Brexit and free trade fallacies Part Two

The British government is displaying an abject grasp of global trade politics; ironically the EU red tape the Brexiteers wish to burn is the very basis on which the ‘free trade’ they hope for rests

Matthew BishopIn the previous post, I discussed how negotiations around ‘free trade’ and the agreements that sustain it are no longer really about tariffs.  Rather they are about harmonising the rules under which globally mobile sources of investment can be captured and retained, particularly in high value-added sectors.

This fiendishly complicated cornucopia of bilateral and multilateral agreements is often referred to as a ‘spaghetti bowl’, a term coined by Jagdish Bhagwati in the mid-1990s.  That is, a web of overlapping – and sometimes conflicting – rules and regulations that determines, in the most arcane ways, how and where goods or services can be produced before moving into different markets.  The more trade we desire, the more these rules proliferate, because the fragmented and infinitely complex nature of modern production, distribution and consumption requires ever-more esoteric and finely grained forms of governance.

This sits utterly at odds with the way pro-Brexit politicians and commentators seem to think about the subject: for them, it is the slashing and burning of such regulation that will allow trade to flourish. This is, of course, a major impulse for leaving the EU.  But they are wrong, and dangerously so.

Such a problematic view stems not only from the fundamental apparent lack of comprehension that I described in the first part of this blog, but also because nostalgic conservative narratives about ‘trade’ are still rooted in eighteenth century imagery of ships taking cotton or steel to the colonies and coming back laden with spices and fabrics.  I often wonder if it is this unreconstructed worldview that explains the hubristic post-imperial delusions of grandeur that infect the proclamations of so many English ‘leave’ politicians and pundits on trade.  To quote one example: as a supposedly ‘great trading nation’, Britain could unilaterally slash all of its tariffs to zero and reap the astronomical rewards that will inevitably follow.

Even if we take these ideas on their own terms, they are deeply misguided. The liberal myth of free trade is exactly that.  The now-rich countries only ever reduced their tariffs after they had enjoyed significant growth and created highly competitive industries.  Comparatively few of Britain’s industries are today operating at the innovation frontier, particularly in the higher value-added segments of the new growth sectors.  From railways to renewable energy, Britain is overwhelmingly dependent on foreign investment and technology, and many firms are engaged in lower value-added activity.  As others at SPERI have pointed out frequently – especially Colin Hay – the UK growth model is essentially bust.

Most tariffs on goods are already at historic lows and those that remain are often in the most sensitive sectors (agriculture being the most obvious, and contentious, example).  So, were Britain to unilaterally cut them – and, presumably, any related quotas or subsidies – it is more likely that it would lead to a weakening of the economy than a boost in trade as the few key industries that rely on a degree of protection would become uncompetitive.  The government would also be throwing away some of the few cards that it can bring to the table in any future negotiations.  Given how finely poised the world trading system is – because of the tightly wound spaghetti bowl of regulations – such a rash move could also lead to retaliatory measures by EU countries and litigation from other World Trade Organisation (WTO) members.

Moreover, if Britain plumps for a ‘hard’ Brexit, it would have to renegotiate WTO schedules and quotas that were painfully constructed over decades – and are therefore rarely messed with – on just about everything, so any unilateral action that has not been properly thought through could have untold unanticipated consequences.  One wrong move, and entire sectors of the economy could be seriously undermined.

For example, Ian Dunt has shown brilliantly how just dealing with one seemingly innocuous product, lamb, is fraught with problems that could take many overworked negotiators many arduous years to resolve.  It boggles the mind to consider how overstretched a civil service that has not employed trade negotiators – let alone negotiated an agreement – for decades might be when dealing with thousands at once.  What is actually more likely, as Dunt also notes, is that we will probably not change a great deal because it will be too difficult, complicated and laborious – not to mention damaging – which rather begs the question: why bother with so much expensive and unnecessary upheaval if it is, ultimately, all just to achieve limited change?

Yet Britain’s problems run far, far deeper. This is all intrinsically challenging, but extricating such a distinctive economy from the EU is also probably more difficult and potentially destructive than it would be for almost any other country.  As The Economist put it when discussing the May government’s approach to Brexit: ‘This is not some hermit state, but one of the most globalised and internationally interdependent economies on the planet. It rises and falls on its relations with the outside’. It also has a widening balance of payments deficit and a still-growing public and private debt mountain. Any British ‘trade’ strategy therefore has to be far more concerned with ensuring continued inflows of investment capital than, say, the German or French equivalents.

This is what renders the archaic view of international trade propounded by the Brexiteers so frustrating. They are blithely gambling with the livelihoods of generations of people in a country that is considerably (and terrifyingly) more exposed to the vagaries of the global economy than any of its European partners.  Many reasons exist for this dependence, of which three are worth briefly assessing.

Firstly, the Global Value Chains (GVCs) in which Britain operates are overwhelmingly in services, which depend even less on the tariffs that feature in the vapid pronouncements by Brexiteers regarding prosecco or cheese, and even more on the kinds of deep ‘behind the border’ regulation typified by the EU single market and new generation trade agreements like TTIP.  Our key industries and ability to attract investment, particularly at the higher value-added end, are dependent on more, not less, regulation.  Anything less than full EU membership is, by definition, second-best, and a ‘hard’ Brexit does not bear thinking about.

Secondly, because Britain trades so many ‘invisibles’, these rely to a greater extent on human capital as an input than other forms of industrial production. In a country where the skills base has deteriorated, any tightening of immigration rules will deter investment, as firms will not be able to successfully operate. It is also far easier for firms to subsequently move elsewhere because the plant, which essentially consists of offices, computers and clever people, is relatively straightforward to shift.

Thirdly, the UK has a far higher penetration of foreign capital than comparable economies, with much infrastructure and plant, both public and private, owned by outside interests. This investment is also highly financialised, and its ‘national’ character is weaker than elsewhere, giving it less incentive to remain – and the state fewer levers through which to induce it to do so – when times are tough.

In sum, one of the great fallacies of our time is that firms desperately wish to slash red tape and burdensome rules. Yet for most UK firms it is the advanced, extensive regulation provided by contemporary trade agreements that actually confers on them market power by raising the barriers to entry for weaker competitors.  So, if a post-Brexit UK wishes to participate in the highest value-added segments of GVCs in the kinds of services it is currently adept at producing, then it will have to accept a significant degree of labour and capital mobility, as well as having its hands tied to some extent when it comes to permissible forms of regulation.

What this means is that, ultimately, the kind of bonfire of EU red tape that Brexiteers have long fantasised about will, if it ever comes to pass, undermine, not facilitate, the free trade that they claim to stand for. Put simply: if you get rid of the regulation, you inherently rid yourself of the right and ability to participate.

If Brexiteers do not grasp this – despite endless warnings that their fantasies are exactly that – they are arguably incompetent and unfit to be negotiating Brexit.  If they do, then they need to start displaying some intellectual honesty, explain how they intend to achieve the impossible, and assuage the fears of those of us who are petrified that they appear to be taking the country down an irresponsibly reckless path from which it will be fortunate to ever recover.