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.
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