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UK Economics

Don’t worry about Brexit negotiations, no deal is better than what we have now with the EU

Britain prepares for its Brexit deadline
CREDIT: LUKE MACGREGOR /BLOOMBERG


In response to Theresa May’s view that “no deal is better than a bad deal“, Donald Tusk – subsequently joined by Pascal Lamy and Jean-Claude Juncker –  made it clear they believe such a scenario would, in fact, be bad for the UK.

While some of this rhetoric can be seen as the first plays of a negotiating strategy, the answer to this challenge is crucial for the UK Government to understand. The answer, based on our detailed analysis at Economists for Free Trade,  is actually not as complicated as many will have you believe. Our work shows that not only is the WTO option better than a bad deal, it can actually be better than the deal we have at the moment.

First, however, we must deal with the myths surrounding what is misleadingly called the “WTO option”. It’s a misleading term because every option for the UK in its new trading arrangement will be a “WTO option”, given that the UK will take up its full (founding) membership of the WTO and will trade under its rules once we leave the Single Market.

In fact, there is no other way we can leave, regardless of whether we have done a deal with the EU or not. The WTO will be merely the referee in our trading relationships, as it already is with other trading nations of the world such as the US, Japan, India, and so on.

Yes, it sets the rules of engagement, but, as explained below, it certainly will not dictate our tariff levels. Unfortunately, because we have been tied up in the EU for such a long time, most UK politicians, commentators and voters really have no idea of the role it performs, let alone what trading as an independent body of this organisation actually means in practice.

Therefore, because the UK has been a member of the EU Customs Union, when we leave the Single Market, initially we will adopt the EU’s Most-Favoured-Nation (MFN) tariff schedules (as the Government has already said it will).
If we have agreed a deal with the EU, the terms of that deal will govern our trading relationship with the EU but WTO rules will govern the larger part of our trade with the rest of the world. If we have not agreed an EU deal, MFN rules then will apply to the EU as well.

It is crucial to understand that these MFN schedules dictate only the maximum tariff levels the UK can impose. Importantly, and to bust another myth, it is then for the UK to decide whether to reduce those tariffs, including the possibility of getting rid of them altogether. There is no obligation to maintain them – our only obligation is to treat all countries the same (except for those countries with which we have concluded a trade agreement).

We can reduce tariffs across the board (including to zero) or, for example, reduce tariffs on selected goods that we do not produce in the UK. Most importantly, if we do not reach a free trade agreement with the EU, it will be the choice of the UK to decide what level of tariffs it sets against the EU and – consequently – the rest of the world. It is that one single decision that will decide whether the UK will prosper or not in this new trading environment.

So what happens if we remove tariffs against the EU (and the rest of the world), even if the EU (and the rest of the world) does not reciprocate? In summary, a standard world trade model shows unilaterally removing tariffs creates a long-term GDP gain of 4 per cent, a fall of 8 per cent in consumer prices, and an increase in Treasury revenue of more than 7 per cent, compared to the status quo.

About half of this gain comes from eliminating our tariffs on goods imported from non-EU countries, abolishing our relatively few non-trade-barriers, and eliminating the CAP and its associated levies. The other part of the gain are tariffs on manufactured goods with the EU that average about 3.5 per cent on our exports to the EU; about 4.8 per cent on their exports to us.. If we do not implement our 4.8 per cent tariffs on the EU, then we achieve the full 4 per cent gain.

Clearly, this will be a better situation than we have today – a massive gain for the consumer – even though the EU may have raised tariffs against us, no other country may have reciprocated our zero tariffs, and we will have “fallen off the cliff” into the dreaded WTO.

However, problems occur if we engage in a “tit for tat” tariff policy against the EU. If we retain goods and agricultural tariffs against the EU (and, consequently against the rest of the world, unless we achieve free trade agreements rapidly with most other countries), GDP drops 4 per cent from today’s levels, virtually no decrease in consumer prices is obtained, and the Treasury loses about 2 per cent of its current revenue.

Furthermore, such a policy would disrupt manufacturing supply chains severely. These was, in fact the very scenario the Treasury and others used in Project Fear to discredit the “WTO option”.

Many argue – driven by the entrenched interests of producers as the principal beneficiaries of protectionism – that unilateral free trade is politically complicated, or even “politically impossible”. However, this argument should be seen for what it is: the modern resurrection of the age old producer vs consumer debate that Cobden and Bright so notably turned on its head over the Corn Laws. This result set the British economy on a course of expansion for the better part of a century. We have been part of the EU Customs Union for so long, that many have forgotten – or have never learned – this important lesson. We should also remember that consumers and voters will be watching these trade negotiations closely. Primed by the referendum debate, they will want those falls in consumer prices enabled by free trade.

Of course, it is also possible to pursue free trade through a series of free trade agreements with the rest of the world. Under this approach, the UK would not unilaterally eliminate import barriers but would attempt to achieve the same objective via negotiating such agreements.

It will take time, may not cover some important countries, and there are risks it could stall. And, if we retain tariffs on the EU, half of the potential gain will not be achieved. Consequently, if the government decides to go down this road, it should spare no effort toward getting as many free trade agreements virtually in place with major like-minded countries before the two-year Article 50 negotiation period completes. In order to complete the free trade process that brings us the full trade gains of Brexit, it must then gradually and finally eliminate any tariffs remaining against the EU.
No deal really is better than the status quo

Finally, producers need not suffer in order that consumers benefit. Our research shows that manufacturing – aided by Sterling’s lower exchange rate (likely to last for several years) – can prosper without protection. Even without the benefit of a lower currency, a modicum of productivity improvement coupled with new opportunities to re-source supply chains at better value from both the UK and the rest of the world will allow manufacturers to compete successfully.

Thus, the decision is not complicated, the WTO is not be dreaded, and there are clear economic benefits to the UK of embracing free trade, irrespective of how negotiations with the EU turn out. No deal really is better than the status quo and Mr Tusk and his colleagues would do well to remember that during the next two years. Perhaps, David Davis already recognises this and, consequently, does not feel the need for complex analysis.

 Edgar Miller is Convener at Economists for Free Trade and Senior Visiting Fellow at Cass Business School
http://www.telegraph.co.uk/news/2017/03/29/dont-worry-brexit-negotiations-no-deal-better-have-now-eu/

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