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.
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)
- 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?
President-elect Donald Trump has blamed free trade for much of America’s economic problems. He argues that cheap imports from China, partly from an undervalued yuan, have led to a loss of jobs and to large-scale income flows from the USA to China. “They have taken our jobs; they have taken our money; and on top of that they have loaned the money to us and we actually pay them interest now on money,” he claimed to The Economist.
And it’s not just trade with China that he criticises. He sees cheap imports from developing countries generally as undermining US jobs. The solution he advocates is the imposition of tariffs on imports that threaten US jobs and scrapping, or fundamentally renegotiating, trade deals.
He refers to NAFTA – the North American Free Trade Agreement with Canada and Mexico – as the worst trade deal in US history and blames it for the loss of thousands of US manufacturing jobs. He has said that he will demand better terms from Mexico and Canada. If they don’t agree to them, he’d pull the USA out of NAFTA altogether.
A more recent trade agreement is the Trans-Pacific Partnership (TPP) with 11 other Pacific rim countries (but not including China). The agreement was signed on 4 February 2016, but is awaiting ratification from member countries. Amongst other things, the agreement cuts over 18,000 tariffs. Donald Trump has said that he would block the deal, even though it would lead to the elimination of tariffs on most US manufactured and agricultural products exported to the other countries. He argues that it would lead to a large-scale loss of US jobs from cheap imports.
Another major trade deal criticised by Trump is that being negotiated between the USA and the EU – the Transatlantic Trade and Investment Partnership (TTIP). It has already faced fierce opposition in Europe, with many fearing that it would give too much power to US corporations in their operations in Europe. With the opposition from Trump, it looks unlikely that the agreement will be signed, even in an amended form.
So is this more protectionist stance by Donald Trump in America’s interests? The main argument against restricting imports is that people generally in the USA would be poorer. This is the prediction from the law of comparative advantage. Trade allows a country to consume beyond its production possibility curve by specialising in the production of goods with relatively low opportunity costs and importing goods which would have had a higher opportunity cost if they were produced domestically (see, for example, Economics, 9th edition, pages 711–4). By imposing tariffs or other restrictions on cheap imports, consumers would end up paying more for such goods if they now have to be produced domestically. Cheap Chinese t-shirts would be replaced by expensive US ones. Real US incomes would be lower.
Another danger of pursuing protectionist policies is that other countries might retaliate. Trade wars might result, with the world ending up poorer.
Then there is a problem of locating products. It is not a simple question of saying a product is made in the USA or elsewhere. With complex modern supply chains, many products use components and services, such as design and logistics, from many different countries. Imposing restrictions on imports may lead to damage to products which are seen as US products.
An open trade policy, by contrast, not only leads to higher consumption, it stimulates economic growth and the extra competition it creates improves domestic productivity. As the pro-free trade article by Graeme Leach, linked below, argues:
There is overwhelming evidence that free trade improves economic performance by increasing competition in the domestic market. Trade disciplines domestic firms with market power, and simultaneously promotes productivity growth. Research also shows that a 10 per cent increase in trade leads to a 5 per cent increase in per capita income. More open trade policies are associated with higher per capita incomes.
And as the article by Clark Packard argues:
There is no question that America’s middle and lower classes have benefited from our trade liberalization. Through the widely accepted principle of comparative advantage in our trade policies, productivity has surged and prices have declined. Lower prices save the average American family thousands of dollars a year on goods they consume, raising the standard of living through enhanced purchasing power.
Despite these arguments, there is one crucial problem with free trade. Although overall levels of consumption may be higher, trade may make some people poorer. If workers in the US steel or garment industries lose their jobs because of cheap imports, they will certainly feel worse off, especially if there is no prospect of them getting another job elsewhere. They may lack transferable skills or have too many family or personal ties to move elsewhere in the country.
The government could help to ameliorate the problems of those made unemployed by providing retraining or resettlement grants or by investing in infrastructure projects that require relatively low skilled, but local, construction workers. But, as the Forbes article states:
It is in helping displaced workers of all types that US government, as well as the leaders of other rich countries, have largely failed. Little has been done to assist laid-off workers whose industries simply cannot compete in developed countries anymore.
What is more, inequality has been growing in the USA, and in most other developed countries too. International trade and investment and the growing concentration of power in large corporations has meant that most of the gains from trade have gone to the richest people. Many of the poor blame trade for their plight and the argument that they have still made some gains is either not believed or is not enough to appease them.
An interesting insight into why people may have voted for Trump and his policy of protectionism is provided by the Ultimatum Game (see also). As the final article below explains:
The game itself involves two players. The first player receives a sum of money, and gets to propose how to divide it between the two players. The second player can do only one thing: accept or reject the proposal. If the second player accepts, then the money is divided between the two players as proposed. But if the second player rejects the proposal, then neither player gets anything.
It might seem that the rational thing for the second person to do is to accept whatever the first person proposes, however little it gives to the second person providing it is something – after all, even a little is better than nothing. But experiments show that people playing the second person do not behave in that way. They seek a fair distribution. If the proposed distribution is perceived as unfair, they would prefer to reject the proposal, with both players getting nothing.
This may help to explain the psychology of poor blue-collar workers. They would rather punish the rich a lot, and possibly themselves a little, than let the rich continue getting richer while they are stuck on low wages with little prospect for improvement. But, of course, they may also believe Trump’s rhetoric that they will indeed be better off from protectionist policies that help save their jobs.
What precisely Donald Trump will do about trade agreements and protection, we will have to wait and see. Often what is pledged in an election campaign is not carried out in office or is substantially watered down.
How Donald Trump thinks about trade The Economist (9/11/16)
What President Trump’s victory means for the most important trade deal in the world Independent, James Moore (9/11/16)
Trump and trade: A radical agenda? BBC News, Ben Morris (9/11/16)
Trump could change trade stance, says former Bush adviser BBC News, Tom Espiner (11/11/16)
3 Ways President-Elect Trump May Shake Up Trade Policy NPR, Marilyn Geewax (9/11/16)
Donald Trump Win to Upend Trade Policy Nasdaq, William Mauldin and John Lyons (9/11/16)
Stiglitz Grades Donald Trump an F on Economics Bloomberg, Enda Curran and Angie Lau (19/9/16)
Trump can kill trade deals but he can’t kill globalisation The Conversation, Remy Davison (10/11/16)
Anti-free trader Donald Trump is on a collision course with economic reality City A.M., Graeme Leach (9/11/16)
What Trump And Clinton Both Get Wrong On Trade Forbes, Simon Constable (4/11/16)
The Rabble Understands Trade Pretty Well Huffington Post, Brad Miller (4/11/16)
Contrary to Donald Trump’s claims, free trade benefits the poorest Americans U.S.News, Clark Packard (27/10/16)
The Meaning of Open Trade and Open Borders The New Yorker, Bernard Avishai (17/10/16)
We just saw what voters do when they feel screwed. Here’s the economic theory of why they do it. Quartz, James Allworth (9/11/16)
- Use a simple two-product production possibility diagram to demonstrate the possible consumption gains to a country from trading with another country and specialising in exporting the good in which it has a comparative advantage.
- Search Donald Trump’s speeches to identify statements he has made about the trade policies he will pursue as president.
- Explain why some people may gain more from free trade than others. Why do the people who have gained the most tend to be the richest people?
- What are the arguments for and against the free movement of labour (a) within countries; (b) between countries?
- Compare the relative benefits and costs of tariffs and various forms of administrative constraints on trade.
- If the second player in the ultimatum game rejects an ‘unfair’ offer, should this behaviour be described as ‘irrational? Explain.
- Find out the details of the Trans-Pacific Partnership agreement. In what ways, other than through increased trade, would the agreement benefit the residents of the member countries?
- Does free trade threaten employment in the long term? Explain.
According to the law of comparative advantage, trade can benefit all countries if they export goods which they can produce at lower opportunity costs than their trading partners. Trade enables all countries to consume beyond their production possibility frontier. What is more, trade can increase competition, which encourages firms to be more efficient.
That trade is beneficial has been generally accepted by governments around the world since the Second World War, with the General Agreement on Tariffs and Trade (GATT) and then the World Trade Organization (WTO) advocating the dismantling of trade barriers. Countries have participated in a series of trade ’rounds’, such as the Uruguay Round (1986–94) and most recently the Doha Round (2001–15). But since the financial crisis of 2008, there has been waning enthusiasm for freer trade and growing calls to protect strategic and/or vulnerable industries. To some extent this mirrors the growth in protection after the Great Depression of the early 1930s as countries sought to boost their own industries.
After some progress in the Doha round talks in Nairobi in December 2015, the talks effectively marked the end of a fourteen-year road for the round (see also). There was a failure to agree on a number of items and chances of resurrecting the talks seem slim.
The classic response to calls for protection is that it can lead to a trade war, with a net loss in global output as less efficient domestic industries are shielded from competition from lower-cost imports. Consumers lose from no longer having access to cheaper imported goods. Trade wars, it is argued, are a negative sum game. Any gains to one country are more than offset by losses elsewhere. In fact, it is likely that all countries will lose.
One argument for protection recognises the efficiency gains from free trade, but argues that current trade is distorted. For example, countries may subsidise the export of products in which they have a comparative disadvantage and dump them on the rest of the world. The WTO recognises this as a legitimate argument for tariffs, if they are used to offset the effect of the subsidies and make import prices more reflective of the cost of production.
But increasingly arguments go beyond this. Industries that are regarded as strategic to a country’s future, such as the steel industry or agriculture, are seen as warranting protection. With protection, investment may flow to such industries, making them more efficient and even gaining a comparative advantage at some point in the future.
Then there is the question of income distribution. Trade with poor countries may help to close the gap somewhat between rich and poor countries. The reason is that poor countries, with an abundance of labour, are likely to have a comparative advantage in labour-intensive products. The demand for exports of such products will help to drive up wages in such countries. However, income distribution within the rich countries may become less equal. Cheap imports from developing countries may depress the wages of unskilled or low-skilled workers in the rich countries.
Another argument concerns the devastation caused to communities by the closure of plants which are major employers. Workers made redundant may find it hard to find alternative employment, especially if their skills are specific to the plant that has closed. At least in the short term, it is argued that such industries warrant protection to allow time for alternative employers to be attracted into the area.
Arguments such as these are being used today in many countries as they struggle with slowing growth in China, a glut of global resources and overcapacity in certain industries.
The steel industry is a case in point. The announcement by Tata Steel that it intends to close the Port Talbot steel works has been met with consternation and calls for protection against subsidised Chinese steel imports. The USA already imposes tariffs of 256% on corrosion-resistant Chinese steel. The EU has proposed raising tariffs on Chinese steel to the full amount of the subsidy, but the UK has blocked this, not wishing to trigger a trade war with China. In the meantime, China has announced the imposition of a tariff of 46% on a particular type of hi-tech steel imported from the EU.
On the other side of the Atlantic, there have been growing protectionist calls from presidential front runners. Donald Trump and Ted Cruz on the Republican side, and Bernie Sanders and now Hilary Clinton on the Democratic side, are opposed to the trade agreement that President Obama has been seeking with the EU – the Transatlantic Trade and Investment Partnership (TTIP). Donald Trump has proposed imposing tariffs of 45% on all Chinese imports.
The following articles look at the growing calls for protection, especially against China, and at the arguments about what should be done to protect the UK and EU steel industry.
Defiant China slaps steel tariffs on Britain as trade war looms The Telegraph, Ambrose Evans-Pritchard (1/4/16)
China’s soaring steel exports may presage a trade war, The Economist (9/12/15)
Trade, at what price? The Economist (30/3/16)
Free trade in America: Open argument The Economist (2/4/16)
Can the British steel industry be saved? Financial Times (2/4/16)
Steel crisis: UK government plays down China tariff fears BBC News (2/4/16)
The dogmas destroying UK steel also inhibit future economic growth The Observer, WIll Hutton (3/4/16)
UK accused of leading efforts to block limits to Chinese steel dumping The Guardian, Frances Perraudin (1/4/16)
There’s always an excuse to justify suspending free trade – Tata is the latest The Telegraph, Allister Heath (1/4/16)
Can one of the world’s top economies live without making steel? Bloomberg, Thomas Biesheuvel (1/4/16)
Trade policy is no longer just for political nerds: it matters in the UK and US The Guardian, Larry Elliott (27/3/16)
Steel shrivels while Britain’s balance of payments crisis grows The Observer, WIlliam Keegan (3/4/16)
Trump’s tariff plan could boomerang, spark trade wars with China, Mexico Reuters, David Lawder and Roberta Rampton (24/3/16)
Analysis: A Trump trade war could cost the U.S. millions of jobs Daily Herald (Chicago), Jim Tankersley (3/4/16)
- What is meant by the ‘law of comparative advantage’? Does the law imply that countries will always gain from totally free trade?
- Demonstrate the gains for each of two countries which choose to trade with each other (see, for example, pages 711–3 in Economics, 9th edition).
- What is meant by ‘strategic trade theory’? How would such theory relate to the case of steel production in south Wales?
- What are the arguments for and against the EU imposing tariffs on Chinese steel imports equal to the subsidy given by the Chinese government?
- Is protectionism always a negative sum game? Explain.
- Assess the validity of various arguments for protection.
- Why did it prove impossible to complete the Doha round?
- What is meant by the ‘Transatlantic Trade and Investment Partnership (TTIP)’? Why is there so much opposition to it?
- Are bilateral trade deals, such as the TTIP, the best way of moving forward in reaping the gains from freer trade?
The UK’s balance on trade continues to be sharply in deficit. At the same time, both manufacturing and overall production are still well below their pre-crisis levels. What is more, with a sterling exchange rate that has appreciated substantially over recent months, UK exports are at an increasing price disadvantage. The hoped-for re-balancing of the economy from debt-financed consumption to investment and exports has not occurred. Investment in the UK remains low relative to that in other major economies (see).
But other developments in the global economy are working in the UK’s favour.
Manufacturing globally is becoming more capital intensive, which reduces the comparative advantage of developing countries with low labour costs.
At the same time, the dividing line between manufacturing and services is becoming more blurred. Manufacturers in developing countries may still produce parts, such as chips or engines, but the design, marketing and sales of the products may take place in developed countries, such as the UK. Indeed, as products become more sophisticated, an increasing amount of value added may occur in developed countries.
The UK may be particularly well-placed in this regard. It can provide many high-end services in IT, business support and financial services to international manufacturers. It may have a comparative advantage in idea-intensive production.
Finally with a higher exchange rate, the UK’s terms of trade have been improving. The downside is that it makes UK exports more expensive in foreign currency terms, but it also makes commodity prices cheaper, which have already fallen in dollar terms, and also the prices of imported component parts. This helps offset the effect of the appreciation of the exchange rate on exports.
The following article by Jeremy Warner considers whether, despite its poor performance in traditional manufacturing, the UK might have hit an economic ‘sweet spot’ in its trade position.
Unbalanced but lucky, Britain hits an economic sweet spot The Telegraph, Jeremy Warner (8/9/15)
UK Trade (Excel file) ONS (9/9/15)
(See, for example, Worksheet 1. You can search for longer series using Google advanced search, putting www.ons.gov.uk in the ‘site or domaine’ box and searching for a particular series, using the series identifier found at the top of each column in the Excel file, such as BOKI for balance on trade in goods.)
Exchange rate data Bank of England Statistical Interactive Database
- Explain the difference between the balance on trade, the balance on trade in goods and the balance of payments on current account.
- Why has the UK not experienced a re-balancing of the economy as hope for by the Chancellor of the Exchequer, amongst others?
- What is meant by the ‘terms of trade’?
- What would cause an ‘improvement’ in the terms of trade?
- Are the UK’s terms of trade likely to move in the UK’s favour in the coming months? Explain.
- What current factors are mitigating against a recovery of UK manufacturing exports?
- Is de-industrialisation necessarily a ‘bad thing’?
- Does the development of new capital-intensive technologies in manufacturing mean that the UK could become a net exporter of manufactures? Explain why or why not.
A deal has just been signed between 26 African nations to form a new free trade area, the Tripartite Free Trade Area (TFTA). The countries have a population of 625 million (56% of Africa’s total) and a GDP of $1.6 trillion (63% of Africa’s total). The deal effectively combines three existing free trade areas: the Common Market for Eastern and Southern Africa, the Southern African Development Community and the East African Community.
Although the deal has been signed by the nations’ leaders, it still needs parliamentary approval from each of the countries. It is hoped that this will be achieved by 2017. If it is, it will mark a major step forward in encouraging intra-African trade.
The deal will involve the removal of trade barriers on most goods and lead to a reduction in overall tariffs by more than 50%. The expectation of the leaders is that this will generate $1 trillion worth of economic activity across the 26 countries through a process of trade creation, investment, increased competition and the encouragement of infrastructure development. But given the current poor state of infrastructure and the lack of manufacturing capacity in many of the countries, the agreement will also encourage co-operation to promote co-ordinated industrial and infrastructure development.
Up to now, the development of intra-African trade has been relatively slow because of poor road and rail networks and a high average protection rate – 8.7% on exports to other African countries compared with 2.5% on exports to non-African countries. As a result, intra-African trade currently accounts for just 12% of total African trade. It is hoped that the development of TFTA will result in this rising to over 30%.
Much of the gains will come from economies of scale. As Kenyan academic Calestous Juma says:
“By having larger markets, it signals the possibility of being able to manufacture products at a scale that is cost-effective. For example, where you need large-scale investments like $200m to create a pharmaceutical factory, you couldn’t do that if you were only selling the products in one country.”
The question is whether the agreement signed on the 10 June will lead to the member countries fully taking advantage of the opportunities for trade creation. Agreeing on a deal is one thing; having genuinely free trade and investing in infrastructure and new efficient industries is another.
Videos and audio
African leaders ink trade deal Deutsche Welle (11/6/15)
African leaders sign pact to create ‘Cape to Cairo’ free trade bloc euronews (10/6/15)
Africa Free Trade Analysis BBC Africa, Calestous Juma (9/6/15)
African Leaders To Sign Free Trade Agreement To Create Common Market International Business Times, Aditya Tejas (10.6.15)
EAC, COMESA and SADC Blocs Ink ‘Historic’ Trade Deal allAfrica, James Karuhanga (11/6/15)
Tripartite Free Trade Area an Opportunity Not a Threat allAfrica, Sindiso Ngwenya (9/6/15)
Africa a step closer to free trade area Business Report (South Africa), Rob Davies (11/6/15)
The Cape to Cairo trade ‘super bloc’ is here; 15 surprising – and shocking – facts on trade within Africa Mail & Guardian (Kenya), Christine Mungai (8/6/15)
The tripartite free trade area agreement in Africa is bound to disappoint Quartz Africa, Hilary Matfess (10/6/15)
Africa creates TFTA – Cape to Cairo free-trade zone BBC News Africa (10/6/15)
Will the Cape to Cairo free-trade zone work? BBC News Africa, Lerato Mbele (10/6/15)
African free trade still some way off BBC News, Matthew Davies (10/6/15)
Zambia not to benefit from Africa’s TFTA Medafrica, Geraldine Boechat (10/6/15)
- Distinguish between a free trade area, a customs union and a common market.
- What does the law of comparative advantage imply about the gains from forming a free trade area?
- Distinguish between trade creation and trade diversion.
- Why is it likely that there will be considerable trade creation from TFTA? Would there be any trade diversion?
- Why are small countries with a relatively low level of economic development likely to experience more trade creation than larger, richer ones?
- What barriers might remain in trade between the TFTA countries?
- Why might smaller, less developed members of TFTA be worried about the removal of trade barriers?
- Why might concentrating on developing local capacity, rather than just lowering tariffs, be a more effective way of developing intra-African trade
- What ‘informal’ barriers to trade exist in many African countries?
- Why is it that ‘Ordinary Africans are most probably not holding their breath’ about the gains from TFTA?