Stephen Says...

Stephen Says...

This is my blog

sharing occasional thoughts about things that interest me

The Economic Consequences of Brexit

the state of the countryPosted by Stephen Thu, August 31, 2017 15:39:49

Back in the day, before Britain joined the EEC, the world economy meant an outside world into which only superfluous production (production that by accident emerged without a predetermined destination) was consigned for residual disposal. As a corollary to this, no country relied upon ad hoc purchases from the outside world as the basis for their own local supply.

Nowadays all that is changed. The global market place has lost its residuary character. Prices are no longer the outcome of unrepresentative disposal sales. Instead prices are determined by the interaction of global effective demand and global availability of supply. Mobile personal information technology makes buyers and sellers well aware of market conditions, thus meaning that prices are struck across the world that properly represent commercial reality.

In this situation, when a country imposes tariffs (putting taxes on imports) it raises the price that its residents have to pay in order to get foreign produce (by the amount of the tariff). And this also allows its domestic producers to charge a higher price for their own output which is sold to local residents. But of course these domestic producers will still only get the world price for anything they sell abroad.

When a group of countries agree to operate a customs union they all agree to charge the same tariffs on produce brought into the union from outside, whilst allowing tariff-free movement of goods and services between the member countries themselves. This means that the producers in all the member countries share the benefit of the same higher prices they get than are being charged in the world outside. Likewise the residents of all the member countries are taxed equally for buying stuff from countries outside the customs union as well as paying higher prices for local products.

When a group of countries agree to operate as a single market they agree to impose the same rules and regulations regarding product quality standards and business operating procedures. By doing this they facilitate trans-border commercial activity and hope to capture benefits from economies of scale.

The European Union is both a customs union and a single market. Brexit might mean the UK being automatically outside not only the political organisation of the EU but also outside both these economic institutions (the customs union and the single market). There has been a lot of discussion about how much this might or might not matter.

The most important thing to bear in mind when considering the consequences of Britain adopting an independent (post-EU) international trading policy is that it will be based on the rules of the World Trade Organisation and that these rules forbid discrimination. This means that the EU cannot impose tariffs on British exports of goods and services that are more onerous than those applied to trade from any other country outside the EU. So there can be no ‘punishment’ for Britain in these terms.

WTO data indicate that the EU average tariff is 5%. And the simplest trade policy for the UK to adopt, when it leaves, would be to apply the same tariffs as it does already as a member of the EU. This would simply result in Britain treating EU countries the same as it already treats all other (non-EU) countries, and being treated in turn by the EU countries the same as they treat other non-member states.

The result for UK producers would be to leave existing domestic prices unchanged because they would still be defended by the same tariffs as at present. But prices received for UK exports to the EU would now fall to the same levels as apply across the ‘outside world’ (i.e. ‘world prices’, by implication on average about 5% lower). Similarly, EU exporters would now only be able to get the ‘outside world’ price for their sales to the UK (and of course the UK government will now receive the proceeds of the UK’s own 5% tariff on those imports).

A rough estimate of the implications for the British economy can be arrived at using data from recent years. In 2014 the value of total exports was £511,654m. At the same time the value of total output was £3,889,971m, meaning that exports represented 13% of the value of UK total economic output. According to the House of Commons Library (Briefing Paper Number 7851, 4 July 2017) UK exports are currently split 44% to the EU and 56% elsewhere. So the estimated value for UK exports to the EU therefore comes to £225,128m (44% of total exports and about 6% of UK total output). Now if, after Brexit, because the UK will be outside the customs union, UK exporters receive 5% less for their goods and services (their sales to EU countries no longer taking place inside the protection of the 5% EU tariff) that will mean a reduction in revenue of £11,256m. The total profits of UK producers in 2014 amounted to £700,923m. This means that if all the drop in revenue was taken away from profits it would mean a fall in profits of 1.6%. In fact, because only half the economic activity that takes place in the UK is potentially exportable, this probably means that the reduced profits will apply to only half of all the economic operators in the country and so amount to the equivalent of a 3% reduction for those companies engaged in these activities. The consequential fall in share values for such companies would also be 3%. Given that the FTSE100 is at record levels at the moment this seems a very small ‘price to pay’ for what the chatterati are calling ‘a hard Brexit’. Any preferential trade deal between Britain and the EU would be expected to soften this impact.

Of course, lest there be any doubt, I’m well aware that averages conceal degrees of variation: not all tariffs charged by the EU are 5%. As the House of Commons Library says: “The trade-weighted average EU tariff for non-agricultural products was 2.3% in 2014 and 8.5% for agricultural products”. So because existing EU tariffs on agricultural products are often more than 5%, farmland prices might fall by more than the 3% I’ve mentioned for exporters’ share prices. On the other hand anything currently EU-tariff-free might be completely unaffected. But the main thrust of my point is still germane: leaving the EU (single market and customs union) is not the economic big deal that it’s been hyped as.

In fact I rather strongly suspect that Brexit and its much exaggerated supposed economic consequences will be used to cloak a wide range of measures introduced to benefit interest groups not excluding the organs of government themselves (and including established political parties).