Brexit: concerns about reduced economic openness and lessons from NZ’s terms of trade

LONDON CORRESPONDENT:  The UK’s central bank, the Bank of England, last Wednesday published a series of gloomy Brexit scenarios.  Supporters of Britain’s departure from the EU erupted in fury – but accusations of bias and bad faith miss the point. While civil servants do their utmost to avoid telling lies, ignoring, obscuring and arguing from carefully selected premises are part of the stock-in-trade.  Behind the politically chosen scenarios, the analysis is revealing and helpful to reasoned argument from all camps.

The scenarios modelled run from close economic partnerships (a version of which is currently before Britain’s parliament), through transition to World Trade Organisation trade terms, and on to a no-deal/no-transition ‘hard Brexit‘.  All of them suggest that the UK’s economy would be smaller over time than if the UK had remained in the EU, up to 10% smaller in the most dire, disorderly Brexit scenario.

The basis of the bank’s modelling (affirmed throughout the report’s 86 pages) is the assumption that all of the scenarios lead to a less open, and thus less productive, UK economy.   The economic literature is abundantly clear that openness to trade in goods and services and to foreign investment, facilitates competition, innovation and specialisation, and thus productivity.  QED one might say.

But this assumption begs some rather important questions.  As New Zealanders who lived through the Douglas and Richardson reforms at the end of the last century will remember, economic openness is firstly an internal policy setting. Free of the constraints of the EU single market, the UK would have the choice of responding to disruption of its European trading patterns by opening to the wider world, unilaterally if necessary.

The bank also caveats its analysis by pointing out that, while the association of openness with productivity is clear, there are not many examples of abrupt withdrawal from trading arrangements to illustrate how quickly it might work in reverse. The example they choose (reflecting perhaps the interests of New Zealand-born Deputy Governor Sam Woods) is the impact on New Zealand of losing preferential access to the British market for agricultural products when – surprise – Britain joined the European Economic Community in 1973.

Lessons drawn by the bank include: lack of preparatory adjustment before the shock, rapid reduction in trade (and its subsequent diversion to new markets) post-shock; and a clear negative impact on investment and economic growth.

An even broader perspective might perceive Britain’s joining the EEC as just one fury in a perfect storm striking the most open and competitive part of the economy – the export-oriented agricultural sector.  New Zealand’s terms of trade peaked at an all-time high in 1973, just as the UK entered the EU.  Then they plummeted and stuck at an all-time low between 1975 and 1986.  Sustained economic growth returned only with improvement in the terms of trade and greater openness and competition (including more exposure to imports) in the more sheltered parts of the economy in the late 1980s and early 1990s.

At this stage, the UK government’s commitment to a post-Brexit openness strategy is at best half-hearted.  But it is striking – and hardly remarked on – that the only party to the negotiations committed in principle to reducing economic openness is the EU, which insists that existing compliant trade must be shut down if strict political conditions are not met.

Indeed it raises the question of just how open the EU wants to be.  Its defenders are voluble in pointing to its vast single market and its low external tariff rates.  But as the Bank of England helpfully points out on page 16 of its report, EU tariffs haven’t changed much since 2000, while non-tariff barriers have proliferated.

More worrying for economic liberals is the trend in EU-wide regulation inside the single market – in areas as diverse as energy, chemicals, financial services, transport and data.

EU regulatory debate in the tech field, , for example, is marked by hostility to uncontrolled innovation and market outcomes, and preference for detailed and often-costly universal standards, usually developed in conjunction with European incumbents.

It should not be surprising, then, if markets become less open and competitive.  These trends may have been facilitated by the 2009 Lisbon constitutional changes which shifted much of the power for economic regulation from an inter-state negotiation requiring unanimity to a structure with more EU-level influence and majority voting.

If one accepts the Bank of England’s proposition that economic welfare is closely linked to openness and competition (which should ring true for New Zealand policymakers), one is left to ponder precisely what wider policy settings for the UK might achieve that, and whether they are more politically attainable outside or inside the EU.

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