, with various WTO trade rounds, are much lower than in the past. Many imports from Australia are already tariff free, with meat currently having a tariff of 12%. Modern trade deals are more about reducing or eliminating non-tariff barriers, such as differing standards and regulations. This is the area where there is a high degree of concern in the UK. Import-competing sectors, such as farming, fear that their products will be undercut by Australian imports produced to lower standards.

Costs of a trade deal

In a perfectly competitive world, with no externalities, labour mobile between sectors and no concerns about income distribution, eliminating tariffs would indeed provide an efficiency gain. But these conditions do not hold. Small farmers are often unable to compete with food producers with considerable market power. The danger is that by driving out such small farmers, food production and supply might not result in lower long-run prices. Much would depend on the countervailing power of supermarkets to continue bearing down on food costs.

But the question of price is probably the least worrying issue. Meat and grain is generally produced at lower standards in Australia than in the UK, with various pesticides, fertilisers and antibiotics being used that are not permitted in the UK (and the EU). Unless the trade deal can involve UK standards being enforced on products produced in Australia for export to the UK, UK farmers could be undercut by such imports. The question then would be whether labelling of imported food products could alert consumers to the different standards. And even if they did, would consumers simply prefer to buy the cheaper products? If so, this could be seen as a market failure with consumers not taking into account all the relevant health and welfare costs. Better quality food could be seen as a merit good.

Then there are the broader social issues of the protection of rural industries and societies. Labour is relatively immobile from farming and there could be a rise in rural unemployment, which could have local multiplier effects, leading to the decline of rural economies. Rural ways of life could be seriously affected, which imposes costs on local inhabitants and visitors.

Trade itself imposes environmental costs. Even if it were privately efficient to transport products half way around the world, the costs of carbon emissions and other pollution may outweigh any private gains. At a time when the world is becoming increasingly concerned about climate change, and with the upcoming COP26 conference in Glasgow in November, it is difficult to align such a trade deal with a greater commitment to cutting carbon emissions.

Articles

Questions

  1. Why might the UK government be very keen to sign a trade deal with Australia?
  2. Does the law of comparative advantage prove that freer trade is more efficient than less free trade? Explain.
  3. What externalities are involved in the UK trading with Australia? Are they similar to those from trading with the USA?
  4. If a trade deal resulted in lower food prices but a decline in rural communities, how would you establish whether this would be a ‘price worth paying’?
  5. If some people gain from a trade deal and others lose and if it were established that the benefits to the gainers were larger than the costs to the losers, would this prove that the deal should go ahead?
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The UK and the EU: all change, or is it?

At 23:00 on 31 December 2020, the UK withdrew from the European single market. This ended the transition period which followed the UK’s departure from the EU on 31 January 2020. But, with the Trade and Cooperation Agreement (‘the deal’) signed on 30 December, it was agreed that there would be no tariffs or quotas on trade in goods between the UK and the EU.

So what are the new economic relations between the EU and the UK and how will they impact on the UK economy? What new restrictions are there on trade in goods and on the movement of labour and capital? How is trade in services, including financial services, affected? What new agreements, such as on fishing, will replace previous agreements?

What will happen to trade between Northern Ireland and the Republic of Ireland? What will happen to trade between Great Britain and Northern Ireland?

What will happen to regulations over standards of traded products and their production? Will the UK government be able to provide subsidies or other types of support for goods or services exported to the EU? How will disputes about standards and support to companies be resolved?

How will trade with non-EU countries change? If the EU has trade agreements with such countries, do these agreements now apply to trade between the UK and such countries? How free is the UK now to negotiate new trade agreements with non-EU countries? How will the UK’s negotiating strength be affected by its withdrawal from the EU?

Rather than listing the changes here, follow the links below to the articles and assess the nature of the changes and then attempt the questions. The articles represent a balance of views.

What is clear is that these are all big issues and are likely to have a significant impact on the UK economy. Most economists argue that the net effect will be negative on trade and economic growth, but there is huge uncertainty about the magnitude of the effects. Much will depend on how arrangements between the UK and the EU develop over the coming months and years.

Articles

UK and EU documents

Questions

  1. Summarise the main features of the Trade and Cooperation Agreement and how the UK’s new relationship with the EU differs from being a member.
  2. What are the potential economic benefits from being outside the EU?
  3. What are the economic drawbacks for the UK from having left the EU, albeit with the new Trade and Cooperation Agreement?
  4. On balance, do you think that the UK will gain or lose economically from having left the EU? Explain your answer.
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Economists and the real world

Economists are often criticised for making inaccurate forecasts and for making false assumptions. Their analysis is frequently dismissed by politicians when it contradicts their own views.

But is this fair? Have economists responded to the realities of the global economy and to the behaviour of people, firms, institutions and government as they respond to economic circumstances? The answer is a qualified yes.

Behavioural economics is increasingly challenging the simple assumption that people are ‘rational’, in the sense that they maximise their self interest by weighing up the marginal costs and benefits of alternatives open to them. And macroeconomic models are evolving to take account of a range of drivers of global growth and the business cycle.

The linked article and podcast below look at the views of 2019 Nobel Prize-winning economist Esther Duflo. She has challenged some of the traditional assumptions of economics about the nature of rationality and what motivates people. But her work is still very much in the tradition of economists. She examines evidence and sees how people respond to incentives and then derives policy implications from the analysis.

Take the case of the mobility of labour. She examines why people who lose their jobs may not always move to a new one if it’s in a different town. Partly this is for financial reasons – moving is costly and housing may be more expensive where the new job is located. Partly, however, it is for reasons of identity. Many people are attached to where they currently live. They may be reluctant to leave family and friends and familiar surroundings and hope that a new job will turn up – even if it means a cut in wages. This is not irrational; it just means that people are driven by more than simply wages.

Duflo is doing what economists typically do – examining behaviour in the light of evidence. In her case, she is revisiting the concept of rationality to take account of evidence on what motivates people and the way they behave.

In the light of workers’ motivation, she considers the implications for the gains from trade. Is free trade policy necessarily desirable if people lose their jobs because of cheap imports from China and other developing countries where labour costs are low?

The answer is not a clear yes or no, as import-competing industries are only part of the story. If protectionist policies are pursued, other countries may retaliate with protectionist policies themselves. In such cases, people working in the export sector may lose their jobs.

She also looks at how people may respond to a rise or cut in tax rates. Again the answer is not clear cut and an examination of empirical evidence is necessary to devise appropriate policy. Not only is there an income and substitution effect from tax changes, but people are motivated to work by factors other than take-home pay. Likewise, firms are encouraged to invest by factors other than the simple post-tax profitability of investment.

Podcast

Article

Questions

  1. In traditional ‘neoclassical’ economics, what is meant by ‘rationality’ in terms of (a) consumer behaviour; (b) producer behaviour?
  2. How might the concept of rationality be expanded to take into account a whole range of factors other than the direct costs and benefits of a decision?
  3. What is meant by bounded rationality?
  4. What would be the effect on workers’ willingness to work more or fewer hours as a result of a cut in the marginal income tax rate if (a) the income effect was greater than the substitution effect; (b) the substitution effect was greater than the income effect? Would your answers to (a) and (b) be the opposite in the case of a rise in the marginal income tax rate?
  5. Give some arguments that you consider to be legitimate for imposing controls on imports in (a) the short run; (b) the long run. How might you counter these arguments from a free-trade perspective?
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UK free trade agreements with non-EU countries – a work in progress.

On 21st February 2019, the Department for International Trade (DIT) published a document outlining the UK’s progress in negotiating new free trade agreements (FTAs) with a number of non-EU countries. It advises UK firms that FTAs with Turkey and Japan will not be finalised before the official exit day from the European Union – 29th March 2019. Many business groups expressed concern at this news.

The EU has successfully negotiated a number of FTAs. These deals enable all 28 states in the European Union Custom Union (EU-CU), including the UK, to trade at preferential (i.e. lower) tariffs with over 70 non-EU countries. These include Canada, South Korea, Mexico, Israel, Norway, South Africa and Turkey. Research by the CBI estimates that UK exports to these countries were approximately £41bn in 2017 – approximately 13 per cent of all UK exports. In July 2018, the EU signed its largest ever FTA – with Japan. This deal covers 635 million people.

If the UK leaves the European Union without a deal on the 29th March, then it immediately loses membership of the EU-CU. Preferential tariffs will no longer apply to trade between the UK and the non-EU countries which signed the FTAs. Without any new arrangements in place, tariffs and quotas will revert to the non-preferential (i.e. higher) rates outlined in registered schedules with the World Trade Organization.

Given the economic significance of this trade, the UK government has spent the past two years trying to negotiate new FTAs to replace those previously agreed by the EU. For example, on February 11th, the government announced that it had signed a ‘continuity agreement’ with Switzerland covering trade worth £32bn per year. Deals have also been finalised with Chile, Israel, and the Faroe Islands that replicate the terms of the EU agreements. However, government officials informed 30 business groups in early February that it was highly unlikely that most of the new replacement FTAs would be concluded in time for March 29th.

The document published by the DIT on the 21st February confirms this position and describes the current status of most of the new FTAs as:

Engagement ongoing

For both Japan and Turkey, the outlook is more negative. The guidance states:

We will not transition this agreement for exit day.

The head of EU negotiations at the CBI commented that:

We are really concerned that firms could be blindsided by this.

The government stated that it would significantly increase the resources devoted to the trade negotiations and expected to sign more deals over the next couple of weeks.

If the UK leaves the EU on the 29th March with a deal, then it remains in the EU-CU during the 21-month transition period. Trade will still be covered by the 40 existing EU deals. This gives UK officials until the end of December 2020 to conclude a new set of FTAs.

Articles

Government information

Questions

  1. Using a demand and supply diagram, illustrate the impact of tariffs on imported goods.
  2. The EU is perhaps the most famous example of a customs union. Find out some other examples.
  3. Discuss some of the potential disadvantages of free trade.
  4. Discuss some of the advantages and disadvantages of the UK remaining in the European Union Custom Union.
  5. What is a ‘registered schedule’ at the World Trade Organization?