Future UK Trade Patterns: Fantasy & Reality

Introduction

In the debate about the UK’s membership of the EU, a number of alternative arrangements to promote and protect Britain’s trade (both with the EU countries and with the wider world) have been suggested.  Among supporters of the UK leaving the EU, a consensus has developed that Britain leaving but remaining in the Single Market (often referred to as the “Norway option”) would not suit the UK’s needs, not least because it concedes wide control over economic regulation to the EU without the UK having a vote on that regulation, and because it would involve continued free movement of people and payments into the EU budget.¹  Similarly, the notion that the UK could take the approach of Switzerland and negotiate a series of bilateral arrangements with the EU has been discredited, partly because of suggestions that the EU might be unwilling to agree to such an arrangement but also because Switzerland’s arrangements do not include privileged access to the Single Market in services.²

Increasingly it is suggested that the UK should leave the EU and trade with other countries on the basis of its membership of the World Trade Organisation (WTO).³  Alternatively, it is suggested that the UK could negotiate its own free trade agreement with the EU.  Part of the reasoning behind these approaches is the claim that UK trade with the rest of the EU is declining and that future economic growth will come from deepening ties with the emerging markets – countries such as Brazil, China, India, Nigeria, Russia and South Africa.⁴ Advocates of this approach say that these economies are growing faster than those of the eurozone and their younger populations represent the future of the global economy as Europe’s citizens age and the EU loses global trade share.

This paper does not consider all the possible alternatives to UK membership of the EU.⁵  Instead this paper looks more narrowly at the question of what it would be like for the UK to trade with the EU on the same terms as other non-member countries, such as Canada, China, South Korea and the USA.  In addition, it looks at whether increased trade with emerging markets would be an adequate substitute for any loss of trade with EU Member States.

This paper explores these issues by looking at the UK’s current trade with the EU, examining the differences between the emerging economies and those of the EU and asking what trading under WTO rules without privileged access to the Single Market would mean in practice.

UK Trade with the EU

About 45 per cent of the UK’s goods and services exports go to the EU and about 53 per cent of its goods and services imports come from the EU.  The EU’s share of UK exports has fallen from 55 per cent in 2002 to 45 per cent in 2014.⁶

Share of UK trade with EU (%): Goods and services (Quarterly data)

Source: Office for National Statistics

The change in trading patterns seen over the last 15 years is largely because the rate of growth in exports to the EU has been less than the rate of growth in exports to non-EU countries.⁷  This may in turn reflect the slow growth in eurozone countries of recent years.  It should be noted too that although the UK has historically had a deficit in its trade in goods with the EU, its balance of trade in services with the EU is positive, with a surplus each year since 2005, reaching £15.4 billion in 2014.⁸

The EU supports trade.  In addition to the earlier removal of tariffs, it has opened markets through ‘passporting’ for financial services and liberalisation (e.g. telecommunications and aviation); it helps firms comply with non-tariff barriers such as environmental and safety standards by providing a single set of rules for all 28 Member States; and common rules on cross-border selling give retail consumers confidence to shop across borders.  This means that the Single Market of 500 million consumers is the UK’s home market.  In addition, foreign direct investment into the UK often reflects investors’ desire to be located inside the Single Market – for example, US banks, Japanese car makers and naturally investors from other EU Member States.

UK businesses trade more with the EU than any other single destination.  The total effect of EU membership on our trade in goods in particular has been calculated to be 55 per cent higher because of the UK’s membership of the EU than it would be if we were not a member.⁹  In value terms, total UK trade with the EU in 2013 amounted to £364 billion so the “EU effect” generated £130 billion; in contrast, UK trade with China was worth £43 billion that year.¹⁰  These pieces of research are just two of the many reports by independent experts that show the UK gaining significantly from its easy access to the EU Single Market.

A further point is that in addition to its trade with the rest of the EU, the UK does much of its non-EU trade with countries that already have a free trade agreement (FTA) with the EU.  In total, UK trade with the EU, and with countries that have an FTA with the EU, amounted to 64 per cent of UK trade in 2014.¹¹

It is sometimes suggested that if the UK left the EU it would be able to preserve its easy access to the Single Market because it would be in the interests of the EU Member States to keep access both ways because they export so much to the UK.  In fact, while the UK buys about 10 per cent of the rest of the EU’s exports we sell nearly half of ours to the EU.  Furthermore, not all EU Member States have a trade surplus with the UK; half of the EU’s trade surplus with the UK is accounted for by two countries, Germany and the Netherlands.¹²  It is also often claimed that outside the EU the UK would continue to get privileged access to the Single Market on the same terms as a Member; this is something no other country has been granted.

Services

Almost 80 per cent of the UK’s economy is in services and they form the majority of our exports.  The UK has had a trade surplus in services with the EU every year since 2005; that surplus was £15.4 billion in 2014.¹³  The single market in services is underpinned by the Treaty’s principles of free movement of services, capital and people, as well as the right of establishment.  But regulatory support to trade in services is more advanced in some areas (e.g. financial services) than others.  Thus, in financial services the flexibility created by the passporting rule (under which a financial services business operating in one Member State can operate in all the others without a further authorisation requirement) has encouraged non-EU based financial services businesses to set up subsidiaries in the UK so that they can benefit from the passporting arrangements.  Swiss financial services businesses, which do not have easy access to the EU’s services market, have subsidiaries in London so they can trade easily with the EU.¹⁴

Outside the EU, the UK would have to rely on the far more limited World Trade Organisation rules on trade in services which would allow EU countries to impose non-tariff barriers on many UK services exports and financial services businesses would lose the benefit of passporting.[Gavin Thompson, The economic impact of EU membership on the UK, House of Commons Library Standard Note 13/6730, 17 September 2013, pp. 9-10]  A survey of financial services businesses found that 37 per cent were very or fairly likely to relocate staff in the event of the UK leaving the EU.¹⁵

Foreign direct investment

In 2014 the UK was the largest destination for foreign direct investment (FDI) in the EU in both the numbers of investment decisions and in value terms, well ahead of its nearest competitor, Germany.¹⁶  FDI matters both for the jobs it creates directly in the UK (for example, through overseas businesses having factories or offices here) but also the indirect benefits of the investment.  For example, the opening of a foreign-owned car plant in the UK to produce vehicles for the European market generates jobs and growth in other goods and services sectors, such as shipping and transport, spare part suppliers, banking and finance and travel.

Future trends

Estimating future trends in the UK’s trading relationship with the EU means making difficult assumptions about future growth and other factors that might influence it.  There are, however, some factors that can be identified now:

• the relatively poor performance of the eurozone economy of the last few years has steadied and growth of around 1.5 per cent is expected in 2016 with higher levels thereafter;¹⁷
• the shift in direction under the present Commission, which has led to substantially fewer items of legislation in the work programme, and a re-energised commitment to making the EU more competitive, is a significant re-focusing of effort around a pro-growth agenda;
• the EU’s shift in trade policy in 2006, following the stalling of the Doha trade round, from negotiating multilateral trade agreements through the World Trade Organisation to seeking bilateral free trade agreements with major trading partners, is bearing fruit; there are now over 50 such agreements covering 60 countries; furthermore, the EU is negotiating free trade agreements with the USA, India, Japan and Mercosur which would take total UK trade with the EU and its trade partners to 80 per cent;
• the services sector will continue to expand; removing existing barriers to trade in services within the EU could expand the UK economy by seven per cent.¹⁸

Taken with the commitment of the European Council to complete the Single Market in energy and in digital services, these developments suggest that the EU is likely to remain the UK’s largest trading partner for the foreseeable future.

UK Trade with Non-EU Countries including the Emerging Markets

It is sometimes suggested that EU membership inhibits the UK from exporting to non-EU countries, including emerging markets.  This is not so. For example, Germany exports about four times as much to China as the UK does.¹⁹

At present, less than ten per cent of UK exports go to the leading emerging markets (Brazil, Russia, India, China and South Africa), according to figures from the Office for National Statistics.  Any growth is likely to be gradual and susceptible to the development of these economies.

Exports of UK goods and services by destination, 2014

Source: Office for National Statistics

The Chinese economy accounted for approximately one third of global economic growth over the last seven years.²⁰ This huge growth means that the Chinese economy has almost doubled in size in the last six years.²¹  But this rapid growth slowed down in 2015 with the economy burdened by high debt levels, a surplus of unsold properties and excess manufacturing capacity.²²

Since the liberalisation of the Indian economy in 1991 that country too has seen very rapid growth.  In 2015, its growth rate was about seven per cent, just ahead of that of China.  On current predictions, India is expected to be the third largest economy in the world by 2030, pushing the UK down to seventh place.²³  The Indian economy is heavily protected from foreign competition in many sectors and progress towards opening it up has been slow.²⁴

Brazil’s economic rise has been less spectacular than that of China or India and accompanied by sharp reversals of fortune.²⁵  Now plagued by high inflation, a 60 per cent fall in the value of its currency and political scandal, Brazil is not performing at the level that would be expected of the fifth largest country in the world (in both landmass and population) and its economy is forecast to contract in 2016 for the second year running.²⁶

Russia has some of the problems that Brazil has – it is over-reliant on commodity exports and suffers from both political corruption and sharp inequalities of wealth.  The fall in the oil price in 2014/15 has hit Russia hard because of its dependence on energy exports.  In addition, it has been faced with economic sanctions by the international community since its seizure of Crimea in March 2014.  Russia’s economy contracted by around four per cent in 2015 with little or no growth predicted for 2016.²⁷  Current predictions are that the Russian economy will fall in global rankings from eleventh to twelfth place by 2030.

In the larger group of countries whose economies have experienced high levels of growth in the last decade, Mexico, Indonesia and Nigeria are all expected to be in the world’s top 20 economies by 2030.²⁸  South Africa has experienced disappointing levels of growth in recent years with GDP increasing by just 1.3 per cent in 2015 and predicted to rise at the even lower rate of 0.8 per cent in 2016.  A lack of competition in the economy has hampered growth and contributed to the country having a quarter of its workforce unemployed.²⁹

World Trade Rules

It is sometimes suggested that Britain outside the EU should either negotiate a privileged trade relationship with the remaining members of the EU (the ‘Norway’ or ‘Swiss’ options) or seek a free trade agreement similar to that negotiated between the EU and Canada.  Alternatively, the UK would rely on world trade rules to pursue its relationship with the EU and the rest of the world (the ‘World Trade Organisation’ option).

The World Trade Organisation (WTO) is a very different from the EU.  It draws up international trade treaties, lays down a commonly agreed set of basic rules for international trade and provides arbitration mechanisms to settle disputes between countries.  It developed out of the General Agreement on Tariffs & Trade.  It has been effective in several areas of policy-making and its dispute services are widely used.  The WTO agreements include the General Agreement on Trade in Services (GATS).  But while GATS sets a general framework for trade in services, it has not yet brought about the market-opening for services that the EU has begun to achieve.  Seventy-eight per cent of the UK’s economy is in services.

Relying on our WTO membership would prevent EU Member States from adopting discriminatory or protectionist policies directed against UK goods in certain ways.  But it would have to apply the EU’s Common External Tariff on UK exports.  This would mean, for example, tariffs on our food exports to the EU of anything between five and 36 per cent depending on the product, 10 per cent in the case of cars and five per cent on car components.³⁰  In addition, if the UK wanted to apply higher tariffs than the present EU common external tariff, it would have to make equivalent trade concessions under WTO rules to all those countries (outside the EU) adversely affected.

The GATS has so far led to relatively little dismantling of barriers to trade in services.  Moreover, it includes a Financial Services Annex allowing new restrictions on financial services to be introduced for prudential regulatory reasons.  UK financial services trade with the EU, post-Brexit, could be dangerously exposed to unilateral EU action.  For example, London is the largest centre in the world for trade in euros, buying and selling twice as many euros as the whole of the 19-member eurozone.³¹  The European Central Bank (ECB) has already tried to force London clearing houses to move their euro business to the eurozone; it lost that argument when the Court of Justice ruled in the UK’s favour in 2015.³²  Outside the EU the UK could not look to the GATS to protect the financial services sector against future regulatory decisions of that kind by EU regulators under WTO rules.

Being a member of the EU in terms of trade matters means that:

• UK exports to other EU countries are not subject to any form of import tax (tariffs);
• we are part of a customs union with the rest of the EU so there are no checks on our goods at the port of entry to see that they comply with national product, health or safety rules, nor are they impounded until a customs check is completed;
• British businesses have the freedom to export their goods and services across the Single Market, including sending their staff to work in other EU countries for them;
• British transport companies can carry goods across the EU;
• the UK has a seat on the rule-making bodies of the EU (the Council of Ministers and the Parliament), nominates a member of the European Commission, and is a member of the EU’s Trade Policy Committee;
• the UK can challenge the decisions of the governments of other Member States or of the EU institutions in the Court of Justice;
• EU competition policy enables the European Commission to take action over national subsidies or other actions that put our businesses at a competitive disadvantage;
• the UK can influence the EU’s legislative agenda, e.g. to further open the market for services and digital products where we have opportunities to expand our exports; and
• we benefit from the EU’s free trade agreements with third countries.

Outside the Single Market none of those things would apply.  UK goods would be subject to the EU’s Common External Tariff, would go through customs checks (delaying their delivery), there would be no right to sell services across the Single Market, to deliver them or to send employees there.  We would be entirely outside the decision-making structures of the EU and we would not benefit from the EU’s FTAs, present and future.

The UK has a deep and complex trading relationship with the other EU countries.  It is becoming less and less usual for a relationship of this kind to be managed simply through WTO membership; it is the kind of close relationship for which trading partners would usually arise under a bilateral free trade agreement.³³

Nor could trading arrangements under the WTO rules replicate the magnet that the UK’s presence within the Single Market provides for foreign direct investment into the UK.  One expert has estimated the loss of FDI at £210 billion over four years if the UK voted to leave the EU.³⁴  This figure is made up of a loss of FDI from within the EU (a 20 per cent fall) and an even larger loss from Asia and the US.³⁵  These losses would be because investors in the UK would no longer have access to the Single Market.  Overseas merchant banks locate in London because around 40 per cent of the City’s trades are with other EU countries.³⁶

It is sometimes argued that if countries like the US, exporting under WTO rules, can export successfully to the EU while outside it and without benefit of access to the Single Market, then so could the UK.  However the US clearly thinks it would benefit from a trade and investment agreement with the EU and one is now under active negotiation.  Beyond that, even without an agreement beyond the WTO rules, US export success reflects its comparative advantage in areas where the UK does not compete at the same level; for example, commodities including oil, machine tools and other manufactures, large aircraft, defence equipment and some services.

An alternative suggestion is that the UK should negotiate an agreement similar to recently reached between the EU and Canada (CETA).  But, as a former Canadian Trade Minister has made clear, if Canada did as much trade with the EU as the UK does now with the rest of the EU, they would want something far better than CETA.³⁷  The Canadian agreement does not cover all financial services, does not remove all non-tariff barriers to trade and still requires goods from Canada to be subjected to cumbersome rules of origin checks.  Furthermore, it has taken seven years for Canada to negotiate this agreement and it has still not been ratified.  CETA is awaiting approval by the European Parliament and the agreement of all 28 Member States before it can be implemented.

Future Trade Patterns

Over forty years the UK has built a close trading relationship with the other EU Member States.  This high degree of integration has led to the share of UK trade with the EU rising rapidly from 41 per cent when we joined to a peak of 59 per cent in the early 1990s.  The growth of emerging markets has led to the EU’s share falling over time but they remain only a small share of our overall trade.³⁸

The challenge for the UK – in or out of the EU – is to develop all our global trading relationships in the long-term.  In the EU we have a ready-made market of 500 million people with which we already do the largest share of our trade.  As a member of the EU the UK can expand that share by further expanding the Single Market into areas such as energy and digital services and keep a downward pressure on regulation.  It can also make the most of the opportunity to push forward EU trade agreements with third countries.  This opportunity arises because of the stalling of global multilateral trade deals in recent years and because the size of the Single Market is a powerful incentive for third countries to reach agreement with the EU.

Outside the EU and relying on WTO rules, we would lose our privileged access to the Single Market, would face tariffs on our exports to the EU and would be unlikely to achieve free trade agreements with other countries as good as those the EU has negotiated.  We could not rely on any likely expansion of our exports to the emerging markets to make up for the loss of trade with EU countries, given the uncertainties about the performance of those economies in the future.

Conclusion

The contention that the UK needs to withdraw from the EU in order to get access for our exports to emerging markets flies in the face of economic reality and negotiating experience.  It is in any case a false and unnecessary choice.  By remaining in the EU we can have the best of both worlds, retaining access and influence on our biggest markets in Europe and opening up better access to the markets of the emerging economies.