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.
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.
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.
Explain the trading agreement between Norway and the EU.
How does the Norwegian arrangement with the EU differ from the Turkish one?
What are meant by the terms ‘hard Brexit’ and ‘soft Brexit’?
How does a customs union differ from a free trade area?
Is it possible to have (a) a customs union without a single market; (b) a single market without a customs union?
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?
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?
If agreement is not reached by 29 March 2019, what happens and what would be the consequences?
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?
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.
What elements would be included in a UK-US trade deal?
Explain the gains from trade that can result from exploiting comparative advantage.
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’.
Why is it difficult to work out in advance the likely effects on trade of a trade deal?
What would be the benefits and costs to the UK of allowing all countries’ imports into the UK tariff free?
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.
Explain the difference between a free-trade area, a customs union, a common market and a single market.
What arrangement does Norway have with the EU?
How would the UK’s future relationship with the EU differ from Norway’s?
Distinguish between trade creation and trade diversion from joining a customs union. Who loses from trade diversion?
Will leaving the EU mean that trade which was diverted can be reversed?
What will determine the net benefits from new trade arrangements compared with the current situation of membership of the EU?
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?
Explain what is meant by ‘passporting rights’ for financial services firms. Why are they unlikely still to have such rights after Brexit?
Discuss the argument put forward in The Conversation article that ‘Theresa May’s hard Brexit hinges on a dated vision of global trade’.
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:
Full Customs Union (CU) with the EU-27
Partial Customs Union with EU (based on EU-Turkey CU)
Free Trade Area (FTA) with access to the Single Market (European Economic Area)
Free Trade Area without automatic access to Single Market
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”.