Brexit and Free Trade

The handling of the post EU referendum has been pitifully slow and bumbling for two main reasons: the first, which is obvious, no-one close to the reins of power actually wants to leave and the second is the belief that Britain must secure a free trade deal with the EU in a post-Brexit world. Almost all economists, even Paul Krugman, believe that a world entirely shorn of tariffs would be a better place. Each country would be able to specialise where it has its comparative advantage (a situation of having a lower opportunity cost than another country in producing that good), leading to lower prices, more innovation and overall greater welfare. This is even in the case where you have predominantly agricultural third world economies trading with leading world economies, such as the UK. The principle is sound.

Why Trade Benefits the Genius and the Dunce

Imagine you have Barry the barrister who can only work eight hours a day and for every six hours of work in court he generates paperwork that takes him two hours to complete. If he is paid £100 per hour for his work in court this gives him a possible maximum earnings per day of £600. Duwayne the Dunce, however, can complete the paperwork to the same standard as Barry but, crucially, it will take him all day. It may appear that Barry has nothing to gain from trading with Duwayne, however, if the barrister hires him to complete his paperwork it will allow him to work an extra two hours in court earning him an extra £200 per day. Thus, all the barrister needs to do is to hire Duwayne at less than £200 per day and both parties will be better off even in the situation where one party is hugely less productive in all areas than the other. Therefore, there should not be any artificial increase in the costs of trading between countries as it will retard the beneficial specialisation.

Trade Deals are Voluntary Rape Contracts

Nevertheless, the tariff free world as yet is a land of fiction. How then should the UK respond if the EU slaps huge tariffs on UK car exports into mainland Europe following Brexit? They may do this out of spite or to attempt to protect their own car manufacturers , such as Volkswagen. If they do, this could cripple, so the argument goes, UK exports as the EU is the UK’s most important export market making up 44% of total exports [1]. The seemingly obvious response by the UK government would be to retaliate by placing tariffs on imports from the EU to the UK. Yet, this could lead to further escalation and yet higher tariffs on both UK and EU products which is clearly undesirable. Thus, the solution seems to be a free trade agreement – both countries mutually agree to abolish tariffs on each other at the same time so no one country can actually gain by retaining some tariffs whilst the other country abolishes them. This sounds as if it could fit on a postcard, “we the undersigned agree to place no tariffs on each others’ exports”, which seems like a perfect solution, however, in practice free trade agreements are akin to voluntary rape contracts: if they really are free trade agreements, why do they run to hundreds of pages? -the agreement between Israel and the EU runs to 152 pages double columned[2]. They are surely not simply free trade agreements but a managed trade deal more than likely set-up to further politically connected corporate interests. As Stephan Kinsella noted[3], the now dead in the water Trans-Pacific Partnership “free-trade” deal   was essentially a vehicle to export US intellectual property laws to South-East Asia; it was no surprise the Motion Picture Association of America (MPAA) amongst others were highly supportive of this deal.

Tariffs = Economic Suicide

If free trade agreements are then as honest as a politician’s election promise how should the UK proceed in the event of tariffs being placed on UK exports by the EU? To make this easier to comprehend let’s not imagine countries but two city states trading: Manchester and Edinburgh. Suppose the Chieftain of Edinburgh slaps tariffs on imports from Manchester: who does this harm? It will clearly make imports from Manchester more expensive in Edinburgh than before , likely leading to falling sales and profits for Manchester’s exporters. However, there is nothing stopping the Manchester exporters switching into other markets such as Glasgow; clearly this will be relatively less profitable than Edinburgh, since they originally traded there instead, but at least it gives them another option unlike Edinburgh’s consumers: they either buy Manchester’s goods with the tariffs or purchase Edinburgh’s goods which will likely be as expensive – there is no escape from high prices and no market they can purchase from to avoid tariffs.  On the other hand, it makes absolutely no difference to Manchester’s consumers as they can consume whatever they did prior to the tariffs.

The more sophisticated defender of tariffs may argue that it is true, tariffs harm Edinburgh’s consumers but they benefit their producers since the previously cheap foreign goods are now more expensive due to the tariff, making them relatively more profitable. Now since production necessarily precedes consumption, thriving domestic businesses with high paying jobs are required to generate the wealth to improve standards of living- such prospects could be significantly reduced in the absence of a tariff. However, tariffs only aid Edinburgh’s firms if they are in direct competition with Manchester’s e.g. an Edinburgh television manufacturer competing against a Manchester one. If Edinburgh’s firms use TVs as part of their service provision, such as most hotels, this will increase their operating costs, reduce profitability and could lead to lower employment.   If this is the case with what would generally be considered a consumer good (a good purchased for its own sake, not to be used in another production process) the effect will be more greatly magnified with raw materials, such as shale gas, since at some point they’ll be a part of most firms’ production process or service provision.

In summary, tariffs aid the businesses in direct competition with foreigners but certainly increase prices for all consumers and production costs for many domestic firms – foreign firms however can sell in other markets to avoid the tariffs. Would it then make economic sense for Manchester to put up a tariff in retaliation? Hardly, all it would do is increase prices for its consumers and many of its producers: it’s like shouting “Choose life!” and jumping off the top of Shard. Thus, “free trade” deals are at best unnecessary – a country cannot improve its wealth by unilaterally making goods more expensive for many of its domestic  businesses  and all of its consumers.

Cheap Chinese Steel is Good

A different objection worth considering to unilateral free trade is where foreign governments  heavily subsidise their exports thereby making them far cheaper than domestically produced products, for example Chinese steel. This creates unfair competition which undercuts any chance of the UK steel industry being price competitive, which will cause unemployment and also prevent the UK from producing a strategic good which we would need to produce domestically in the case of war. Imagine however, instead of cheaper steel, the Chinese gave an annual free gift of steel of 100,000 tons, would this make the UK worse off? When was the last time a free gift made you worse off?  Essentially, subsidised exports are a partial gift from the Chinese taxpayer. It will reduce input costs for steel using firms and ultimately prices for UK consumers; also note that unemployment due to foreign competition is in principle no different to more efficient domestic steel companies putting  relatively less competitive steel firms out of business. In addition, the newly unemployed can be reallocated elsewhere to produce new and different products which previously did not exist;  if they end up not being able to do this to a great extent and/or at a decent wage this would be largely caused by the cripplingly high government regulations; these increase the barriers to entry which reduce the number of firms in the market thereby reducing the demand for labour and thus wages – in addition, fiat money (paper money not backed by a commodity, such as gold or silver) and central banking exploits the many to the benefit of the few – these twin causes have as much in common with unilateral free trade as Enoch Powell and Tony Blair. Also, whilst the National Security argument for protection may seem plausible it fails to understand that trade itself promotes peace: the Israelis and the West Bank Arabs would be much less likely to kill each other if they were major trading partners as they’d have a lot more to lose. I have long thought that the Argentinian invasion of the Falklands in 1982 would have been much less likely if the UK hadn’t joined the then European Economic Community as the UK would have been a much more important export market for Argentina: Argentine steak even in the early 2000s was taxed at 75% by the Common External Tariff.

Further, if one declares the subsidised exports unfair competition, what then counts as fair competition? How do you distinguish in reality between a market based comparative advantage and a government induced advantage? Even if you could distinguish between them, why on earth would we possibly expect the government to tax at the right level? The government is a legal monopolist (that is, the sole organisation that can legally operate in a given market and geographical area) in law and so suffers the universal results of legal monopoly:  higher prices and lower quality. Imagine if Clarks had a legal monopoly over shoe production:  poor quality shoes, little choice and high prices. Likewise, the government would set bad tariff rates. Further, it’s even worse in the case of government as you could at least attempt to make your own shoes, you can’t have home-made tariffs – this also answers a final objection to free trade from Vox Day [4] who argues subsidised exports can be a form of welfare to the importing country and continuing to subsidise a man who is making foolish decisions will not turn him toward virtue: it may be welfare, but the government will make the situation as a whole, far, far worse.

Unilateralism is the Only Option

Therefore, the only sane policy solution following Brexit is to move to unilateral free trade like Hong Kong and Singapore: the UK should have zero tariffs on foreign goods irrespective of tariffs placed on UK goods. This would immediately bring down the prices of goods from outside the EU, it would cut the price of sugar cane by half (it is taxed at 100% under the Common External Tariff) and lead to a significant boost to refiners like London-based Tate and Lyle. It would also serve as an example to other countries that they too can benefit from adopting unilateral free trade, hopefully leading to a domino effect towards a genuinely free trade future.

Notes

[1] https://fullfact.org/europe/uk-eu-trade/ accessed 14/04/17

[2] http://eur-lex.europa.eu/resource.html?uri=cellar:411c0668-144d-44a1-a5e3-dd2342f7a5b5.0017.02/DOC_1&format=PDF accessed 14/04/17

[3] http://bamsouth.com/beware-the-trans-pacific-partnership-its-not-about-free-trade/ accessed 14/04/17

[4] https://www.youtube.com/watch?v=BMi-c9_4v-c accessed 18/04/17

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