7 December 2017

This government doesn’t understand Brexit’s trade-offs


If Britain is to make the best of Brexit, its future trade strategy is of utmost importance. So it is alarming that ministers are relying on the advice of someone who, as Martin Wolf points out in the Financial Times, engages in magical thinking on trade. Shanker Singham has responded to Mr Wolf on CapX, arguing that “a narrow-minded Brexit is doomed to fail”. But really it is the sort of Brexit Mr Singham pushes that would end in disaster. Whatever political choices the government ultimately makes, it ought to do so on the basis of a clear-eyed, informed analysis of the economic trade-offs involved. Our economic future – and the Conservatives’ political fate – are at stake.

Contrary to what International Trade Secretary Liam Fox claims, we will not be entering a “post-geography trading world” any time soon. Countries tend to trade much more with their neighbours, especially when they are large and rich. America’s top trading partner is Canada; Britain exports 50 per cent more to Ireland than to China. So, for the foreseeable future, the UK’s largest trading partner will be the economic superpower on its doorstep, the European Union. That’s why a post-Brexit trade deal is so crucial.

Since the EU single market accounts for nearly half of UK trade and offers incomparably better access to the services exports in which the UK specialises than any other trade pact around the world, there is a powerful economic logic to remaining as integrated with the EU as possible. Joining Norway in the European Economic Area (EEA) would fulfil the referendum mandate to leave the EU. It would retain the benefits of the single market, not least in services. And it would still allow the UK scope to strike other trade deals; through the European Free Trade Association (EFTA), Norway has 27.

For political reasons – the economically harmful desire to control EU migration and the wish to “take back control” of EU regulation – the government seems more likely to seek a free-trade agreement along the lines of the EU’s recent deal with Canada. That is a legitimate choice, but it has unavoidable consequences.

While Prime Minister Theresa May still hopes for a “deep and special partnership”, the EU is not going to offer the UK better access to its services markets, notably financial ones, than it does Canada. Regulatory divergence has a cost. As the government’s recent capitulation to the EU’s exit-deal demands has highlighted, the UK has very little leverage; it must accept a deal more or less on the EU’s terms or none at all.

Even if the EU were minded to cut the UK a sweetheart deal, its agreement with Canada stipulates that any concessions on services would need to be offered to Canada too. That isn’t going to happen; the Canadian deal, which was almost scuppered by the regional parliament of Wallonia, was scarcely ratified as it is.

The trade-off, then, is stark: if the UK wants its regulations and standards to diverge from those of the EU, it will inevitably suffer a big loss of exports, especially in services, to its main trading partner. To have any hope of offsetting those losses, the benefits from deregulation and new trade deals with the rest of the world need to be very large indeed.

There is much to be said for global free trade. In an ideal world, all countries would open their markets unilaterally and recognise each other’s broadly comparable standards on everything from food safety to data privacy. At the very least, governments ought to harness the lobbying power of exporters to overcome the protectionist interests of companies that compete with imports. They should also agree rules to govern international trade, ensure domestic standards hamper trade as little as possible and establish a mechanism for settling disputes.

The good news is that we have such a multilateral trading system – the World Trade Organisation, where I once worked as special adviser to its director-general. The bad news is that the WTO hasn’t concluded a big trade deal for two decades, scarcely covers services and its dispute-settlement body is being sabotaged by the Trump administration. Worse, President Trump has threatened to pull the US out of the WTO. It is bonkers to think that the UK – which accounts for 3 per cent of the world economy – can shift this geopolitical context by banging the drum for global free trade.

It is also a fantasy that Britain could swap its membership of the EU for that of another plurilateral trading arrangement, such as the North American Free Trade Agreement (NAFTA) or the Trans-Pacific Partnership (TPP). As their names suggest, that would be a geographical stretch. Besides, Trump has already pulled the US out of the TPP, is renegotiating NAFTA in a way that would gut its benefits to Canada and Mexico and is threatening to withdraw from it too.

Realistically, then, Britain’s focus will be on bilateral trade deals. The top priority is to try to replicate the agreements with 66 countries that the EU has negotiated on the UK’s behalf, which to its credit the Department for International Trade is trying to do. The government can then try to strike deals with countries with which the EU does not have an agreement.

Unfortunately, the UK has no experience of negotiating trade agreements and very little leverage, because other countries know that the government is desperate to strike deals.

While replicating the EU’s existing agreements might seem straightforward, it isn’t. Since the UK market is only a seventh of the existing EU’s, access to its market is less appealing to foreign exporters, so governments are reluctant to offer the UK the same terms as they did the EU. Indeed, given the UK’s inexperience and desperation, many are tempted to see what they can get away with – as is also happening at the WTO as the UK tries to agree its own schedule of commitments.

Another big issue is rules of origin. Take the EU’s deal with South Korea. It stipulates that for a car made in, say, Sunderland to count as originating in the EU and thus be sold in the South Korean market duty-free, at least 55 per cent of the value of the inputs used to make it need to come from the EU or South Korea. But if you simply copy and paste the agreements replacing “EU” with “UK”, that car made in Sunderland could only be sold freely in the South Korean market if most of its parts and components were sourced in the UK, not the entire EU.

Last but not least, there are the countries with which the EU does not have a trade deal. Here, the government’s strategy, insofar as it has one, is scarily simplistic. It focuses on size, speed and symbolism – America first! – and ignores substance and sequencing.

Yet negotiating with the biggest and most difficult countries first is wrong-headed. At the best of times, the US is the toughest of trade negotiators, even with close allies. Its one-sided deal with Australia, negotiated in 2003-04 in the midst of the Iraq War in which Australian troops were fighting alongside American ones, gave US firms preferential access to Australian markets and offered little in return.

So it’s delusional to think that a protectionist President Trump whose mantra is America First is going to cut UK-based firms a special deal. The Bombardier case underlines that point. Since the US wasn’t willing to discuss financial services during its trade negotiations with the EU, it certainly won’t do so with the UK alone. And if the price of a trade deal with the US is accepting American standards on chlorinated chicken and much else, that may not just be unpalatable to British consumers, it would also hamper trade with the EU, as Sam Lowe has pointed out in a piece for OPEN, the think-tank that I founded.

So my advice is simple: don’t try to run before you can walk. If a country tries to negotiate its bilateral deals in the wrong order, it may quickly find itself without the leverage needed to open up bigger markets and forced to make bigger concessions than it would otherwise need to, as my OPEN co-founder Hosuk Lee-Makiyama, a former trade negotiator, points out. Sequencing is particularly important for the UK because its negotiating resources are scarce and on a learning curve.

The UK should therefore start small and then move on to bigger fish. It needs to decide what sectors to prioritise; pharma or farmers – which matters more? And it needs to move quickly to develop its own template trade agreement with a like-minded and experienced negotiating partner across all chapters of a modern trade deal.

New Zealand springs to mind; its free-trade deals are exemplary and a deal with the Kiwis would then be a blueprint for bigger future deals. The UK could then build outwards: to Australia and then Association of Southeast Asian Nations (ASEAN) countries, for instance, steadily building up confidence and negotiation leverage. The US should come much later, when President Trump is hopefully out of office.

I won’t pretend to think that Brexit is a good idea. Nationalism leaves me cold. But if we’re going to make the best of it, the government needs to listen to sound advice on trade. We haven’t had enough of experts.

Philippe Legrain is a senior visiting fellow at the London School of Economics’ European Institute and the founder of OPEN, an international think-tank on openness issues