Category: Essentials of Economics: 8e Ch 14

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.

At a meeting of the G7 finance ministers in London from 4–5 June, it was agreed to adopt a minimum corporate tax rate of 15% and to take measures to prevent multinational companies using tax havens to avoid paying taxes. It was also agreed that part of the taxes paid should go to the countries where sales are made and not just to those where the companies are based.

This agreement is the first step on the road to a comprehensive global agreement. The next step is a meeting of the finance ministers and central bank governors of the G20 countries in Venice from 9 to 10 July. The G7 ministers hope that their agreement will be adopted by this larger group, which includes other major economies such as Russia, China, India, Brazil, Australia, South Korea and South Africa.

Later in July, the proposals will be put to a group of 139 countries and jurisdictions at a meeting co-ordinated by the OECD. It is hoped that this meeting will finalise an international agreement with precise details on corporate tax rules. It follows work by the OECD on reforming international taxation under its Framework on Base Erosion and Profit Shifting (BEPS).

These meetings follow growing concerns about the ability of multinational companies to avoid taxes by basing regional headquarters in low-tax countries, such as Luxembourg or Singapore, and declaring their profits there, despite having only a tiny proportion of their sales in these countries.

The desire to attract multinational profits has led to a prisoners’ dilemma situation, whereby countries have been competing against each other to offer lower taxes, even though it reduces global corporate tax revenues.

With many countries having seen a significant rise in government deficits as result of the COVID-19 pandemic and the support measures put in place, there has been a greater urgency to reach international agreement on corporate taxes. The G7 agreement, if implemented, will provide a significant increase in tax revenue.

Details of the G7 agreement

The agreement has two parts or ‘pillars’.

Pillar 1 allows countries to tax large multinationals earning global profits of more than 10% if these companies are not based there but earn revenues there. Countries will be given tax rights over at least 20% of the profits earned there which exceed the 10% margin. The level of profits determined for each country will be based on the proportion of revenues earned there.

Pillar 2 sets a minimum corporate tax rate of 15% for each of the seven countries, which call on other countries to adopt the same minimum. The hope is that the G20 countries will agree to this and then at the OECD meeting in July a global agreement will be reached. If a country chooses to charge a rate below 15%, then a top-up tax can be applied by the home country to bring the total rate up to the 15%.

It is possible that these proposals will be strengthened/amended at the G20 and OECD meetings. For example, the 15% minimum rate may be raised. Indeed, the USA had initially proposed a 25% rate and then 21%, and several EU countries such as France, have been pushing for a substantially higher rate.

Analysis

The agreement was hailed as ‘historic’ by Rishi Sunak, the UK Chancellor of the Exchequer. This is true in that it is the first time there has been an international agreement on minimum corporate tax rates and locating part of tax liability according to sales. What is more, the rules may be strengthened at the G20 and/or OECD meetings.

There have been various criticisms of the agreement, however. The first is that 15% is too low and is well below the rates charged in many countries. As far as the UK is concerned, the IPPR think tank estimates that the deal will raise £7.9bn whereas a 25% rate would raise £14.7bn.

Another criticism is that the reallocation of some tax liabilities to countries where sales are made rather than where profits are booked applies only to profits in excess of 10%. This would therefore not affect companies, such as Amazon, with a model of large-scale low-margin sales and hence profits of less than 10%.

Also there is the criticism that a 20% reallocation is too low and would thus provide too little tax revenue to poor countries which may record large sales but where little or no profits are booked.

The UK was one of the more reluctant countries to sign up to a deal that would have a significant impact on tax havens in various British overseas territories and crown dependencies, such as the British Virgin islands, Bermuda, the Cayman Islands, the Channel Islands and Isle of Man. The agreement also calls into question whether the announced UK freeports can go ahead. Although these are largely concerned with waiving tariffs and other taxes on raw materials and parts imported into the freeport, which are then made into finished or semi-finished products within the freeport for export, they are still seen by many as not in the spirit of the G7 agreement.

What is more, the UK has been pushing for financial services to be exempted from Pillar 1 of the deal, which would otherwise see taxes partly diverted from the UK to other countries where such firms do business. For example, HSBC generates more than half its income from China and Standard Chartered operates mostly in Asia and Africa.

Videos

Articles

Questions

  1. How are multinationals currently able to avoid paying corporate taxes in many countries, even though their sales may be high there?
  2. If the deal is accepted at the OECD meeting in July, would it still be in the interests of low-tax countries to charge tax rates below the agreed minimum rate?
  3. Why was the UK reluctant to accept the 21% rate proposed by the Biden administration?
  4. Find out about the digital services tax that has been adopted by many countries, including EU countries and the UK, and why it will be abolished once a minimum corporate tax comes into force.
  5. Argue the case for and against taxing the whole of multinational profits in countries where they earn revenue in proportion to the company’s total global revenue. Would such a system benefit developing countries?
  6. Should financial services, such as those provided by City of London firms, be exempted from the deal?

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?

Many developing countries are facing a renewed debt crisis. This is directly related to Covid-19, which is now sweeping across many poor countries in a new wave.

Between 2016 and 2020, debt service as a percentage of GDP rose from an average of 7.1% to 27.1% for South Asian countries, from 8.1% to 14.1% for Sub-Saharan African countries, from 13.1% to 42.3% for North African and Middle Eastern countries, and from 5.6% to 14.7% for East Asian and Pacific countries. These percentages are expected to climb again in 2021 by around 10% of GDP.

Incomes have fallen in developing countries with illness, lockdowns and business failures. This has been compounded by a fall in their exports as the world economy has contracted and by a 19% fall in aid in 2020. The fall in incomes has led to a decline in tax revenues and demands for increased government expenditure on healthcare and social support. Public-sector deficits have thus risen steeply.

And the problem is likely to get worse before it gets better. Vaccination roll-outs in most developing countries are slow, with only a tiny fraction of the population having received just one jab. With the economic damage already caused, growth is likely to be subdued for some time.

This has put developing countries in a ‘trilemma’, as the IMF calls it. Governments must balance the objectives of:

  1. meeting increased spending needs from the emergency and its aftermath;
  2. limiting the substantial increase in public debt;
  3. trying to contain rises in taxes.

Developing countries are faced with a difficult trade-off between these objectives, as addressing one objective is likely to come at the expense of the other two. For example, higher spending would require higher deficits and debt or higher taxes.

The poorest countries have little scope for increased domestic borrowing and have been forced to borrow on international markets. But such debt is costly. Although international interest rates are generally low, many developing countries have had to take on increasing levels of borrowing from private lenders at much higher rates of interest, substantially adding to the servicing costs of their debt.

Debt relief

International agencies and groups, such as the IMF, the World Bank, the United Nations and the G20, have all advocated increased help to tackle this debt crisis. The IMF has allocated $100bn in lending through the Rapid Financing Instrument (RFI) and the Rapid Credit Facility (RCF) and nearly $500m in debt service relief grants through the Catastrophe Containment and Relief Trust (CCRT). The World Bank is increasing operations to $160bn.

The IMF is also considering an increase in special drawing rights (SDRs) from the current level of 204.2bn ($293.3bn) to 452.6bn ($650bn) – a rise of 121.6%. This would be the first such expansion since 2009. It has received the support of both the G7 and the G20. SDRs are reserves created by the IMF whose value is a weighted average of five currencies – the US dollar (41.73%), the euro (30.93%), the Chinese yuan (10.92%), the Japanese yen (8.33%) and the pound sterling (8.09%).

Normally an increase in SDRs would be allocated to countries according their IMF quotas, which largely depend on the size of their GDP and their openness. Any new allocation under this formula would therefore go mainly to developed countries, with developing economies getting only around $60bn of the extra $357bn. It has thus been proposed that developed countries give much of their allocation to developing countries. These could then be used to cancel debts. This proposal has been backed by Janet Yellen, the US Secretary of the Treasury, who said she would “strongly encourage G20 members to channel excess SDRs in support of recovery efforts in low-income countries, alongside continued bilateral financing”.

The G20 countries, with the support of the IMF and World Bank, have committed to suspend debt service payments by eligible countries which request to participate in its Debt Service Suspension Initiative (DSSI). There are 73 eligible countries. The scheme, now extended to 31 December 2021, provides a suspension of debt-service payments owed to official bilateral creditors. In return, borrowers commit to use freed-up resources to increase social, health or economic spending in response to the crisis. As of April 2021, 45 countries had requested to participate, with savings totalling more than $10bn. The G20 has also called on private creditors to join the DSSI, but so far without success.

Despite these initiatives, the scale of debt relief (as opposed to extra or deferred lending) remains small in comparison to earlier initiatives. Under the Heavily Indebted Poor Countries initiative (HIPC, launched 1996) and the Multilateral Debt Relief Initiative (MDRI, launched 2005) more than $100bn of debt was cancelled.

Since the start of the pandemic, major developed countries have spent between $10 000 and $20 000 per head in stimulus and social support programmes. Sub-Saharan African countries on average are seeking only $365 per head in support.

Articles and blogs

Podcast

Report

Data

Questions

  1. Imagine you are an economic advisor to a developing country attempting to rebuild the economy after the coronavirus pandemic. How would you advise it to proceed, given the ‘trilemma’ described above?
  2. How does the News24 article define ‘smart debt relief’. Do you agree with the definition and the means of achieving smart debt relief?
  3. To what extent is it in the interests of the developed world to provide additional debt relief to poor countries whose economies have been badly affected by the coronavirus pandemic?
  4. Research ‘debt-for-nature swaps’. To what extent can debt relief for countries affected by the coronavirus pandemic be linked to tackling climate change?

In his March 2021 Budget, Rishi Sunak announced the setting up of eight freeports in England. These will be East Midlands Airport, Felixstowe & Harwich, Humber, Liverpool City Region, Plymouth and South Devon, Solent, Teesside and Thames. The locations were chosen after a bidding process. Some 30 areas applied and they were judged on various criteria, including economic benefits to poorer regions. Other freeports are due to be announced in Scotland, Wales and Northern Ireland. The Scottish government is stressing their contribution to the green agenda and will call them ‘green ports’.

Unlike many countries, the UK in recent years chose not to have freeports. There are currently around 3500 freeports worldwide, There are around 80 in the EU, including the whole or part of Barcelona, Port of Bordeaux, Bremerhaven, Cadiz, Copenhagen, Gdansk, Luxembourg, Madeira, Malta, Plovdiv, Piraeus, Riga, Split, Trieste, Venice and Zagreb. The UK had freeports at Liverpool, Southampton, the Port of Tilbury, the Port of Sheerness and Prestwick Airport from 1984, but the government allowed their status to lapse in 2012.

Freeports are treated as ‘offshore’ areas, with goods being allowed into the areas tariff free. This enables raw materials and parts to be imported and made into finished or semi-finished products within the freeport area. At that stage they can either be imported to the rest of the country, at which point tariffs are applied, or they can be exported with no tariff being applied by the exporting country, only the receiving country as appropriate. This benefits companies within the freeport area as it simplifies the tariff system.

The new English freeports will provide additional benefits to companies, including reduced employers’ national insurance payments, reduced property taxes for newly acquired and existing land and buildings, 100% capital allowances whereby the full cost of investment in plant and machinery can be offset against taxable profits, and full business-rates relief for five years (see paragraph 2.115 in Budget 2021).

Benefits and costs

Freeport status will benefit the chosen areas, as it is likely to attract inward investment and provide employment. Many areas were thus keen to bid for freeport status. To the extent that there is a net increase in investment for the country, this will contribute to GDP growth.

But there is the question of how much net additional investment there will be. Critics argue that freeports can divert investment from areas without such status. Also, to the extent that investment is diverted rather than being new investment, this will reduce tax revenue to the government.

Then there is the question of whether such areas are in breach of international agreements. WTO rules forbid countries from directly subsidising exports. And the Brexit trade deal requires subsidies to be justified for reasons other than giving a trade advantage. If the UK failed to do so, the EU could impose tariffs on such goods to prevent unfair competition.

Also, there is the danger of tax evasion, money laundering and corruption encouraged by an absence of regulations and checks. Tight controls and thorough auditing by the government and local authorities will be necessary to counter this and prevent criminal activity and profits going abroad. Worried about these downsides of freeports, in January 2020 the EU tightened regulations governing freeports and took extra measures to clamp down on the growing level of corruption, tax evasion and criminal activity.

Articles