Tuesday, July 5, 2016

Brexit and its Impact on International Trade and the manufacturing industry in the UK

In the previous two articles we covered the potential Brexit impact on immigration and public finances. Now, lets look at the likely impact of Brexit on the UK’s International Trade and Manufacturing Industry.
We will start off by looking at Britain’s current trade links with the European Union. Then we will look at the potential trading relationship that might follow Brexit. Then we will assess the cost of leaving the Single market and even look at potential benefits of Brexit to Trade.

Britain’s Current Trade Links with the European Union

The United Kingdom’s trade links with the European Union are considerable. Official trade statistics show that the European Union is the destination of about half of all British goods exports. Of course, this is just the UK nations. If we take into account the various countries that have a free trade agreement with the EU (And trade with UK as a result) the % of Britain’s exports that is linked to the EU membership goes up to around 65%.
So, if we take into consideration the fact that Exports account for about 30% of the British GDP, the value of the exports linked to EU accounts for at least 15-20% of the overall UK Economy.

Potential Trading Relationship between EU and UK

Let me start off by saying that the potential trading relationship between the EU and the UK will be similar to what they have now and the chances of the UK getting a favorable trading agreement post Brexit are very high.
Reason: British Markets are equally important to the rest of the EU.
If you take the overall share of the rest of EU exports going to UK, it is about 18%.
If you take the % share of the exports from major EU nations that end up in the UK, it paints a slightly different picture. Look at the picture below:

As you can see, except Germany, UK is a very important market for most of the large EU economies. So, it is equally important for the EU to negotiate a favorable trading deal with the UK. Also, given the fact that the EU is currently negotiating free trading agreements with countries that are far less important to it from a trading point of view, it would be crazy if they don't end up reaching a good deal with the UK.

On a related note, the chances of countries that have a free trade agreement with EU, continuing the same with the UK post Brexit are relatively high too.

What Options does UK have to gain Access to the EU Single Market?

The European single market is more than just a free trade agreement between member nations without tariffs. Goods can move freely because all members adhere to common regulatory requirements and technical standards. In addition, the single market provides for the free movement of services, capital and people.
Post Brexit – the UK could go two ways in trying to maintain this free access to the EU Market.
Option 1: Be a Member of European Economic Area
Britain could in effect remain part of the single market by becoming a member of the European Economic Area. Norway, Iceland and Liechtenstein are outside the European Union, but in the European Economic Area and hence enjoy access to the single market.

Of course, this is something that the people who voted in favor of Brexit wouldn't prefer. The whole point of leaving the European Union would be to gain substantial extra freedoms; which in this case would not be possible.

Option 2: Follow the Switzerland Model

The Swiss are members of the European Free Trade Association but not the European Economic Area. They have established free trading relations with the EU and have access to the single market through a series of bilateral agreements. This could be a more preferable approach for the Brits who voted in favor of Brexit but would require tough negotiations because if the EU goes soft on the UK, it could open the door for further exits by member states which the EU wouldn't want. 

Single Market – In or Out?
Assuming Britain does not remain in the single market, then even if the United Kingdom managed to negotiate a free trade agreement, exporters would face additional costs in selling into the European Union. These would include extra costs of clearing customs and the administrative costs of complying with the European Union’s rules of origin.
The important fact is that other countries, such as the United States, manage to export successfully to the European Union despite facing these barriers. Plus, it is very easy to forget that the remaining 50% of exports from the UK are actually to Non-EU nations in spite of additional overheads like customs clearance, duties etc.

With the single market as it stands today, the United Kingdom needs to apply European Union regulations to the whole of the economy. For example, the National Health Service must comply with the Working Time Directive and retailers are affected by the Agency Workers’ Directive from the EU. These can be dropped by the UK if they feel they are redundant or are not in alignment with their national policies. Nevertheless, the benefits of getting rid of EU regulations should not be overstated because, Britain would probably want to keep many of them anyway for ease of operation.
For Ex: To be able to trade freely with the EU, manufacturers in the UK would still have to adhere to European product standards. If the UK decides to adopt a different set of standards, then the manufacturing cos would have to  produce the same goods in one way to meet the EU standards and the others in another way. This would be an inconvenience and following the EU Standards would make lives much easier & simpler for the Brits, wouldn't it?

Brexit – Worst Case scenario

The worst case scenario for UK post Brexit would be one in which the UK fails to negotiate a free trade agreement with the EU. Such an outcome might result from the Union playing hard ball in order to discourage any other members from leaving or, alternatively, the EU may demand too high a price; such as the continued free movement of labor which the Brits may not agree.
Nevertheless, even in that pessimistic case, the losses for British trade or manufacturing industry would not be catastrophic. If it transpired, British exports to the European Union would face the latter’s common external tariff. This is sometimes called the ‘World Trade Organization option’, as the United Kingdom’s trade with Europe would be governed by the ‘Most Favored Nation’ rules.
Anyways, there are a few reasons why this worst case scenario may not be catastrophic for the UK.

Firstly, tariffs have fallen substantially as part of a world-wide trend towards reducing trade barriers. The average tariff under the Most Favored Nation tag is just 4%. For starters, a 4% extra cost doesn't sound like too much isn’t it? On top of this, the GBP has been a very strong currency and could potentially offset a good chunk of this fee if the destination currency is weaker. However, this won’t be the case for all sectors. For ex: The tariff for some of the food and dairy product categories carry a tariff ranging from 10% to up to 50%. For such manufacturers, the Brexit impact could be much higher than those who fall closer to the average tariff range.

Of course, from the other side, the UK could start imposing its own tariffs on imports from the EU. The reason I want to make this point is because many of the EU nations have sizeable experts to the UK and if the EU plays hard ball with the UK, they can try and return the favor to make things hard for everyone involved. But, at the end of the day, this escalation of trade barriers would clearly have a detrimental effect on all parties involved.
But if the European Union steadfastly stuck to its decision to raise tariffs, then it would be in the United Kingdom’s best interests to nonetheless maintain its own free trade position vis-à-vis the European Union.
Nevertheless, those countries which have a free trade agreement with the European Union generally have higher tariffs than 4%. For example, the United Kingdom would face an effective tariff to Egypt of 35%. However, Britain should be able to negotiate its own agreements with those countries. Even if not, the countries with the highest tariffs are generally small markets for the United Kingdom.

Secondly, the % of Exports from the UK that end up in the EU has been consistently coming down. Over 60% of the Goods and Services produced in the UK ended up in the EU at the beginning of the year 2000 but the number is closer to 50% now. And to put things in perspective, this reduction in % is in spite of the membership expansion of the EU with newer nations joining the fold.

As you can see, the worst case scenario wouldn't hurt the UK today as much as it would have a few decades ago.

The government may choose to use the savings from its contributions to the European Union budget to compensate the hardest hit sectors (including some manufacturing industries) and regions, at least in the short term.

Are there any Benefits in Leaving the EU?

The Proponents of the Brexit Movement have long been arguing that leaving the EU will be beneficial for the UK. Of course, they wanted to drive their agenda and hence will claim it will be beneficial but does the argument hold any merit?

Talking purely from a Trade perspective, leaving the EU could actually create long term opportunities for the UK. They can boost their trade with other countries by signing their own trade deals with non-EU countries. In the recent years, export growth for the UK has in fact come from outside the EU and if the UK can sign sweet deals with other nations, this could potentially be a game changer for the UK industries. This kind of negotiations with non-EU nations is presently not possible because trade negotiations can only be carried out for the EU as a whole. There are many countries with whom EU doesn't have a good trading deal and it could be easier for the UK to individually reach out to them and sign deals rather than EU as a whole.

To make things better for the UK, they could even reduce the tariffs on imported goods from those non-EU nations in return for favorable deals for exports. This would boost domestic production and make UK a better & more profitable manufacturing destination than the EU (If they reduce their tariff to be lower than EU figures)
Of course, on the flip side, the opponents of Brexit argue that countries would not want to negotiate trade deals with UK on its own because its contributes a very small % to the global output. But, reality is, it would definitely be easier and quicker for countries to negotiate a trade deal with the UK than it is with the EU. The Swiss have been successful in negotiating free trade agreements better than the EU has been and there is no doubt UK will be able to, considering the fact that most non-EU nations have some sort of history with the UK.
Striking new trade deals and, in turn, opening up fast growing markets outside Europe and improving the competitiveness of Britain’s manufacturing industry and goods exports would be likely to help rebalance the economy away from its current reliance on services. In 2014, Britain had a goods deficit of £121.2bn and a surplus on its services trade of £85.9bn. Hence, services play a disproportionate role in supporting Britain’s trade account. Boosting exports of goods could help in strengthening the United Kingdom’s current account and creating a well-balanced economy.

Some Last Words

The opponents of Brexit have always suggested that an exit from the EU would spell doom for the manufacturing and trade industry in the UK. As you saw just now, the figures have been exaggerated. Some statements like Trade between EU and UK may cease makes me wonder how much these guys know about the trade relationship between the UK and the EU. The UK needs the EU almost as much as the EU needs the UK and neither can afford to mess with the other and get away unscathed.
Of course, the section on Opportunities or Benefits of Brexit is all conjecture based on assumptions that the UK would be able to strike up good trading deals with the EU as well as with rest of the world.
Nevertheless, contrary to the claims of many folks both in favor of and against Brexit, it is entirely possible that the Impact of Brexit on Trade would be relatively small.
Lets see how things unravel…

Disclaimer: All views presented in this article are those of the Author and are not endorsed by anyone. While every effort has been made to ensure that the data quoted and used in this article is reliable, there is no guarantee that it is correct, and the Author accepts no liability whatsoever in respect of any errors or omissions. This article is only economic research and is not intended to constitute investment advice, nor to solicit dealing in securities or investments.

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