An “independent trade policy” is one of the main prizes proponents of Brexit wish to claim. The issue was barely mentioned during the referendum campaign. But both the Withdrawal Agreement and the Political Declaration state it as one of the main objectives for the UK. And opponents of both frequently point to provisions within these documents they see as impeding this objective.
But “independent trade policy” has never really been defined. The tacit understanding is that this means that the UK is able to repatriate trade policy formulation from Brussels and determine its trade policy independently of the EU’s common commercial policy. A more politically visible understanding is that independence means the ability of the UK to sign free trade agreements (FTAs) with non-EU partners, specifically those with whom the EU has not been able to negotiate preferential liberalisation.
But these ways of looking at things are not sound. For a start, the language of repatriation and focus on the common external tariff belies an incomplete view of trade policy. This is partly because in some areas , policy vis a vis external parties is largely determined at home anyway. This is notably the case with services. The profile of services liberalisation vis a vis non-EU partners differs in significant ways across EU members states. It is revealing that in FTA’s negotiated by the EU, services chapters include country-specific annexes that set out liberalisation commitments applied by each EU member state.
Secondly, the focus on whether the UK can or not sign new FTA’s approaches the question from the wrong end. The better approach is first to work out what a suitable trade policy for the UK looks like, and then to consider what this might means in terms of treaties with other parties. The danger in doing otherwise is seen in the “boo-hoorah” discourse that currently dominates UK trade policy, in which the prospects of a FTA with, say, the US versus remaining in a customs union with the EU elicit strong feelings reflecting political predilections
What are then the ingredients of a suitable trade policy, and how do notions such as repatriation and independence fit in with these?
Independence in an interdependent world
Trade has changed dramatically over the last few decades. The emergence of global value chains means that countries increasingly trade in tasks along these value chains rather than simply in different varieties of products. This means that the export performance of a country, and beyond that its growth prospects, depend on reducing trade costs between countries. This in turn enables goods and services (and increasingly, bundles of goods and services) to move between various points on these value chains.
Falling tariffs globally and technological change, especially digitisation, have contributed to falling trade costs. This has in turn cast the spotlight on the costs associated with regulation, and (to a lesser extent in industrialised countries), administrative process such as customs administration and logistics services.
As a member of the EU, the UK has taken part in significant cross-border regulatory harmonisation, on everything from food to chemicals to data. This has facilitated the emergence of cross-border value chains within the EU and has also made the UK a more attractive place for foreign investment. The absence of customs compliance requirements on intra-EU trade and the liberalisation of intra-EU logistics services complete the picture.
Where does that leave the language of “repatriation”? Regulatory harmonisation reduces trade costs, but that does not necessarily mean that all harmonisation is optimal. Whether harmonisation is optimal depends on factors like the compliance costs of regulation and also social preferences regarding risk. The challenge for the UK is that value chains will tend to adapt to standards set by the largest markets, particularly if these are stricter than others. So even if the UK might spot potential gains from tailoring regulation more closely to its own needs, it would need to consider how far that might isolate it from major markets like the EU.
If the issue is signing on to FTAs that involve regulation, and regulation differs in fundamental aspects between partners (as they do between the EU and the USA), then hard choices will need to be made. That is partly a trade question: will the UK trade off linkages to one market (e g the EU) to gain linkages in another ( e.g. the US). But it is also a question of public policy, and indeed democracy: put crudely, would UK citizens prefer a more European approach to managing risks (whether environmental, health, finance, rules on media ownership and advertising, or data) or a more American one. Negotiations between the EU and the US on a “mega-FTA” floundered largely on the back of regulatory issues.
Similar trade offs occur on matters such as customs processes and rules. The question of rules of origin has been discussed elsewhere. Multiplying FTAs is likely to mean that the UK would need to implement multiple rules of origin, increasing compliance costs for value chains spanning the UK and the-EU.
In sum, trade policy in an interdependent world will inevitably mean convergence of some sort with other partners, particularly larger ones (or groupings of these) that by virtue of their size are looking to be rule-makers. That in turn involves thinking more deeply – and more transparently- about social preferences that underpin the choice of appropriate regulation.
Micro details behind the big picture
The conventional approach to trade policy was that reform at home and in partners would boost trade. Research over the last two decades has highlighted that the story is more complicated than that.
The first point to note is that not all firms benefit equally from market opening. Firms are heterogenous. More productive firms within a particular sector are better placed to seize the opportunities offered by liberalisation, and therefore expand and become more productive, while less productive ones shrink and exit. There is thus a self-selection effect into trade. What this does is to point to the importance of measures that could stimulate productivity at the firm level. This includes labour market policy, skills policies, and policies towards innovation.
A second point is that trade relies heavily on the clustering of activities and skills. That is because these clusters create economies of scale. They also stimulate productivity, via the diffusion of knowledge and by making it easier for businesses to access the skills they need.
A new trade policy for the UK will be therefore as much about integrating various aspects of domestic policy with “conventional” trade policy as anything else. And one of the challenges that the UK faces is that its departure from the EU may have negative effects on some of the very ingredients – skills and knowledge inputs – that drive trade performance.
This is because the UK’s current position is to leave both the single market for services and single market principles on the movement of people. The former is seen as a price to be paid to achieve the latter. But as we have argued elsewhere, this is a misguided trade-off. And what is more, losing access to the single market for services will likely raise trade costs. While losing access to skills for the EU will erode the competitiveness of businesses in precisely those sectors (such as knowledge intensive services and manufacturing) that the UK sees as being sources of trade growth. The combined effects of services and skills shocks could well offset, if not outweigh, any gains from market access negotiated via free trade agreements.
Mind the gap: the political economy of trade policy is getting more complex
Historically, trade policy was seen to be challenging because while the upsides of liberalisation are bigger than its downsides, the former are more diffuse while the latter are concentrated in inefficient sectors that lobby for protection. That concentration creates political visibility. The way around this problem was through reciprocal liberalisation, which created coalitions of winners (consumers and exporters) big enough to offset protectionist constituencies.
That picture is now more complicated. Firstly, as tariffs have fallen, regulatory measures have become the focus of attention. Regulation fits much less easily into the standard bartering framework that historically worked for tariff liberalisation. Secondly, the fact that firms and workers differ in productivity and skills, and that clustering effects occur, mean the gains from trade are not evenly spread. These distributional effects explain in part the recent backlash against trade in industrialised countries, and indeed probably explains to some extent the vote for Brexit. Dealing with these issues is more complicated than simply redistributing economic gains through transfers. What those hostile to trade are seeking is greater access and participation. Again, that will require some new thinking on a wide range of matters, from skills development and regional policy.
A long way from Kansas
The idea of an independent trade is said to be one of the prizes of Brexit. But there has been precious little discussion of what this means, let alone how it would work in practice. The main lesson is that a trade policy for the UK will need to recognise both cross-border interdependencies, and the need for domestic policy action. Building a trade policy from the bottom-up is complicated by the range of issues that need to be addressed, and also an awkward political economy context. Not to mention the fact that the particular position the UK has taken as to what Brexit means – particularly in relation to services and to labour – is likely to create further obstacles to the UK’s ambitions in the trade policy sphere.