Category: Economics for Business: Ch 24

TATA steelworks, Ijmuiden, Netherlands: photo JS

Since running for election, Donald Trump has vowed to ‘put America first’. One of the economic policies he has advocated for achieving this objective is the imposition of tariffs on imports which, according to him, unfairly threaten American jobs. On March 8 2018, he signed orders to impose new tariffs on metal imports. These would be 25% on steel and 10% on aluminium.

His hope is that, by cutting back on imports of steel and aluminium, the tariffs could protect the domestic industries which are facing stiff competition from the EU, South Korea, Brazil, Japan and China. They are also facing competition from Canada and Mexico, but these would probably be exempt provided negotiations on the revision of NAFTA rules goes favourably for the USA.

TATA steel works IJmuiden Netherlands (photo JS)Assuming there were no retaliation from other countries, jobs would be gained in the steel and aluminium industries. According to a report by The Trade Partnership (see link below), the tariffs would increase employment in these industries by around 33 000. However, the higher price of these metals would cause job losses in the industries using them. In fact, according to the report, more than five jobs would be lost for every one gained. The CNN Money article linked below gives example of the US industries that will be hit.

But the costs are likely to be much greater than this. Accorinding to the law of comparative advantage, trade is a positive-sum game, with a net gain to all parties engaged in trade. Unless trade restrictions are used to address a specific market distortion in the trade process itself, restricting trade will lead to a net loss in overall benefit to the parties involved.

Clearly there will be loss to steel and aluminium exporters outside the USA. There will also be a net loss to their countries unless these metals had a higher cost of production than in the USA, but were subsidised by governments so that they could be exported profitably.

Valancia port: photo JSBut perhaps the biggest cost will arise from possible retaliation by other countries. A trade war would compound the net losses as the world moves further from trade based on comparative advantage.

Already, many countries are talking about retaliation. For example, the EU is considering a ‘reciprocal’ tariff of 25% on cranberries, bourbon and Harley-Davidsons, all produced in politically sensitive US states (see the first The Economist article below). ‘As Jean-Claude Juncker, president of the European Commission, puts it, “We can also do stupid”.’ In fact, this is quite a politically astute move to put pressure on Mr Trump.

But cannot countries appeal to the WTO? Possibly, but this route might take some time. What is more, the USA has attempted to get around WTO rules by justifying the tariffs on ‘national security’ grounds – something allowed under Article XXI of WTO rules, provided it can be justified. This could possibly deter countries from retaliating, but it is probably unlikely. In the current climate, there seems to be a growing mood for flouting, or at least loosely interpreting, WTO rules.

Articles

Report

Questions

  1. Explain how, by countries specialising in goods in which they have a comparative advantage, all countries can gain.
  2. Can tariffs or other trade restrictions ever be justified? Explain.
  3. Is there any economic justification for the US tariffs of 25% on steel and 10% on aluminium?
  4. Can putting tariffs on US imports be justified by countries whose steel and/or aluminium industires are faced with US tariffs?
  5. Can trade wars be won? Explain.

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’.

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?

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?