A prosperous future after Brexit will involve positioning Britain strategically in the global economy.
The UK can do this by securing trade deals to become a hub for global trade, including for services trade. Positioning Britain as a global trade hub would strategically exploit the fact that regional and bilateral free trade agreements (FTA) govern trade that is not covered by the World Trade Organization (WTO). For instance, Mexico has a FTA with the European Union (EU) as well as one with the US as part of the North American Free Trade Agreement (NAFTA). US companies exporting from Mexico enjoy tariff-free access to the EU whereas selling directly from America would entail paying a 10% tariff on cars under WTO rules, to give one example.” If the UK had a trade deal with the EU after Brexit together with FTAs with countries that do not have a FTA with the EU, then Britain could serve as a hub into the world’s biggest economic bloc. Given that it’s predominately a service-based economy, the UK would benefit from greater liberalisation of services trade. Britain has been a force for a greater opening of the services sector in the EU, which it can continue to pursue in a FTA. It would also benefit from continuing to support global initiatives, such as the EU-led Trade in Services Agreement (TiSA) that seeks to open up global markets for services trade in the same way as manufactured goods trade under the WTO regime. This would notably benefit the UK as the second biggest exporter of services in the world. If the UK can strategically position itself to remain a hub for international trade while pushing for services liberalisation, then its economic future will look more assured.” To be 'Global Britain' and realise the benefits of being an open economy that has allowed the UK to prosper through the years requires access to markets around the world. Of course, it’s possible to trade without specific free trade agreements (FTA) and instead operate under World Trade Organisation (WTO) rules, but that would be more restrictive and therefore more costly to export and import manufactured goods. It’s why there are a number of regional and bilateral trade agreements being pursued across the world, as countries recognise that there are gains from accessing global markets beyond what’s been liberalised under the WTO.
Even though the biggest economic entities in the world - the European Union, the United States, and China - do not have free trade agreements with each other, they are among each other’s largest trading partners. This shows there is still scope to expand world trade, which is why the EU is pursuing a trade deal with America and an investment treaty with China. Indeed, China doesn’t have many FTAs and its relatively closed markets are a perennial source of complaint by foreign companies. Therefore, how Britain manages its trade agreements with the rest of the world will have a significant impact on its post-Brexit economic future. The multipolar world economy Since the 2008 financial crisis emerging and developing countries have for the first time accounted for more of world GDP than advanced economies, according to the International Monetary Fund (IMF). Mirroring this trend, Britain now trades more with the rest of the global economy than with the world’s biggest economic bloc and its neighbour, the European Union. One of the reasons is because that is where demand is growing quickly. In the past decade, the EU has had to contend with both the 2008 global financial crisis and the 2010 euro crisis, which depressed economic growth. By contrast, emerging economies were not as affected by these crises and have continued to grow, becoming more important than advanced economies in driving global demand. As these economies grow, their new middle class consumers will demand more goods, including services, which is a strength of Britain. Since the UK is the world’s second biggest exporter of services after the U.S., the emergence of a new global middle class bodes well for both countries. That’s not to suggest that a trade deal with the EU is unimportant. The EU is on Britain’s doorstep. With supply and distribution chains that permeate much of international manufacturing, greater trade with countries that are geographically close is expected. The EU also has the most liberalised services sector among economic blocs, even if further reform is needed. The bulk of the UK economy is comprised of services, so negotiating post-Brexit access to the EU market of half a billion consumers is important. Services are also the next big global trade push. If the global market for services were as liberalised as the market for manufactured goods, then that would benefit Britain and other services-based economies as well as the world economy. This is what the European Union is pursuing. In 2013, they, together with the United States, launched the Trade in Services Agreement (TiSA) that could eventually open up world markets for services trade in the same way that the WTO regime opened up the trade in goods. Services account for 70% of both world GDP and the national output of the 28 nations of the European Union. Yet, services comprise just 25% of EU exports. If TiSA were to come to pass and become adopted as the next multilateral round of trade liberalisation, that would boost growth for rich economies, including Britain. Thus, supporting TiSA would fit well with Britain’s post-Brexit trade strategy. This is especially as the U.S., under President Trump’s 'America First' policy, is unlikely to continue to provide leadership on this global trade initiative. China is also unlikely to take a significant lead since its still developing services sector remains relatively protected, especially since segments of its financial sector remains state-dominated. Therefore, there is scope for Britain to help shape the trade regime that will underpin an increasingly multipolar world economy. With less involvement by the biggest and second biggest economies, Britain, as the world’s fifth biggest economy, can play a leading role in moving forward global initiatives such as TiSA. The UK is currently supporting TiSA from within the EU. It would certainly be possible for the UK to continue its current engagement on TiSA after it leaves the European Union. Trade strategies As a general approach to trade, retaining its current trade engagements could serve as a useful principle after Brexit for the UK. Of course, offering support for services liberalisation would not be as involved as forming new trade agreements, so the former is simpler. But, aiming to retain current trade relations after Brexit would be less disruptive and practical given limited negotiating capacity. For comparison, the United States is said to have perhaps the most efficient trade negotiating team of some 200 people in the office of USTR (U.S. Trade Representative) and they focus on one, and at most two, trade negotiations at a time. Since Britain would be leaving some 80 FTAs as a consequence of Brexit, adopting a continuation strategy to retain these FTAs in roughly their current form would be pragmatic. Britain’s newly formed Department for International Trade has indicated that it will try to adopt wholesale the existing free trade agreements that the UK is currently party to as a member of the European Union after Brexit. At present, the EU has 32 free trade agreements in place. There are another 43 which are partly in place while awaiting ratification. Another four are being updated, while 19 are being negotiated. Negotiating some 100 trade deals from scratch isn’t very feasible as it would take years for Britain to get back to its current position. Since the UK is already part of these trade agreements, retaining them would maintain the status quo and not be disruptive to businesses which are accustomed to these trade regimes. Pulling out of existing trade arrangements and re-negotiating them afresh would be far more challenging. A retention policy would depend on its trading partners agreeing to “crossing out EU, writing in UK” on the existing trade agreements. Some may want to extract more concessions from Britain since it is a smaller market than the European Union. But, many are others are more open, such as Canada, who have indicated that they would be open to copying and pasting the existing provisions of CETA (Canada-European Union Trade Agreement) to form a UK-Canada FTA. If there are issues with these existing trade agreements, then they can be addressed further down the line when Britain is past the immediate structural changes necessary to realise Brexit and would have greater capacity to re-examine trade relations. This approach would offer a 'status quo' transition whereby UK trade with non-EU markets would be unchanged. In other words, right now, all of the UK’s trade agreements are via the EU. So, if it retained all of its current FTAs, then there would be no change in this respect on the day after Brexit in March 2019 since all existing trade arrangements would remain in place. The UK could avoid a 'two-step change' of dropping out of a FTA and then renegotiating it, which would entail two sets of operational adjustments for British companies that are exporting to those markets. The UK has already announced that it will maintain an EU trade deal that allows in duty-free, quota-free imports from 48 of the least developed countries in the world, including South Asian nations such as Bangladesh, African countries such as Ethiopia, and the Caribbean including Haiti. It benefits these developing countries to have uninterrupted access to the market of one of the world’s biggest economies. Some small developing countries rely on British markets, e.g., nearly a quarter of Belize’s exports go to the UK while it’s 10-20% of exports from Mauritius, Gambia, Sri Lanka, and Bangladesh. For Britain, it helps to ensure undisrupted imports after Brexit, e.g., 79% of tea imports, 45% of clothing, and 22% of coffee, come from these nations. The UK is exploring extending this deal to Ghana, Jamaica, and Pakistan, where tariffs are already zero on some goods. Along these lines, if Britain replicated the EU-CARIFORUM trade deal, which is the 2008 EU FTA agreed with 16 Caribbean nations, the UK would retain cheap access to imported commodities, including mining products, minerals, and agricultural products such as bananas and sugar. The EU exports mainly cars, boats, telecoms equipment, and engine parts to the Caribbean. The trade is not negligible since the CARIFORUM nations are the EU’s second largest trading partner after the United States. There are also efforts to integrate services sectors. Both higher tech manufacturing and services are strengths of the British economy, so maintaining the market access that the EU has spent years negotiating with the Caribbean and dozens of other countries would be a practical way forward for Britain as it contemplates its post-Brexit trade negotiating strategy. If Britain can maintain its current trade arrangements, then that would cover some 80 countries. A related move would be to treat the 23 countries that the EU is currently negotiating with as ongoing talks after Brexit. In other words, take as the starting point the already agreed provisions in the EU negotiations with countries such as Japan, India, and the United States. Since Britain is party to these negotiations, it has already essentially accepted where these talks have progressed to. So, rather than starting talks afresh, the UK could consider adopting the EU negotiating stance as of March 2019 as the initial British position in forging new trade deals. Of course, it is unlikely to be that straightforward. Also, some of these trade talks, particularly the TTIP (Trans-Atlantic Trade and Investment Partnership) with the U.S., appear stalled. But, there is also the possibility that some of these nations could find it easier to do a trade deal with Britain since it does not represent 28 different national interests. The challenge will be to prioritise trade talks with Britain since other countries, just like the UK, have negotiating capacity constraints so pursuing several FTAs at any one time is a stretch. Britain as a hub The global economy is characterised by overlapping regional trade agreements (e.g., NAFTA covers the U.S., Canada, and Mexico) and bilateral FTAs. This allows for the creation of trade 'hubs'. For instance, Mexico is in NAFTA and also has a FTA with the European Union, so it benefits from being a 'hub'. U.S. car companies that manufacture in Mexico can sell into the EU tariff-free. The same car produced in America would be subject to a 10% tariff under WTO rules since there is no free trade agreement between the U.S. and EU. Another example is Israel. Until the late 1990s, Israel was in the unique position of having a FTA with both the U.S. and EU. It benefitted from its 'hub' status since trade was channelled through it in order to gain preferential access into American and European markets. Britain has the potential of becoming a 'hub' into other major economies given its deep links with the EU and the U.S. Should the UK negotiate a preferential trade deal with the EU while also having FTAs with countries that the European Union does not have trade deals with, then that would make the UK an attractive 'hub' for international trade. Therefore, if Britain were to agree trade agreements with countries that don’t have a FTA with the EU - a list which includes the biggest economies in the world such as the U.S., China, and India as well as Commonwealth countries with which the UK has historical links such as Australia, Malaysia, and Singapore - then it could serve as a “hub” for trade. If Britain were to benefit from the 'special relationship' and forge a trade deal with the U.S., alongside a comprehensive trade agreement with the EU, it would be in an enviable position. The U.S. has only 14 FTAs with 20 countries. None are in the European region; all bar three in the Asia Pacific (Australia, Korea, Singapore) are centred in the Americas and the Middle East. As a sizeable economy with a well-developed services sector to facilitate trade and investment, Britain would be an attractive hub for cross-Atlantic trade. Should the UK enter into a trade deal with China or India, then it would also be a 'hub' for Asian trade with the West. This is a big 'if' given the discussion earlier about negotiating capacity and the intrinsic challenge of negotiating trade deals, especially with major economies. Trade is tied up with politics, so what looks like a simple deal often does not turn out to be straightforward. Nevertheless, realising the aims of 'Global Britain' will require a long-term strategic vision and positioning the UK as an important hub in a changing world economy. Conclusion None of this will happen overnight and there is a long road until Britain’s post-Brexit economic path is clear. But, strategically positioning itself in the world trade order would be an important part of the country’s continued economic prosperity. Continuing to be a liberalising influence on global trade negotiations would be particularly beneficial given the latest initiatives that are centred on opening up the global services economy. Pragmatically speaking, by retaining and shadowing EU trade agreements and ongoing talks, it may be possible for Britain to have trade deals with over 80 countries not too long after Brexit. By offering tariff-free imports of agricultural products from developing countries, the UK can also quickly notch up some limited trade agreements that helps preserve cheap access to foodstuffs. With that foundation, Britain would have trade deals with about half of the world’s economies which could serve as a template with which to negotiate further FTAs. In deciding which countries to pursue, it would be advisable to consider which trade deals can help promote Britain as a 'hub' for international trade. That would help make the country 'Global Britain'. In a historic referendum, Britain has voted to leave the European Union. Some of the polling suggests that a backlash against globalisation played a role in what has been dubbed Brexit, alongside issues such as sovereignty and immigration. The government has insisted that Britain will maintain its global outlook, but how challenging will that be in the face of disengaging from the world’s biggest economic entity while forging a new path? The UK is doing so with some notable weaknesses in its large trade deficit, which has hit a record high after its 2008 financial crisis.
What does the economic future hold for Britain? Of course, the dust has not yet settled, as there are a lot of unknowns facing the first country to leave the European Union. There is no question that the decisions to be taken will involve re-defining Britain’s trade relationship not only with the EU, but also with the rest of the world, for years to come. This article explores the economic uncertainties of Brexit and potential ways forward. The economic impact of Brexit Some hiring and investment decisions had been delayed even before the vote on 23rd June 2016; in fact, since February, when the announcement for the referendum on continued EU membership was made by the British government (Economic Policy Uncertainty, 2016). Investors’ expectation of sterling volatility in the period before the referendum was the highest since the 2008 financial crisis when the entire banking system could have brought the economy down. The market reaction reflected uncertainty about what would happen to the pound, which dropped sharply, as predicted, after the UK voted to exit. Investors apparently placed their money on just one outcome – a hit to the economy, regardless of the referendum results. That was reflected in gilt yields, that is, the interest rate that the UK pays on its government bonds. Gilt yields had fallen even before the vote took place. After the results were in, yields on benchmark 10-year government debt fell to record lows, as have those on 20-year and 30-year debt. Bond yields reflect where markets expect interest rates to be, which is affected by the Bank of England (BOE) base rate and the state of the economy. And those are related. If the economy is contracting or weak, the BOE would be expected to cut rates. Indeed, that is what has happened as the BOE cut interest rates just a couple of months after Brexit to a record low 0.25 per cent. It’s the first time that the central bank has cut rates and also extended quantitative easing (QE) since the 2009 recession that followed the banking crash. QE was not only revived, it was also expanded as the BOE announced that for the first time it would also purchase corporate debt as part of its programme. Conversely, bond yields are also influenced by the world economy, which in turn affects Britain. The global outlook doesn’t look too rosy either. Worldwide, developed economies’ government bond yields have dropped dramatically. Slow growth and aggressive easing by central banks, along with Brexit for the UK, are among the factors driving real yields lower. A lower interest rate in the future signals that investors are concerned about a weaker economy. But, they are not concerned about the ability of the British governments to pay its debt, which would send yields higher. Confidence in the government alone of course doesn't move yields on longer-term debt as much as interest rates, economic growth, and inflation. Now that Britain has voted to leave, there will be at least two years of uncertainty, which is the period allowed under Article 50 of the Lisbon Treaty to negotiate a new relationship with the EU. Uncertainty tends to dampen economic activity (Baker, Bloom, and Davis, 2015). Investors may or may not be getting it right, but uncertainty tends to make businesses cautious. And, for the economy, that tends to mean being conservative about where it’s headed. Amidst the uncertainty, there is also some clarity about the next steps. The basic trade-off is between remaining within the Single Market and wresting back ‘control’, notably over migration. Therein lies the problem, however, as the European Union views the freedom of movement of people as one of the four pillars of the Single Market (the others being the free movement of capital, goods, and services). Under this privilege, the EU grants the right to people within it to live and work freely anywhere within its boundaries. In other words, as a member of the EU Single Market, the British have the right to live and work in the EU, just as other EU citizens have the right to live and work in the UK. Is it possible to retain access to the European market but not be subject to EU laws, including the freedom of movement of people? So far, the EU has not granted that status to the non-EU countries which have negotiated the right to access the Single Market. There are three countries (Norway, Liechtenstein, and Iceland) in the European Free Trade Association (EFTA) plus Switzerland, which also has unfettered access to the Single Market via a series of treaties. All four members accept the pillar of ‘freedom of movement of people’ in principle, in exchange for which they get varying degrees of access to the largest economic bloc in the world. The nation of Liechtenstein with its tiny population of 36,000 was allowed to retain an immigration quota, but it must be reviewed every five years. Thus, the free movement of people is described by EFTA as ‘perhaps the most important right for individuals, as it gives citizens of the 31 EEA countries [EU plus the above mentioned states] the opportunity to live, work, establish business and study in any of these countries’ (EFTA, 2016). To give a sense as to how integral free movement of people is, Switzerland’s two year struggle to impose a quota on EU migrants is telling. In February 2014, the Swiss voted in a referendum for controls on EU migration. But the EU would not budge, so the negotiations have dragged on with no conclusion in sight. Ironically, they are exploring the possibility of using the ‘emergency brake’ that the former British Prime Minister David Cameron had negotiated prior to the EU referendum in the UK that would have restricted in-work benefits for new migrants and potentially lessened the ‘pull factor’ of economic migration to a higher income country. Remaining in the European Single Market has also been touted by a range of businesses and policymakers, including the Mayor of London, as being crucial in Britain’s future relationship with the EU. Not all Leave campaigners may agree, of course, since some had advocated leaving the Single Market and just having a free trade agreement (FTA) with the EU. An FTA, however, would not confer the right on British citizens to live, study, and work in the EU, so it remains to be seen what can be delivered. It is important to note that the Single Market is much more than a free trade agreement. By applying the same rules and standards on goods and services, it frees up trade and investment in ways that allows a business to treat the half a billion people in the EU as a single market for their business. So, it is not about tariffs but what economists call non-tariff barriers (NTBs) that matter in some instances more, especially for small businesses where the ease of selling across borders can be heavily affected by standards and rules (Breinlich et al., 2016). And, for businesses, small and large, the European market is important. The Institute of Directors based in London surveyed its members directly after Brexit. Of the 1,092 UK firms, a quarter were freezing recruitment, some 20 per cent were considering moving their operations abroad, and 5 per cent even said redundancies were possible. This reaction reflects the uncertainty that has been seen most vividly in markets, but also importantly for the economy, the big question marks over the UK’s future relationship with Europe. It may well be that the cost of gaining access to the Single Market will be considered by the policymakers to be too great if it means accepting the free movement of people. Of course, it is not just about immigration policy. Like the other non-EU countries that have free access to the Single Market, the UK would also have to accept the rules set by Brussels. And that may well be unacceptable as some in the Leave camp also campaigned on the basis that Britain will no longer be governed by EU laws. But, that is the unavoidable trade-off: unfettered access to the EU Single Market versus control over migration. At publication time, it seems the British Prime Minister doesn’t expect to retain much access to the Single Market precisely because the UK government will prioritise immigration controls. As stated earlier, the EU has yet to compromise on migration with any major country, though there is still much debate on the issue. Some have argued that Britain is a more important economy than, for instance, Switzerland or Norway, and that the EU indeed may want to sell and thus offer more concessions, while others insist that granting Britain the benefits of the Single Market without the free movement of people would set the wrong example for other EU countries and who may also want to control migration and then exit, too. A break-up of the European Union is an outcome that the EU leaders certainly want to avoid. There is no doubt that this is a challenging trade-off with a lot at stake for the British economy. There is also a lot at stake for Europe in its negotiation of Brexit, since the process will affect how it reforms its own institutions. Europe’s economic paths Brexit was a seismic political event, but there have been other rumblings across Europe, which highlights the challenge of negotiating with an economic bloc that is still in the process of formation and subject to some of the same anti-globalisation pressures evident in the UK. To take an example, the former French prime minister described the votes won by the far-right National Front and Eurosceptic parties as a ‘political earthquake’. And the gains made by anti-EU and anti-Euro parties in the last European elections in countries ranging from Denmark to Greece have generated debate over the European project and Europe’s economic future. In general, the growing influence of Brussels has also led to debates over a ‘democratic deficit’. That said, the pro-Europe mainstream parties – the centre-right European People’s Party (EPP) and the centre-left Socialists and Democrats (S&D) – still retain a majority, having worked toward further integration that had been challenged during the Euro crisis in May 2010, when Greece was rescued. But EU policymakers should take heed of the views of more critical voters as they shape the emerging institutions of the Eurozone. Seen from a historical perspective, the EU has already changed a great deal. Beginning as the European Coal Community after WWII, it then expanded when the UK joined the European Economic Community (EEC) in 1973 (Venables, Winters, and Yueh, 2008). The motives were political: to tie together nations previously at war. But the EEC later evolved into the European Union and, in fact, the biggest economic unit in the world, larger than the United States both in terms of output and population. The creation of the single currency in 1999 split the EU into Eurozone countries and the rest, though all of the remaining non-euro EU members – with the exception of Denmark and the UK – are slated to join the euro area in the coming years. After the Greek crisis erupted in 2010, the reaction by Eurozone leaders was ‘more Europe.’ The ensuing euro crisis, which saw other countries get rescued in addition to Greece, revealed the fragility of a monetary union that lacked a banking union, as banks had lent large amounts to peripheral countries such as Ireland. Rescuing the banks also led to the need for Ireland itself to be rescued. Since then, a Banking Union has been created, but this measure has in turn raised operational questions for non-euro EU countries with large banking systems, such as Sweden. Eurozone leaders also reinforced the need for member countries to pay better attention to fiscal discipline. Before the crisis, Greece borrowed at the same rates as Germany, since bond markets seemed to view the Eurozone as one entity. The result was too much borrowing. Though that situation is unlikely to happen again in the future, additional reforms were implemented in an effort to enforce fiscal restraint. The outcome was the European Semester, by means of which there was greater monitoring of national budgets by Brussels to ensure that countries sharing a currency did not run large deficits. Building on these developments to continue the transfer of economic decision-making power to supra-national entities, other institutions were created, such as the Single Supervisory Mechanism (SSM), which gave the Frankfurt-based European Central Bank (ECB) more powers to oversee banks, and the Luxembourg-based European Stability Mechanism (ESM), a permanent rescue fund that is like a European IMF. For economists, the euro crisis raised the prospect of a euro break-up and opened the door to consider whether the peripheral countries belonged to the same ‘optimal currency area’ (OCA) as Germany and its northern European neighbours (Krugman, 2013). In other words, they asked, should all euro countries – including the EU countries that are slated to accede –share a currency? And have the criteria of trade integration and convergence in business cycles and incomes been met? European countries trade a great deal with each other, but convergence is a different matter. If a country is not converging with the rest of the member countries, then it is a high cost to lose control over its interest rate and currency. Could reforming the euro institutions improve the prospects of convergence? There is a middle path: a European single market that does not share a single currency. This type of connection could lead to deeper integration and a linking of markets, but without countries giving up their currency. The UK, Denmark, and the other non-euro EU countries are examples of those who operate in a shared market while retaining their own currencies. This is an old debate that has again moved to the forefront, particularly among observers outside the single currency who watched the euro crisis unfold. Indeed, the deep integration of the European Single Market goes beyond a free trade area, which is what the US has developed with Canada and Mexico in the form of NAFTA (North America Free Trade Area). The Single Market eliminates not just tariffs, but non-tariff barriers. Common standards enable a firm located in the Single Market to sell anywhere within it as if it were a domestic market. For small countries in particular, that advantage allows its firms to gain economies of scale when competing against multinationals from America and China which count huge domestic customers as their home market. These considerations are what make the debate over Britain’s continuing access to the Single Market so acute. But, as mentioned before, free access to the Single Market appears to require the acceptance of free movement of people, which is the antithesis of the Brexit vote seeking to wrest back control over migration. Undoubtedly, the rise of both anti-EU and Eurosceptic parties will trigger more discussion about all of these possible paths for the Union. Upcoming elections in major European countries will not be determinative, but the economic future of the European project will surely be discussed in the coming years. So, as Europe continues to evolve and the political landscape on the continent shifts, Britain’s exit will be tricky. What’s needed now is a parallel pursuit of free trade agreements with the world’s other major economies. Britain’s future outside of Europe Global trade is far from free, so negotiating market access for trade and investment for British businesses is important, especially if the UK is to retain the international outlook that has contributed to its economic growth and positioning as the world’s fifth largest economy. The European Single Market’s deep integration eliminates non-tariff barriers through common standards. A vast market on Britain’s doorstep is certainly economically valuable and should be a priority for a new FTA after Brexit. But developing trade agreements takes years, as will Britain’s negotiations on its future with the EU, so the sensible approach is to start informal talks now with the US, China, and Japan. Of course, there are other trade partners worth considering, but focusing on these three largest economies and the EU is a good start. New trade agreements are also being pursued by other countries seeking to open up markets and raise economic growth. And they’re getting a lot of buzz, such as those led by China (RCEP or Regional Comprehensive Economic Partnership), TPP (Trans-Pacific Partnership) between America and Asia, and TTIP (Trans-Atlantic Trade and Investment Partnership) between the United States and Europe. In this context, then, Britain would do well to start parallel talks as soon as possible. As far as the United States is concerned, the Republican Speaker of the House of Representatives of the US Congress has expressed a strong interest in speaking with Britain while the Brexit sorts itself out. In the case of China, the world’s second largest economy, a UK leaving the EU may appear less attractive as a gateway to Europe, but that outcome will depend on the Brexit negotiations. In the meanwhile, it would be sensible for Britain to build on its existing strong links with China to secure a free trade agreement. In many respects, Britain and China have complementary strengths and needs in their economies. China is seeking expertise in services and high tech industry, which Britain can offer. In turn, Britain needs to maintain sizeable investment inflows due to its persistent and large current account deficit, which could be achieved by China’s outward investment push. Unlike the EU, which has a larger industry and agricultural sector to consider, the UK is in a comparably better position to agree on an FTA with China. Of course, the detail and protection of losers from globalisation would have to be taken into account in an FTA, as would a range of other political considerations. And China, a tough negotiating partner, has only a few FTAs and is currently going through a challenging time while it re-aligns its external and internal priorities to reform its slowing economy. In any case, moving towards an FTA with China would help with Britain’s negotiations with the EU if the UK can become the gateway to over a billion Chinese customers for EU businesses. The same rationale of securing FTAs applies to the world’s third largest economy, Japan, as well as to other major economies. There is also another grouping worthy of mention: often overlooked, the Commonwealth is a network that Britain is well placed to pursue more trade with. After all, economic studies consistently show that among the determinants of greater trade are historical ties and shared language and institutions (Makino and Tsang, 2011). The 52 nations of the Commonwealth have that strong advantage. Trade among these nations, which range from wealthy, such as Britain and Singapore, to poorer nations in Africa, has grown rapidly. Even without being a formal trade bloc, intra Commonwealth trade was estimated at USD 592 billion in 2013 and is forecasted by the Commonwealth Secretariat to surpass USD 1 trillion by 2020. That is due to the rapid economic growth, including in trade in these countries, over the past few years. Since 2000, global exports of Commonwealth countries have nearly tripled from USD 1.3 trillion to USD 3.4 trillion, accounting for 14.6 per cent of world exports in 2013. In other words, if it were one economic entity, the Commonwealth would be the world’s largest trader, surpassing China. But it must be noted that just six Commonwealth countries account for 84 per cent of Commonwealth trade: Australia, Canada, India, Malaysia, and Singapore as well as Britain itself. So, these five nations are partners for Britain to focus on, which it can do more efficiently by turning its attention to the Commonwealth. There are also yet untapped smaller export markets within this network, including some of the fastest growing economies in Asia and Africa. A shift in UK trade is already silently underway, with both current and previous governments seeking to develop greater links with fast growing emerging economies. To take an example, in 1999, 55 per cent of exports went to the EU. Now, the scale has tipped and Britain exports more to non-EU countries than to the EU. And Britain’s trade with the Commonwealth is less than 25 per cent of that of the EU, so there’s room to grow. Certainly, the faster economic growth of Commonwealth countries offers greater opportunities than ever before. In terms of share of global GDP, the Commonwealth overtook the European Union in 2010. A lot has to do with demography: the United Nations estimates that population growth in the Commonwealth is expected to increase by 29.4 per cent until 2020, while the Eurozone is expected to fall by 1.4 per cent. Finally, it is worth recalling in 1973, the UK had to end its special trade ties with the Commonwealth because it joined the EU, which is a customs union that has common trade rules with the rest of the world. That won’t be a constraint anymore after Brexit. So, with a combined population of 2.3 billion across six continents, many of them faster growing than the rich economies of the West, fostering greater trade and investment links with the Commonwealth could prove to be helpful. The next section reviews the rapid growth of FTAs around the world and what it means for post-Brexit Britain. The global push for free trade areas What’s happening around the world in terms of existing free trade deals that are in the works is an important shift in global context. In different regions around the world, there’s a noteworthy push for free trade areas that reduce tariffs and adopt other measures to ease trade and investment. Of course, the election of Donald Trump adds uncertainty to America’s push, but the rest of the world, notably China, are keenly pursuing regional and bilateral trade agreements not only encompassing goods but also services and investment. First, here’s a reminder of what tariffs encompass and why they are economically inefficient: tariffs are the charges that governments impose on imports and exports. They are a tax; wherever they are imposed, they can distort the prices of goods and services. Because tariffs add a cost and thus reduce economic efficiency, they can be a drag on growth. So, free trade areas aim to eliminate most of them. Of course, a number of governments use them to protect their industries from competition from big global companies until they are more mature. Labour groups also want protection for domestic jobs. It’s a messy area. Non-tariff barriers (NTBs) also add to the mix. NTBs are the other ways to be protectionist without imposing tariffs, such as through standards for certain industries that can restrict imports. For instance, Thai prawn exporters found it hard to meet American standards for the type of net that allowed them to sell to the US. Indeed, the still to be ratified Trans Pacific Partnership (TPP) would be the world’s biggest free trade area that links North America with parts of Latin America and Asia. The Americans had hoped to gain from this new free trade area since 61 per cent of US goods exports and 75 per cent of US agricultural exports go to the Asia Pacific region. The TPP would allow partner countries to access the world’s largest market in return by reducing (perhaps eventually eliminating) the tariffs they would have to pay to export to the United States. As part of a broader foreign policy shift, President Obama has been re-orienting toward fast growing Asia. Obama’s ‘Asia pivot’ could be viewed as a counter-balance to China’s economic and strategic impact that stretches from the North China Sea to the Persian Gulf. However, it is proving a difficult task to re-focus away from the Middle East and Russia. As well, it is certainly still unclear what the future Trump administration will do in terms of foreign and trade policy. In any case, Europe is also pursuing an equally ambitious free trade agreement with the US: the TTIP is the trans-Atlantic FTA that would link the US with an EU that will eventually exclude Britain, if it comes into force. The rise of these massive regional FTAs is also a reaction to stalled expansion of the World Trade Organisation (WTO). After all, it has been well over a decade since the last big WTO initiative – the Doha Round – was launched and there are no signs of significant progress. So, instead of trying to get to a deal with almost the entire world, these regional trade agreements have sprung up. Bilateral agreements, too, fill the void. It would be better for all countries to trade on equal terms with all others, but a multilateral trade deal under the WTO has been put on hold, so countries are going for second best options. The problem with this approach is that if a country has not signed up to the rules (or hasn’t even been invited to join) for any of the new free trade areas, it gets excluded and cannot share the benefits. This prospect might face Britain. China is also confronted with it: being left out of TPP and TTIP means doing its own thing, so China is currently negotiating with ASEAN (Association of Southeast Asian Nations) to form its own regional free trade agreement. There is also an offer on the table to set up a Free Trade Area of the Asia Pacific (FTAAP) in reaction to President-elect Trump’s announcement that the US will pull out of TPP. These regional FTAs are not the best outcome, but they are perhaps better than not having any new trade deals. The result is the potential creation of sizeable free trade areas where domestic companies can gain economies of scale by selling to a much larger customer base than otherwise possible. The competitive advantage to be gained is potentially sizeable. That is why Southeast Asia is also pursuing an ambitious free trade area. But the single market launched by the 10 nations of Southeast Asia (ASEAN) at the end of 2015 will not include a single currency. Nor will the ASEAN Economic Community (AEC) have an equivalent to the European Central Bank in the foreseeable future. The ASEAN single market rivals the EU in terms of population. With over 600 million people, ASEAN links together 10 countries – ranging from rich Singapore to poor Laos – into a free trade area with free movement of labour, removal of tariffs, and common standards. The AEC is even aiming to rival the EU and perhaps overtake it by 2020 based on the 5 per cent plus economic growth rate of ASEAN as compared to the 1-2 per cent growth of the EU. Still, there are numerous challenges facing the AEC. For one thing, there are not many pan-regional institutions to learn from. There is also no entity comparable to the European Commission. The AEC also lacks institutions to protect human rights and workers, including a court like the European Court of Justice. That will be challenging, as political differences in the region, which includes non-democratic states, will make it tough to integrate both politically and socially. Besides institutions, the region also faces challenges in terms of what economists call ‘deep’ integration, so, for instance, NTBs aren’t typically removed (Baldwin, 2008). There are many trade links in the region, but intra-regional trade in ASEAN is only around a quarter of total trade as compared with the EU or, in particular, the euro zone, where the biggest trade partners are the other European economies. Trade has increased in the past few decades in Southeast Asia, but there are still non-tariff barriers that protect some home industries. ASEAN policymakers emphasise that the impetus behind the AEC is to compete with the sizeable markets of the EU, the US and neighbouring China and India. The rise of regional free trade agreements being negotiated such as the TPP linking America to Asia, and TTIP tying the US to the EU, highlight the urgency for Southeast Asia to link their economies in order to compete. With twice the population of the United States and one that is similar to the scale of the EU, the AEC has the potential to become one of the largest economic entities in the world. We’ll soon see if the AEC becomes a common reference point for the rest of the world, like the EU, and a market like the US, where global businesses have to be a part. It seems that Southeast Asians certainly have that ambition. So, within this context of countries joining regional FTAs, Britain is rather unusually leaving one and embarking on bilateral trade deals. The question is whether Britain will be successful going at it alone outside the EU. On the other side, Britain does have a long track record of benefitting from its global outlook. Britain’s long-standing international orientation Britain is ‘open for business.’ That is the message that has been sent out by successive UK governments, particularly after the Brexit vote. It is already the case that many British brands are foreign-owned. The stock of foreign direct investment in the UK is around half of GDP, which is appreciably higher than the global average of one-third. But it is a two-way street: The UK also has its share of global companies and makes a tidy return from overseas investments. In recent years, many of Britain’s iconic brand names have been snapped up by foreign companies. The car industry is a particularly good example. Britain’s most prestigious marques, Rolls Royce and Bentley, have been respectively owned by BMW and Volkswagen since 1998. Four years earlier, BMW had acquired the ailing Rover group. Unable to turn it around they broke it up in 2000 and only kept the Mini, which proved to be a commercial success. Ford bought Land Rover while MG Rover was sold first to the Phoenix Consortium before being rescued by China’s Nanjing Automobile Group in 2005. In 1990 Jaguar had been purchased by Ford, who then sold it, along with Land Rover, to India’s Tata Motors in 2008. A notable exception is Aston Martin, which is now back in British hands. The Oxfordshire-based Prodrive led a consortium to purchase the company from Ford in 2007. However, Ford maintained a 10 per cent stake and the financing for the deal mainly came from US and Kuwaiti backers. Later on, 37.5 per cent was sold to an Italian private equity company. Such is the way with big business today. A company from somewhere might be owned by another company from somewhere else, whose investors in turn come from all around the world. It makes the question of ownership hard to pin down. A survey conducted by the trade magazine The Grocer and the research firm Nielsen found that of the biggest 150 biggest grocery brands in the UK, just 44 are domestically owned. And of the 91 brands created in the UK, only 36 were still owned by British companies. The rest are owned by foreign multinationals and private equity groups. This follows a series of high profile takeovers of famous British brands. HP brown sauce was the inspiration of Frederick Gibson Garton, a Nottingham grocer in the late 19th Century. The product got its name after Garton learned of its being consumed in the Houses of Parliament. In June 2005 the brand became part of the Heinz empire. And to show what goes around comes around, Heinz itself was purchased by Warren Buffet’s Berkshire Hathaway and the Brazilian global investment fund 3G Capital. The Chinese company Bright Foods took a controlling 60 per cent stake in Weetabix Ltd, which also owned the Alpen and Ready-Brek brands. Branston Pickle, of which 28 million jars are sold every year in the UK, was acquired by the Japanese firm Mizkan who, by the way, already owns Sarsons Vinegar and Hayward’s Pickled Onions. Cadbury, founded in Birmingham in 1824, was bought by the American Kraft Foods in 2010. It was then spun off into Mondelez International, Kraft group’s international snack and confectionary business. Britain’s other large confectioner Rowntree Mackintosh, founded in York in 1862, was bought by the Swiss conglomerate Nestlé in 1988 only one year after becoming a public company. In 2008, the alcoholic drinks company Scottish & Newcastle was jointly purchased by Heineken of The Netherlands and Carlsberg of Denmark. Traditionally British brews such as Newcastle Brown Ale, John Smiths Bitter and Strongbow Cider are now part of Heineken UK, so they are basically owned by the Dutch. One of the clear trends is that international brands are becoming increasingly owned by a small number of very large conglomerates. For instance, Pepsico, Coca-Cola, Kraft, Nestlé, Mars, Procter & Gamble, and Unilever own a staggering number of the world’s most recognisable brands between them. Unilever, the Anglo-Dutch conglomerate, alone owns over 400 brands. This goes to show that big business increasingly dominates the global landscape. But it is also the case that Britain has a number of its own global titans. When it comes to acquisitions involving British and foreign companies is not just a one-way street. For instance, Guinness is synonymous with Dublin and Ireland, while Smirnoff originated from a Moscow distillery in the 1860s and is now one of the best-selling brands of vodka around the world. Both brands are owned by Diageo, a British company listed on the London FTSE and headquartered in London. The company also owns 34 per cent of Moet Hennessy. So, the iconic French champagne brands Moet & Chandon and Veuve Cliquot, as well as Hennessy cognac are now one-third British. Among the big British companies that have expanded aggressively around the world, the Vodafone group is notable. In terms of numbers of subscribers, it is second only to China Mobile and has a presence in over 70 countries. It has gobbled up several foreign rivals and rebranded them along the way. In 2000, Vodafone bought the German company Mannesmann for GBP 112 billion. At the time, this was the largest corporate merger and is still the largest by some considerable distance in UK corporate history. The deal caused unrest in Germany as never before had such a large company been acquired by a foreign owner. Further disquiet was caused when Vodafone reneged on a pre-merger deal to maintain the Mannesmann name and rebranded the company Vodafone D2. Tesco is the third largest retailer in the world after Walmart and Carrefour. It has as many outlets outside the UK as it does within it, with operations in 14 countries across Europe, Asia, and North America. Tesco has already been in China for nearly a decade where it has over 100 stores. But Britain’s really big beasts are in oil and finance. BP, formerly British Petroleum, started life as the Anglo-Persian Oil Company in 1909 to manage the empire’s oil discoveries in Iran. It now has operations in over 80 countries and is the second largest producer of oil and natural gas in the US. In 2008, it merged with Amoco and largely rebranded their US operations as their own. Shell is an Anglo-Dutch company with operations in over 100 countries. According to the Fortune Global 500 list, which ranks firms in terms of revenue, it is the largest company in the world ahead of Wal-Mart. British banks and insurance companies are also massive players on the world stage. Britain’s biggest bank is HSBC, the Hong Kong and Shanghai Banking Corporation. It’s also the second largest bank in the world in terms of assets held only after the Chinese state-owned Industrial and Commercial Bank of China (ICBC). It was founded in Hong Kong in 1865 as the British Empire expanded trade into China. It essentially became a British bank in the early 1990s. The takeover of Midland Bank was conditioned on it moving its headquarters to London that was part of the calculus in any case as the handover of Hong Kong back to China loomed then. However, it remains predominantly a global bank with subsidiaries and operations in over 80 countries. And Britain’s fifth biggest bank, Standard Chartered, operates in over 70 countries but has no retail business in the UK. In fact, most British people would have never heard of the bank if it did not currently sponsor Liverpool football club. This makes sense given the popularity of the English Premier League in its key overseas markets. 90 per cent of its profits come from Africa, Asia and the Middle East. It is a good example of a British company with a stronger presence overseas than at home. The Office for National Statistics (ONS) estimates that over half the shares in quoted UK companies are currently owned by foreign investors. Ten years ago, a third of the shares were foreign owned. Twenty years ago, the proportion was only 13 per cent. So, Britain is indeed open for business and British companies are clearly attractive to overseas buyers. Why? Perhaps it is because they are relatively easy to buy. A high proportion of companies are publically listed (PLC), so the shares can be bought and sold freely. Furthermore, fewer British firms are controlled by family trusts than in the US and Europe. These can form powerful controlling groups that make direct takeovers difficult if the family does not want to sell. In addition, the British government rarely blocks deals even if there is a ‘strategic’ argument for doing so. The privatisation programme starting in the 1980s has made many utility and infrastructure companies into PLCs and foreigners are free to buy shares. Four of the big six energy companies, including most of the nuclear industry, are foreign owned. The same goes for British seaports, airports and railways. Not least, since the Brexit vote, the fall in the value of the pound has made British companies cheaper to acquire. When foreigners buy shares in or takeover a British company, the profits and dividend payments are transferred overseas. There is a suspicion that these earnings are enhanced by outsourcing jobs to cheaper parts of the world and re-routing profits through jurisdictions with lower tax rates. Thus, there is a recent push for tax reform and the current government is seeking to publish a roster of ownership. Among the possible benefits of foreign ownership, statistics show that foreign-owned plants are on average more productive than domestically-owned establishments (Bloom, Sadun, and Van Reenen, 2012). Multinationals can also bring in fresh ideas and expertise, such as new technologies and management practices. Of course, the same applies in the case of British multinationals setting up in foreign countries. Not surprisingly, foreign investment is also welcome when there is a need for cash. The Spanish bank Santander already owned the Abbey National, but there were few complaints in 2010 when it absorbed the Bradford & Bingley and the Alliance & Leicester building societies to become one of the largest UK retail banks. To the contrary, there was considerable relief following Santander’s announcement to use its balance sheet to avert two further potential Northern Rocks. In any case, Britain still owns far more direct investment assets overseas than vice versa. The ONS estimates that Britain has GBP 1.1 trillion direct investment assets overseas, which is GBP 300 billion more than the rest of the world owns in the UK. Britain also typically enjoys a surplus in investment income. Since 2000, inflows of investment income have averaged 13.5 per cent of GDP compared to outflows, which have averaged 12.4 per cent of GDP. This means that each year Britain has received a net flow of investment income equal to 1.1 per cent of GDP from the rest of the world. Such capital inflows are of course essential to continue to finance Britain’s significant current account deficit. It also explains why the British government is so keen to stress the country’s long-standing openness to investment from around the world. And that leaving the European Union does not change its openness. It does have a long track record to draw upon, and the UK government is indeed touting its openness in order to convince the rest of the world that the vote to exit the EU will not lead to greater protectionism. Post-Brexit path forward for the UK Few things are as uncertain as Britain’s economic relationships in the years ahead. Still, one important factor will be attitudes towards globalisation and their impact on the UK’s ability to maintain its global outlook. It is one of the main issues that its major trading partners will be looking for, given the perception that Britain has turned inward by leaving the EU. The UK government, though, has focused on maintaining the country’s long-standing international outlook. The tussle between the UK and China over the nuclear plant at Hinkley Point is an example of the uncertainty going forward. After Brexit, the new British government under Prime Minister Theresa May announced that it wished to re-consider the agreement to build the Hinkley Point nuclear plant that would be financed by the French company EDF and China. This step shouldn’t have come as a surprise, considering that nuclear energy is a strategic sector that usually warrants additional scrutiny; and Britain approved the deal once again shortly thereafter. However, from a Chinese perspective it became a flashpoint for where the UK might be headed. In response, the Chinese ambassador warned that the decision comes at a ‘crucial historical juncture’ and China hopes Britain retains its openness. As China wishes to maintain good relations both with the EU, its largest export market, and with the UK, which is a more welcoming Western hub than the US, it will continue to monitor what happens in the new post-Brexit UK. As will many other countries. For Britain, convincing its trading partners and businesses that Brexit is not a rejection of globalisation will be key. In its favour is Britain’s long history of being open to trade and international investment, as discussed earlier. The UK’s internationalist outlook has undoubtedly contributed to its position as the world’s fifth biggest economy with a relatively small population of 63 million. Pursuing free trade deals will be the clearest signal that Britain retains that outlook despite voting to leave the world’s biggest economic bloc. Britain will also need to convince its potential FTA partners such as China that the Brexit vote will not change its course. Admittedly, some backlash against economic globalisation figured into the Brexit vote. So it is a bit ironic that leaving the EU has led to an aggressive push on the part of the new government to agree to more free trade deals to secure Britain’s economic future. In any case, continuing global integration will be important for the UK’s economic growth. The challenge will not just be in agreeing on deals quickly, but how Britain will compete in a world where major economies are pushing for regional trading blocs just as the UK is leaving one. There’s no doubt that Britain’s future is uncertain, but its long-standing global orientation will help to overcome the concern that Brexit is a statement against globalisation. The General Election, which saw the Conservatives lose their majority in Parliament, has widened the potential future economic relationships with the EU. The start of formal Article 50 negotiations between the EU and the UK this week has cast into stark relief the Brexit dilemma.
In economics, there is a concept known as the impossible trinity or the macroeconomic policy trilemma. It says that you cannot achieve all three aims of monetary policy autonomy, fixed exchange rates, and capital mobility. Only two of the three are possible. For instance, as capital moves freely across borders, then a country has to choose between managing the currency or independent monetary policy. So, if monetary policy raises interest rates, then more money will flow into the economy and erode the pegged currency. Fixing the exchange rate means that monetary policy is geared at the currency since money supply must adjust to meet the peg and not to fine-tune the business cycle. From the recent developments in the Brexit negotiations, it seems that there is a Brexit dilemma or even trilemma. After leaving the European Union, Britain will have to choose between the EU Single Market, forming a customs union with the EU, or negotiating its own trade agreements. All three are unlikely to be possible. At present, the UK is in the EU Single Market and Customs Union, so it has not set its own trade policy since 1973 when it joined the European Economic Community. Thus, not all three aims are possible. Just before Article 50 talks kicked off, European leaders such as French President Emmanuel Macron, German Finance Minister Wolfgang Scheuble, and European Parliament Brexit coordinator Guy Verhofstadt said that if the UK changes its mind, then the door is “open” for it to remain in the EU. According to the panel of economists and politics experts that I chaired at the London Business School last night, that did not seem likely politically for Britain where both major parties have opted for Brexit. In which case, the Brexit dilemma will require tough choices to be made. After Brexit, if the UK were to negotiate a customs union agreement, then it would share a common external tariff with the EU. It would maintain frictionless goods trade with the EU which also means that no “hard border” would be imposed between Northern Ireland and Ireland. With the Northern Irish party, the DUP, in talks to support the minority Tory government, the border issue in Ireland has come to the forefront. But, a customs union would preclude Britain from doing its own free trade deals, which has been one of the benefits frequently mentioned after Brexit, i.e., establishing trade agreements with the rest of the world for the first time in over four decades. Turkey’s customs union agreement with the EU has precluded it from negotiating a free trade agreement with the United States since they must have the same outward facing tariff. So, the EU has insisted that Turkey must accept what it negotiates with America in the on-going TTIP (Trans-Atlantic Trade and Investment Partnership) agreement even though Turkey does not have a say. But, Turkey also controls its borders and sets its own migration policy. Thus, in this scenario, independent trade policy aim is not feasible. If the UK were to negotiate instead to remain in, or have largely unfettered access to, the Single Market, then it could negotiate its own free trade agreements so that would rule out a customs union. For instance, Norway does so as part of the European Economic Area that includes countries that have entered into the European Free Trade Association (EFTA) but are outside the EU. Norway negotiates its own free trade deals, but is subject to what can be sold into the EU. In return, Norway pays into the EU Budget, has no say in Single Market rules, and accepts free movement of people, which is a sticking point for Britain as the Prime Minister has said that she wants to control migration. But, the German Foreign Minister Sigmar Gabriel has hinted that the UK may be able to remain in the Single Market if it accepts free movement of workers. So, free movement only for those with jobs. He also suggested that a joint EU-UK court may be feasible, which also addresses another British concern about sovereignty. Like the EFTA court which governs the EFTA countries, any such court would be expected follow the European Court of Justice in principle. Therefore, the UK must decide whether it wishes to do its own trade deals, which rules out remaining in the Single Market, leaving the Norway option. Then, there’s also the choice of aiming for a comprehensive free trade agreement with the EU that must include services which are excluded from a customs union. That would also mean prioritising trade deals over a frictionless border for goods trade in a customs union. But, if it needs a customs union, particularly for the Irish border, then it’s unlikely to be able to negotiate free trade agreements with the rest of the world. Of course, as the saying goes, “politics is the art of the possible.” Still, hard choices are likely needed among these aims given the Brexit dilemma or trilemma. On this day in two years’ time, the UK will likely have left the European Union as the Prime Minister Theresa May has today sent formal notification to the EU to trigger Article 50 of the EU treaty that starts the Brexit process. Brexit will then have taken place less than three years after the EU referendum of June 2016.
That is the most certain outcome of Brexit thus far, though that is less than 100% certain because there is the possibility of extending the two-year negotiating window if all 28 nations agree that more time is needed. It’s not to say that we don’t have more detail than before. We know that Britain will prioritise the ability to control migration. The PM believes that means that Britain will not have unfettered access to the EU Single Market. Rejecting the free movement of people also means the Norway model of being in the European Economic Association is out. Yet, there are murmurings from Switzerland, which has its own migration issues, and even reportedly from Germany that some degree of control may be possible, though perhaps not that likely. Similarly, PM May wants the UK to negotiate its own trade deals, so that excludes being part of the EU Customs Union which requires members to have a common external tariff with the rest of the world. A piecemeal approach has been deemed unlikely by European policymakers and may also violate World Trade Organisation rules too. Still, could some kind of deal be done since the UK is prioritising getting tariff-free access for its biggest manufactured goods export, cars, for instance? Minimising customs requirements at the border is another reason to seek some type of Customs Union associational membership, as the PM puts it. What about financial and other services? That will require a separate agreement since Customs Union only covers goods, so the PM will have to negotiate a free trade agreement (FTA) with the EU to determine what access the services sector will have to the European Single Market. Since services comprise nearly 4/5th of the UK economy and Britain is the world’s second largest exporter of services, this is hugely important and a complicated area since non-trade barriers like standards are more relevant than tariffs and customs arrangements. There are few FTAs that comprehensively cover services. In fact, the most advanced FTA, the EU Single Market, is undergoing continuing liberalisation of the services market, so it is likely to take some time to craft such an agreement. Finally, we also know that the British government will contemplate an implementation or transitional period after leaving the EU. But, until we know what the trade arrangements are with the European Union, which will likely take years to negotiate, what are Britain and the EU transitioning towards? That is clearly better than a “cliff edge” where current EU trade rules don’t apply on March 30, 2019. Still, what would transition itself look like? That’s another area of uncertainty. The WTO regime would apply then, which would help. But, given the gulf between the preferential access to the EU at present and what the WTO rules cover, that still leaves ambiguity. At least in terms of the WTO, there is more economic certainty. Of course, between now and then, the UK and EU have to agree to split their current quotas, etc. to establish new WTO membership terms for both sides which needs to be agreed by the WTO member countries. Even if the rest of the 160 or so WTO members don’t agree to the new terms for the UK, the WTO rules dictate that the old rules would apply which in Britain’s case will be largely the same terms anyways. It doesn’t cross the T’s or dot the I’s, but the working arrangement will offer some certainty at least. The European principle that nothing is agreed until everything is agreed means that we will unlikely see the end of economic uncertainty until March 2019 at the earliest. In one sense, less than three years from the vote to departure seems fairly quick in terms of unravelling international treaties. But, in another sense, it’s rather a long time to know where everything stands in post-Brexit Britain and in an EU that excludes the UK. The UK’s Prime Minister Theresa May has said that no deal with the EU is better than a bad one, which may force the UK to rely on the World Trade Organization (WTO)’s rules for trading. But what happens the day after Brexit is confirmed? British businesses don’t want the uncertainty of being outside the EU with potentially no trade deals. So what are the options?
Until Brexit happens, the UK has to negotiate any trade deals as part of the European Union. That will obviously change following Brexit. But it also means that the UK can't negotiate trade deals with other nations formally until it leaves the EU. So the question is: can the UK just rely on the WTO rules to buy and sell goods in the absence of any other trade deals? In theory, it could but the UK and EU need to agree on how to divide up the shared WTO “schedules” – the list of tariffs and quotas that the EU applies to other countries. This is because the UK is a member of the WTO through the union. To become a fully independent member of the WTO, the UK would have to establish its own schedules. As a member of the EU Single Market, the UK can import cars without facing any tariffs, for instance. But there will be tariffs of 10% on cars after Brexit and smaller amounts on other goods, plus a few higher rates on agriculture. There may not be an immediate economic impact, but there could be longer term ramifications the longer term for, say, car production chains. Bureaucratic issues Becoming a full WTO member presents a major challenge as the UK would need to disentangle itself from all the tariffs and quotas it has signed up to through the EU. It could take years to sort everything out and that’s before we’ve even considered free trade agreements. But trade experts have told me that it can be done, as long as the negotiators are sensible. It’s in everyone’s interests for there to be no disruption, so the UK should be looking to get on good terms with the EU and WTO. America is a good example of how to negotiate. The US has around 200 trade negotiators, which doesn’t sound like it’s many but they are incredibly efficient as they only do one or two deals at a time. Britain can learn from this by looking to agree terms with a small number of countries first and then going from there. It’s really important for the UK to rack up a few trade deals. It can then use those deals to entice other nations to come to the table. Getting the US on board would be a major move. We know that Prime Minister May and US President Donald Trump have met to discuss Britain’s relationship with America. But Trump has made it very clear that he prefers bilateral trade deals to free trade agreements. It’s really difficult to imagine Trump giving Britain a very good deal while talking about putting America’s interests first. After all, “hire American, buy American” was the mantra throughout his presidential campaign. Brexit’s impact on the UK economy Will London still be an international financial centre if there are no firm trade agreements in place after Brexit? I’ve spoken with officials in China and other emerging markets who say they’re really worried about this. But it’s really hard to dislodge a city with such financial expertise. London has been a global financial capital for a long time, even though Britain’s not the biggest economy in the world. The British government is trying to prevent efforts to entice financial services firms from London to Paris, Frankfurt or Luxembourg. This is fuelled by international banks with European headquarters expressing concern about Britain leaving the single market. British financial services providers are also worried. To diversify, Lloyd’s of London is setting up operations in Europe, while HSBC will relocate some staff to Paris when the UK leaves the EU. Striking trade deals won’t happen overnight. In the meantime, the UK would need an implementation or transitional deal with the EU after finalising Brexit to help smooth the process and avoid any disruption. I think we will see one, but what will the UK transition to if it has no free-trade deal with the EU? This is the practical question that British businesses are asking. Whatever happens, we know the only certainty about Brexit is uncertainty. However, it’s important to recognise that as the fifth biggest economy in the world, the UK is resilient. The key to maintaining that position long-term is to open up new markets after leaving the EU. Trade agreements are about opening up markets, but they’re also about reducing the frictions of cross-border trade. In other words, the gains from international trade result from, among other things, the reduction of tariffs and duties, especially in an era of global supply chains.
Once Britain leaves the European Union, these economic factors will come into play. The white paper detailing the UK exit from the EU confirms that Britain will not seek to remain in the EU single market or the customs union. The UK will try to get preferential access for certain exports like cars into the EU. But, if there are differential tariffs and duties, there will be customs checks at the border to establish which duty should apply. These frictions largely pertain to manufacturing and agricultural products, and less so to services which make up more than three-quarters of the UK economy. After Brexit, there will be a lot more customs checks at Britain’s national borders. Just under half of British exports go to the European Union. They face minimal customs procedures. The principle is known as RORO or ‘roll-on, roll-off’. After Brexit, shipments to and from the European Union will be subject to the same level of checks as non-EU trade. These include customs declarations at the border, assessing the tariff or duty to be paid, and lorries as well as inspection checks for ships and planes. Direct and indirect tariff costs The British Chambers of Commerce estimate that by 2019, owing to Brexit and the overall increase in global trade through Britain, the annual number of customs declarations will rise to 390 million per annum from 90 million. A quadrupling of the paperwork will require an IT system that can manage the additional load, as well as additional physical infrastructure to ensure that the customs checks don’t cause excessive delays for the shipments or gridlock on the roads. In a measurable way, additional customs requirements will increase the cost and frictions of trading with the UK. There are also likely to be greater trading costs associated with the fall-back position of relying on the World Trade Organisation if there is no trade deal with the EU. Under the WTO, the UK would trade under ‘most favoured nation’ status with the rest of the world. Around one-third of British exports would be zero tariff and many would have tariffs of just 2-3%. But for Britain’s biggest goods export, cars, tariffs would rise to 10% from the current zero. Others, mainly agricultural products, would be subject to higher tariffs. Tariffs are an example of trade frictions that countries seek to reduce through free trade agreements. Although most tariffs are not large in magnitude, countries around the world have sought further FTAs in addition to their WTO membership to reduce these costs of trade further. An increase in tariff rates and customs costs may well be manageable in the short term. But it adds pressure to the British government to maintain the long-term competitiveness of British goods exports by agreeing FTAs to bring those costs down. What that implies is greater competitive pressure on British exports. EU officials have stated that Britain must trigger Article 50 of the Treaty of Lisbon before a trade deal can be discussed. Being in the EU also means that Britain cannot formally negotiate trade agreements with other countries. Informal talks are taking place and groundwork has been laid in the U.S., but it still means the UK won’t have any FTAs in place when it leaves the EU. One implication is that those British products which now attract zero tariffs when exported to the 50 countries with which the EU has FTAs will see those taxes rise from zero to 'most favoured nation' levels after Brexit. Therefore, the additional friction will increase not just for exports to the EU, but also for exports to places like South Korea and Canada. WTO membership terms Friction surrounds the potential uncertainty regarding which tariffs or quotas apply once Britain has left the EU. The UK is a member of the WTO as part of the EU. It can replicate existing WTO schedules for tariffs and others by essentially crossing out EU and writing in UK for the most part in a process called rectification. But there are two areas where that is not feasible. WTO subsidies and quotas are set for the EU as a whole and not for individual nations. There are about 100 quotas for imports of mutton and the like which will need to be divided between the EU and the UK. The EU and UK then need to present the new schedules to the other more than 160 WTO members which must agree unanimously to the new WTO membership terms. To avoid confusion over which quotas or tariffs apply after Brexit, it is in the interest of both the UK and EU to agree their WTO membership terms quickly. It’s the sort of trade friction that is avoidable and suggests that the Brexit talks with the EU can’t be wholly devoid of trade negotiations. In other words, in a ‘no deal’ scenario with the EU, the UK will still need to do a deal with the EU. We need to keep in mind that trade takes place under WTO rules. China is the U.S.’s biggest trading partner, despite no free trade agreement being in place. Of course, if Trump were to pull out of the WTO, then that would be a game changer. But, globalisation, especially e-commerce and the Internet linking markets and people, will mean that trade is likely to continue across borders as it’s hard to see a significant roll-back Costs of trade, of course, are another issue to be focused on.
Luckily, the Trump administration hasn’t honed in on e-commerce, which is good news for procurement and supply chains. Currently, one in ten transactions are already undertaken via e-commerce, and this figure will continue to grow. Trump may have moved quickly to sign the TPP withdrawal order on his first day in office, but that wasn’t a formal agreement. Extricating the United States from NAFTA for instance will require renegotiation time and then a period of notice before that free trade agreement would end. Even then, most trade agreements include implementation periods, so a “cliff edge” is unlikely which gives businesses time to plan. Therefore, there’s no need to panic or overhaul your supply chain immediately. But, of course, forward planning and following economic policies would be wise. Also, take Brexit as an example – if Britain succeeds in triggering Article 50 in March 2017, then the UK is scheduled to leave the EU by the end of March 2019 – almost three full years after the people’s vote. And even there, the Prime Minister has indicated that there may be an implementation period to allow more time for businesses to adjust to leaving the Single Market. Things to watch 1) U.S. border taxes – recently, Trump threatened BMW with a 35 per cent border tax on foreign-built cars imported to the U.S. market. This isn’t an isolated incident and American companies are under even more pressure to produce in the U.S.. Congress is also considering a similar tax, so that is worth bearing in mind as that would have the force of legislation. 2) U.K. Tariffs – one of the consequences of a “hard” Brexit where the UK leaves the EU without any preferential trade deal, which would include no agreement on the Single Market, Customs Union, is the re-emergence of customs for EU trade. Right now, significant customs procedures only apply to non-EU shipments. But, with around half of UK exports going to the EU, taking leave of Britain’s membership in the EU with no deal would means the end of free movement of goods. More customs declarations and duties would raise costs, slow down supply chains and certainly add time at border checks. A potential ‘hard border’ would be a particular issue for Ireland. 3) Resourcing Brexit – the UK Government also needs to think about the resourcing challenges involved in ramping up staff as well as IT systems to cope with the doubling of customs checks on the UK border. 4) NAFTA – As mentioned earlier, Trump has also flagged that the North American Free Trade Agreement (between Canada, Mexico and the U.S.) is up for renegotiation. If you’re a U.S. company, you need to start making plans now about how these changes will affect you. The same applies to any other of America’s free trade deals with 20 countries that Trump would have the authority to re-examine. 5) China? – Globalisation has helped China become a manufacturing powerhouse, but with numerous closed markets.However, there are very good reasons to continue to do business with China. Wages may be rising but that helps businesses to think about China as a market as well as one production locale in a supply chain. Plus, with growing protectionism in America, China’s President has signalled that China may take more of a lead in globalisation. There’s a lot to watch for. Our Chair contributes to the FT annual survey
1. Economic prospects How much, if at all, do you expect UK economic growth to slow in 2017? Please explain your answer. I expect UK economic growth to remain fairly resilient, supported by relatively optimistic consumer confidence, a slower pace of fiscal austerity, and a weaker Pound. The UK will still be in the European Union in 2017, so there will be no fundamental change to market access to the EU Single Market. However, growth may be weaker than in 2016 if businesses defer investment decisions as a result of the continuing policy uncertainty related to Brexit. 2. Brexit Compared to what you thought 12 months ago about the UK's long-term economic prospects outside the EU, are you now more optimistic or more pessimistic than you were? More optimistic than 12 months ago Feel about the same as 12 months ago More pessimistic than 12 months ago Please explain your answer. I feel the same. Access to global markets is the key to the UK's long-term economic prospects. So, on the positive side there is undoubtedly a renewed vigour for striking international trade and investment deals, especially in fast-growing parts of the world and in the trade in services. However, it is likely to take longer than the rather optimistic assessments of how quickly these negotiations can be done. 3. Inflation Inflation has started to increase in recent months. To what extent do you expect inflation to rise in 2017? I expect inflation to rise but not to the heights seen in the aftermath of the 2008 financial crisis as the driver is the weaker Pound and not global price pressures. But, as we have seen in recent months, some of these price pressures are likely to be absorbed into profit margins, so the pass-through into consumer price inflation may be weaker than expected. 4. Monetary policy In December, the Monetary Policy Committee said the next interest rate move could as easily be up as down. Will there be a shift in this monetary policy stance by the end of 2017? Please explain your answer. The chances are that the MPC will not increase interest rates in 2017. The impact of Sterling's weakness on inflation is likely to be viewed as a temporary issue and not a serious risk to the inflation target over a two-year horizon. Plus, with the ECB extending QE to the end of 2017 (albeit with a smaller programme) while the Fed may well raise rates again, the contradictory impact from the UK's major trading partners will also contribute to a wait-and-see tendency. 5. Immigration Immigration is likely to be central to the Brexit negotiations in 2017. How much do you think immigration will change and what effect do you think this will have on the UK economy? I don't see much change in immigration next year as the process for leaving the EU is unclear and likely to take some time, so freedom of movement will be unaffected for a while. Of course, as the UK may want to remain in the EU Single Market at least for certain sectors, much of the economic impact will depend on if the EU will insist on maintaining free movement of people for any such access. 6. Fiscal policy Philip Hammond is expecting government borrowing to fall in 2017. His new fiscal rules provide headroom for more borrowing than currently forecast. To what extent will he need to use it and why? If growth disappoints, or higher borrowing costs result from rising inflation, then the Chancellor may find he borrows slightly more than expected. But unless anything major hits the economy or the public finances, he will likely hold back from any significant change in fiscal policy in the next year and wait until the impact of Brexit is clearer. 7. Donald Trump How do you think Donald Trump's presidency will affect the UK economy in 2017? Trump may favour trade deals with similarly developed economies as those tend to have less of a negative wage impact, so the UK could find itself as one of the trading partners the U.S. is looking to forge a bilateral trade deal with. But, Trump's focus appears to be on withdrawing from trade agreements or renegotiating current America's current 14 FTAs. In any case, if any informal trade talks were to occur, it would boost sentiment with respect to the British economy. Otherwise, his fiscal stimulus is likely to boost the dollar which will contribute to a weaker Sterling, among other currencies. Of course, Trump will continue to add uncertainty to the world, and any change to global growth will also affect the UK economy in 2017. What are the strategic implications of President-elect Donald Trump’s decision to withdraw the U.S. from the Trans-Pacific Partnership (TPP)?
It would be the reverse of President Barack Obama's rationale for pursuing the TPP as part of his Asia Pivot, which is his wider foreign policy aim to re-orient America toward the fast growing economies in the region. President Obama pushed the TPP as a way of securing American influence in Asia and as a counter-weight to China, which was not part of the TPP. As President-elect Trump has now indicated that he will withdraw from the TPP on his first day in office, it opens up space for China to take the lead in establishing a free trade area in the Asia Pacific and increase its influence, both economic and geopolitical, in the region. Of course, much depends on what President-elect Trump chooses to do in Asia, as he is not indicating that he is withdrawing from the region – just from this free trade agreement. Explain the potential impact of the Regional Comprehensive Economic Partnership (RCEP) and Free Trade Area of the Asia Pacific (FTAAP). These China-led regional free trade agreements have the potential of cementing China's influence in the wider Asia Pacific region, including the nations of the Pacific Rim and Latin America. As a middle income country, as compared with the U.S. which is a rich nation, China's aims and goals will be different and geared more at opening up markets for technology, services, and high-end manufacturing. This may well benefit other emerging markets, and there has already been interest from countries like Peru in joining a FTAAP. As the "hub" of a free trade area, China would be strongly positioned to set the terms of trade negotiations. Indeed, it would replace America which had been behind not just the TPP but also a free trade agreement with the European Union known as Transatlantic Trade and Investment Partnership (TTIP) which also looks uncertain. With the U.S. presidential transition underway, identify three indicators of what a Trump trade policy approach might look like. President-elect Trump has said repeatedly that he will put "America First." It appears he is concerned about American jobs and also wages. Of course, there are a lot of reasons as to why median wages have been stagnant in the U.S. for decades, which include trade as one cause. Trade always entails "winners and losers" and those who have been left behind in this era of globalization are calling for reforms. When America trades with a poorer nation, there is more of a negative impact on wages in the traded sector. Manufacturing jobs come to mind, for instance. There are ways to address the distributional impact of trade, but those thus far have not been entirely satisfactory. So, Trump's trade policy may focus on pushing trade with comparably wealthy nations where there is less of a wage differential. For instance, during the campaign, Canada was less of an issue than Mexico in NAFTA [North America Free Trade Agreement]. Secondly, Trump is likely to use trade negotiations to address these distributional concerns, which is arguably better done through domestic fiscal policy. Third, Trump has more authority as President to withdraw or re-negotiate trade deals and impose tariffs than enter into new ones which requires Congressional approval. And he seems more focused on withdrawing than entering into new ones, so that may well be the priority in his trade policy. How might President Xi Jinping and President-elect Trump build a pragmatic and productive relationship? As the leaders of two economic superpowers, they surely must find a way. China has always been pragmatic in its economic reforms. Appealing to businessman President-elect Trump may go some way toward speaking a common language about how to build a working relationship between two major economies which need each other's markets to grow. Specifically, it is in no country's interest to end up in a trade war. That's damaging for not only the countries involved but also the rest of the world which looks to the U.S. and China as the engines of global economic growth. And in numerous respects, the Chinese currency which had been a sore point for many years is no longer as under-valued as before, for instance, as China becomes more consumption-oriented and a middle-income country. Of course, there are other flash points such as over-capacity in Chinese industry in sectors like steel which are exported overseas. It's certainly in the interest of both nations to try to resolve differences short of tit-for-tat trade measures. Identify three Asia-related economic and trade consequential challenges facing the Trump administration. The Trump administration needs to determine where Asia sits in its priorities. The U.S. has historically close ties with Japan, for instance, which go beyond economic interests. But, the U.S. also has a number of foreign policy challenges in other parts of the world, so where does Asia fit in? President Obama's Asia Pivot is most unlikely to be the way forward, so what is the new agenda? Second, does the U.S. wish to pursue trade agreements, including with nations in Asia as a collective? With global trade liberalization moving very slowing on a multilateral basis, other nations are pursuing regional trade deals. For instance, the ASEAN Economic Community (AEC) linking 10 Southeast Asian nations is a single market with a similar population to the European Union has just been established. Is Trump interested in a FTA on a regional basis with the AEC or just bilateral trade deals? Bilateral FTAs are of course also being pursued around the world, but those take time just like larger deals and also don't usually deliver the access to a huge market like the AEC or the EU, for instance. Third, given the focus on the impact on American wages and jobs, how interested is the Trump administration in negotiating trade deals with Asia which consists of a number of poor and still emerging nations? Will American attention shift more to the advanced nations in the region, such as Japan, Korea, and Australia? What about emerging markets like India? Since trade is increasingly via American companies establishing production and supply chains across borders, there may well be an impact on the competitiveness of U.S. multinationals who often locate low-end production in developing nations, including in Asia which dominates consumer goods production. |