China and India’s regional trade squabble echoes in Europe

India’s decision not to join the Regional Comprehensive Economic Partnership promoted by China is politically significant.  But its impact on trade and prosperity is more nuanced, as Bloomberg explains.

It avoids some market opening on both sides (India to agriculture; others to services) that would have been economically beneficial.  But the greater significance of the pact is the restrictions on access it would impose on those outside the regional trade grouping.

“Still, the effect of harmonizing standards at the regional-agreement rather than global level is the opposite of an opening of trade  … The standards that are established across the zone inevitably resemble those of its largest member. That would be fine in a global agreement, but in a regional deal the effect is to raise barriers to nations outside the bloc with different rules.”

The razmataz surrounding international agreements can obscure the importance of the more prosaic drivers of prosperity: openness to trade and competition, a skilled workforce, good institutions and sensible regulatory policy settings.

The risk of locking into the regulatory standards of any bloc is that they turn out to be not very good – particularly if the institutions of the bloc themselves lead to sub-optimal policymaking.  Small and peripheral countries hoping for disproportionate gains in access, risk losing disproportionately from having the least influence on standards and by not being able to buy from the best sources.

This is fundamental to the debate on how the UK will prosper in a post-Brexit world.

Oxford-based academic Ngaire Woods wrestles with the question at Project Syndicate, posing it as a binary choice:

“But assuming the UK does leave the EU, its next government will need to begin the long, difficult process of negotiating new relationships with the rest of the world. That will involve tough choices, one of the thorniest of which is whether the UK should align its regulations in key economic sectors with those of the EU or the United States. Where, then, is Britain headed?”

Aspirations for an increase in the UK’s economic growth rate rest very much on two industries: finance and tech.

Woods explores the case for staying in close alignment with EU standards – stressing finance’s need for access to EU markets and the desirability of joining the EU in curbing tech companies pretensions.

Both premises are worth pondering, not least because there is not just a spectrum, but a veritable universe of choices for alignment / divergence.

However, the hope that full alignment with Brussels’ rules would protect the UK’s role as the EU’s financial centre – and particularly its ability to profit by rationalising Europe’s financial industries and moving their highly-paid jobs to London – always smacked of the delusional, even when the UK was at the heart of the EU. Through the long process of European financial integration there was zero indication that national governments were going to let that happen.

London’s strength is that it provides cutting edge global services – in specific areas such as insurance or derivatives – settled in a political and legal environment which few others can match. This is the source of most of its current European business and future international growth.  It is likely to remain so post-Brexit.

If so, the key for London is not replicating a more extensive and expensive European post-crisis financial regime (itself reflecting a particular balance of EU economic and political forces) but setting distinctive standards within global parameters.

This seems to be where the UK’s regulators are heading.  An early statement of principle by the head of Britain’s Financial Conduct Authority, Andy Bailey, put it this way:

First, can open financial markets and free trade exist on a stable basis?  Second, is the regulatory system so complicated and delicate that it can only exist in a manner that supports free trade and open markets inside regional trade blocs? You will by now be unsurprised to know that my answers to these questions are – yes, free trade in financial services can exist on a stable basis, and – no, it does not have to be confined within regional blocs. Common regulatory standards are a necessary condition for free trade in finance, and they can also be a sufficient condition.”

On tech, the battle lines seem even more clearly drawn.  Europe’s animus for big tech just keeps growing. The latest blast is from German Chancellor Angela Merkel, with the Financial Times reporting that she wants the EU to assert ‘digital sovereignty’ and take control of data from US tech firms.

The EU’s strategy is two-fold: first to claw money out of the tech giants (taking a leaf out of the US government’s playbook) through competition policy; and secondly, detailed regulation which mandates service provision rather than letting it respond to consumer-provider interaction.  There is a growing pressure for pre-licensing of new developments (eg, for AI – Artificial Intelligence) requiring innovation to conform to regulatory standards before being market tested. 

This won’t necessarily stop tech firms offering services in the EU – as long as there is demand.  But it will cost consumers and harm those businesses that would utilise the latest innovations. And it’s likely to discourage tech development inside the EU.  

If the UK really wants to have the second best tech industry in the world after the US, it will need to be open to skilled personnel, permissive of innovation, remaining close enough to the US environment for interchangeability while offering some valuable distinctions (perhaps the UK liability regime or speed of permissioning).  Sounds rather like the business, legal and regulatory model which evolved for the UK creative sector (ie, film, television, theatre, advertising etc): a highly-skilled internationally-focused domestic industry with seamless trans-atlantic integration.

One thing seems sure.  Adopting the EU bloc’s standards wholesale in the hope of hanging on to marginal business looks like the worst of all worlds.

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