Friday 11 December 2020

Why did some people think the UK/EU deal would be the “easiest in human history"?

A lot of people think free trade is all about tariffs. I think this is why some people thought the deal between the UK and EU would be the “easiest in human history”.

The logic for free trade is compelling because it is not immediately obvious. If you know the basic story, you may know a little bit more about trade than the average person. This may lead you to believe that anyone who disagrees with you is simply misguided. Cod economics, ya da ya da.

I am going to explain the Econ101 version of free trade which has become a bit of an Econ101ism. A lot of people may roughly understand the arguments in favour of free trade but haven’t got the complete picture.

So, a tariff is just a tax on a good that you import from another country. A tariff not only raises revenue for the government but also gives an advantage to home producers over foreign producers. Why does this happen? Let’s take a simple example.

You are in the UK and want to buy some chocolate. You see that the UK and US make similar quality* chocolate and are available at the same price, so it’s hard to decide which to buy. If, however, the UK imposed a tariff on chocolate coming into the country, then US chocolate would now be more expensive. The decision is easy, you buy chocolate made in the UK as the price is lower.

When governments put a tariff on imports like this, it is thought of as protecting home producers - hence the term protectionism.

So why is this a problem? Well let's say that US firms find a new way of making cheaper chocolate via some nuclear reaction or whatever. US chocolate would now be cheaper than the UK if it wasn’t for the tariff. What this means is that consumers in the UK are going to lose out (this is why some people think Brexit will mean cheaper food prices).

But this is not the main compelling argument for free trade. Reducing tariffs means that the whole of society gains by more, on average, than under tariffs. Tariffs impose what is known as a dead-weight loss on society. We can prove this with lots of nice graphs that involve little triangles. The upshot of all this is that even though UK chocolate makers may gain from tariffs, the overwhelming majority of people lose from them. In fact, because there is a net gain from free trade, the winners can compensate the losers – everyone wins.

And because we can rework this example from a US perspective, the same logic applies to the US. As the logic for free trade is undeniable, both countries sit down and agree not to impose tariffs over a cup of tea and it will be the easiest deal in history…

There are a number of important criticisms of this theory that are not as widely known as the above. Not least, the idea that the winners compensate the losers has not really happened in practice. This is related to the whole globalisation and inequality issue. But this is not what I am going to focus on as I want to talk about why trade deals are not actually so easy.

Tariffs are probably the most conceptually obvious way in which you can prevent free trade. But, they are not the only way.

Subsidies are another way you can distort the process of free trade. A subsidy is the opposite of a tax. Instead of taking away, the government gives. For example, rather than imposing a tariff on US chocolate, the UK government could subsidise UK chocolate. This would allow UK firms to charge a lower price than US firms, giving them a competitive advantage. Even though those subsidies** would actually give us cheaper chocolate than putting a tariff on US chocolate, we are going to have to pay higher taxes to fund those subsidies. So there is still a deadweight loss (despite chocolate lovers gaining).

Regulations are also another example of distortions. If the UK allows the use of less expensive graphite tips in their nuclear chocolate reactors and the US doesn’t, then the UK has a competitive advantage over the US.

Now at this point, you may be thinking “isn’t government regulation a market distortion in itself?”. You would be correct in thinking that. This was seen as a benefit of Brexit, to be free from the red tape of Brussels.

This, however, is where trade deals get complicated. This is because regulations are what sovereignty is all about. What is a law other than a regulation? One person's red tape is another person's necessary safety measures. You can make your own regulations that are different from other countries, but if this gives you an artificial competitive advantage over other countries, then you shouldn’t be surprised if that country won’t sign a trade deal with you.

To put it simply, there is a trade-off between sovereignty and free trade. 

You can’t have your chocolate cake and eat it too. This is literally baked into free trade theory. However, when you learn the basics of free trade you just assume (for pedagogical purposes) that the other country has the same preferences as yours. 

This does not mean, however, that Brexit was a bad thing. If the UK has different preferences to the rest of the EU then it makes sense to sacrifice some wealth (via trade) to satisfy those different preferences. The problem, however, is that many people who voted to leave not only had different preferences from the EU, but also different preferences from each other. Some wanted more protectionism/regulations, whereas others wanted less.

When the UK was inside the EU, they had a say in what regulations were imposed, but other countries could also influence these regulations. As the UK leaves, it can impose its own regulations, but other countries are still going to influence these regulations via trade deals.

You can’t really escape the fact that if you want to trade, and preferences differ, you are going to have to find some way of compromising over these regulations.

 The trade-off is real. This is why, sadly, it wasn’t so easy and was never going to be.

*If you are from the UK and have ever tried a Hershey’s kiss, this quality analogy might be a bit of a stretch. Perhaps this is why the US needs so much ice if they have to put wax in their chocolate to stop it from melting.

**The EU does actually allows a certain level of subsidies (or state aid). The crucial point though is that the rules have to be the same for everyone or else there is a risk of other countries having an unfair advantage.

No comments:

Post a Comment

The UK smoking ban: can paternalism be justified?

Every day I tell my toddler off for doing something he shouldn't. He has no idea why playing with plug sockets are bad but light switche...