How Britain will react to a WTO-based Brexit Patrick Minford is Professor of Applied Economics at Cardiff Business School and Chairman of Economists for Free Trade (EFT), a group of leading economists In its attempts to force through its EU Withdrawal Agreement the previous government painted a ‘No Deal Brexit’ as some sort of disaster. The current government of Boris Johnson is committed to leaving the EU at the end of October, whether or not the EU will renegotiate, which it has repeatedly said it will not; and so this ‘No Deal Brexit’, or more accurately a Brexit under WTO rules, is the most likely outcome. This outcome is in fact, as I explained in the Spring edition of World Commerce Review, a recipe for UK economic success, free of the shackles of EU protectionism, budget costs, intrusive regulation and subsidisation of unskilled immigration. Our estimates of how a full Brexit impacts on the economy To recapitulate the main points I made, a Clean Brexit produces long-run gains from four main sources (Minford, 2017): 1. Moving to free trade with non-EU countries that currently face high EU protection in goods trade 2. Substituting UK-based regulation for EU-based Single Market regulation 3. Ending the large subsidy that the ‘four freedoms’ forces the UK to give to EU unskilled immigrants 4. Ending our Budget contribution to the EU. In total these four elements, according to research in Cardiff, create a rise in GDP in the long term over the next decade and a half of about 7%, which is equivalent to an average rise in the growth rate of around 0.5% per annum. If we leave with No Deal, ie. under WTO rules with piecemeal side-agreements, we gain on top of this about £650 billion in one-off present value terms from extra tariff revenues, not paying the Deal’s £39 billion, and making Brexit policy changes two years earlier; the EU loses £500 billion from all this. At the heart of our estimates lie models which assume a world of tough long run competition in which industries can only survive by matching the competitive norm. By contrast the consensus among trade theorists is that competing firms have significant monopoly power due to their unique brands; this theory is known as ‘gravity’ modelling, in which natural monopoly power arises simply from size and proximity to consumers. On this view cutting into rival markets is hard, and this fact also protects their own market position. Along with this view goes an interventionist theory of regulation: that ‘rights’ can be awarded to ‘stakeholders’ at the expense of monopolist firms, with little damage to their competitive position. Along with it too goes the view that productivity growth occurs automatically as a result of growing trade, itself a product of proximity. In our research we find a very different world: a world in which lagging firms can be largely destroyed, with examples like Nokia and Blackberry coming to mind. We see the role of supply chains as squeezing out uncompetitive intermediate producers who do not devote enough effort to raising productivity via innovation. In this world business regulation can easily damage competitiveness. This is particularly true of labour market regulation, for which we have good estimates of the damage based on UK experience (see chapter 2 of Minford et al 2015). In our Cardiff World Trade Model we embed these assumptions and test their predictions against the facts of UK trade. We also set up a rival ‘gravity model’ as set out above. We test these models by indirect inference against the UK facts (Minford and Xu, 2018). This test is based on simulating each model many times to generate a full range of counterfactual histories due to randomly chosen reruns of historical shocks; we then ask how probable the actual UK history would have been if the model were correct. What we find is that the gravity model is highly improbable, well below a 5% minimum threshold of rejection, whereas the Cardiff model is fairly probable, comfortably above this rejection level. The implications of the Cardiff models for Brexit are radical. Brexit will usher in a world in which for the first time in our post-war history the UK market will be entirely dominated by world competition, finally admitted by abandoning EU protection of farming and manufacturing. UK firms and farms will have to be competitive with the best the world has to offer; this plainly will lower prices to the consumer and raise UK productivity. Notice that because UK service sectors have never had EU protection, not much changes for them in terms of necessary world competitiveness. To ensure this competitiveness UK regulations will have to be business-friendly; utterly gone will be the idea that there is some ‘free lunch’ of ‘rights’ to be exacted from the business community for the benefit of particular constituencies. What then of the position of EU firms in these UK markets? It will have fundamentally changed. Instead of being able to sell food and manufactures to UK consumers at inflated prices, owing to the lack of world competition, they will have to sell here at world prices, some 20% lower if EU protection is entirely removed. Were they not to match these prices they would simply be pushed out of the UK market, to sell nothing at all. It needs to be understood just how large a change this is for EU exporters to the UK. The UK constitutes about a quarter of the whole EU consumer market. If prices fall by a fifth, their margins on a quarter of their sales may well be entirely wiped out. But matters do not end there. If there is no UK-EU Free trade agreement then both sides must levy tariffs on the other, to comply with WTO rules; otherwise they must abolish their tariffs on everyone. But the EU will not because it is protectionist; the UK will not, because it wants to use its tariffs as leverage in FTAs with other countries. UK tariff revenues from EU exports are estimated at £13 billion a year. But notice that these cannot be passed on to UK consumers after Brexit and UK FTAs around the world. EU exporters must match those world prices in the UK market; so bang goes another £13 billion bite into their margins. Can the EU recoup these losses by their tariffs on UK exporters? This revenue is estimated at £5 billion a year. But notice these UK exporters now can sell their output at world prices at home; they will sell abroad at the same prices- arbitrage will force that. Abroad now includes the EU. The EU tariffs will therefore be passed on to EU consumers. This will not damage their sales compared with pre-Brexit, because their prices will still be competitive; pre-Brexit they were equal to world prices plus EU protection (tariffs plus non-tariff barriers), post-Brexit equal to home/world prices plus tariffs (only as there cannot be non-tariff barriers with the UK, standards being identical). UK trade negotiations with the EU and the rest of the world: a struggle by the EU to control UK policy This analysis based on our Cardiff models sheds light on why the EU has so bitterly opposed Brexit. When the UK leaves, not only will it stop contributing money to the EU budget and also stop the inflow of unskilled workers from the EU but also it will greatly reduce the UK profits made by EU exporters due to more UK competition and new tariffs. Furthermore, the UK will introduce lighter regulation designed to improve UK competitiveness, so reducing the scope for EU regulations to place burdens on EU industry which must compete with the UK. However, our discussion also shows that the UK gains from leaving straightforwardly under WTO rules and rapidly proceeding on FTAs with the rest of the world, starting with the US, our biggest single trading partner, with whom we have a mutual interest in abolishing our EU- inherited import barriers. All that the EU achieves by refusing to agree a simple FTA with the UK is not to stop Brexit but rather to force the mutual imposition of tariffs, which makes EU losses even bigger. If the EU were to intervene diplomatically to oppose US-UK FTA discussions, it would risk inflaming its existing trade disputes with the US. The main political weapon the EU has wielded has been the Irish border, claiming that there must be a ‘hard border’ if Brexit goes ahead and that this would create renewed IRA terrorism. However, this claim is not just irresponsible but also incredible, as the EU itself has admitted it would not impose a hard border under Brexit, while the UK has said the same, and the current government has committed to using technology and off-border checks to avoid it. Another EU tactic has been to raise concerns about administrative disruption in the short run. However, any such disruption is mutually damaging and would be highly unpopular in both the UK and the EU- and if it involves border hold-ups is positively illegal, as I showed at length in my last piece for this Review. Plainly short-term disruption by definition is temporary while long term gains persist and so are the dominant consideration. Conclusions In sum, the key element in any immediate Brexit strategy designed to obtain the gains available from it is to achieve Brexit and so sovereignty. The best way to achieve this is via a simple exit under WTO rules. However, if the EU should finally decide to negotiate seriously with the UK, then to relief all round a UK-EU FTA would be agreed. In the long run this has to happen anyway if EU losses from tariffs are to be avoided. Whereas the UK is indeed better off with No Deal, it is damaging to the EU, our neighbour. Better for neighbours to have good relations than to score off each other. References Minford, P, with Gupta, Le V, Mahambare, V and Xu, Y (2015) Should Britain leave the EU? An economic analysis of a troubled relationship, second edition, December 2015, pp. 197, (Cheltenham, 2015). Minford, P and Xu, Y (2018) ‘Classical or gravity: which trade model best matches the UK facts?’ Open Economies Review, July 2018, Volume 29(3), pp 579–611 Minford, P, (2017) ‘From Project Fear to Project Prosperity, an Introduction’, Minford, P, (2019) ‘No deal is the best deal for Britain’, World Commerce Review Spring 2019
In sum, the key element in any immediate Brexit strategy designed to obtain the gains available from it is to achieve Brexit and so sovereignty. The best way to achieve this is via a simple exit under WTO rules