29 June 2016

Brexit: The trade consequences

Storm Clouds In London

Richard Baldwin, Professor of International Economics, assesses the potential trade consequences of Brexit.

UK citizens have voted to leave the EU. This sad decision was brought on by a combination of three things.

  • Short-sighted political expediency on the part of David Cameron.
  • A strong sense of disillusionment, disenfranchisement and/or real economic pain on the part of many older and unemployed British voters.
  • British voters’ and the British establishment’s inexperience with direct democracy.

Although there is some possibility of reversing this very mistaken decision, the odds are that Britain will be outside the EU by the end of 2019. It is also likely that Britain and the UK will no longer be synonyms; Scotland will almost surely leave the United Kingdom (and maybe Northern Ireland as well to avoid creating a border with Ireland) if the UK leaves the EU.

Richard Baldwin, Professor of International Economics

What happens to the legacy trade agreements?

Trade policy has always been the business of the EU, so for the last 40 years, the UK’s trade policy has been run by the European Commission (with political guidance from the leaders of EU member states). During these decades, the EU signed agreements with well over a hundred nations. All of these will have to be renegotiated by London. How difficult this will be depends upon the generosity of the other nations. Will they use the new talks to extract new concessions from Britain? The best outcome would be that all the existing agreements signed by the EU are just replicated for the UK. When it comes to agreements with most developing nations, this may be possible. With larger emerging markets like Korea, Mexico, Turkey and India, the outcome is less clear as they have greater bargaining power against Britain than they did against the EU (and they may be tempted to use this). The Canadian-EU free trade agreement is an important one for Britain, but I hope the Canadians will be generous.

The elephant in the room is the trade relationship with the EU. There are really three models (beyond the non-starter of relying on Britain’s WTO membership):

  • A simple free trade agreement that maintains the status quo of tariff-free trade, but results in the imposition of non-tariff barriers to trade and investment;
  • A deeper trade agreement such as the EU has with Canada or Korea;
  • An agreement of the type that Norway and Switzerland have that provides two-way Single-Market access (free movement of goods, services, capital and people), and has the European Court of Justice as the final authority in disputes.

The first would, I believe, be easy since this is the status quo. There have been no tariffs either way for 40 years and there is little appetite, in my view, to blocking British exports of goods (especially since Britain doesn’t export ‘sensitive’ products like agricultural goods).

However, and this is the key point, this would not include the so-called ‘passporting’ that allow London to sell financial services automatically throughout the EU. Passporting will not come easily since there are many, politically powerful firms in the EU who would love to see their British-based competitors hobbled by registration procedures and other regulatory barriers. It would also be unlikely to include mutual recognition of regulations and standards, so new frictional barriers would appear and this would especially hit the UK manufacturing sector.

The second would take a lot of talking but it would seem possible since there are a lot of businesses in the EU who would not want their business relations disrupted. This could avoid the imposition of many non-tariff barriers and facilitate some trade in services, but it would not include ‘passporting’, or the free movement of people.

The third option is the one that would minimise the economic damage, but it would require the British government to renege on the Leave campaign’s main promises on migration and the budget contribution. The point is that the “single” in Single Market comes from the fact that everyone plays by the same basic rules when it comes to the free movement of goods, services, capital and people. If the EU allowed Britain to have a special deal, every EU member would want a special deal and the Single Market would become 28 single markets. Moreover, politicians in Spain, for example, are worried about their own separatism so they won’t want to create a comfortable halfway house to full membership.

The relationship with the EFTA nations (Norway, Iceland and Switzerland) would probably mimic whatever agreement is struck between Britain and the EU, since they are in the Single Market de facto.

In summary, Britain will survive this shock and remain competitive if its wages and salaries fall enough to compensate for the inferior access that it will soon have to the EU market of 500 million customers.