Bracing ourselves for Brexit
There is a new ambivalence about trade in western societies. Remarkably, this unpicking of the pro-globalization orthodoxy of the post-Cold War period has come not from the world’s poor, nor from the ranks of the usual protectionist suspects, but from within the two great advocates of open trade: America and Britain. We have an American President who says ‘protection will lead to great prosperity and strength’, while Britain is turning its back on the European Union internal market it invented.
This is a difficult context in which to pursue the vision of Global Britain. It is ironic that the first step towards this involves leaving the world’s most sophisticated international trade and regulatory system.
Making a reality of the soundbite will require a new, hard-headed and evidence-based strategy for future British trade; one which reflects the realities of our markets in the world, the changing nature of trade, with its complex international supply chains and the growth of services and digital commerce, and the relative strengths of the UK economy. Brexit also makes it more important than ever for the UK to defend an international trade system in the World Trade Organization with rules ensuring non-discrimination, fair competition and enforcement. Alone, we will be less equipped to cope in a trade environment driven by the bilateral and power-based instincts of the new US administration and China, or indeed the sheer trading weight of the future EU.
The journey to our new trade relationships can only start from where we stand today. In 2015, the EU accounted for 44 per cent of UK exports and 53 per cent of UK imports. Some 13 per cent of our trade was with the 50 countries with which the EU has preferential Free Trade Agreements (FTAs), which means that almost 60 per cent of our trade will be directly affected when we leave the EU.
In the same year, the US accounted for around 16 per cent of our trade, the BRICS countries – Brazil, Russia, India, China and South Africa – around 8 per cent and the Commonwealth around 9.5 per cent. The EU provides 54 per cent of our direct inward investment, while 32 per cent comes from the US and only 1.6 per cent from the BRICS.
These ratios have changed in recent years and will change again after Brexit, but by any calculation the new trade strategy for Global Britain must start with Europe and America.
By prioritizing domestic politics over economics, the government has made achieving a strong trade outcome with the EU more difficult. None of the possible forms of Brexit could have preserved our current access and influence in the EU market. A relationship based in a Free Trade Agreement, which is the best we can now hope for, will significantly reduce both. A breakdown, or late completion of the talks without transitional arrangements, would lead to much greater economic damage.
We cannot complete trade agreements outside Europe before we have left the EU. Nor can we negotiate seriously until we and others know more about our future relationship with the EU, for example on a customs arrangement or regulatory equivalence. It is essential to grasp that our new trade agreements with the EU and with other countries cannot be seen in isolation; they will be inextricably linked, because what we agree with one will affect the options available with others.
With that proviso, given the positive political signals, a second high priority in trade policy should be the US, our close ally, where a small percentage increase in trade will deliver big economic benefits. What matters is not getting a fast deal, but rather what it contains, which needs a lot more thought. For the UK, the answer is not tariff reductions on goods, but better trade arrangements for services and investment, mutual recognition of standards, qualifications and regulation, or agreed treatment for data.
These are politically sensitive issues on both sides, as we know from the EU/US TTIP negotiation, which offers both a launch-pad and some cautionary lessons. The US will also have other objectives in our market, for example for hormone-treated beef and genetically modified foods, which the British public may baulk at. However much political goodwill there is, finding a balance of advantage will be tricky, and the UK will be the weaker party offering access to a smaller market.
Another priority will be new arrangements with the countries with which the EU has FTAs or other forms of preferential status, especially Norway, Switzerland, South Korea and Turkey. When we leave, we will lose our privileged access in these markets unless we can continue EU agreements or negotiate new deals.
Trade would not stop, but it would cost more, placing UK-based businesses at a competitive disadvantage against European competitors. The EU’s South Korea FTA, for example, eliminated 97 per cent of tariffs and broke new ground on services. In its first five years, EU exports to Korea rose by 55 per cent, with the UK benefiting more than most. Global Britain will need to stay in this agreement, or negotiate something new that is as good or better. The same is true for Canada or Switzerland.
Some have claimed that any European trade disadvantages from Brexit will rapidly be outweighed by gains in more dynamic markets such as China and India, or in Russia or Brazil. We will indeed have important new opportunities there, which we should pursue with vigour. But we need to keep this in perspective. If we lost 5 per cent of our trade with the EU, we would need a 25 per cent increase with the BRICS just to get back to square one.
Reaching the sunlit uplands could also take time. Australia took ten years to agree an FTA with China, and India took six years with ASEAN. Those who complain about red tape in the EU may also overlook the bureaucratic or political hurdles in these markets, which can include onerous customs requirements, language barriers, legal uncertainty and discriminatory tax. At present our performance in these markets is mixed. We have been losing market share in India to Germany and France. In China, Germany does four or five times more trade than the UK.
Commonwealth trade ministers met recently in London, and we should definitely seek new opportunities with them. Australia and New Zealand are keen for bilateral trade agreements, but between them account for less than 2 per cent of UK exports. Early agreements are politically desirable, but secondary in economic terms. Should they be a priority for our inevitably limited negotiating resources?
It is a little remarked fact that 32 Commonwealth countries, mainly in Africa and the Caribbean, are covered by EU foreign trade agreements or have tariff-free access to our markets. Until we negotiate new agreements with them we risk being in the odd position of having worse trading terms with these Commonwealth countries than the EU does. The UK will also no longer be able to champion their access to the EU market as we have in the past.
These are some of the opportunities, priorities and challenges for Britain’s future trade relationships. There will be other important openings in markets such as the Gulf. Whatever any of us may think about the choice to leave the EU, and the way the Government is putting it into practice, we should look forward and prepare to pursue the new opportunities with rigour and realism.
We will not succeed abroad unless we have the right attitude, policies and capacity at home. In a worsening international context, Britain should remain a positive force for sustainable growth, cooperation, tolerance and respect. Fair trade, conducted in a rules-based system, is an essential pillar of international security and prosperity. Withdrawal into nationalism and protection is the route to economic loss and insecurity.
This calls for strong political leadership. We will only rebuild confidence in open trade if people believe it serves their interest. Making this case is harder than offering simplistic answers that store up future disappointment.
Government also needs to understand the attitudes of business. Large companies will adjust to find new ways to operate in international markets. But their decisions will be driven by commercial considerations of profit and shareholder interest, not patriotism or national identity. And they cannot wait too long: they need to activate contingency plans well in advance. Smaller businesses have fewer options and may need more help to operate in international markets after Brexit.
The Government’s proposal for a new Industrial Strategy is welcome. We need to find ways to give people education, skills, opportunities and the confidence to believe that they have a stake and can compete in a high-quality, high-technology knowledge economy. This is a long-term challenge that will require consistent policies and investment. It will be achieved neither through a low-tax, low-regulation economy, nor through heavy state intervention or protection. Either of these approaches would invite damaging international retaliation.
This agenda is huge and complex. New opportunities will arise, but even focusing on the highest priorities will be an enormous task for Parliament, ministers and civil servants, which will test our system to the limit. We shall need determination, clear thinking and sufficient expertise at home and abroad to meet the challenge.
Sir Simon Fraser, Deputy Chairman, Chatham House; Adviser, Europe Programme.