Category: Economics for Business: Ch 25

The Economist is probably not the kind of newspaper that you will read more than once per issue – certainly not two years after its publication date. That is because, by definition, financial news articles are ephemeral: they have greater value, the more recent they are – especially in the modern financial world, where change can be strikingly fast. To my surprise, however, I found myself reading again an article on inequality that I had first read two years ago – and it is (of course) still relevant today.

The title of the article was ‘You may be higher in the global wealth pyramid than you think’ and it discusses exactly that: how much wealth does it take for someone to be considered ‘rich’? The answer to this question is of course, ‘it depends’. And it does depend on which group you compare yourself against. Although this may feel obvious, some of the statistics that are presented in this article may surprise you.

According to the article

If you had $2200 to your name (adding together your bank deposits, financial investments and property holdings, and subtracting your debts) you might not think yourself terribly fortunate. But you would be wealthier than half the world’s population, according to this year’s Global Wealth Report by the Crédit Suisse Research Institute. If you had $71 560 or more, you would be in the top tenth. If you were lucky enough to own over $744 400 you could count yourself a member of the global 1% that voters everywhere are rebelling against.

For many (including yours truly) these numbers may come as a surprise when you first see them. $2200 in today’s exchange rate is about £1640. And this is wealth, not income – including all earthly possessions (net of debt). £1640 of wealth is enough to put you ahead of half of the planet’s population. Have a $774 400 (£556 174 – about the average price of a two-bedroom flat in London) and – congratulations! You are part of the global richest 1% everyone is complaining about…

Such comparisons are certainly thought provoking. They show how unevenly wealth is distributed across countries. They also show that countries which are more open to trade are more likely to have benefited the most from it. Take a closer look at the statistics and you will realise that you are more likely to be rich (compared to the global average) if you live in one of these countries.

Of course, wealth inequality does not happen only across countries – it happens also within countries. You can own a two-bedroom flat in London (and be, therefore, part of the 1% global elite), but having to live on a very modest budget because your income (which is a flow variable, as opposed to wealth, which is a stock variable) has not grown fast enough in relation to other parts of the national population.

Would you be better off if there were less trade? Certainly not – you would probably be even poorer, as trade theories (and most of the empirical evidence I am aware of) assert. Why do we then talk so much about trade wars and trade restrictions recently? Why do we elect politicians who advocate such restrictions? It is probably easier to answer these questions using political than economic theory (although game theory may have some interesting insights to offer – have you heard of the ‘Chicken game‘?). But as I am neither political scientists nor a game theorist, I will just continue to wonder about it.

Articles and information

Questions

  1. Were you surprised by the statistics mentioned in this report? Explain why.
  2. Do you think that income inequality is a natural consequence of economic growth? Are there pro-growth policies that can be used to tackle it?
  3. Identify three ways in which widening income inequality can hurt economies (and societies).

The President of the United States, Donald Trump, announced recently that he will be pushing ahead with plans to impose a 25% tariff on imports of steel and a 10% tariff on aluminium. This announcement has raised concerns among the USA’s largest trading partners – including the EU, Canada and Mexico, which, according to recent calculations, expect to lose more than $5 billion in steel exports and over $1 billion in aluminium exports.

Source: Bown (2018), Figure 1

A number of economists and policymakers are worried that such policies restrict trade and are likely to provoke retaliation by the affected trade partners. In recent statements, the EU has pledged to take counter-measures if the bloc is affected by these policies. In a recent press conference, the Commissioner for Trade, Cecilia Malmstrom, stated that:

We have made it clear that a move that hurts the EU and puts thousands of European jobs in jeopardy will be met with a firm and proportionate response.

She added that, ‘I truly hope that this will not happen. A trade war has no winners.’

Why is everyone so worried about trade wars then? Trade wars, by definition, result in trade diversion which can hurt employment, wealth creation and overall economic performance in the affected countries. As affected states are almost certain to retaliate, these losses are likely to be felt by all parties that are involved in a trade war – including the one that instigated it. This results in a net welfare loss, the size of which depends on a number of factors, including the relative size of the countries that take part in the trade war, the importance of the affected industries to the local economy and others.

A number of studies have attempted to estimate the effect of trade restrictions and tariff wars on welfare: see for instance Anderson and Wincoop (2001), Syropoulos (2002), Fellbermayr et al. (2013). The results vary widely, depending on the case. However, there seems to be consensus that the more similar (in terms of size and industry composition) the adversaries are, the more mutually damaging a trade war is likely to be (and, therefore, less likely to happen).

As Miyagiwa et al (2016, p43) explain:

A country initiates contingent protection policy against a trading partner only if the latter has a considerably smaller domestic market than its own, while avoiding confrontation with a country having a substantially larger domestic market than its own.

As both Canada and the EU are very large advanced market economies, it remains to be seen how much risk (and potential damage to the local and global economy) US trade policymakers are willing to take.

Articles and Academic Papers

Questions

  1. Explain how trade diversion works and why it relates to economic prosperity.
  2. What are the key advantages of international trade?
  3. What are the key disadvantages of international trade?

With the Conservatives having lost their majority in Parliament in the recent UK election, there is renewed discussion of the form that Brexit might take. EU states are members of the single market and the customs union. A ‘hard Brexit’ involves leaving both and this was the government’s stance prior to the election. But there is now talk of a softer Brexit, which might mean retaining membership of the single market and/or customs union.

The single market
Belonging to the single market means accepting the free movement of goods, services, capital and labour. It also involves tariff-free trade within the single market and adopting a common set of rules and regulations over trade, product standards, safety, packaging, etc., with disputes settled by the European Court of Justice. Membership of the single market involves paying budgetary contributions. Norway and Iceland are members of the single market.

The single market brings huge benefits from free trade with no administrative barriers from customs checks and paperwork. But it would probably prove impossible to negotiate remaining in the single market with an opt out on free movement of labour. Controlling immigration from EU countries was a key part of the Leave campaign.

The customs union
This involves all EU countries adopting the same tariffs (customs duties) on imports from outside the EU. These tariffs are negotiated by the European Commission with non-EU countries on a country-by-country basis. Goods imported from outside the EU are charged tariffs in the country of import and can then be sold freely around the EU with no further tariffs.

Remaining a member of the customs union would allow the UK to continue trading freely in the EU, subject to meeting various non-tariff regulations. It would also allow free ‘borderless’ trade between Northern Ireland and the Republic of Ireland. However, being a member of the customs union would prevent the UK from negotiating separate trade deals with non-EU countries. The ability to negotiate such deals has been argued to be one of the main benefits of leaving the EU.

Free(r) trade area
The UK could negotiate a trade deal with the EU. But it is highly unlikely that such a deal could be in place by March 2019, the date when the UK is scheduled to leave the EU. At that point, trade barriers would be imposed, including between the two parts of the island of Ireland. Such deals are very complex, especially in the area of services, which are the largest category of UK exports. Negotiating tariff-free or reduced-tariff trade is only a small part of the problem; the biggest part involves negotiating product standards, regulations and other non-tariff barriers.

All the above options thus involve serious problems and the government will be pushed from various sides, not least within the Conservative Party, for different degrees of ‘softness’ or ‘hardness’ of Brexit. What is more, the pressure from business for free trade with the EU is likely to grow. Brexit may mean Brexit, but just what form it will take is very unclear.

Articles

Free trade area, single market, customs union – what’s the difference? BBC News, Jonty Bloom (12/6/17)
Brexit: What are the options? BBC News (12/6/17)
After the election, the real test: Brexi The Economist (8/6/17)
May’s Ministers Plot Softer Brexit to Keep UK in Single Market Bloomberg, Tim Ross, Alex Morales and Svenja O’Donnell (11/6/17)
UK’s Hung Parliament Raises Business Hopes for a Softer Brexit Bloomberg, Stephanie Baker and James Paton (12/6/17)
Do not exaggerate the effect the election will have on Brexit Financial Times, Wolfgang Münchau (11/6/17)
What is soft Brexit? How could it work as UK negotiates leaving the EU? Independent, May Bulman (12/6/17)
Brexit-lite back on the table as Britain rethinks its options after election The Guardian, Dan Roberts (11/6/17)
Review plan to quit EU Customs Union, urges FTA FoodManufacture.co.uk, James Ridler (12/6/17)
Freight leaders urge government to review decision to leave EU customs union RTM (12/6/17)

Paper
Making Brexit work for British Business: Key Execution Priorities M-RCBG Associate Working Paper No. 77, Harvard Kennedy School, Peter Sands, Ed Balls, Sebastian Leape and Nyasha Weinberg (June 2017)

Questions

  1. Explain the trading agreement between Norway and the EU.
  2. How does the Norwegian arrangement with the EU differ from the Turkish one?
  3. What are meant by the terms ‘hard Brexit’ and ‘soft Brexit’?
  4. How does a customs union differ from a free trade area?
  5. Is it possible to have (a) a customs union without a single market; (b) a single market without a customs union?
  6. To what extent is it in the EU’s interests to negotiate a deal with the UK which lets it maintain access to the customs union without having free movement of labour?
  7. The EU insists that talks about future trading arrangements between the UK and the EU can take place only after sufficient progress has been made on the terms of the ‘divorce’. What elements are included in the divorce terms?
  8. If agreement is not reached by 29 March 2019, what happens and what would be the consequences?
  9. Will a hung parliament, or at least a government supported by the DUP on a confidence and supply basis, make it more or less likely that there will be a hard Brexit?
  10. For what reasons may the EU favour (a) a hard Brexit; (b) a soft Brexit?

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?

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’.