The Treasury has published a paper analysing the costs of Britain leaving the EU. Its central assumption is that the UK would negotiate a bilateral trade deal with the EU similar to that between Canada and the EU. Under this assumption the Treasury estimates that, by 2030, GDP would be 6.2% lower than if the UK had remained in the EU, meaning that the average household would be £4300 per year worse off than it would otherwise have been. The analysis also finds that there would be a total reduction in tax receipts of £36 billion per year – far greater than any savings from lower contributions to the EU budget.
Not surprisingly the ‘Vote Remain’ campaign for the UK to stay in the EU has welcomed the analysis, seeing it as strong evidence in support of their case. Also, not surprisingly, the Vote Leave campaign has questioned both the analysis and the assumptions on which it is based.
The Treasury analysis looks at three possible scenarios: (a) a Canada-style bilateral arrangement (the central estimate); (b) the UK becoming a member or the European Economic Area – the ‘Norwegian model’ (according to the Treasury, this would reduce GDP by 3.8%); (c) no specific deal with the EU, with the UK simply having the same access to the EU as any other country that is a mamber of the WTO (this would reduce GDP by 7.5%). Thus the Norwegian model would probably result in a smaller reduction in growth, but the UK would still continue to make contributions to the EU budget and have to allow free movement of labour. Only in option (c) would it have total control over migration. Each of the estimates has a margin of error, giving a range for the reduction in GDP across the three scenarios from 3.4% to 9.5%.
The Treasury used a three-stage process to arrive at its conclusions, as explained in the FT article below:
First, it uses gravity models to estimate the effect of different trade relationships on the quantity of trade and foreign direct investment. Gravity models take into account how close countries are to each other geographically, as well as their historical links, rather than assuming that trade flows to wherever the lowest tariffs are.
Second, it uses external academic results to estimate the consequences for productivity – the efficiency of the UK economy – from different levels of trade and foreign direct investment.
Third, it plugs the productivity numbers unto a global economic model run by the National Institute of Economic and Social Research to estimate the long-run differences in national income and prosperity.
Clearly there is large-scale uncertainty over any forecasts 14 years ahead, especially when the relationship with the EU and other countries post-EU exit can only be roughly estimated. The question is whether the assumptions are reasonable and whether there would be substantial costs from Brexit, but not necessarily of £4300 per household.
The following articles look at the analysis and its assumptions. Unlike many newspaper articles, which clearly have an agenda, these articles are relatively unbiased and try to assess the arguments. Of course, it would be difficult to be totally unbiased and it would be a good idea to try to spot any biases in each of the articles.
Articles
Treasury’s Brexit analysis: what it says — and what it doesn’t Financial Times, Chris Giles (18/4/16)
A Treasury analysis suggests the costs of Brexit would be high The Economist (18/4/16)
George Osborne says UK would lose £36bn in tax receipts if it left EU The Guardian, Anushka Asthana and Tom Clark (18/4/16)
Will each UK household be £4,300 worse off if the UK leaves the EU? The Guardian, Larry Elliott (18/4/16)
FactCheck Q&A: can we trust the Treasury on Brexit? Channel 4 News, Patrick Worrall (18/4/16)
Reality Check: Would Brexit cost your family £4,300? BBC News, Anthony Reuben (18/4/16)
Brexit sparks outbreak of agreement among economists Financial Times, Chris Giles (27/4/16)
Treasury analysis
EU referendum: HM Treasury analysis key facts HM Treasury (18/4/16)
HM Treasury analysis: the long-term economic impact of EU membership and the alternatives HM Treasury (18/4/16)
Questions
- Would households actually be poorer if the Treasury’s forecasts are correct?
- What alternative trade arrangements with the EU would be possible if the UK left the EU?
- What are the Treasury model’s main weaknesses?
- What considerations are UK voters likely to take into account in the referendum which are not included in the Treasury analysis?
- Make out the case for supporting the analysis of the Treasury.
- Make out the case for rejecting the analysis of the Treasury.
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.
Articles
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)
Questions
- 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?
Governments of twelve Pacific rim nations, including the USA, Canada, Japan and Australia have just agreed to a trade deal – the Trans-Pacific Partnership (TPP). This represents the most significant trade deal since the completion of the Uruguay Round and the creation of the World Trade Organisation in 1994. Together these countries account for some 40% of global GDP. The deal must still be signed by the leaders of the TPP countries, however, and, more importantly, ratified by their legislatures, where, to put it mildly, agreement is not universal.
The deal is hailed as a move towards freer trade in a number of areas, including agriculture and services. But it also provides greater protection for owners of intellectual property. Proponents of the deal argue that it will to lead large-scale reductions in tariffs and other trade restrictions. As the Economist article states:
For American exporters alone, 18,000 individual tariffs will be reduced to zero. Much the same will be true for firms in the other 11 members. Even agricultural barriers, usually among the most heavily defended, will start to come down. Foreigners will gain a toehold in Canada’s dairy sector and a bigger share of Japan’s beef market, for example.
But despite this being the biggest trade deal for some 20 years, it has been highly criticised by various groups. Freer trade threatens industries that will face competition from other countries in the TPP. This unites both corporations and unions in trying to protect their own specific interests. However, the agreement gives ground to many special industries by retaining protection in a number of areas, at least for several years.
It has also been criticised by environmentalists who worry about the removal of various environmental safeguards. In answer to these concerns, there are several provisions in the agreement that provide some measure of environmental protection so as to slow things such as deforestation, overfishing and carbon emissions. But environmentalists argue that these provisions do not go far enough.
Others are concerned that the agreement will allow corporations to challenge governments and undermine the ability of governments to regulate them.
The articles look at some of the details of the agreement and at the arguments for and against ratifying it. Some of these arguments go to the heart of the age-old free trade versus protection debate.
US, Japan and 10 countries strike Pacific trade deal Financial Times, Shawn Donnan and Demetri Sevastopulo (5/10/15)
What Trade-Deal Critics Are Missing Wall Street Journal, Zachary Karabell (8/10/15)
The Trans-Pacific Partnership: Weighing anchor The Economist (10/10/15)
A trade deal is no excuse to milk taxpayers Globe and Mail (Canada), Yuen Pau Woo (7/10/15)
What Is the Trans-Pacific Partnership Agreement (TPP)? Electronic Frontier Foundation
Wikileaks release of TPP deal text stokes ‘freedom of expression’ fears The Guardian, Sam Thielman (9/10/15)
TPP’s clauses that let Australia be sued are weapons of legal destruction, says lawyer The Guardian, Jess Hill (10/11/15)
Questions
- Who are likely to benefit from the TPP?
- Why are American republicans generally opposed to the agreement?
- What are the objections to the TPP’s provisions for the protection of intellectual property rights?
- Would the current twelve members of the TPP gain if China joined?
- What are the objections of environmentalists to TPP?
- What effect will the TPP on European countries?
- Other than a reduction in tariffs, what other types of measures are included in the TPP?
- What is the Investor-State Dispute Settlement mechanism and what criticisms have been made of it? Are they justified?
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.
Article
Unbalanced but lucky, Britain hits an economic sweet spot The Telegraph, Jeremy Warner (8/9/15)
Data
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
Questions
- 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.
One thing that economists often argue for is free trade. It promotes competition, allows greater choice and generates efficiency gains through specialisation to name a few of the advantages. Barriers to trade have gradually been brought down across the global economy, but some do still exist.
Although free trade does have many advantages, there are also arguments for barriers to trade, especially for developing or emerging economies. In some cases, barriers to trade can help a country to develop a particular industry or offer protection to a new sector from the giants of the world. In the case of China, it had a quota system in place since 2009 to restrict exports of ‘rare earth materials’, such as Tungsten and Molybdenum. Many of the hi-tech products that China specialises in require these rare minerals during production and, as the dominant producer of these minerals, Beijing had imposed restrictions on exporting them in an attempt to develop these industries.
However, other countries had raised concerns about the quota system being used, suggesting that by restricting exports of rare earth minerals, China was driving up their price. It was also suggested that the restrictions benefited domestic producers, at the expense of foreign competitors, given that domestic producers were able to access the raw materials at cheaper prices.
A complaint was made to the World Trade Organization in March 2014 by the USA, supported by the EU, Canada and Japan. Following an investigation by a WTO panel, the panel found that China had failed to show sufficiently that the quotas were justified. After an appeal by China, the panel’s findings were upheld in August by the WTO.
In response to the failure of its appeal, China has just announced that it is removing the quotas on exports of rare earth materials. However, this is unlikely to be the end of the story, as other policies may well be imposed, including a resources tax; and an export licence is still required. The following articles consider this battle.
China axes rare earth export quotas Financial Times, Lucy Hornby (5/1/15)
China scraps quotas on rare earths after WTO complaint BBC News (5/1/15)
China ends rare-earth minerals export quotas Wall Street Journal, Chuin-Wei Yap (5/1/15)
China scraps rare earth export controls after losing WTO appeal Bloomberg (6/1/15)
China abolishes rare earth export quotas: state media Reuters (4/1/15)
Questions
- What are the benefits of free trade?
- Why do some countries choose to impose protectionist measures and what type of measures can be put in place?
- Using a diagram, explain the impact that export quotas would have on Chinese firms using these rare minerals and also on foreign firms.
- Why have other countries argued that export quotas push up prices of these minerals?
- What other policies might China put in place in order to protect its industries?
The Treasury has published a paper analysing the costs of Britain leaving the EU. Its central assumption is that the UK would negotiate a bilateral trade deal with the EU similar to that between Canada and the EU. Under this assumption the Treasury estimates that, by 2030, GDP would be 6.2% lower than if the UK had remained in the EU, meaning that the average household would be £4300 per year worse off than it would otherwise have been. The analysis also finds that there would be a total reduction in tax receipts of £36 billion per year – far greater than any savings from lower contributions to the EU budget.
