How will Brexit affect trade?

published 7 August 2016

160803-may-merkel-b — Low taxes and free trade will force the EU's hand

What's going on?

Following Britain's vote to leave the European Union (EU), one major area of focus has been the potential effecton trade. On the one hand, Britain will be able to negotiate its own Free Trade Agreements (FTA) once it has left the EU, and countries are lining up to do deals with us. At the latest count, according to Guido Fawkes' blog, 27 countries including most of the ten largest economies in the world (the exceptions being Italy and France) have expressed at least an interest in securing a post-Brexit trade deal with Britain.

On the other hand, negotiating such deals is a complicated, time-consuming business. Few countries will want to sign any deal with us at all until they know the precise nature of our post-Brexit relationship with the EU. The negotiations will be made all the trickier by Britain's lack of experienced trade negotiators (we haven't needed them because the EU has done most of that work for us in recent decades).

What's the status quo?

Currently, Britain is part of the EU single market. Members impose a common tariff on imports from non-member countries and can trade freely with each other although this applies to goods far more than services, where there are still many barriers to trade between EU nations.

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Trade deals with non-member countries are made collectively by the EU. Last year, about 44% of Britain's exports in goods and services £220bn of a £510bn total went to other EU nations, making the EU by far our largest trading partner. The US was our second-largest, accounting for 17% of our exports.

What should we aim for?

Analysts at Open Europe a think tank dedicated to free-market reform in Europe argue that the best outcome would be to strike an FTA with the EU to maintain as much access to the single market as possible, and also to "maintain the FTAs Britain has with other states via the EU". The next step would be to establish FTAs with other major trading partners. For example, "striking deals with the US and China would bring the UK's share of trade covered by FTAs to over 81% slightly higher than Norway's".

Of course, this is easier said than done. The nature of any FTA between the UK and the EU ultimately boils down to the trade-offs that each side is willing to make on immigration controls (see below for the Swiss dilemma on this).

FTAs are also time-consuming to put together. According to US think tank the Peterson Institute for International Economics, it took the US across 20 bilateral trade deals an average of 18 months to reach agreement, and roughly three and a half years from launch to implementation, depending on the scale and complexity.

Do trade deals matter?

It may seem an odd question to ask, but as Professor Gene Grossman points out in the Harvard Business Review, "the evidence suggests that recent agreements have had much more modest effects than those on both sides of the debate would have us believe".

Trade deals appeal to proponents of globalisation and draw the wrath of its opponents, but "they explain only a tiny fraction of the growth in trade that has occurred in recent decades". After World War II, the creation of GATT (the precursor to the World Trade Organisation) saw tariffs slashed, and helped to establish an agreed set of rules for resolving disputes.

As a result, modern trade deals start from a point where trade barriers are already low, and so gains to be had are minimal. The experience of rapid globalisation has been less about liberating trade and more to do with the rise of China and India, and vast technological improvements in transportation and communication.

Meanwhile, notes Mark Wu of Harvard Law School, modern trade deals increasingly founder on citizens' fears of "a chilling effect on their ability to regulate local issues", such as food safety and the environment. For example, CETA a flagship EU-Canada trade deal is now struggling after France and Germany insisted the deal must be ratified by the EU's 38 national and regional parliaments, rather than the European Commission alone.

So what's the alternative?

Rather than replicate its existing FTAs, Britain could cut the Gordian knot by unilaterally cutting import barriers and embracing full-blown free trade the Singapore option, under which lower import prices help to offset tariffs imposed by other countries on exports.

The trouble with "unilateral tariff disarmament", as Jeremy Warner notes in The Daily Telegraph, is that some UK sectors notably agriculture benefit from existing protectionism. However, even if this option is not pursued in the end, even the threat of a low-tax, free-trade UK on the EU's doorstep should be a big incentive to Europe to reach a reasonable "accommodation" with the UK on the balance between free movement and access to the single market.

The Swiss dilemma

In February 2014, Switzerland voted in a referendum to cap immigration numbers within three years. This puts Switzerland in a tricky position it isn't part of the EU, but it does have access to the single market via various bilateral agreements, and freedom of movement for workers (ie, no EU immigration restrictions) is part of the deal.

European Commission President Jean-Claude Juncker and Swiss Confederation President Johann Schneider-Ammann meet next month to discuss, but both sides agree that Brexit has made finding a middle ground harder, reports Politico.EU. Even an "emergency break on benefits"-style compromise that was agreed with David Cameron ahead of the UK's EU vote now appears to be "off the table". If a deal can't be reached, Switzerland could have to renegotiate its bilateral deals "one by one... with far-reaching consequences in many areas, not least its financial services sector".

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.