Saturday, 5 March 2016

Are EU ready for the Referendum? Part 1: Trade

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= post Econ exam celebration
I will be sitting my ECON4/A2 Macroeconomics paper on June 23rd 2016– which will also be the day when I and millions of others will be voting in the referendum on the European Union (EU). There are many issues to cover and so this will be the first blog in a series. I intend to look at it impartially and desist from any scaremongering! I shall evaluate important points before reaching a decision in my concluding blog post in a style not dissimilar to an essay question.
Forefront on many economist’s minds, thus also an important area for me, is the issue of trade. After all, isn’t it money which makes the world go round? According to The Economist, 47.2% of all exported British goods go to the EU; this is proof of the extent to which Britain is involved in the single largest free market area in the world. Exports from the UK grew on average by 3.6% a year from 1999 to 2015 yet exports from the UK to non-EU countries grew on average by 6.5% annually in the same period; a much bigger increase. This helps back one of the arguments of ‘Brexit’ campaigners; if we left the EU, Britain could then enter into trade agreements with non-EU countries.

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Yet this matter is not so simple and there are assumptions being made. The current business expectations are not being considered, and exports & imports are affected by this. I am thinking of this current period of 'smaller growth' being experienced in China & the continuing problems in the Eurozone. If firms and consumers have negative expectations, they will reduce consumption and investment. Therefore such export growth may not be sustained. Furthermore, we cannot discount the fact that the EU remains our single largest trading partner. Leaving the union could result in tariffs being imposed which could decrease overall competitiveness of British goods and therefore also affect our deals with non-EU countries.

Moreover, it is being assumed that other countries will easily enter into trade agreements with Great Britain. Negotiations could be long and uncertain, with countries such as South Korea rumoured to be quite “tough negotiators”. Finally, countries may prefer to enter into negotiations with a supranational institution such as the EU, since they enter into an instant agreement with 28 member states. Great Britain, however, is just one country. Nevertheless, Britain would still benefit from membership of the World Trade Organisation (WTO) even if it were to leave the EU. According to the IMF Direction of Trade Statistics (quoted in The Economist above), the value of exports to the EU from Britain is $210 billion whilst EU exports to Britain had a value of $357 billion. One could argue that the EU as a whole benefits more from Britain’s membership than the other way around.

No country has ever left the EU and therefore we cannot be sure of what the consequences of a ‘Brexit’ would be. However there are existing ‘non-EU European’ economic models that Britain could potentially follow. Norway is a member of the European Economic Area which allows it to be part of the EU single market. It has some freedoms i.e. it can follow its own rules on agriculture, justice, home affairs and fisheries. There is the Swiss model where Switzerland makes sector by sector trade agreements with the rest of the EU and Turkey has entered into a customs union with the EU which means that it can freely import and export manufactured goods with the EU.

There are points which need to be further addressed. These models are in place but it is quite unlikely that following a ‘Brexit’, we would be allowed a ‘pick and mix’ approach regarding EU trade agreements. This is because the EU could want to show that they are not ‘soft’ on those who leave, and would probably use the British example to show member states the possible consequences of leaving. Furthermore, we currently have a say in the regulations that we follow. On the other hand both Norway and Switzerland have no voice and cannot contest the rules they must follow. Yet Britain’s small businesses, which do little or no trade with the EU, are burdened with unnecessary costs linked to EU regulations. Leaving the EU could potentially result in the rise and success of small business entrepreneurship, ‘kick-starting’ domestic economic growth.

That brings us to the question - why is international trade so important? A reason for this could be found in David Ricardo’s theory of comparative advantage. Comparative advantage exists when the marginal cost of production of a particular good/service is lower in one country than another. The UK has comparative advantage in areas such as: pharmaceuticals, insurance, medical technology and computer services. What does this actually mean?

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- British economist David Ricardo 

If a country enjoys a comparative advantage in a particular sector, i.e. Britain and financial services, it is able to produce these goods and services at a lower opportunity cost than elsewhere. This is because they are able to make best use of their abundant factor inputs; in Britain there are high levels of both physical and human capital. We specialise in the production of these goods and export them, earning money for the country. This money could then be spent on imports. This is especially important to Britain, as British people have a high propensity to spend on imports.

I hope this has provided a good starting point upon which to build your opinions on trade and the EU referendum. If you’re interested in further reading, I’d recommend looking at the articles in the links below. I also thank Miss Prabhleen Kaur Chhabra for permitting me to use some of the information gathered as part of her research into Britain's trade with the EU.