Tag: trade deals

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.

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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.

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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?

A general election has been called in the UK for 12 December. Central to the debates between the parties will be their policy on Brexit.

They range from the Liberal Democrats’, Plaid Cymru’s and Sinn Féin’s policy of cancelling Brexit and remaining in the EU, to the Scottish Nationalists’ and Greens’ policy of halting Brexit while a People’s Vote (another referendum) is held, with the parties campaigning to stay in the EU, to the Conservative Party’s policy of supporting the Withdrawal Agreement and Political Declaration negotiated between the Boris Johnson government and the EU, to the DUP which supports Brexit but not a version which creates a border between Great Britain and Northern Ireland, to the Brexit Party and UKIP which support leaving the EU with no deal (what they call a ‘clean break’) and then negotiating individual trade deals on a country-by-country basis.

The Labour Party also supports a People’s Vote, but only after renegotiating the Withdrawal Agreement and Political Declaration, so that if Brexit took place, the UK would have a close relationship with the single market and remain in a customs union. Also, various laws and regulations on environmental protection and workers’ rights would be retained. The referendum would take place within six months of the election and would be a choice between this new deal and remain.

But what are the economic costs and benefits of these various alternatives? Prior to the June 2016 referendum, the Treasury costed various scenarios. After 15 years, a deal would make UK GDP between 3.4% and 7.8% lower than if it remained in the EU, depending on the nature of the deal. No deal would make GDP between 5.4% and 9.5% lower.

Then in November 2018, the Treasury published analysis of the original deal negotiated by Theresa May in July 2018 (the ‘Chequers deal’). It estimated that GDP would be up to 3.9% lower after 15 years than it would have been if the UK had remained in the EU. In the case of a no-deal Brexit, GDP would be up to 9.3% lower after 15 years.

When asked for Treasury forecasts of the effects of Boris Johnson’s deal, the Chancellor, Sajid Javid, said that the Treasury had not been asked to provide forecasts as the deal was “self-evidently in our economic interest“.

Other forecasters, however, have analysed the effects of the Johnson deal. The National Institute for Economic and Social Research (NIESR), the UK’s longest established independent economic research institute, has estimated the costs of various scenarios, including the Johnson deal, the May deal, a no-deal scenario and also a scenario of continuing uncertainty with no agreement over Brexit. The NIESR estimates that, under the Johnson deal, with a successful free-trade agreement with the EU, in 10 years’ time UK GDP will be 3.5% lower than it would be by remaining in the EU. This represents a cost of £70 billion. The costs would arise from less trade with the EU, lower inward investment, slower growth in productivity and labour shortages from lower migration. These would be offset somewhat by savings on budget contributions to the EU.

Under Theresa May’s deal UK GDP would be 3.0% lower (and thus slightly less costly than Boris Johnson’s deal). Continuing in the current situation with chronic uncertainty about whether the UK would leave or remain would leave the UK 2% worse off after 10 years. In other words, uncertainty would be less damaging than leaving. The costs from the various scenarios would be in addition to the costs that have already occurred – the NIESR estimates that GDP is already 2.5% smaller than it would have been as a result of the 2016 Brexit vote.

Another report also costs the various scenarios. In ‘The economic impact of Boris Johnson’s Brexit proposals’, Professors Anand Menon and Jonathan Portes and a team at The UK in a Changing Europe estimate the effects of a decline in trade, migration and productivity from the various scenarios – again, 10 years after new trading arrangements are in place. According to their analysis, UK GDP would be 4.9%, 6.4% and 8.1% lower with the May deal, the Johnson deal and no deal respectively than it would have been from remaining in the EU.

But how much reliance should we put on such forecasts? How realistic are their assumptions? What other factors could they have taken into account? Look at the two reports and at the articles discussing them and then consider the questions below which are concerned with the nature of economic forecasting.

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Questions

  1. What are the arguments in favour of the assumptions and analysis of the two recent reports considered in this blog?
  2. What are the arguments against the assumptions and analysis of the two reports?
  3. How useful are forecasts like these, given the inevitable uncertainty surrounding (a) the outcome of negotiations post Brexit and (b) the strength of the global economy?
  4. If it could be demonstrated beyond doubt to everyone that each of the Brexit scenarios meant that UK GDP would be lower than if it remained in the EU, would this prove that the UK should remain in the EU? Explain.
  5. If economic forecasts turn out to be inaccurate, does this mean that economists should abandon forecasting?

There have been many analyses of the economic effects of Brexit, both before the referendum and at various times since, including analyses of the effects of the deal negotiated by Theresa May’s government and the EU. But with the prospect of a no-deal Brexit on 31 October under the new Boris Johnson government, attention has turned to the effects of leaving the EU without a deal.

There have been two major analyses recently of the likely effects of a no-deal Brexit – one by the International Monetary Fund (IMF) and one by the Office for Budget Responsibility (OBR).

IMF analysis

The first was in April by the IMF as part of its 6-monthly World Economic Outlook. In Scenario Box 1.1. ‘A No-Deal Brexit’ on page 28 of Chapter 1, the IMF looked at two possible scenarios.

Scenario A assumes no border disruptions and a relatively small increase in UK sovereign and corporate spreads. Scenario B incorporates significant border disruptions that increase import costs for UK firms and households (and to a lesser extent for the European Union) and a more severe tightening in financial conditions.

Under both scenarios, UK exports to the EU and UK imports from the EU revert to WTO rules. As a result, tariffs are imposed by mid-2020 or earlier. Non-tariff barriers rise at first but are gradually reduced over time. Most free-trade arrangements between the EU and other countries are initially unavailable to the UK (see the blog EU strikes major trade deals) but both scenarios assume that ‘new trade agreements are secured after two years, and on terms similar to those currently in place.’

Both scenarios also assume a reduction in net immigration from the EU of 25 000 per year until 2030. Both assume a rise in corporate and government bond rates, reflecting greater uncertainty, with the effect being greater in Scenario B. Both assume a relaxing of monetary and fiscal policy in response to downward pressures on the economy.

The IMF analysis shows a negative impact on UK GDP, with the economy falling into recession in late 2019 and in 2020. This is the result of higher trade costs and reduced business investment caused by a poorer economic outlook and increased uncertainty. By 2021, even under Scenario A, GDP is approximately 3.5% lower than it would have been if the UK had left the EU with the negotiated deal. For the rest of the EU, GDP is around 0.5% lower, although the effect varies considerably from country to country.

The IMF analysis makes optimistic assumptions, such as the UK being able to negotiate new trade deals with non-EU countries to replace those lost by leaving. More pessimistic assumptions would lead to greater costs.

OBR analysis

Building on the analysis of the IMF, the Office for Budget Responsibility considered the effect of a no-deal Brexit on the public finances in its biennial Fiscal risks report, published on 17 July 2019. This argues that, under the relatively benign Scenario A assumptions of the IMF, the lower GDP would result in annual public-sector net borrowing (PSNB) rising. By 2021/22, if the UK had left with the deal negotiated with the EU, PSNB would have been around £18bn. A no-deal Brexit would push this up to around £51bn.


According to the OBR, the contributors to this rise in public-sector net borrowing of around £33bn are:

  • A fall in income tax and national insurance receipts of around £16.5bn per year because of lower incomes.
  • A fall in corporation tax and expenditure taxes, such as VAT, excise duties and stamp duty of around £22.5bn per year because of lower expenditure.
  • A fall in capital taxes, such as inheritance tax and capital gains tax of around £10bn per year because of a fall in asset prices.
  • These are offset to a small degree by a rise in customs duties (around £10bn) because of the imposition of tariffs and by lower debt repayments (of around £6bn) because of the Bank of England having to reduce interest rates.

The rise in PSNB would constrain the government’s ability to use fiscal policy to boost the economy and to engage in the large-scale capital projects advocated by Boris Johnson while making the substantial tax cuts he is proposing. A less optimistic set of assumptions would, of course, lead to a bigger rise in PSNB, which would further constrain fiscal policy.

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Questions

  1. What are the assumptions of the IMF World Economic Outlook forecasts for the effects of a no-deal Brexit? Do you agree with these assumptions? Explain.
  2. What are the assumptions of the analysis of a no-deal Brexit on the public finances in the OBR’s Fiscal risks report? Do you agree with these assumptions? Explain.
  3. What is the difference between forecasts and analyses of outcomes?
  4. For what reasons might growth over the next few years be higher than in the IMF forecasts under either scenario?
  5. For what reasons might growth over the next few years be lower than in the IMF forecasts under either scenario?
  6. For what reasons might public-sector net borrowing (PSNB) over the next few years be lower than in the OBR forecast?
  7. For what reasons might PSNB over the next few years be higher than in the OBR forecast?

One of the key questions about Brexit is its effect on UK trade and cross-border investment. Once outside the customs union, will the freedom to negotiate trade deals lead to an increase in UK exports and GDP, as many who support Brexit claim; or will the increased frictions in trade with the EU, and the need to negotiate new trade deals with those non-EU countries which already have trade deals with the EU, lead to a fall in exports and in GDP?

Also, how will trade restrictions or new trade deals affect capital flows? Will there be an increase in inward investment or a flight of investment to the EU or elsewhere? Will many companies relocate away from the UK – or to it?

Although there has been a cost up to now from the Brexit vote, in terms of a depreciation in sterling and a fall in inward investment (see the first article below), the future effects have been hard to predict as the terms on which the UK will leave the EU have been unclear. However, with a draft withdrawal agreement between the EU and the UK government having been reached, the costs and benefits are becoming clearer. But there is still uncertainty about just what the effects on trade and investment will be.

  • First, the 585-page draft withdrawal agreement is not a trade deal. It contains details of UK payments to the EU, commitments on the rights of EU and UK citizens and confirmation of the transition period – initially until 31 December 2020, but possibly extended with mutual agreement. During the transition agreement, the UK would remain a member of the customs union and single market and remain subject to rulings of the European Court of Justice. The withdrawal agreement also provides for a continuation of the customs union beyond the transition period, if no long-term trade agreement is in place. This is to prevent he need for a hard border between Ireland and Northern Ireland.
  • Second, there is merely a 26-page ‘political declaration‘ about future trade relations. Negotiations on the details of these can only begin once the UK has left the EU, scheduled for 29 March 2019. So it’s still unclear about just how free trade in both goods and services will be between the UK and the EU and how freely capital and labour will move between them. But with the UK outside the single market, there will be some limitations on trade and factor movements – some frictions.
  • Third, it is not clear whether the UK Parliament will agree to the withdrawal agreement. Currently, it seems as if a majority of MPs is in favour of rejecting it. If this happens, will the UK leave without an agreement, with trade based on WTO terms? Or will the EU be prepared to renegotiate it – something it currently says it will not do? Or will the issue be put back to the electorate in the form of a People’s vote (see also), which might contain the option of seeking to remain in the EU?

So, without knowing just what the UK’s future trade relations will be with (a) the EU, (b) non-EU countries which have negotiated trade deals with the EU, (c) other countries without trade deals with the EU, it is impossible to quantify the costs and benefits from the effects on trade and investment. However, the consensus among economists is still that there will be a net cost in terms of lost trade and inward investment.

Such as view is backed by a government analysis of various Brexit scenarios, released in time for the House of Commons vote on 11 December. This concludes that the UK will be worse off under all Brexit alternatives compared with staying in the EU. The main brake on growth will be frictions in trade from tariff and non-tariff barriers.

This analysis was supported by a Bank of England paper which modelled various scenarios based on assumptions about different types of Brexit deal. While recognising the inherent uncertainty in some of the empirical relationships, it still concluded that Brexit would be likely to have a net negative effect. The size of this negative effect would depend on the closeness of the new relationship between the UK and EU, the degree of preparedness across firms and critical infrastructure, and how other policies respond.

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Questions

  1. Identify the main economic advantages and disadvantages for the UK from leaving the EU?
  2. How does the law of comparative advantage relate to the question of the relative trade gains from leaving and remaining in the EU?
  3. What is the difference between the following models of relationship with the EU: the Switzerland model; the Norway model; the Turkey model; the Canada (plus or plus, plus) model; trading on WTO terms?
  4. Why is the consensus among economists that there will be a net economic cost from leaving the EU, no matter on what terms?
  5. Is the UK likely to achieve more favourable trade deals with non-EU countries as an independent country or as a member of the EU benefiting from EU-negotiated trade deals with such countries?