Category: Economics for Business: 8e Ch 25

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.

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?

Each week, BBC Radio 4 broadcasts readings from a book serialised in five 15-minute episodes. In the week beginning 18 January 2021, the readings were from English Pastoral: An Inheritance by James Rebanks, a farmer from the Cumbrian fells. His farm is relatively small, covering 185 acres.

He has attempted to make it much more sustainable and less intensive, reintroducing traditional Herdwick sheep, having a mixture of cows and sheep rather than just sheep, a greater sub-division of fields, and more natural scrubland, peatbogs and trees. As a result, soil quality has improved and there has been an explosion of biodiversity, with an abundance of wild flowers and insects.

Apart from being an autobiography of his time as a farmer and his attempt to move towards more traditional methods, the book examines broader issues of agricultural sustainability. It looks at the pressures of consumers wanting cheap food, the market power of supermarkets and wholesalers, the cost pressures on farmers pushing them towards monoculture to achieve economies of scale, and the role of the agrichemicals industry promoting fertilisers, feeds and pesticides which bring short-term financial gains to farmers, but which cause longer-term damage to the land and to biodiversity.

Rebanks has gained quite a lot of media attention after the publication of his first book, The Shepherd’s Life, including being one of the guests on Desert Island Discs and the subject of an episode of The Food Programme.

Listen to the Food Programme podcast and try answering the questions, which are all based on the podcast in the order of the points made in the interview.

Podcast

Reviews

Questions

  1. What are the incentives of an unregulated market for food that result in monoculture and a loss of biodiversity?
  2. To what extent are consumers responsible for changes in farming methods?
  3. Have the changes helped the urban poor?
  4. How is the monopsony power of supermarkets and food wholesalers impacting on food production and the pattern of agriculture?
  5. There are various (private) economies of scale in food production, but these often involve substantial external costs and long-term private costs too. How does this impact on land use?
  6. What are some of the limits of technology in increasing crop, meat and dairy yields?
  7. Will more recent changes in the pattern of food consumption help to increase mixed farming and biodiversity?
  8. Is it ‘rational’ for many farmers to continue with intensive farming with high levels of artificial fertilisers and pesticides?
  9. Is diversity in farming across farms within a local area a public good? If so, how could such diversity be achieved?
  10. How can farmers be encouraged to think and act holistically?
  11. Is there a trade-off between food output and biodiversity?
  12. What are the dangers in the UK reaching an agricultural trade deal with the USA?
  13. What are the benefits and costs of encouraging local food markets?

According to the Brexit trade agreement (the Trade and Cooperation Agreement (TCA)), trade between the EU and the UK will remain quota and tariff free. ‘Quota free’ means that trade will not be restricted in quantity by the authorities on either side. ‘Tariff free’ means that customs duties will not be collected by the UK authorities on imports from the EU nor by the EU authorities on imports from the UK.

Article ‘GOODS .5: Prohibition of customs duties’ on page 20 of the agreement states that:

Except as otherwise provided for in this Agreement, customs duties on all goods originating in the other Party shall be prohibited.

This free-trade agreement was taken by many people to mean that trade would be unhindered, with no duties being payable. In fact, as many importers and exporters are finding, trade is not as ‘free’ as it was before January 2021. There are four sources of ‘friction’.

Tariffs on goods finished in the UK

This has become a major area of concern for many UK companies. When a good is imported into the UK from outside the EU and then has value added to it by processing, packaging, cleaning, remixing, preserving, refashioning, etc., under ‘rules of origin’ regulations, it can only count as a UK good if sufficient value or weight is added. The proportions vary by product, but generally goods must have approximately 50% UK content (or 80% of the weight of foodstuffs) to qualify for tariff-free access to the EU. For example, for a petrol car, 55% of its value must have been created in either the EU or UK. Thus cars manufactured in the UK which use many parts imported from Japan, China or elsewhere, may not qualify for tariff-free access to the EU.

In other cases, it is simply the question of whether the processing is deemed ‘sufficient’, rather than the imported inputs having a specific weight or value. For example, the grinding of pepper is regarded as a sufficient process and thus ground pepper can be exported from the UK to the EU tariff free. Another example is that of coal briquettes:

The process to transform coal into briquettes (including applying intense pressure) goes beyond the processes listed in ‘insufficient processing’ and so the briquettes can be considered ‘UK originating’ regardless of the originating status of the coal used to produce the briquettes.

In the case of many garments produced in the UK and then sold in retail chains, many of which have branches in both the UK and EU, generally both the weaving and cutting of fabric to make garments, as well as the sewing, must take place in the UK/EU for the garments to be tariff free when exported from the UK to the EU and vice versa.

Precise details of rules of origin are given in the document, The Trade and Cooperation Agreement (TCA): detailed guidance on the rules of origin.

Many UK firms exporting to the EU and EU firms exporting to the UK are finding that their products are now subject to tariffs because of insufficient processing being done in the UK/EU. Indeed, with complex international supply chains, this is a major problem for many importing and exporting companies.

Documentation

Rules of origin require that firms provide documentation itemising what parts of their goods come from outside the UK/EU. Then it has to be determined whether tariffs will be necessary on the finished product. This is time consuming and is an example of the increase in ‘red tape’ about which many firms are complaining. As the Evening Standard article states:

Exporters have to be able to provide evidence to prove the origin of their products’ ingredients. Next year, they will also have to provide suppliers’ declarations too, and EU officials may demand those retrospectively, so exporters need to have them now.

The increased paperwork and checks add to the costs of trade. Some EU companies are stating that they will no longer export to the UK and some UK companies that they will no longer export to the EU, or will have to set up manufacturing plants or distribution hubs in the EU to handle trade within the EU.

Other companies are adding charges to their products to cover the costs. As the Guardian article states:

“We bought a €47 [£42] shelf from Next for our bathroom,” said Thom Basely, who lives in Marseille. “On the morning it was supposed to be delivered we received an ‘import duty/tax’ demand for over €30, like a ransom note. It came as a complete surprise.”

In evidence given to the Treasury Select Committee (Q640) in May 2018, Sir Jon Thompson, then Chief Executive of HMRC, predicted that leaving the single market would involve approximately 200 million extra customs declarations on each side of the UK/EU border at a cost of £32.50 for each one, giving a total extra cost of approximately £6.5bn on each side of the border for companies trading with Europe. Although this was only an estimate, the extra ‘paperwork’ will represent a substantial cost.

VAT

Previously, goods could be imported into the UK without paying VAT in the UK on value added up to that point as VAT had already been collected in the EU. Similarly, goods exported to the EU would already have had VAT paid and hence would only be subject to the tax on additional value added. The UK was part of the EU VAT system and did not have to register for VAT in each EU country.

Now, VAT has to be paid on the goods as they are imported or released from a customs warehouse – similar to a customs duty. This is therefore likely to involve additional administration costs – the same as those with non-EU imports.

Services

The UK is a major exporter of services, including legal, financial, accounting, IT and engineering. It has a positive trade in services balance with the EU, unlike its negative trade in goods balance. Yet, the Brexit deal does not include free trade in services. Some of the barriers to other non-EU countries have been reduced for the UK in the TCA, but UK service providers will still face new barriers which will impose costs. For example, some EU countries will limit the time that businesspeople providing services can stay in their countries to six months in any twelve. Some will not recognise UK qualifications, unlike when the UK was a member of the single market.

The financial services supplied by City of London firms are a major source of export revenue, with about 40% of these revenues coming from the EU. Now outside the single market, these firms have lost their ‘passporting rights’. These allowed such firms to sell their services into the EU without the need for additional regulatory clearance. The alternative now is for such firms to be granted ‘equivalence’ by the EU. This has not yet been negotiated and even if it were, does not cover the full range of financial services. It excludes, for example, banking services such as lending and deposit taking.

Conclusions

Leaving the single market has introduced a range of frictions in trade. These are causing severe problems to some importers and exporters in the short term. Some EU goods are now unavailable in the UK or only so at significantly higher prices. Some exporters are finding that the frictions are too great to make their exports profitable. However, it remains to be seen how quickly accounting and logistical systems can adjust to improve trade flows between the UK and the EU.

But some of these frictions, as itemised above, will remain. According to the law of comparative advantage, these restrictions on trade will lead to a loss of GDP. And these losses will not be spread evenly throughout the UK economy: firms and their employees which rely heavily on UK–EU trade will be particularly hard hit.

Articles

Official documents

Questions

  1. Explain what is meant by ‘rules of origin’.
  2. If something is imported to the UK from outside the UK and then is refashioned in the UK and exported to the EU but, according to the rules of origin has insufficient value added in the UK, does this mean that such as good will be subject to tariffs twice? Explain.
  3. Are tariffs exactly the same as customs duties? Is the distinction made in the Guardian article a correct one?
  4. Is it in the nature of a free-trade deal that it is not the same as a single-market arrangement?
  5. Find out what arrangement Switzerland has with the EU. How does it differ from the UK/EU trade deal?
  6. What are the advantages and disadvantages of the Swiss/EU agreement over the UK/EU one?
  7. Are the frictions in UK–EU trade likely to diminish over time? Explain.
  8. Find out what barriers to trade in services now exist between the UK and EU. How damaging are they to UK services exports?

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.