The President of the United States, Donald Trump, announced recently that he will be pushing ahead with plans to impose a 25% tariff on imports of steel and a 10% tariff on aluminium. This announcement has raised concerns among the USA’s largest trading partners – including the EU, Canada and Mexico, which, according to recent calculations, expect to lose more than $5 billion in steel exports and over $1 billion in aluminium exports.
Source: Bown (2018), Figure 1
A number of economists and policymakers are worried that such policies restrict trade and are likely to provoke retaliation by the affected trade partners. In recent statements, the EU has pledged to take counter-measures if the bloc is affected by these policies. In a recent press conference, the Commissioner for Trade, Cecilia Malmstrom, stated that:
We have made it clear that a move that hurts the EU and puts thousands of European jobs in jeopardy will be met with a firm and proportionate response.
She added that, ‘I truly hope that this will not happen. A trade war has no winners.’
Why is everyone so worried about trade wars then? Trade wars, by definition, result in trade diversion which can hurt employment, wealth creation and overall economic performance in the affected countries. As affected states are almost certain to retaliate, these losses are likely to be felt by all parties that are involved in a trade war – including the one that instigated it. This results in a net welfare loss, the size of which depends on a number of factors, including the relative size of the countries that take part in the trade war, the importance of the affected industries to the local economy and others.
A number of studies have attempted to estimate the effect of trade restrictions and tariff wars on welfare: see for instance Anderson and Wincoop (2001), Syropoulos (2002), Fellbermayr et al. (2013). The results vary widely, depending on the case. However, there seems to be consensus that the more similar (in terms of size and industry composition) the adversaries are, the more mutually damaging a trade war is likely to be (and, therefore, less likely to happen).
As Miyagiwa et al (2016, p43) explain:
A country initiates contingent protection policy against a trading partner only if the latter has a considerably smaller domestic market than its own, while avoiding confrontation with a country having a substantially larger domestic market than its own.
As both Canada and the EU are very large advanced market economies, it remains to be seen how much risk (and potential damage to the local and global economy) US trade policymakers are willing to take.
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.
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?
Theresa May has said that the UK will quit the EU single market and seek to negotiate new trade deals, both with the EU and with other countries. As she said, “What I am proposing cannot mean membership of the single market.” It would also mean leaving the customs union, which sets common external tariffs for goods imported into the EU.
The single market guarantees free movement of goods, services, labour and capital between EU members. There are no internal tariffs and common rules and regulations concerning products, production and trade. By leaving the single market, the UK will be able to restrict immigration from EU countries, as it is currently allowed to do from non-EU countries.
A customs union is a free trade area with common external tariffs and uniform methods of handling imports. There are also no, or only minimal, checks and other bureaucracies at borders between members. The EU customs union means that individual EU countries are not permitted to do separate trade deals with non-EU countries.
Once the UK has left the EU, probably in around two years’ time, it will then be able to have different trade arrangements from the EU with countries outside the EU. Leaving the customs union would mean that the UK would face the EU’s common external tariff or around 5% on most goods, and 10% on cars.
Leaving the EU single market and customs union has been dubbed ‘hard Brexit’. Most businesses and many politicians had hoped that elements of the single market could be retained, such as tariff-free trade between the UK and the EU and free movement of capital. However, by leaving the single market, access to it will depend on the outcome of negotiations.
Negotiations will take place once Article 50 – the formal notice of leaving – has been invoked. The government has said that it will do this by the end of March this year. Then, under EU legislation, there will be up to two years of negotiations, at which point the UK will leave the EU.
The articles look at the nature of the EU single market and customs union and at the implications for the UK of leaving them.
Explain the difference between a free-trade area, a customs union, a common market and a single market.
What arrangement does Norway have with the EU?
How would the UK’s future relationship with the EU differ from Norway’s?
Distinguish between trade creation and trade diversion from joining a customs union. Who loses from trade diversion?
Will leaving the EU mean that trade which was diverted can be reversed?
What will determine the net benefits from new trade arrangements compared with the current situation of membership of the EU?
What are the possible implications of hard Brexit for (a) inward investment and (b) companies currently in the UK of relocating to other parts of the EU? Why is the magnitude of such effects extremely hard to predict?
Explain what is meant by ‘passporting rights’ for financial services firms. Why are they unlikely still to have such rights after Brexit?
Discuss the argument put forward in The Conversation article that ‘Theresa May’s hard Brexit hinges on a dated vision of global trade’.
Many of the arguments used by both sides in the referendum debate centre on whether there will be a net economic gain from either remaining in or leaving the EU. This involves forecasting.
Forecasting the economic impact of the decision, however, is difficult, especially in the case of a leave vote, which would involve substantial change and uncertainty.
First, the effects of either remaining or leaving may be very different in the long run from the short run, and long-run forecasts are highly unreliable, as the economy is likely to be affected by so many unpredictable events – few people, for example, predicted the financial crisis of 2007–8.
Second, the effects of leaving depend on the nature of any future trading relationships with the EU. Various possibilities have been suggested, including ‘the Norwegian model’, where Britain leaves the EU, but joins the European Economic Area, giving access to the single market, but removing regulation in some key areas, such as fisheries and home affairs. Another possibility is ‘the Swiss model’, where the UK would negotiate trade deals on an individual basis. Another would be ‘the Turkish model’ where the UK forms a customs union with the EU. At the extreme, the UK could make a complete break from the EU and simply use its membership of the WTO to make trade agreements.
Nevertheless, despite the uncertainty, economists have ventured to predict the effects of remaining or leaving. These are not precise predictions for the reasons given above. Rather they are based on likely assumptions.
In a poll of 100 economists for the Financial Times, ‘almost three-quarters thought leaving the EU would damage the country’s medium-term outlook, nine times more than the 8 per cent who thought the country would benefit from leaving’. Most fear damage to financial markets in the UK and to inward foreign direct investment.
Despite the barrage of pessimistic forecasts by economists about a British exit, there is a group of eight economists in favour of Brexit. They claim that leaving the EU would lead to a stronger economy, with higher GDP, a faster growth in real wages, lower unemployment and a smaller gap between imports and exports. The main argument they use to support their claims is that the UK would be more able to pursue trade creation freed from various EU rules and regulations.
Then, less than four weeks before the vote, a poll of economists who are members of the Royal Economic Society and the Society of Business Economists came out strongly in favour of continued membership of the EU. Of the 639 respondents, 72 per cent thought that the most likely impact of Brexit on UK real GDP would be negative over the next 10 to 20 years; and 88 per cent thought the impact on GDP would be negative in the next five years (see chart: click to enlarge).
Of those stating that a negative impact on GDP in the next 5 years would be most likely, a majority cited loss of access to the single market (67%) and increased uncertainty leading to reduced investment (66%).
International organisations, such as the OECD, the IMF and the WTO, also argue that leaving the EU would create great uncertainty over future trade relations and access to the Single Market and would reduce inward foreign direct investment and the flow of skills.
But the forecasts of all these organisations depend on their assumptions about trade relations and that, in the event of the UK leaving the EU, would depend on the outcome of trade negotiations. The Leave campaign argues that other countries would want to trade with the UK and that therefore leaving would not damage trade. The Remain campaign argues that the EU would not wish to be generous to the UK for fear of encouraging other countries to leave the EU and that, anyway, the process of decoupling from the EU and negotiating new trade deals would take many years and, in the meantime, the uncertainty would be damaging to investment and growth.
The articles linked below looks at the economic arguments about Brexit and reflect the range of views of economists. Several are from ‘The Conversation’ as these are by academic economists. Although some economists are in favour of Brexit, the vast majority support the Remain side in the debate.
Summarise the main economic arguments of the Remain side.
What assumptions are made by the Remain side about Brexit?
Summarise the main economic arguments of the Leave side.
What assumptions are made by the Leave side about Brexit?
Assess the realism of the assumptions of the two sides.
If the UK exited the EU, would it be possible to continue gaining the benefits of the single market while restricting the free movement of labour?
Would it be beneficial to go for a ‘free trade’ option of abolishing all import tariffs if the UK left the EU? Would it mean that UK exports would face no tariffs from other countries?
If forecasting is unreliable, does this mean that nothing can be said about the costs and benefits of Brexit? Explain.
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.
The President of the United States, Donald Trump, announced recently that he will be pushing ahead with plans to impose a 25% tariff on imports of steel and a 10% tariff on aluminium. This announcement has raised concerns among the USA’s largest trading partners – including the EU, Canada and Mexico, which, according to recent calculations, expect to lose more than $5 billion in steel exports and over $1 billion in aluminium exports.
Why is everyone so worried about trade wars then? Trade wars, by definition, result in trade diversion which can hurt employment, wealth creation and overall economic performance in the affected countries. As affected states are almost certain to retaliate, these losses are likely to be felt by all parties that are involved in a trade war – including the one that instigated it. This results in a net welfare loss, the size of which depends on a number of factors, including the relative size of the countries that take part in the trade war, the importance of the affected industries to the local economy and others.
