No Deal is the safest option, given the UK’s increasingly unsustainable trade relationship with the EU 

No Deal is the safest option, given the UK’s increasingly unsustainable trade relationship with the EU 

The fateful decision about whether the UK should leave the EU with or without a withdrawal agreement has to be informed by evidence comparing the UK’s past experience of trading within the EU Customs Union and Single Market, with its trade under World Trade Organisation (WTO) rules. 

The data released by the ONS in March 2019 provides the best available comparative evidence of this kind since it distinguishes UK trade in goods and services with the EU over the twenty years 1999-2018 from that with ‘non-EU’ markets. The latter are not, of course, identical with those trading under WTO rules. Just over 25% of their total value arises from trade with European Free Trade Association (EFTA) members and countries that have trade agreements with the EU, which might inflate their overall value. However, comparative analyses of Switzerland, Norway and Turkey with the UK’s WTO-rules trade partners show they do not do so. On the contrary, they fractionally lower the growth rates of the UK’s non-EU goods exports. The ONS data therefore enable us to make a fair comparison between the UK’s trade performance within the EU and with partners under WTO rules from 1999 to 2018. No better data is available.       

It provides a grim warning about the costs of continuing to trade with EU under any form of agreement that continues the existing trade relationship.

  • Despite the benefits of the Customs Union and Single Market, UK goods exports to EU markets have grown by just 0.3% per annum in real terms over the past 20 years. They cannot therefore have contributed significantly to the growth of employment in the UK. The number of EU members increased over these years of course, so the 0.3% per annum might fractionally overstate or mis-state real growth. The Compound Annual Growth Rate (CAGR) of the EU15 alone was still lower at 0.08% per annum. 
  • UK goods exports to non-EU countries, by contrast, have grown over ten times faster – by 3.2% per annum. Worth just 64% of EU exports in 1999, they overtook exports to the EU in value in 2015, and have plainly therefore contributed far more than the EU trade to the growth of employment in the UK over the past two decades.
  • Imports from the EU meanwhile have surged. Consequently, the UK’s goods trade deficit with the EU has grown from just £7.9bn in 1999 to £93.5bn in 2018. If that rate of growth were to continue for the next 20 years, its exponential trend line indicates that it would reach £246bn by 2030. By contrast, the higher value UK exports to non-EU countries produced a deficit in 2018 of £44.6bn. This is less than half the size of deficit with the EU, and almost half of that (£21 billion) is due to trade in crude oil and natural gas, not manufacturing.

This combination of virtually static exports to the EU, and surging imports from it, seems to be peculiar to the UK. Earlier analyses have shown that the growth of goods exports to the EU of almost all developed economies – including the US, Canada, Singapore, Hong Kong, Brazil, Korea, and South Africa – out-performed the UK from 1993 to 2015. Trading without an agreement, the US decisively overtook the UK as a goods exporter to the EU in 2008. Rising 1.9% faster per year, they are now worth 37% more than those of the UK. 

One may delve further into the distinctive trade relationship that the UK has established with the EU by analysing its ten most-valuable manufacturing export sectors in 2018, manufacturing being 88% of all UK goods exports. In every single sector, from motor vehicles and parts with its 14.4% share of the total, to beverages with a 2.7% share, exports to non-EU countries have outpaced exports to EU countries – by an overall average of 2.9% per annum. In only two major sectors have UK exports to EU countries grown moderately well since 1999 – aerospace and pharmaceuticals – and they happen to be the two sectors where, with zero or near-zero global tariffs, the UK gains little or no market advantage from membership of the Customs Union.

In nine sectors out of the ten there was a trade deficit in 2018 with the EU, ‘aerospace & transport’ vehicles being the sole exception, while in trade with the non-EU countries there is a deficit in only four sectors, with motor vehicles earning the largest surplus of the other six, at £16bn and pharmaceuticals the second largest at £8.3bn.

Goods deficits are offset, of course, by surpluses of services exports. In 2018 services exports to the EU totalled £117bn, and over the previous 20 years have grown at a healthy 5.1% per year. Currently, the surplus in the UK’s EU trade in services, worth £29bn, covers about a third of the UK’s EU goods deficit, but by 2030, if rates of growth of goods and services remained the same till then, it wouldn’t even cover a quarter. The UK’s EU deficit in goods would swallow the UK’s entire projected surplus in services – that of the EU plus the far more valuable non-EU surplus – and still leave the UK with an overall net deficit of £136bn. 

Her Majesty’s Treasury (HMT) and the Bank of England have warned about the costs of leaving the EU, but they have overlooked the risk of an unsustainable trade deficit – and the mother of all balance of payments crises – and its extremely unpleasant consequences for the public finances if the UK were to agree to continue its existing trade relationship with the EU for a transition period and an indeterminate period beyond. This oversight is especially surprising in the case of HMT, since Denis Healey, the Chancellor at the time of the unsustainable balance of payments crisis in 1976 which lead to a massive IMF bailout, later discovered that it was due in large part to figures provided by the Treasury being ‘grossly overstated.’ One would therefore expect them to be super-cautious on this score.

Why have these risks been overlooked, and the failure of the Single Market from the point of view of British exports or productivity remained unanalysed? Every UK government since 1973 has fondly hoped, of course, that the EEC and the EU would generate economic benefits for the UK. However, they have all preferred to assume that the UK was enjoying the economic benefits they had hoped for, and resolutely declined to measure and monitor them, apart from a small classified one-off HMT study in 2005, which only became public in 2010 because of a Freedom of Information request. 

When preparing the case for Remain prior to the 2016 referendum, HMT ‘forgot’ its own 2005 analysis, which showed UK goods exports to the EU rising by just 16% over the 30 years from 1973 to 2004. Instead, its long-term predictions, were based on the idea that ‘EU membership boosts intra-EU trade by 115% relative to a position of WTO membership’, (p.163, para A47), so that if the UK decided to Remain, the trade losses would necessarily be catastrophic, the symmetric equivalent of a 115% increase in trade ‘is a fall in trade of 53% from leaving the EU.’ 

Many of those who oppose No Deal today still rely on the dire predictions based on such assumptions. A later analysis using the same model and evidence, but focusing exclusively on UK experience rather than making inferences from the experiences of the EU as a whole, estimated the likely increase in UK goods exports by 2030 ‘in the range 20-25%’. Back in the real world, the ONS data we now have shows that UK goods exports to the EU over the past 20 years actually grew by just 5.4%. 

As a result of the reluctance of the government, and of the CBI and other trade associations, to regularly collect, analyse and report data about UK trade with the EEC/EU over the 46 years of membership, they have both been unable to recognise the distinctive characteristics – and distinctive problems – of the trading relationship that has evolved over these years. Neither governments nor trade associations have therefore ever asked critical policy questions.

Why has membership done nothing to raise UK GDP, or productivity, or exports and employment? Why has this failure remained unexamined and unnoticed for so long? Why has the UK never identified the deficiencies of most EU trade agreements for its own exporters? Why has the growth of goods exports of countries trading with the EU under WTO rules commonly exceeded that of countries trading with them under a Free Trade Agreement (FTA), and even that of members’ exports to each other? Why have UK exports grown fastest in markets where the Customs Union delivers no advantage? Why are the UK’s exports under WTO a picture of health, while those to the EU a record of failure across the board over two decades and more?

Further critical policy questions arise from the records of particular sectors which their own trade associations have singularly failed to ask. Is UK’s luxury vehicle manufacturing now moving to the EU because of competitive advantage or because of EU-compliant state subsidies? Is the pharmaceutical industry decamping to Ireland as has been claimed,  and if so, is it also because of competitive advantage, or Ireland’s low corporation tax rates? Will these moves adversely affect the UK’s non-EU exports over the long term? And looking at trade from the consumer’s perspective: what’s the likely future cost to UK’s food consumers as the EU’s grip on UK imports of food products and agriculture passes 70%, which it did last year.

Economists have years ahead of them to answer these and other questions. Unfortunately, the new UK Government, Parliament and the electorate have only weeks to decide on the key question of whether to continue the existing EU trade relationship into a transition period and beyond or to leave without an agreement.

The ONS data strongly indicate that the UK should make every effort to avoid the risks of doing so, and that it should try to bring two and more decades of disappointing failure to an end. If the EU decides that they cannot agree to a joint application to the WTO for a temporary tariff standstill while negotiating a new trade agreement, the Article XXIV option, then leaving without a deal must be the best option. 

Those who argue against it continue to rely on HMT’s fantastical long-term predictions or, when they offer any evidence at all, on various sequels prepared before the scheduled meaningful vote in late 2018. These adopted, without explanation or apology, a new economic model, but made similar far-fetched assumptions and estimates to make sure trading under WTO rules always appeared to be the worst option. 

Some of these are worth mentioning since they are the basis of the only ‘evidence’ that the current campaign against no deal can muster. In the EU Exit Analysis: Cross Whitehall Briefing published in various forms between January and July 2018, it was estimated that UK goods trading with the EU under WTO rules would immediately incur tariff, non-tariff and customs charges with a total tariff equivalent value (TTE) of 30%, which accounted for nearly 90% of the GDP loss of 7.7% that no deal would supposedly incur. Patrick Minford pointed out that, since the UK’s product standards are identical to those of the EU, it is difficult to see why the TTE would be higher than the 20% TTE value known to be incurred by such barriers on Japanese and American goods exports to the EU. Once this and other more realistic estimates were incorporated into the analysis, the predicted GDP loss after No Deal simply disappears. 

In the EU Exit Long-term Economic Analysis of November 2018, it was estimated (p.49, Figure 4.1) that the total value of FTAs that the UK might conclude with the US, Australia, Canada, India, China and 12 other non-members would be a 0.2% gain to UK GDP, even though, as Andrew Lilico observed, the European Commission had previously estimated that the gain to EU GDP of concluding agreements with a similar set of countries would be 1.9%. Negotiating exclusively in its own interest, the UK would apparently only realise about one tenth of the value that it might gain from EU template agreements, even though research shows that the vast majority of past EU FTAs have not helped UK exports in the least. This analysis also decided that the UK could not expect any GDP gain at all from any other trade policy or from taking back control of immigration or regulation. 

By such tendentious estimates and assumptions, the Treasury constructed its case against a no-deal exit which appears to have convinced many MPs, though some no doubt have found arguing against a no-deal exit a politically convenient cover of arguing for Remain. Our analysis, by contrast, rests firmly on how UK trade has actually performed inside and outside the Customs Union over the past 20–40 years, and the findings are virtually uniform across all major manufacturing sectors. They demonstrate beyond any doubt that a no-deal exit is now the best option.

Leaving with no trade deal would provide an opportunity – and the strongest possible incentive – for the new Government to devise and implement trade and fiscal policies that build on the UK’s remarkable success when trading under WTO rules. It would also encourage policy-makers to understand and address the UK’s chronic failure in EU goods markets before resuming EU trade negotiations. And it would provide an opportunity to re-negotiate trade agreements with other countries that have been designed to serve the common interests of EU member countries which the UK plainly has not shared. Above all, it would require policy-makers to discover exactly where UK’s comparative advantage in trade lies and to tailor future UK trade agreements to build on demonstrated success.

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