Its not over yet - Why a good Trade Deal with the EU is Needed

Something has been going badly wrong with UK-EU Trade. The UK-EU Trade Deficit was £66 billion in 2018. Why? It is not because the UK is failing to produce the goods and services that people want because the UK is in surplus with the world outside the EU by £ 36 billion.

What is happening is that EU companies have been purchasing UK companies and using them as shells from which they supply goods and services produced in the EU. Foreign owned UK companies accounted for 50% of all UK business turnover in 2014 of which EU owned UK companies (£686bn turnover) accounted for 25% of UK business turnover.  Much of this turnover is based on stock produced by the EU-based parent company. As an example, PSA Vauxhall is a French company that owns “Vauxhall”, the car maker and supplies 75% of the parts for cars that are badged “British Vauxhalls”. What appear to be buoyant sales for a “British” company is in fact buoyant exports by a French company and a trading deficit for the UK.

But surely trade deficits don’t matter, all the experts say so. It depends what you mean by “matter”. Here is a quote from a modern economist:

”According to our static analysis, the main welfare cost of eliminating the current account deficit is simply the loss of the free lunch, i.e. the loss of goods that we currently consume but do not pay for until later. That cost is on the order of six percent of GDP.” UNBALANCED TRADE Robert Dekle et al

The debt incurred by the trade deficit is 6% of GDP in the USA and likely to be similar here. Trade deficits don’t matter if you are prepared to get into debt. Debt is a “Free Lunch” apparently. Apart from the fact that debt is not a “free lunch” because it comes with interest payments and must eventually be repaid, the trade deficit also has two other major adverse effects. Firstly a large deficit is a sign that foreign production is dominating whole areas of the production of goods and services and secondly it can lead to Austerity. The removal of production capability is bad news for the future of any economy and Austerity is not wanted by anyone.

Of course, if the trade balance were to show a surplus the debt could be repaid but how do we return the trade balance to surplus? To return to a Balance of Trade of zero rather than a deficit it is important to understand why we are in deficit. The key indicator is that the deficit is largely with the EU, although the deficit with China is growing at £22bn in 2018 it is dwarfed by the deficit with the EU of around £65bn. Why does the EU Single Market cause a trade deficit?

The simple answer to why the Single Market causes a deficit is Regionalisation. Any large economy tends to have the headquarters of large corporations near to the centre of power, finance and spending. In the UK this centre is around London and in the EU the centre is around the Northern Rhine. Companies at the centre purchase regional producers and hollow them out so that they become little more than fronts for sales of goods and services acquired by the parent company. This process can be stopped by regulations, borders and tariffs. The Single Market removes regulations, borders and tariffs so permits rampant regionalisation. If it is any consolation the south of Europe (Greece, Italy etc) has experienced more severe regionalisation than the UK.

Having escaped from the Single Market the very worst thing that could happen to the UK is to sign a Free Trade Agreement with the EU that re-instates it. At the bare minimum the UK must insist that at least 60% of parts and services that are used by EU owned subsidiaries operating in the UK are sourced from UK firms. The EU demands no less of foreign enterprises operating in the EU so the UK should make this an absolute red line. Certainly a 10 year transition period could be arranged so that EU owned manufacturers can move from 80% EU sourcing to 40% but the target must be set.

The UK must also tackle the free movement of capital. The movement of profits back to the EU should be hindered so that re-investment in the UK is encouraged.

Our trade negotiators should be told clearly that the objective is balanced trade, not the continuance of deficits. To this end there should be a clear out of Treasury staff who supported the EU. There can be no doubt that the Treasury were so ideologically motivated by the EU project that they were prepared to suppress any considerations of the real reasons for leaving such as the dire Trade Deficit and even worse Current Account Deficit. They were prepared to see the UK sink into the oblivion of being a regional economy within the EU and so must be regarded as antagonistic to the interests of the country.

The perfidy of the Treasury has led many people, even those who desired to leave the EU, into believing that the UK will be much worse off without re-instating the conditions of the Single Market. The Treasury biased their reports by using gravity models of economic benefits that applied to mainland economies and which did not actually apply to the UK (see  How the Economics Profession got it wrong on Brexit). They also ignored the corrosive effect of the deficits with the EU which is equivalent to ignoring an elephant in the room. Tariffs on the goods that the UK produces are generally low and our near neighbours are not the boon to sales that is assumed. We have little to fear from a WTO brexit.

Despite the fact that a WTO Brexit will be fine we can do better by having a good trade deal. Regulating our trade with the EU will allow us to counteract the effects of EU ownership of UK industry in a structured way and permit a higher flow of goods and services between the UK and EU than might otherwise be the case. However, our negotiators in all trade deals must have balanced trade and a balanced current account as their primary objective, they must not be empowered to commit the UK to eternal deficits.