Busting more myths about the free trade deals we can do around the world after Brexit

The usual anti-Brexit groups, including the LSE’s Centre for Economic Performance, the IFS with its Green Budget Citibank partner, and the King’s College economists who run the ESRC’s The UK in a Changing Europe programme, are already attacking Boris Johnson’s EU deal, saying it will bring no benefits from free trade agreements with non-EU trade partners, but that it will create damage from new barriers that will spring up on UK-EU trade. In these views they echo the Treasury’s Cross-Whitehall studies of Brexit, published when Philip Hammond was Chancellor and Theresa May was Prime Minister. These groups also attack possible future moves to deregulation, and possible restrictions on immigration.

The first point to note in reply is that none of these policies is written into the EU deal. This merely commits us to negotiate some future trade relationships with the EU in future. Essentially these debates belong to a future dialogue, not the current one on the current EU deal.

However, these arguments about future policies under Brexit are being used to attack Brexit itself and effect strengthen the case for Remain or a Brexit in Name only deal keeping us in the EU Customs Union and Single Market. They can be rebutted on two levels. First, that of policy assumptions. Second, that of models being appealed to.

Take policy assumptions. Free trade agreements with non-EU countries have the capacity to sweep away high levels of EU protection, estimated generally at around 20% on food and manufacturing. When abolition on this scale is simulated in the GTAP model now being used by the Treasury, it raises UK GDP by 4%. The mechanism by which it does so is to lower UK consumer prices and exert competitive pressure on home industries, forcing them to raise productivity. Some critics admit this but then go on to argue that it will sweep away home industry and jobs, and so is unacceptable: in effect they argue for continued protection.

But notice that the two criticisms cannot be right at the same time: if free trade produces trivial benefits, it cannot also sweep away home industries and if it sweeps away home industries, it cannot be producing trivial effects. The truth is neither criticism is correct. Free trade does have big effects and by creating strong competition it does not destroy home industries, rather it strengthens their productivity; as jobs are reduced by this productivity surge in these sectors, jobs are created in other sectors favoured by the economy’s restructuring. As always, strong demand policies will support general job creation that will keep unemployment low as this supply-side policy goes to work.

Now turn to the criticism based on the supposed barriers to spring up on the UK-EU border on leaving the Customs Union and Single Market. These are a myth of the windiest sort. The EU’s trade with non-EU countries, of whom we will become one, actually thrives. In the past few decades its growth rate has been nearly double that of the EU’s intra trade, as extensively documented by Michael Burrage in work published by Civitas. There are good reasons for this, in that this trade is protected by WTO rules that are embedded in EU law. These rules outlaw discrimination in product standards and enforce ‘seamless’ customs procedures, under which 98% of goods are pre-cleared by computer declaration and not inspected physically in port.

Exporters of course make sure their goods are in line with EU export standards, and so meet no delays or other barriers. They pay the mandated tariffs through separate payment procedures. For UK firms that currently sell into the EU, their products are already in line with EU standards, as they have been for many years. They will now switch into a new regime whereby they cross a seamless border; these crossings are repeated events and once the first has been arranged, at some small one-off cost in switching computer and other systems, the others will be costless repetitions. At the Swiss-EU border, a leading Swiss ex-customs expert has put these costs at 0.1% of trade value. Notice that under an EU free trade deal, no tariffs would be payable. So in short this great supposed new UK-EU trade barrier melts on inspection to virtually nothing.

Essentially this disposes of the two big critical arguments from policy assumptions. We can see that free trade with non-EU countries, contrary to criticism No 1, does indeed bring big gains and these will not cause job losses overall in the economy. We can also see that, contrary to criticism No 2, new border barriers between the UK and EU will under an EU-UK Free Trade Agreement be a big fat zero. When these revised assumptions are put into the models, these critical groups use nicely exemplified by the GTAP model now being used by the Treasury, instead of giving large negative effects on the economy, they produce large positives.

When one turns from trade to regulation and immigration, again the assumptions of the critics are at variance with a reasonable interpretation of intended policy. UK policy’s stated intention on regulation is to follow the advice of experts in the relevant sectors, such as cancer scientists over cancer regulation, and City experts over City regulation, to ensure regulation assists innovation and prosperity. It is hard to quarrel with such an approach; and there is much evidence that this has not been followed by the EU in setting the regulations under which we we currently labour. Finally, on immigration, the Johnson Government’s stated policy is to have a points-based system that prioritises skilled immigration and ends the taxpayer costs created by uncontrolled unskilled EU immigration. Again, it is hard to see what can be quarrelled with on this; yet, amazingly, the Treasury itself assumed among its negative assumptions that EU skilled immigration would be totally stopped.

This leaves the final questions about modelling. The critics do not in all cases use a full general equilibrium (CGE) model such as GTAP in assessing trade effects. Several, such as LSE CEP, use a mixture of a short cut CGE model of output and a host of microeconomic relationships, ‘gravity equations’, at the same time: this ‘mix and match’ approach does not ensure internal consistency in trade, output and factor markets, as for example GTAP does. This is why the Treasury , which originally followed this method, switched to using GTAP. The GTAP model can be described as a ‘weak-form gravity’ model, in that it assumes imperfect substitutability between and within all commodities; one of the key assumptions of gravity trade theory is this imperfect substitutability. Another key one, that GTAP does not have, is that trade itself raises productivity via mechanisms such as foreign direct investment that it encourages.

Hence the GTAP model itself is controversial; its very structure increases the influence of UK-EU trade relative to UK-non-EU trade. In Cardiff we have done research recently testing a smaller, more manageable CGE World Trade Model on its ability to match UK trade facts; one with gravity features and one without. We find that the one without (‘classical’) matches the facts well, the gravity one is statistically rejected.

The dominance of the classical model has implications for policy. It means that the key question is how quickly we conclude trade agreements with key wide-ranging trade partners like the US. For example, if we did a US FTA tomorrow that meant US products could be freely bought here, then we would at a stroke enjoy the equivalent gains of complete free trade, given that the US is the world’s most efficient supplier of almost all food and manufactured products.

If we were to do that, any FTA with the EU would essentially be irrelevant since it would not affect UK prices or output, dominated now by world prices. If we then traded with the EU under WTO rules, with mutual tariffs being levied, the burden of these would entirely fall on EU traders, since the prices EU exports could get in the UK would be world prices, so any UK tariffs would have to be absorbed by EU exporters; as for the prices of UK exports to the EU, they would be also set by world prices, their alternative market at home and abroad; so any EU tariffs on them would be absorbed by EU importers and still the UK exports would sell as EU prices are higher not just by these tariffs but also by the non-tariff barriers they levy on non-UK products. The implications of this calculation are that WTO status with tariffs costs the EU £13 billion a year in tariff revenue, which is also a gain to the UK Treasury. Clearly this is a material factor in the EU’s keenness on a trade deal in the future.

The above is the summary of a longer report published here by Economists for Free Trade.   

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* This article was originally published here