The recent exchanges between EU leaders and the May government have shown a huge gap between the two sides’ views. Yet it is commonly assumed that there must be a deal or all hell will break loose. This is simply not the case.
Put on one side the need for the nuts and bolts of trade to continue, which they will and must: these include the delivery of the usual computerised customs service and the adherence to the normal rules of mutual agreement on standards observed between all countries. Only a lunatic would not follow such basic rules of behaviour, since not to do so is actually illegal.
The UK’s best option is to go unilaterally for free trade.
When it comes to the substantive policy matters, failure to agree is quite possible. The EU wants the rights of its citizens to be justiciated by the ECJ. It may demand continued free migration. It may want large sums of money. If these are the conditions for a trade agreement, there will not be one; nor will these other items be agreed. So imagine Britain is simply left with no agreement. What would occur?
EU citizens would continue as now with de facto rights of abode, provided similar rights accorded to our citizens. Free migration from Europe would stop. Britain would pay the EU no money, as it is at liberty to do.
But what about trade? Would Britain not face trade barriers selling into the EU? And would Britain not impose similar barriers to their exports sold to us? Would all this not destroy the British economy? This is where the misunderstandings come thick and fast, for two reasons. On the British side, we have never much thought about these matters, as they have all been handled by Brussels on our behalf for the past 45 years. On the EU side, a view of trade rules that says “exports good, imports bad” – the doctrine of mercantilism; so they believe that, as their exports to Britain are a smaller percentage of their GDP than Britain’s to them, we must come off worse if trade barriers go up between us. Yes, they will suffer but Britain will suffer more because of this preponderance of British sales to the EU in the economy.
Matters have not been helped by the adoption of similarly mercantilist thinking by the Treasury and its allies in the IMF, the OECD, the NIESR and the LSE. This has come in the guise of a “gravity” model which alleges that the UK cannot easily sell more on world markets and hence should put its efforts into selling to the EU, its closest and most “natural” market. This model, highly fashionable among trade economists, implies that protection is often a good thing and EU protection boosts British own industries selling into Europe. It assumed that British industries have monopoly positions where we currently sell and face monopolies in other markets.
Just as Keynesianism captured the economics profession after the war and took a lot of dislodging in favour of the return to classical thinking about money, inflation and the economy, so in trade this neo-protectionist view has displaced the classical view that world markets are competitive and that a country’s exports to these markets depend on its comparative advantage created by supply-side factors such as market openness and supplies of skilled labour. Yet it is plain enough that with the advent of globalisation and the elimination of distance by containerisation we live in a world well described by the classical view. This is why the government of Theresa May has proclaimed that it will pursue free trade as the post-Brexit policy. Both policy common sense and the evidence favour this approach. How else would one account for the huge rise in British exports of services around the world, and especially to America and other non-European countries? Gravity modellers claim that trade patterns following “geography” prove that their model is right. It does no such thing, as the same broad patterns also emerge from the classical model. What differs in the classical model is the causal competitive process, which conforms to a market-orientated view of the economy and also accounts for such crucial factors as the boom in UK services trade.
Now consider how the classical model treats the Brexit question. The key element is the high rate of European protectionism on food and manufactures. This erects a peripheral wall around the EU, keeping up the prices of imports from the rest of the world and so raising prices to EU consumers for not just imports but all EU-made products competing with them. In both sectors the protective rate (from tariffs and non-tariff barriers) is around 20 per cent, raising UK consumer prices by around eight per cent. This in turn artificially boosts farming, the price of land and the inefficient parts of the manufacturing sector. By removing it with Brexit and going to free trade Britain would reverse this and in the process raise consumer welfare and productivity, with a four per cent boost to GDP.
Yes, the EU would levy its tariffs on our exports. Yes, other countries would maintain their existing tariffs against us. But in a competitive world market where Britain would be selling at world prices, this has no effect on Britain’s national welfare.
There are two routes to free trade: a negotiated route via Free Trade Agreements, with the EU and then with significant others, and the route of unilateral elimination of our own protection, such as happened in 1846 when Peel abolished the Corn Laws. He got fed up with foreign recalcitrance over reducing trade barriers and simply struck out with unilateral free trade. Modern Britain too could well get fed up as the mercantilist EU insists on special demands for its industries or its migrants and even other countries hold out for demands Britain cannot meet. The FTA route to free trade depends on others cooperating in genuine free trade.
It might just work and go well. One could hope so.
But realism suggests it could get bogged down and derailed. So suppose it falls at the first fence, with no EU deal. What is the UK’s best option? It is to go unilaterally for free trade, with the gains described above. Britain would simply say to Brussels: look, we abolish these barriers against you anyway and by implication under WTO rules we will do so against all others too. We thus reduce consumer prices, increase competition and productivity and boost GDP.
Yes, the EU would levy its tariffs on our exports. Yes, other countries would maintain their existing tariffs against us. But in a competitive world market where Britain would be selling at world prices, this has no effect on Britain’s national welfare. The reason is straightforward: these world prices reflect world demand and supply and the EU tariffs do not affect the EU’s total demands and so do not affect world prices at all. All they do is cause EU demands to move towards home products away from us, but as they do so their home output is now not available in third markets where Britain will make up the deficit.
The EU tariffs are as it happens rather low – around 3.5 per cent on manufacturing industry. We estimate that they can easily absorb this cost in the short run when sterling is low and boosting their profits; and in the long run they can raise productivity to offset it.
As for British farmers, after Brexit they will face world prices: protection of the CAP and high EU tariffs will be removed. They will sell on world markets for food instead of on European markets where prices are artificially raised. So EU tariffs on British farming are simply irrelevant. Britain will revert to helping struggling farmers whose activities are necessary for the rural environment directly from the public purse. Britain has many large and efficient farmers who will change their practices and adapt by raising productivity.
So no deal is better than a bad deal. Indeed, what the above shows is that no deal is better than any deal. But of course Britain will try to get a sensible EU deal in good faith, simply to maintain good relations even if it is not so sensible in pure economic terms.