Not just for Christmas: UK trade policy and the December election

The UK parliament has voted to convene elections for 12 December 2019. Whether this will clarify the timing and means by which the UK would leave the EU remains to be seen. What is clear is that trade policy will be, explicitly or implicitly, one of the key electoral issues, for the first time in 46 years, and with a profile arguably not seen since the Corn Law debates of the 1840s.

The main challenge for citizens and businesses alike will be to see the substance of the issues through the fog of rhetoric. Expressions such as “independent trade policy” or “customs union” are now less economic concepts and more totems used by various groups to rally voters by eliciting a “boo-hurrah” -type reaction. We look at five key principles that are useful in thinking about the shape of trade policy

What is trade policy for?

Newcomers to trade policy could be forgiven for thinking it’s all about striking trade “deals”. But trade deals are only the tip of a much larger iceberg. Trade reform is about changing relative prices and market structure. The aim is to make sure that a country puts its resources to as productive a use as possible, and, by doing that, to increase living standards. Over the last few decades, our understanding of the conditions in which trade liberalisation leads to higher living standards, and the policies required to make sure trade does not have undesirable effects, has deepened considerably (see below).

But the main point is that trade policy reforms are domestic policy reforms. They need to be designed and implemented regardless of what other parties are doing, or whether they offer anything “in return”. Indeed, removing restrictions on imports often has at least as big an effect, if not bigger, on one’s own exports than measures taken by partners.

The reason trade agreements exist, based on the principle of reciprocity (i.e. give and take), is that trade reforms are politically difficult. Inefficient producers have incentives to lobby for the continuation of protection. Because the gains of trade are more diffuse than protectionist interest, politicians tend to notice the latter more than the former. Trade deals provide a possibility for countries to create pro-liberalisation coalitions, of exporters who gain access to overseas markers and domestic consumers who benefit from cheaper imports.

So far, discussions of trade policy in the UK has been dominated by the type of agreement that the UK can conclude with partners. What is needed is an assessment from the bottom-up i.e. assessing those sectors in which the UK will have a comparative advantage over time, then deciding what sorts of reforms need to be put into place and what these might cost, and then only determining what the right configuration of agreements with trade partners is.

Trade reforms as institutional reforms

The traditional approach to trade reform through the reciprocal bartering of market access worked well when tariffs were the main game. But contemporary trade policy is much less about tariffs, which in the UK and elsewhere in the developed world are generally low, with a few notable exceptions. It is much more about reforming regulations and rules – the institutions that govern how businesses compete and how they interact with consumers.

This is especially true in services trade. Services account for 80% of UK GDP, and are the fastest growing part of  its trade.  Digitisation is also blurring the distinction between manufacturing and services, and has raised a number of sharp regulatory issues, from the treatment of data and privacy, to consumer protection, and to the ways in which market power in platform services could be addressed.

Regulatory questions remain hot topics in more traditional areas such as food and agriculture, transport, health and audio-visual services. In all cases, decisions on regulation require a careful assessment of costs and benefits. Good regulation is heavily context specific and depends on social preferences regarding risk. Proponents of a particular arrangement – for example, closer alignment with the EU or closer alignment with the US – are really taking a normative view on the future shape of regulation and social attitudes towards risk. That needs to be spelled out, and the underlying social choices, which extend to matters well beyond trade, need to be made clear.

Can we escape gravity?

Size and distance matter in international trade. This is why most economists use “gravity models” of trade to measure the various factors that affect trade between countries. Distance can be physical as well as cultural and institutional.

There is some evidence that the distance costs of services trade have fallen over time, reflecting technological progress. They are still nevertheless relevant, and highly dependent on institutional alignment on matters like data. Moreover, they remain stubbornly high for manufacturing. And that in turn has an impact on services, since services account for a significant and rising share of manufacturing value added.

One of the implications of distance costs is that it will be very difficult for the UK to compensate for the trade losses incurred by harder forms of Brexit, by signing  free trade agreements with the rest of the world (even under implausibly optimistic assumptions about their content and the speed at which the can be concluded and then implemented). So the real question will be what is an appropriate strategy that would allow the UK to benefit from its proximity to its largest trading partner and to exploit trade opportunities with the rest of the world.

Micro matters

There has been a great deal of research over the last two decades into the micro-economic foundations of trade. The key insight is that there is a form of self-selection into trade. More productive producers are better at grasping opportunities in world markets and in competing with imports at home. They tend to expand following liberalisation.  Less productive ones will contract and exit. So it is important for authorities to look at the factors that affect productivity in businesses in the first place.

One of these factors is access to skills. Such access has been one of main benefits of the UK’s integration into EU labour markets. The clustering of skills becomes self-reinforcing, as businesses and workers are attracted to locations where skills are abundant. If the UK were to exit the EU single market for labour, it would need to determine how it retains access to skills. Losing access to such skills wold act as a de facto tax on UK exports, regardless of where they go.

Spreading it around

One of the implications of the self-selection hypothesis is that the gains from trade will tend to be concentrated in regions with higher productivity businesses, while lagging regions will fall further behind. Part of the backlash against trade is explained by such widening disparities. If the UK were to embark on an ambitious liberalisation agenda, it will need to find away to make sure it is inclusive.

Inclusiveness is not simply a matter of income redistribution. One of the key insights from the yellow-vests protests in France was that citizens feel disenfranchised from the decisions that are taken on their behalf, especially on sensitive matters like regulation. A distribution of voice will therefore be at least as important as a distribution of the spoils.