Tag: Free Trade

The Simple Way to Avoid any Disruptions to the Flow of Imports to Britain after a No-Deal-Brexit

The deal negotiated by Theresa May is dead. The EU is not going to yield so there will not be a new deal. Hence, many now see a No-Deal Brexit as the most likely outcome. And it seems that much of the British political establishment and the population at large is suffering from a severe panic at the thought of the impact of such a No-Deal Brexit on the flow of imports to Britain. 

The important thing to understand is that, when it comes to the flow of British imports, the big distinction is not between Brexit with a deal and Brexit without a deal but between

    1. a deal that would keep Britain in the European customs union
      and
    2. a No-Deal Brexit or a deal that would not keep the customs union intact. 

Let us for a moment imagine that Britain had achieved a complete free-trade deal (i.e. zero tariffs) with the remaining EU. Would such a free-trade agreement avoid any disruptions to the flow of imports to Britain after its exit from the EU? The answer is “No” – if the British government did not also commit to zero tariffs on imports from the rest of the world.

Here’s why: the EU is not a free trade agreement like NAFTA; it’s a customs union, setting common external tariffs, which means that once you’re in, you’re in: once goods are unloaded at, say,  Hamburg they can be shipped on to anywhere within the customs union without further customs checks.

In the case of Britain leaving the EU with a free-trade agreement EU products could enter Britain tariff-free. But if Britain charged tariffs on products from (all or some) non-EU member countries, this would mean that EU goods entering Britain would still have to face a customs inspection in order to make sure that they were actually produced in an EU member country rather than, say, Chinese goods unloaded in Rotterdam or Hamburg and shipped across the border to bypass British tariffs. So there would be much more friction compared to today.

And frictions, not tariffs, constitute the greatest concern for British businesses relying on supplies from the EU. The risk of customs delays would make “just-in-time” production infeasible for British companies currently relying on prompt arrival of parts from Europe. They would have to maintain higher inventories, which would substantially raise costs.

Furthermore, in the short run things may turn quite ugly. After almost half a century in the customs union Britain does not have in place the infrastructure needed for the customs inspections mentioned above. Hence the fear of massive delays and of shortages.

However, there is a simple way to avoid any disruptions to the flow of imports to Britain after Brexit with or without a deal: unilateral free trade.

In this case the tariff would be the same for all imports regardless of where they come from: zero. Customs inspections would be unnecessary. Brexit – with or without a deal – would not lead to any friction regarding imports.

Anti-Corn_Law_League_MeetingA meeting of the Anti-Corn Law League in Exeter Hall in 1846

The Inexact Science of Economics – and Brexit

Some argue that economics is not a science because it is not able to prove  theories ‘beyond doubt’ the same way as the hard sciences can. Or put another way: most economic theories cannot be disproved in the same way that Popper thought scientific theories could be disproved.

Simon Wren-Lewis objects, defining economics as an inexact science, but science nevertheless. He concedes that in economics no single experiment or regression can kill a theory but points out that economists “[…] have accumulations of evidence that confirm the applicability of some theories and reject the applicability of others. Economists’ views about what models are applicable change as this evidence accumulates.”

I find the term inexact science very fitting and basically agree with Wren-Lewis’ remarks on the topic. But then he ruins it in the last paragraph of the post:

This is why economists views about the (negative – ed) long term impact of Brexit should be treated as knowledge rather than just an opinion. Here knowledge is shorthand for the accumulation of evidence consistent with plausible theory. Sometimes the theories are common sense, like making trade more difficult will reduce trade. Estimates of the size of trade reduction based on evidence are uncertain, but they are better than estimates based on wishful thinking. Empirical gravity equations consistently show that geography still matters a lot in determining how much is traded. Finally there is clear evidence that trade is positively associated with productivity growth. To say that all this has no more worth than some politicians opinion is ultimately to degrade evidence and the science which interprets it.

Not so fast. Economists indeed know that making trade with EU countries more difficult, which Brexit undoubtedly will, will have a negative effect on British incomes. However, the EU is not only a free trade area but also (and arguably more importantly) a political union, producing a large amount of legislation each year.

For example, banking regulation is basically completely defined at the EU level, with national discretion restricted to a couple of unimportant parameters and risk-weights.

That is, Brexit will also have an effect on the laws and regulations under which the UK economy is going to operate. Will this legislative effect of Brexit be positive or negative for British incomes? As I said before, nobody can know for sure.

However, EU legislation certainly has room for improvement (to put it politely) and, in general, smaller political entities tend to be governed better than larger ones. Hence, the legislative effect on British incomes may well be positive. Furthermore, the legislative effect of Brexit might not only be positive but also strong enough to more than offset the negative effect of making trade with EU countries more difficult.

In short, the net effect of Brexit on British incomes may well be positive.

The undue certainty with which many economists have made their predictions on the economic consequences of Brexit is based on ignoring its legislative effect. This effect is, of course, more difficult to measure and to predict than the effect of restrictions to free trade with EU countries. That doesn’t mean it’s not important.

Trump vs Friedman or: Democracy isn’t learning

Apparently Trump is actually preparing measures to restrict free trade.
There is universal agreement among economists that restricting free trade is harmful. Since Adam Smith economists have kept pointing out that free trade is beneficial and politicians have kept putting up trade barriers.

All the nonsense Trump is spouting on the topic of international trade has been debunked by one generation of economists after another. Here is, for example, Milton Friedman:

In other words, the system of democracy is not learning but keeps repeating the same mistakes again and again.

 

Brexit – the long run vs. the short run

There are forecasts that Brexit will precipitate a British recession or at least a significant slowdown of economic growth in the short run.

As Paul Krugman argues here and here, the assumption that the Brexit will be a major negative shock to aggregate demand does not follow from standard macroeconomic theory. Hence, according to Krugman, there is no good reason to expect a UK recession.

I agree with Paul Krugman. There is no strong reason to believe that Brexit will be a major negative shock to aggregate demand. And even if a negative shock to aggregate demand were to occur (for example, because of self-fulfilling negative expectations, i.e. firms believe there will be a recession so they reduce investment which then leads to reduced aggregate demand), monetary policy (maybe even combined with fiscal policy) could offset this negative effect by keeping nominal spending stable.

Of course, Brexit will have an effect on the British economy, namely on the long-run supply side of the economy. Krugman argues that this effect will be negative:

Brexit will almost certainly have an adverse effect on British trade; even if the UK ends up with a Norway-type agreement with the EU, the loss of guaranteed access to the EU market will affect firms’ decisions about investments, and inhibit trade flows.

This reduction in trade relative to what would otherwise happen will, in turn, make the British economy less productive and poorer than it would otherwise have been.

Ceteris paribus, i.e. given all other trade arrangements between Britain and the rest of the world and given the current regulatory framework  in the UK (which is, to a large extent, determined by the EU), Krugman is of course right.

But why would everything else stay equal?

By leaving the EU, Britain will be free to adopt a unilateral free trade policy. Many Brexiteers favour this approach and one can only hope that they will prevail.

Britain would benefit from dispensing with barriers to trade even if other countries did not do the same. It would of course be desirable if other countries also removed their barriers to trade: in this case the gains from trade would be even higher. But moving to free trade unilaterally is the optimal policy for Britain independent of whether or not trade barriers in other countries continue to exist.

Furthermore, Brexit makes it possible for Britain to embark on a new approach to, say, financial regulation. In the UK, there was virtually no government regulation of banking until 1979. Instead, the behavior of banks was subject to tight private regulation. The private regulatory framework for banking was then substituted by government regulation in the 1980s.

This approach has not been a success. Brexit gives Britain the opportunity to return to the principles that served financial markets so well before the 1980s.

Will Britain use the opportunities presented by Brexit – or will Britain’s approach to trade and regulations be more restrictive and intrusive than before?

I don’t know for sure. Nobody knows for sure.

But on the whole I am slightly optimistic. In general, smaller political entities are governed better than larger ones. And many Brexiteers have a fairly libertarian world-view.

The most important effect of Brexit may not (directly) pertain to Britain anyway but to the rest of Europe and the world. Brexit may constitute the beginning of the end of the EU, which – by imposing a large, bureaucratic, uniform governance structure on a diverse continent – is basically the opposite of competitive governance.

Let us hope that, in hindsight, Brexit indeed turns out to be the beginning of a trend towards local autonomy and governance diversity. It would be the best possible outcome.