Monday, October 17, 2016

Six Reasons To Be Wary Of Brexit Optimism

By Victoria Bateman
The Bloomberg View
October 17, 2016

Many of the prominent Conservative Party politicians who led the "leave" campaign in Britain's referendum on the European Union did so with good intentions. They argued that leaving the EU would allow Britain to escape growth-shackling European policies, freeing markets both internally and externally.

It is on this basis that "Economists for Brexit” predicted a Brexit boost of up to 4 percent of U.K. gross domestic product. It's a comforting thought for those of us who would like to see a positive outcome to Britain's withdrawal from Europe. But there are six good reasons to be skeptical of this kind of free-market boast from Brexiters.

First, and beginning with internal markets, removing all the supposed EU red tape and regulations is of questionable benefit. Britain is already a top performer when it comes to economic freedom. According to the OECD product market regulation index, Britain has a score of 1.08 (on a scale of zero to six where zero represents no impediments). Only the Netherlands does better.

In terms of the ease of doing business index, Britain ranks sixth out of 189 countries, one position ahead of the U.S. And while Britain will have the freedom to dismantle EU regulations after Brexit, it will also have the freedom to add more: to subsidize failing businesses and prioritize domestic firms in public procurement, neither of which should be welcomed by free-marketers and neither of which is possible under EU law. One of the most economically damaging sets of regulations in the U.K. at present -- that which restricts planning for new buildings -- does not originate in Brussels.

Second, it's unrealistic to expect Britain to walk into global markets on better terms than if it remained a member of the EU. Britain accounts for only 2.5 percent of global trade in goods and services compared with 16.3 percent for the EU. While the EU accounts for 14 percent of global imported goods and 20 percent of global imported services, the equivalent figures for the U.K. are just 2.2 percent and 2.9 percent. Britain has much less to offer foreign countries in return for them giving British firms tariff-free access to their own markets.

Third, Britain seeks to be a globalizing force at a time of rising protectionism and a slowdown in global trade growth. The pro-Brexit British member of the European Parliament, Dan Hannan, argues that given the declining share of British exports (now 44 percent) going to Europe, Britain’s future exports will be better served by growth outside of Europe, where 90 percent of future global growth is predicted to come from. But trading free access to European markets with what is hoped will be improved access to the rest of the world is wishful thinking at a time of increased protectionism outside of Europe.

Fourth, it's hard to exaggerate the difficulty the U.K. will encounter trying to negotiate eight separate bilateral trade agreements to cover the majority -- 80 percent -- of its present trade, and another 150 to cover all of its existing trade. Given that Britain’s export mix is complex and multifaceted compared with, say, Norway and Switzerland, negotiating these trade agreements will take considerable time. This matters because history shows that regaining markets after even temporary disruption can be very difficult, a phenomenon known as trade hysteresis.

Fifth, there's history. What the globalizing Brexiters seem to think is a bold new plan has, in fact, been tried before. In the first half of the twentieth century, and following an earlier period of integration, the world began to de-globalize. By the 1930s, global trade was collapsing, falling 25 percent between 1929 and 1933. In an effort to boost its own exports, Britain entered into a system of preferential trade deals with its vast global empire known as Imperial Preference. The system sought to promote trade and specialization as advocated by the classical economist David Ricardo.

However, what this system did not do was to expose British firms to countries with a similar enough production structure to its own. It is this intra-industry as opposed to inter-industry trade that is key to rich economies staying at the cutting edge.

Unsurprisingly therefore, Britain’s trade arrangements with its colonies and dominions did not prove sufficient to stop British firms falling behind their competitors. Between 1891 and 1973, Britain’s productivity deficit in industry relative to the U.S. increased to over 100 percent from 40 percent. Competition is vital for productivity growth and, as the University of Warwick economic historian Nick Crafts has shown, competitive pressures were lacking in twentieth century Britain until the 1970s, which brought membership of the European Union followed by Margaret Thatcher’s pro-market reforms. Only then did British productivity begin to recover.

Sixth, trade has benefits not only through the countries with which one directly exchanges goods, but also through the fact that domestic firms are disciplined by the market to keep up with rival producers, many of which in Britain’s case are in the EU. If British firms cannot sell to foreign consumers on the same terms as its rivals in Europe, British firms will not have the sharpening benefit of that competition. That is why bilateral trade deals with countries outside of Europe are not enough.

Optimism is positive, when not misplaced. But in an effort to free Britain to do more and better deals, the Brexiters may well have slowed it down.

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