20 April 2016

Great Britain’s role in the world


There has been much handwringing in the run up to the Brexit referendum in June about Britain’s role in Europe. The larger and more important question is what is Britain’s role in the world. Understanding that will give us a better indication of the most appropriate landing zone for Britain in Europe. The recently released report on the costs of Brexit released by the Treasury assumes that an EU exit means a closing of the UK economy to open trade and competition. While this is a potential outcome, it is not necessarily true. The Report also assumes that structural reform in Europe is not only possible but happening now. Again, this does not appear to be borne out by the facts.

As Treasury notes, access to the European single market is very important to be sure. The European area particularly in its expanded context is a large market for Britain’s exporters of goods and services. The importance of access to this market should not be underestimated.

However, Britain’s role in the world is much more significant than simply its relationship with Europe. Britain has a role in the wider world, both with its traditional trading partners such as the US, its Commonwealth relationships and many other strong historic ties that are being neglected in the relentless focus on Europe. It is this analysis that is missing from Treasury’s Report. It is merely assumed that Britain would not have better trade agreements status than the EU does today with other non-EU countries. Again this is not necessarily the case.

There are also a number of disturbing trends in the world where Britain because of its historic role can play a significant part in finding solutions. For example, Britain’s long and deeply embedded embrace of free trade, free markets and competition should act as a bulwark against the forces of protectionism that are taking hold around the world, including in the EU itself. The foreign investment relationship between Britain and the US and the special relationship between the two countries and more critically its peoples means that Britain can play a role in ensuring a liberal, transatlantic zone that is not necessarily geographically contiguous.

Britain and NATO

Britain’s role in Europe is without question an important one, but is much deeper than simply its role within the European Union. The key relationship that Britain has is within NATO. It is NATO, more than the European Union that has ensured peace and security in Europe. Britain should continue to play an important role in NATO, and increased financial support for it from Britain ought to counterbalance the current seventy-five per cent or so of NATO costs that are borne by the US.

Britain and the European Single Market

In order to understand Britain’s relationship with the European single market, one must first understand how these individual economies interact with the rest of the world. Below is a graph which shows the global import/export breakdown of trade in goods and services for France, Germany, and the UK from 2014.

singham chart

It is most important to note the discrepancy which exists between these three key European economies in terms of the relative importance of trade in goods vs. services. While the total trade in services in smaller than the trade in goods in all three of these countries, the relative importance of trade in services (both imports and exports) is far greater in Britain. Manufacturing and production accounted for only 14% of GDP in 2013, while services accounted for 79% of GDP in the same year. As can be seen in these figures, the trade priorities of the UK are necessarily different from its partners in the EU whose economies remain more dependent upon manufacturing and production. This lends support to the idea that Britain would be better off conducting more of its own trade negotiations, and to the idea (discussed below) that Britain would prosper in a separate Prosperity Zone.

Continued tariff free access to the single market is very important for Britain and this should not be imperilled in any way. It should also be recognized that the financial services sector is one of Britain’s key areas of comparative advantage and will make it very important for the EU to negotiate a single market agreement with the UK in the event of Brexit.Without the City of London, this dynamic would be very different.

Britain in a Wider Prosperity Zone?

Regardless of Brexit, Britain could play an important role in a wider Prosperity Zone, an idea originally floated by Governor Mitt Romney in the 2008 US Republican primary. Such a Prosperity Zone could include a coalition of the willing group of countries that are widely aligned around the core principles of open trade, competitive markets and property rights protection. This Zone could consist of a knitting together of some existing and proposed trade agreements, such as existing US FTAs, NAFTA, US-Australia, US-Singapore, US-Korea, with UK accession. An example of an early win would be a TTIP style agreement which would be very difficult for the US and EU to agree because of radically different approaches to regulatory policy. The US has a standard setting and regulatory approach that is much more based on voluntary exchange and private sector led, whereas the EU is much more top down in its approach (as well as including the Precautionary Principle – something that the US private sector would never countenance). Britain, on the other hand might be less encumbered by these differences and be able to negotiate such an agreement comparatively quickly. Similarly, Britain is not encumbered by as many defensive interests in agriculture and some other areas as some member states that make it more difficult for the EU to negotiate.

Such a zone would enable its members to push deeper into the areas that impede free movement of goods, services and people such as internal market distortions. The Legatum Institute’s work on distortions suggests that many of these countries have fewer distortions and are generally more aligned around open trade, competition and property rights protection in any event. Such a Zone could become a demonstration model and if successful might actually spur rather than slow progress in multilateral institutions such as the WTO. Assuming that the Zone consists of the UK, US, Australia, New Zealand, Singapore, and Switzerland, and that the zone leads to a 20% reduction of economic distortions in their legal, economic and regulatory environments across the dimensions of open trade, competition and property rights protection, then this would represent an injection of $8 trillion into the global economy, an injection of twelve percent of total global GDP. While this will be undoubtedly good for the countries in the Zone, even those countries that are not in the zone and do not make any changes at all benefit as a result of the economic engine that the Zone represents. Of the overall economic output gain, we estimate that $900 billion will spill out of the zone into the rest of the world, creating as many as 6 million jobs and pulling 14 million people from poverty of less than $2.50 per day simply by the existence of the Zone. If the countries outside the Zone opted to join it, and that led to a reduction of their distortions, this would undoubtedly have a much greater impact and lead to far more jobs and people lifted out of poverty in the world.

European External Negotiations with Other Countries

The EU’s negotiations with other countries such as India and Korea are very important for the UK. There are some negotiations where the UK needs the larger trading zone of the EU in order to present an attractive opportunity for other countries. There are other negotiations where the particular trading partner needs access to the UK market, and where the EU’s defensive interests especially in agriculture and in regulatory policy will actually make it more difficult to negotiate trade deals. In these cases, the UK is more likely to reach an agreement than the EU. One example of this would be a TTIP style negotiation where it would be very difficult to see a US-EU agreement on regulatory policy. One can envisage an alternative landing zone where the UK is able to take part in some negotiations by itself and opt in or out of EU negotiations at their commencement. Other countries with whom the EU is negotiating will always see the UK as a positive partner because it represents an important market and because it does not have the range of defensive measures that other EU member states do. The UK also needs to ensure that any negotiation maximizes its interest, particularly in those areas that are key to its future – financial, legal and professional services being an example. These are not areas of significant interest for other member states which tend to be more focused on manufacturing and defending their agricultural policies.

Such a geometry for the UK would not be without precedent. Hong Kong is a WTO member, but is also part of China. Perhaps a case for one Europe, two systems as is the case for Hong Kong’s relationship with China without the commitment to ever closer union.

Britain and the Need for Structural Reform in Europe

Regardless of whether Britain remains in the EU or not, there is a pressing need for structural reform in Europe. One question is whether that is more likely to occur with Britain part of the EU, or whether structural reform in the EU is a lost cause regardless of Britain’s position. When the US was in the midst of negotiating a Free Trade Area of the Americas, then UK Ambassador to the US, Sir John Kerr noted that the special relationship required the US to ensure that its immediate environment was characterized by open trade, competition and property rights protection, and the UK’s role was to do the same in its environment. Back then in the mid-1990s, it seemed that the forces of protectionism and economic distortion had been pushed back. Few would have predicted the circumstances we find ourselves in now. It is thus even more important that the UK and the US play the roles that Sir John Kerr outlined some twenty years ago. The question for the UK’s relationship with the EU is whether it is too late to do so now. It is also worth pointing out that structural reform in the UK is also needed. More competition in many sectors, and a more flexible labour market are important. In some respects, Britain has retreated from this in recent years. The increase in the minimum wage, and the imposition of limits on working hours (albeit 48 rather than 35 hours) suggest that labour market restrictions have been on the rise. Much can be determined about a countries’ embrace of protectionism by their response to crisis. When the going is good, it is easier to be pro free markets and free trade. The recent collapse of the UK steel industry provoked a highly regressive response with government ministers openly talking about nationalization, and even when that bugbear was beaten back, to consider discrimination in government procurement in favour of locally produced steel. This is distressingly similar to the US’ Buy America Act after the fiscal crisis. Such local content regulations are on the rise everywhere, and there will be an increased policy premium on standing up to such pressures.

EU Accession

As we write many countries are seeking to accede to the EU. Britain’s decision might have an impact on the landing zone that these countries touch down in. One of the big problems that newly acceded countries have had is that as soon as they acceded to the EU, they received the structural adjustment assistance from the EU, but immediately face unfair competition from subsidized agriculture which tends to wipe out their own agricultural sectors, and competition from German Mittelstand state subsidized companies that have in addition the huge advantage of the EURO to create a captive market. If accession countries could be guaranteed a better landing zone that enabled them to build up their own industrial capacity on a level playing field, that would certainly be in their long term interests.

Britain’s Landing Zone in Europe

Precisely what landing zone Britain needs in Europe in order to achieve these goals, is a subject for discussion and negotiation on which reasonable people can disagree. The fact that Britain already is in a different landing zone however is not up for debate. David Cameron’s negotiations with Brussels and the dawning realization that Britain has never, and will never commit to political union, which is the sole driver for the single currency means that regardless of what happens in the Brexit referendum, Britain is on a path to an alternative landing zone. Guiding that landing – and making sure that the plane is grounded safely will be the task of the pilots after the referendum itself.

Shanker Singham is Director of Economic Policy and Prosperity Studies at the Legatum Institute, and the Chairman and CEO of Competere.