On Brexit over-optimism

Theresa May today said she wanted a “bolder embrace of free trade” so that the UK can “rediscover its role as a great trading nation.” This echoes Gerard Lyons and Liam Halligan’s view (pdf) that Brexit is an opportunity for the UK to “trade more freely with nations far more populous and fast-growing [than the EU].” For me, there are two problems here.

One is simply that free trade deals might not be so easy to arrange. Trump has promised us a “fair” deal – but “fair” is often a euphemism for “not free”. And as George Magnus has tweeted: “C'mon Twitter, you think Xi JinPing is the new champion of free trade and a liberal trading order?”

That issue will get lots of attention in coming months.

I fear, though, that it effaces another problem – that even if the UK does strike great trade deals, exports might not increase very much. Just because we have the opportunity to do something does not mean we will. I would have thought that Gerard, being a lifelong Fulham fan, would know there can be a distance between opportunity and achievement.

My table gives us a clue about this. It shows goods exports per person to some non-EU countries, taken from World Bank data. You can see from this that Germany exports much more than the UK – more than twice as much person to Japan and China, and more to India and Australia, despite the UK’s historic links with those nations. 

This alerts us to an important fact – that it is not membership of the EU that is holding back UK exports. Germany faces the same trade rules that we do, and is doing much better.

Exactly why this should be is of course a big question. It’s not just that UK businesses are “fat and lazy” (to use Liam Fox’s expression). It’s because the UK has for decades lagged behind in skills and investment in some key exporting industries.

Trade performance isn’t just a matter of gravity – countries export more to their near-neighbours than to distant countries – but also history.

And the thing about history is that it is usually slow to change. This means that even if we do strike great free trade agreements, overall economic growth won’t increase much. Monique Ebell shows that free trade agreements which fall short of really deep integration do little to boost exports.

What’s true for exports is even more true of GDP. In a superb post, Dietz Vollrath shows that most policies have only a small impact upon growth. Even a big rise in potential GDP, he shows, implies only a small uplift to growth simply because actual GDP is slow to converge upon potential*.

And basic maths tells us we won’t get a big increase in potential GDP from free trade deals, simply because exports to most non-EU nations are small as a share of GDP. For example, UK exports to China last year were just 0.7% of GDP. Even if they were to double over a five year period, therefore, we’d get only a 0.13 percentage point rise in GDP growth**.

I say all this to agree with Nick. Brexit – at least on the terms proposed by Ms May – jeopardizes good existing trade arrangements with the EU in favour of chasing agreements which even if they are reached might not actually benefit us much.

This isn’t just economically risky. It’s also in one sense deeply anti-conservative. Michael Oakeshott famously wrote (pdf):

To be conservative, then, is to prefer the familiar to the unknown, to prefer the tried to the untried, fact to mystery, the actual to the possible, the limited to the unbounded, the near to the distant, the sufficient to the superabundant, the convenient to the perfect.

This, of course, is the precise opposite of what Ms May is offering.

* Yes, GDP can converge quickly towards potential as an economy recovers from a recession. But we’re talking here about changes to trend growth, not cycles.  

** In fact, probably much less because we'd have to increase imports to produce those extra exports.

Comments

[Squirrel Nutkin]

It seems May's abandoned conservatism for oxymoronism.

But hasn't the one fundamental policy of political conservatives (as distinct from philosophical conservatism) has been them defending their being in power, rather than doing anything specific while they are?

[droog]

My opinion is that May's argument is nothing but arguing after the fact. Hard Brexit is the only thing she can deliver because it is the default result at the end of this journey. Therefore it is the thing she will pursue and argue for. To argue for anything different is a guaranteed failure to deliver.

This has nothing to do with the economic and social consequences of the hardest of hard Brexits. It is the primitive political calculation with just a hint of awareness of what lies ahead. Painting the results of inaction to look like a bold and achievable quest is probably the only strategy that allows her to salvage something out of this mess.

[Oliver]

Very pertinent comments. I would add that it takes more than a competitive currency to boost exports (and the contribution of net trade to GDP growth). Sterling is down 20% since Nov 2015 (against trade-weighted basket of the currencies of the UK's main trading partners) and the trade deficit has widened, not narrowed.

Now of course some will argue that it takes more time for the trade balance to improve because it takes time for importers to reduce their imports and/or substitute for domestically made goods and services. But the reason it takes so much time (or, as history often shows, never happens) is because domestic companies are unable or unwilling to step up.

Moreover, exports may not rise much despite massively more competitive currency because other factors impact exports' desirability, including quality, technology, rarity-factor, after-sales service etc...BMWs and Porsches are not cheap (their price tends to rise irrespective of what the euro does) because BMW and Porsche have a product which consumers will pay for, whether it's 5-10% cheaper/more expensive.

That's not to say that the UK does not have world-beating companies. It does. But in manufacturing in particular there are at present far too few of these companies for Sterling's collapse to really make a dent in the UK's trade deficit on goods. So in the near-term the UK will remain reliant on household consumption to support growth, which is likely dependent on households continuing to borrow from banks at a decent clip given tepid wage growth. This in itself presents problems (vulnerability to interest rate hikes) which BoE Governor Carney elaborated on in his LSE speech yesterday.

[gastro george]

"This has nothing to do with the economic and social consequences of the hardest of hard Brexits."

Exactly this. May has clearly decided that a long-drawn-out detailed negotiation is politically unacceptable. That's why we have the "Europe Act" on the table - enacting all existing EU laws into UK law - because to start from anywhere else would be chaotic for the legal system. We have the same scenario economically, and the start points can only be "EU membership equivalent" or "Hard Brexit, and then negotiate a few exceptions. May has made a political decision to go for the latter.

[Dave Timoney]

The paradox of May's revolutionary fervour is explained by the aim of restoring a glorious past (so she's more Whig than Tory). Given that Brexit is a "phantastic object", a sober consideration of the practical difficulties or a cautious estimate of the potential isn't likely to get a hearing, as yer man Rogers found.

More worrying is the disconnect between expectation and reality, the characteristic of the patsy, which was evident in the moon-faced glee of Michael Gove faced with a notorious shyster telling him "Yeah, we can do you a great deal". The UK doesn't just lack experienced trade negotiators, too many of its politicians lack an understanding of our own history.

The myth at the heart of Britain's concept of free trade is the idea that our historic partners were just that: partners who freely entered into mutually-beneficial deals rather than mostly subordinates coerced into asymmetric relationships. Philip Hammond (who doesn't appear to be an idiot) has realised that we'll only get what we can secure by force, hence the threat of regulatory arbitrage.

I get the sense that the government is divided between happy-clappy free trade loons and empire nostalgists on one side, and pragmatists and the London interest on the other, the latter advocating a cynical Singapore strategy that will condemn the Brexit-voting heartlands to further decline.

Brexit is going to be well 'ard.

[gastro george]

"I get the sense that the government is divided between happy-clappy free trade loons and empire nostalgists on one side, and pragmatists and the London interest on the other, the latter advocating a cynical Singapore strategy that will condemn the Brexit-voting heartlands to further decline."

Bravo.

[Jonathan Harris]

Excellent article and follow up comments.

It seems that Mrs May has ignored Kenneth Clarke's 1990's mantra that "good economics makes good politics".

May has reversed that equation and put the political interest at the forefront of her "plan".

Time will tell whether economic "events dear boy, events" will derail the government. After all, £Sterling decline is c20% and already worse than 1970's currency crisis and Black Wednesday. So far the decline has stopped short of that in 2008 financial crash.

[Bonnemort]

"And the thing about history is that it is usually slow to change"

Not always. Pressure builds over a long period as the underlying plates strain, then the rupture or shear is quick. It took 43 years of falling real US male median wages and falling US male employment levels to produce the Trump victory, and (at least - couldn't find the stats pre-1997) 19 years of declining real UK male median wages to produce Brexit.

I certainly get the impression history moved quicker 90 years ago, though. A lot of things which make European and US politics 'sticky' today weren't a factor back in the 1920s.

Even economies can change relatively quickly. From laughing at the comical English instructions for a cheap plastic Japanese toy in 1960 to thinking "this Datsun Cherry is a pretty good car" was only 12 years.

[Blissex]

«Ms May – jeopardizes good existing trade arrangements with the EU in favour of chasing agreements which even if they are reached might not actually benefit us much.»

That's not her -- it is a thin majority of voters and her own party that push her that way.

The voters and her party's red lines are: no single market, no customs unions, no freedom of movement, no EU contribution. Her position then can only be to pretend to negotiate, to demand much from the EU and offer nothing, and blame the EU for not getting anything, which she has started doing well in advance. That is "no deal" is the only outcome she can achieve.

[Blissex]

«happy-clappy free trade loons and empire nostalgists on one side, and pragmatists and the London interest on the other»

Good description but the conclusion is not quite right:

«the latter advocating a cynical Singapore strategy that will condemn the Brexit-voting heartlands to further decline»

That was the position of the loons and nostalgics (and investment bankers), as described well by the "Britannia Unchained" persuasion, while the pragmatists (and commercial bankers) wanted soft-brexit to get out of some EU regulation but stay inside the single market/passporting.

My sense is that the pragmatists (and commercial bankers) have decided that they can't stop the loons and nostalgics (and investment bankers) and have converged on the low-wage tax-haven "Britannia Unchained" option with London-as-Dubai (or London-as-Singapore) as "second best".

The overall problem is that the economy of the south is utterly dependent on the housing market and thus debt, and when that bursts again the south will go much the way of the north. So I guess the pragmatists and investment bankers are resigned to let the rest of the country go sooner than expected.

[Lord]

Free trade is rarely about free trade either, often being about the extension of protectionism.

[Lendro]

You have a good argument that comparisons show that it is not EU membership that is holding back our trade with the rest of the world. But isn't the pouint even stronger? One reason we trade as much as we do with the rest of the world is the EU's FTAs and also its MRAs. We lose them straightaway on Brexit. So it's not just a step into the unknown , it's a step backwards into the unknown