Brexit: The way forward

Brexit: The Way Foward.

Before discussing Brexit in detail, it is important to set the scene:

• Dispel the myth circulated by the media: “access to the EU single market”.
• Present Britain’s export performance in the EU.
• Exports to EU by non-EU countries.
• EU tariffs and the WTO.

There is no such thing as the EU “single market“

Quite simply, there is no such thing as the EU single market.  Take a look at the EU treaties (downloadable from this website) and you will find no mention at all of a “single market”.  Instead, the treaties describe the EU customs union and the internal  market consisting of the national markets of the EU member states within the customs union.  The customs union is defined by the Common External Tariff (CET).  The CET is one of the defining features of the EU, it is quite literally a fence behind which the EU member states are corralled.  This fence is owned and policed by the EU institutions.  Flows of goods, services and capital between EU states and non-EU states must go through this fence, and it is the same fence for every EU state.  Flows of goods, services, capital and people between EU member states are not subject to any fence.  This is the internal market – the market that is internal to the EU, and specifically internal to the customs union, with the CET as its boundary.

Thus for trading purposes, the CET has established the EU as a sovereign trading jurisdiction in its own right, just like the USA or South Africa.  The EU and all its member states are full members of the World Trade Organization (WTO).  Because the EU is a customs union, its member states have surrendered their rights to be independently represented for the purposes of international trade, and are therefore represented by the EU at the WTO.  Because the EU is a full WTO member, it is obliged, right now, to give full access of its internal market to every other WTO member, just like every other WTO member has to.  Sceptical?  I suggest you make a visit to B&Q.  Most of the goods on sale there are made in China, and China does not have a free trade agreement with the EU. Instead, China’s access to the EU internal market derives entirely from the WTO, just like the USA’s.

British Export Performance in the EU

Advocates of EU membership, and those clamering to stay inside a non-existant “single market”, argue that British membership of the EU has somehow benefited British exporters.  In a word, they are wrong.

Taking 1992 as a base year, when the scope of the EU’s internal market was hugely expanded by the landmark Maastricht treaty, Britain’s export performance to the last full year (2015) has been lamentable for goods and for services the same as British exports to non-EU countries.

Note to the reader:  In all the discussions below about exports to the EU, whether by Britain or countries outside of the EU such as USA, the EU is the current EU membership less Britain. In this way direct comparisons between Britain and countries outside the EU can be made.  For example, US exports to EU do not include US exports to Britain.

Goods

Between 1992 and 2015 British exports of goods to non-EU increased by 81% in real terms.  In contrast, British exports of goods to the EU only grew 5.7% in real terms over the same period.  In fact if you change the base year to 1995 they actually shrank!

British exports of goods to non-EU (£151 billion in 2015) have now overtaken British exports to the EU (£134 billion in 2015).

Ireland

British exports of goods to the Irish republic were £16.8 billion in 2015, or 12.5% (one eighth) of the total £133.5 billion goods exports to EU by Britain.  British goods exports to France, a country with 14 times more inhabitants than Eire were barely higher at only £17.9 billion, whereas British goods exports to Italy (61 million inhabitants) were only £8.4 billion – half the figure for Eire (4.6 million inhabitants).  What a damning commentary of Britain’s EU membership that we can’t export successfully to large EU nations after 43 years of EU membership.

The high British exports to Eire are a legacy of the historical, cultural and family links between the two countries.  British exports to Eire are totally untypical of British exports to the rest of the EU.  Without Eire in the EU statics British exports to EU would only be £116.7 billion, well below the £151.4 billion of British goods exported to non-EU.

Britain’s trade in goods with Eire generates a £ 4.8 billion surplus for Britain, in contrast with a deficit on goods of £89.5 billion with the whole EU.  So without Eire in the statistics the deficit with EU would be £94.3 billion on goods, with goods exports being £116.7 billion and goods imports £211.0 billion.  Thus imports would be approaching double our exports.  Indeed on Britain’s goods trade with Germany and Italy it is already the case that imports are double exports.

Services

British exports of services, whether to the EU or non-EU, have trebled in real terms since 1992.  So whilst it is true that British exports of services to the EU have grown strongly, this growth was matched in British exports of services to non-EU.  In a nutshell British exports of services have done well, both to the EU and non-EU alike.

British exports of services to non-EU (£137 billion in 2015) are much higher than British exports of services to EU (£89 billion in 2015).

Exports to EU by non-EU countries.

Those who advocate EU membership argue that it helps British exporters, and that by extension, when we do leave the EU, that British exporters will somehow suffer.  In the section above it is shown that from inside the EU British export performance of goods to the EU has lagged massively behind British export performance of goods to non-EU.  In this section the exports of goods to the EU made by the USA and Switzerland are presented.  If the advocates of EU membership are right, US and Swiss export performance to the EU must have been awful – after all if British performance from inside the EU was bad then countries outside the EU must have fared even worse, surely? Let’s see how these countries really performed.

US exports of goods to EU

In 1992 Britain exported 33% more goods to the EU than the USA.  In 2015 the USA overtook Britain as an exporter of goods to EU.  This happened because US exports to the EU grew strongly over this period, whereas British exports stagnated.  It is important to put the strong US export performance into context:

• The USA is outside of the EU, whereas Britain is in the EU, supposedly enjoying trade “benefits” from EU membership.
• The USA does not have a free trade agreement in place with the EU – an attempt has been made to negotiate an agreement in recent years but it has now been abandoned with nothing in place.
• The USA therefore trades with the EU on the basis of ordinary WTO rules and US exporters must pay tariffs to the EU, whereas British exporters do not*.

*It is true that British exporters do not, from their own treasuries, make any direct payments to the EU in respect of exports made to the EU.  However British exporters, like all British businesses, pay local and national taxes to the British state on a huge scale: corporation tax, employers’ national insurance contributions, business rates and so on.  The British state then makes a net contribution to the EU budget, currently running at £11 billion or 8.4% of total British exports to the EU.  So “UK PLC” does pay a trade tariff to the EU – from general taxation, which includes the receipts from British exporters. So indirectly British exporters do pay a tariff to the EU through their taxes.  Of course EU exporters make no contribution to Britain directly or indirectly – EU exports to Britain are literally tariff free.

Swiss exports of goods to EU

Between 1992 and 2015 the growth in real terms of exports of goods to the EU by Britain, USA and Switzerland has been, by country:

• Britain: 5.7%
• USA: 46%
• Switzerland: 58%

Switzerland’s export performance has literally been ten times better than Britain’s.  Like the USA, Switzerland is not (and has never been) an EU member.  If the above statistics are not shocking enough, consider that Switzerland, a country with only 8 million inhabitants, exports more goods in absolute terms to Italy than does Britain, a country with over 65 million inhabitants.  The foregoing is not a one-off fluke:  British exports of goods to Italy have been running at 20 percent below Switzerland’s for the last five years.  Italy is the EU’s third largest economy and historically a fountain of European culture.  How is it, that after more than 40 years in the EU, that British export performance to this large and prestigious market is so bad?  The inescapable conclusion is that EU membership has not helped British exporters.

EU tariffs and the WTO

As stated above the EU is a full member of the WTO and must follow WTO rules in setting tariffs with other countries, which will include Britain when we leave.  So the scaremongers are wrong: EU bureaucrats will not be at liberty to set whatever tariffs they like on British exports to EU.  The two key WTO rules are:

• Most Favoured Nation regulations.
• The obligation to reduce tariffs.

Most Favoured Nation (MFN) regulations 

The MFN regulations forbid countries from levying lower tariffs on imports from one country or group of countries than on another, unless there is a free trade agreement between the countries.  In plain English country A cannot levy lower tariffs on imports from country B than on country C unless there is a free trade agreement between country A and country B.

The MFN regulations mean that the current levels of tariffs levelled by the EU on imports from outside EU  would apply to Britain if we left the EU without concluding a free trade agreement.  On a trade weighted basis, EU tariffs average 3.6%.  So overall EU tariffs are quite low, and this may well explain why the USA has been so successful in increasing its exports to the EU: Tariffs have been too low to make a difference.  So if Britain left the EU tomorrow (hurrah!) the average tariff on British goods exports to EU would be 3.6% and Britain would be entitled to levy the same tariffs on our considerably higher imports from EU.

The obligation to reduce tariffs 

All WTO members, including the EU, have an obligation under WTO treaties to work for the progressive reduction of tariffs.  Indeed this obligation has been transcribed into article 21 of the Treaty of the EU (TEU) – see clause 2(e):

“2.  The Union shall define and pursue common policies and actions, and shall work for a high degree of cooperation in all fields of international relations, in order to:

(e) encourage the integration of all countries into the world economy, including through the progressive abolition of restrictions on international trade;”

Current EU tariffs

As already said above the trade-weighted average EU tariff is 3.6%.  It is important to realise that:

• Tariffs vary very widely.  About 60% of EU goods imports are already tariff-free.  By contrast the average EU tariff on agricultural products is 22.3%.  Agricultural products account for  around 10% of EU goods imports, but account for one third of the total EU tariff burden.  The average EU tariff on non-agricultural products is only 2.3%.
• The MFN regulations apply product group by product group.  So country A cannot levy a tariff on imports of cars from country B of say 10% if it is only levying 8% on cars from country C.  The MFN regulations would oblige country A to level down to 8%.  However different patterns of trade between countries mean that the average tariffs levied by countries can vary whilst respecting the MFN regulations.

Apart from agricultural products, the other significant EU tariff is on cars and car components, where the tariff is 10%.  This tariff would apply to British exports to the EU under WTO rules – but Sterling has devalued by over 15% since June 23rd, so even with this tariff British car exporters would still receive more pounds for each car sold into the EU than they did before the referendum.  This is why Honda and Nissan have publicly committed to keeping and developing their U.K. operations.

Brexit: the negotiations.

The EU negotiating position 

The EU negotiating positions will be determined by two factors:

• The need to replace the £11 billion net contribution from the British taxpayer to the EU every year.
• Prevention of contagion i.e. other member states leaving the EU.

Many Brexiteers argue that the interests of EU, chiefly German, exporters will also be very important to the EU negotiating position.  Brexiters have argued, correctly, that WTO tariffs will hit disproportionately the EU (especially German exporters).  This because The EU has a massive £89 billion goods surplus with Britain (tariffs are not levied on services).  Also the recent devaluation of Sterling against the Euro means that British exporters will receive more pounds for exports priced in Euros even if tariffs are levied.

So is the EU case for a free trade agreement with Britain done and dusted?  What else is at stake for the EU, and most particularly Germany?

Germany and China are the world’s biggest exporters, and both countries owe a large part of this success to currency manipulation.  In the case of China, which is a brutal communist dictatorship, the ressources of the state have been corralled into buying vast quantities of US government securities, thereby holding down their country’s exchange rate against the US dollar.  Germany has a similar policy: it is called the Euro.  Before the Euro Germany could not disguise or offsets her huge trade surpluses and consequently the Mark rose over time against other currencies, and acted as a brake on German export growth.  By joining the Euro Germany is able to hide her strong export and balance of trade performance behind the less impressive performances of the rest of the Eurozone.  The Euro has taken off the brake on German exports by allowing German exporters to trade in a currency that is much weaker than the old Deutsch Mark and consequently Germany can price her exports much more competively than she otherwise could.

In a nutshell Germany’s interest is the continuation and survival of the EU and its currency, the Euro.  If the EU folds and the Eurozone goes back to national national currencies, then Germany will be faced with an immediate and massive appreciation of her trading currency, which will reflect the undiluted strength of the German economy.  To get an idea of the appreciation, consider the appreciation of the Swiss Franc against the Euro since the Euro’s introduction in 1999.  In 1999 a Swiss Franc was worth 0.63 Euros, today it is worth 0,93 Euros i.e. a 50 percent appreciation.  Switzerland and Germany resemble each other in being high savings high export countries, racking up huge trade surpluses year after year.  So in the event of the Deutsch Mark being resurrected, an appreciation of this scale (50%) is to be expected.  Former holders of Euros would be desperate to convert their holdings into Marks.  The underperformance of the rest of the Eurozone relative to Germany (and indeed Britain!) is underlined by the following 2011 data  from the European Commission.  The top three EU exporters of cars to outside the EU in 2011 were:

• Germany: €56.3 billion
• Britain: €12.6 billion
• Belgium: €4.4 billion

France and Italy don’t even make the list.  Germany’s exports are in a different league from her neighbors.  The above German exports to outside EU in just one category – cars – equate to two thirds of total German goods exports to Britain in a single year (£62 billion).  Total German exports are running at £1100 billion a year.  So, whilst WTO tariffs would be a real cost to the German economy (around £2 billion a year), it is likely that Germany would prefer this outcome to an unraveling of the EU that would force German exporters back to the Deutsch Mark and a crippling 50% appreciation that would put all of Germany’s £1100 billion a year exports at risk.

All of the above is a long way of saying that Germany has a massive economic interest in protecting the integrity of the EU, so that its exporters can carry on exporting in Euros instead of Deutsch Marks.  This interest massively outweighs any tariffs Germany might have to pay to Britain under WTO rules, in the ratio of 1100:2 = 550:1!

Brexit, for the EU, is above all an absolutely massive loss of prestige.  Whatever member states are saying publicly, every EU member state is re-evaluating its own membership of the EU club, which has suddenly been devalued by an order of magnitude.  The deputy president of the EU Commission Frans Timmerman has said that he can now envisage the failure of the EU project, in the light of the Brexit vote.  Let us suppose that EU and Britain make a Free Trade Agreement, what would be the immediate political impact?  Look at things from the point of view of Denmark, Sweden and the Netherlands.  Your protector in the EU, Britain, has gone.  Your net contributions to the EU are rising, because the EU Commission now has a £11 billion a year black hole in its finances to fill.  Your country is being overwhelmed by massive immigration forced on you by the EU.  Meanwhile your erstwhile protector, Britain, has left the EU mess behind, is no longer paying into the EU and is not subject to EU rules or EU immigration.  Moreover, thanks to a free trade agreement, British exporters enjoy tariff free access to the internal EU market.  Wouldn’t the natural reaction of sensible and rational Swedes, Danes and Dutchmen be, well, let’s do the same as our British friends?  Let’s trade freely with the EU but stop being dominated by the EU and stop subsidising it.

The huge danger for the EU project is that other countries, particularly the “sorted” countries such as Sweden, Denmark and the Netherlands do the same as Britain.  Agreeing a free trade deal with Britain, whilst benefiting EU exporters, carries the risk of encouraging the likes of Sweden, Denmark and the Netherlands to leave as well.  If these countries left the EU as well then what chance the EU?  If the EU fails then so does the Euro, with huge implications for the German export machine.

In conclusion, despite the £89 billion a year goods surplus the EU has with Britain, the EU is unlikely to agree to a Free Trade Agreement.  This is because such an agreement would encourage other EU member states, particularly those in good economic health, to leave.  So whilst WTO tariffs would cost German exporters around £2 billion a year, this cost could well viewed as minor compared with safeguarding £1100 billion a year of total German exports.

Another factor weighing against a Free Trade Area is the loss of Britain’s £11 billion a year net contribution.  This represents 10% of the whole EU budget – so is very serious for the EU institutions.  At this point it is important to remember that EU members pay all tariff receipts on imports from outside the EU straight to the EU institutions.  So if Britain does not conclude a FTA with the EU, the EU institutions will receive the tariffs levied on British goods exports to the EU.  This would be around £ 5 billion a year.  This would go along way to filling the £11 billion black hole in the EU budget caused by Brexit.

The British negotiating position 

The British position is dominated by the need to actually leave the EU and not be inveigled into accepting an agreement that would be EU-lite membership.  The British people have spoken and their wishes must be accepted.

The Prime Minister’s recent statement (17th January 2017) that Britain will be leaving the EU “Single Market” (in reality EU internal market), provides welcome clarity that the British People’s decision to leave the EU in full.

Britain’s national interest is to reduce the crippling £89 billion deficit we have with the EU on goods.  This interest would be served by trading with the EU on WTO rules.  This is because the recent fall in Sterling would shield British exporters from EU tariffs while accentuating the effect of British tariffs on EU exporters to the United Kingdom.  So the effect of WTO tariffs would be asymmetrical: neutral for British exporters but very hard for EU exporters.  It is reasonable to expect then an improvement in our awful trade balance with the EU.

It is worth putting some numbers to the above:

1) 3.6% is the average WTO tariff on goods imports to EU.  So this number is a good guide to the average tariff British exporters would face.  It is miles away from the 20% depreciation of Sterling.  So on average British exporters will have a very large exchange rate cushion from EU tariffs.

2)  The 3.6% number is a trade-weighted average of many different tariffs: some goods already attract no tariffs whereas others, notably cars and agricultural still face significant tariffs of 10% and 22% respectively.

3)  For cars the 10% tariff would still be well below the 20% depreciation, so British car exporters are still in the clear.

4)  For agricultural exporters the tariffs would be slightly higher than the depreciation: so exporters would lose out without government support – see below.

Under WTO rules the British government would receive a £8 billion windfall of tariff receipts on the £221 billion of EU goods imports, assuming the 3.6% average tariff.  It is proposed that this money be ringfenced and used to support British exporters in general and in particular car and agricultural exporters.

The WTO does not restrict support given to agricultural exporters, so the government would enjoy considerable latitude to support exporters of agricultural products.  For non-agricultural goods WTO rules are much stricter: you cannot subsidise exports, by paying the tariffs on exported cars for example.  But the WTO does allow governments to provide sectorial support.  Thus the government could give British car manufacturers very large tax breaks for example.  Companies making cars or components could be exempt from paying employers national insurance contributions and/or local businesses rates.  Such measures would be entirely compatible with WTO rules and be guaranteed to inject money into the car makers.

In summary, then, WTO rules would actually work very well for Britain.  In this scenario it would be important for the government to do all it can to make sure Sterling continues to “feel” the awful trade and current account deficits and remain weak against the Euro.  Limits on hot money flows into Britain should be applied and large scale purchases of assets by foreign investors should be discouraged.

Tariffs, even when mediated by the WTO, are ultimately regressive.  The government is right to promote free trade, whether with EU or other trading jurisdictions.  So in the negotiations with EU the British government should offer a free trade agreement.  Even if we leave on WTO rules, the tariffs will probably disappear anyway in 20 or 30 years time as a result of future WTO agreements concluded across the World.  The British position is actually very strong:

We leave and trade with EU through a new free trade agreement.  So we regain our sovereignty, stop subsidies to EU and control our borders.

We leave and trade with EU on WTO rules.  We still regain our sovereignty, stop subsidies to EU and control our borders.  British exporters are supported by the exchange rate and by recycling massive EU tariff receipts to British exporting industries such as car making.

Either way we win.  The British government should not offer any concessions and stick to the Prime Minister’s pledge to walk away from a lousy deal.

 

 

 

 

 

 

The most determining factor in the negotiations with the EU will be money.  Britain’s net contribution of £11.4 billion per year to the EU budget means that when we leave, the EU budget, currently running at around £110 billion a year, will face an immediate black hole of 10%.  This will be the main focus of the EU institutions: how to claw money out of Britain even though we will have left, in order to back-fill the gaping hole in their budget.  This is why there will only be two possible outcomes to the negotiations:

• Britain continues to pay into the EU budget, in return for tariff-free trade with the EU.  This will be dressed-up as “access” to the “single market”.  In reality it will be an effective continuation of EU membership, with the continuing requirement to accept free movement of EU citizens into the U.K; or
• WTO rules i.e. a complete break.

Indeed this is what the EU Council President Donald Tusk has said recently: Brexit can only be “hard” – or not be Brexit at all.  He is right.

Many Brexit supporters will be surprised that the EU would ever contemplate WTO rules – after all EU goods exports to Britain are approaching double our goods exports to the EU.  So surely under WTO rules “EU PLC” would pay nearly double what “UK PLC” would.  How could the EU institutions see any advantage in such an arrangement?  At this point it is important to remember that:

• The EU institutions are not “EU PLC”.
• Tariffs on imports into the EU go straight to the EU institutions, regardless of other cash transfers between the institutions and member states.
• The EU institutions will not be paying any tariffs to the Britain – it will be individual EU exporting companies such as Volkswagen and Peugeot that will pick up the tab.

So under WTO rules EU exporters will get hammered whilst the EU institutions will receive a new income flow: the tariffs payable on every single British goods export to the EU.  At current tariffs of 3.6% and £134 billion a year, this tariffs income will be £4.8 billion a year or 42% of Britain’s yearly contribution to the EU budget as a full EU member.

At this juncture it is important to remember the collapse of the EU – US trade talks, and the impending implosion of the Canada – EU deal.  If these two free trade agreements had gone ahead then the EU institutions would have lost the tariffs on imports from these countries.  Now US goods exports to EU are around 5% higher than UK exports, so the corresponding tariffs payable will be 5% higher too – £5 billion a year.  The combined tariffs incomes from US and UK exports to EU will be £4.8 billion + £ 5.0 billion = £ 9.8 billion.  This number is close to Britain’s yearly net contribution of £11.4 billion to the EU budget, without even considering tariffs on Canadian imports.