Wednesday, 18 May 2016

Trade - A World Beyond Tariffs

If the economy is central to the Referendum debate, then understanding trade in relationship to our EU membership is fundamental.  Regrettably, the public debate and understanding of trade is poor and to be honest it takes time and effort to understand properly. In this post I will try and summarise what I have learnt over the last year or so on this crucial topic.

Trade is a primary characteristic of human civilisation. Trade is essentially the exchange of goods or services.  This allows individuals / communities to specialise in the production of specific goods or services and exchange their produce with other individuals / communities who have specialised in a different product. Specialisation, together with innovation (the use of a new idea, device, or method) equals more efficient production of goods and services.  Increased productivity means there is more goods and services to exchange, so everybody is better off.

Markets are simply a place or organisation that promotes the exchange goods or services.  Once money was invented and we left bartering behind, trade and markets multiplied and extended.  As trade multiplies, specialisation and innovation increases, hence productivity increases, everybody is better off. You get the picture, trade is a good thing.

Tariff is the common term used for taxes on imports or exports, effectively a tax on international trade (a tariff is actually a list of  products with their corresponding customs duty).  Mercantilism, the dominant economic practice in 16th to 18th century Europe, featured a national economic policy focused on maximising domestic production and trade surplus, typically applying high tariffs to deter imports especially of manufactured goods. Typically such policies led to war and colonial expansion.  You get the picture, tariffs are a barrier to international trade, and are a bad thing.

Free Trade.  In 1776, Adam Smith published his famous "Wealth of Nations", criticising Mercantilism, and arguing for removal of import /export controls & tariffs, which might protect specific domestic industries but hurt the trading nation as a whole.  Access to more / larger markets allows nations to specialise, so dividing labour more efficiently and increasing productivity. Smith's philosophy is a founding work of classical economics and classic liberalism. Free-trading liberal democracies, based on this philosophy, trade freely for mutual benefit, become inter-dependent and avoid war. You get the picture, free-trade as in removing barriers to international trade, is a good thing.

Adam Smith explained that if one nation is more efficient in one product, but a second nation is more efficient in another product, both countries gain advantage by specialising in their strengths and then trading their products.  This is termed absolute advantage as the basis for trade.  In 1817, David Ricardo demonstrated the counter-intuitive concept of comparative advantage, where even if the first nation is more efficient in every product, both countries still benefit by specialising in their strengths and trading. You get the picture, trade is to mutual benefit, even between mis-matched nations.

Free-Trade area is a group of nations who have signed a free trade agreement (FTA) and co-operate to reduce and remove trade barriers.  Examples include NAFTA (North American Free Trade Agreement covering America, Canada & Mexico) and EFTA (European Free Trade Association) formed by Britain and 6 other European nations in 1960 as an alternative to the Common Market.

A Customs Union also eliminates tariffs and trade barrier between member states, but unlike a free trade area, the member states have a common external tariff for all trade conducted with countries outside the customs union. Member states are unable to negotiate their own external trade agreements. The German Zollverein customs union founded in 1834 was instrumental in unifying the German states. The 1848  "March Revolution" in the German states led to calls for German economic and politicial union. The German empire was formed in 1871 following 3 wars: the Second war of Schleswig against Denmark in 1864, the Austro-Prussian War in 1866, and the Franco-Prussian War in 1870–71. You get the picture, customs unions focus on internal economic and political integration with a protectionist approach to external trade.

In 1931, Arthur Salter proposed the German Zollverein as a model to create a "United States of Europe" funded by a common external tariff on all goods imported into the union, with “a political instrument to determine how the distribution [of those funds] should be made”. Ultimate authority would be given to a permanent body of international civil servants loyal to the union, not their home countries. Tellingly, a 1956 British proposal to create the Common Market based on a free trade area was rejected as it ‘offered no prospect of a European political union’. The Common Market was instead instituted as a Customs Union along Salter's lines in 1957, with Britain opting for free trade in EFTA in 1960.

A "Leap in the Dark" 

"A leap in the dark". An apt description of the UK joining the Common Market or European Economic Community (EEC) in 1973.  In joining the Customs Union, Britain surrendered its independent trade policy to Brussels and with it freedom to strike free trade deals.  Free-trade links with EFTA and the Commonwealth were sacrificed. Britain's efficient agriculture came under control of the Common Agricultural Policy, which required hefty payments from Britain, primarily to subsidise inefficient French agriculture. Britain's territorial fishing waters, home to 70% of Europe's fish stock, became a "shared resource" and over subsequent decades the Common Fisheries Policy decimated British fishing.

The economic case for the EEC was that Britain needed the cold blast of competition with the dynamic common market economies.  But in truth, the most dynamic growth had occurred before the formation of the Common Market. Post-war reconstruction and the economic miracle fostered by Ludwig Erhard in West Germany. A historical shift of workers from the countryside to the cities (which Britain had undergone a century earlier) and so on. The whole case for Britain joining the EEC was in any case undermined when the remaining EFTA countries secured free trade access to the Common Market, culminating in an agreement on industrial goods in 1977.

Subsequent decades have not made Britain's decision look any wiser. Our former EFTA and Commonwealth allies enjoyed stronger growth than the EEC/EC/EU. Australia and New Zealand prospered by unilaterally lowering tariffs, diversifying into new markets and products. By contrast, the EEC/EC/EU economic performance has been "sclerotic", more so as political integration increased and especially with the devastation wreaked by the Euro. The EU's continuing enlargement to 28 member states has not stopped it's share of world GDP shrinking. The Euro-zone has barely grown at all since it started.  While a seemingly dynamic Common Market may have appeared attractive to the "sick man of Europe" that was Britain in 1973, the position now is entirely reversed.

Tariffs around the world are now much lower thanks to the work of GATT (General Agreement on Tariffs and Trade) established in 1948.   I should point out that there is a case for higher tariffs - developing nations should have tariff protection against developed nations while they build up a competitive economy.  The Generalized System of Preferences (GSP) provides such a mechanism. Unfortunately, the developed world, and especially the EU, are pursuing policies that harm rather than help the developing world, as explored by fellow blogger The Brexit Door. The EU protects its own Agriculture (subsidies and high external tariffs), pursues predatory fishing practices and use its "clout" to force African nations to lower their import tariffs on manufactured goods. Africa faces a high barrier to its agricultural exports but is unable to protect its manufacturing industries against the EU's highly developed industries. The result is an Africa dependent on Western handouts and bribes from foreign corporates. The EU seems to resemble a mercantilist empire ignorant of the free trade insights of Smith and Ricardo where trade is for mutual benefit..

So it all seems straightforward and unarguable. Britain should leave the mercantilist, protectionist EU customs union, lower tariffs (following Australia & New Zealand's example in the 1970's), look to global trade for growth and enjoy the ensuing free trade bonanza.  Unfortunately, it is not quite as simple as that.

Non-tariff barriers 

Despite the global reduction in tariffs achieved by GATT and WTO, despite technical advances in containerisation and shipping, despite the expansion of air freight, growth in global trade has stalled. Other barriers to trade have become more significant, so-called Non-Tariff Barriers (NTBs).

Pre-GATT, tariffs are estimated to have been an average of 22%.  Subsequent reductions in tariffs achieved by GATT & WTO have effectively been wiped out by the rise in NTB costs, which are variously estimated at around an average of 20%. There are wide variations between geographical regions and industrial sectors, e.g.: the Atlantic Council estimated 25.5% NTB cost to the the US automotive trade;  the World Bank estimates NTB costs in Africa average 40%.

Supply chain issues and customs procedures are a major barrier to trade with developing nations, as described by EU Referendum blog :
  • Nigeria: Chronic traffic congestion and corruption at the port of Apapa, part of the Lagos complex costs an estimated £20 million per day.
  • Ghana: delayed customs clearances at seaports cost importers $70+ million annually in demurrage charges, and millions more in extra rents.
  • Brazil: Poor internal transport & communications infrastructure creates delays and potential demurrage costs of around US$25,000 per vessel per day. Customs clearance takes 12 times longer than in the EU.
  • South-East Asia: Substandard infrastructure, poor quality control and a corrupt business environment in the rubber market result in an unreliable supply chain. Carried inventories are extended by 90 days, equating to 10% higher landed costs.
  • India: Complex Rules of Origin (ROO) mean that trade beyond raw materials faces expensive hurdles.
  • Air freight: Adopting electronic documentation along the global cargo chain could save US$12 billion per annum and prevent 70-80% delays associated with current physical paperwork.
  • World Economic Forum report suggests reducing supply chain issues could increase global GDP by nearly 5% and global trade by 15%. 
  • The 2013 Bali agreement on Trade Facilitation will boost trade by reducing costs and delays for traders, through measures that provide predictability, simplicity and uniformity in customs and other border procedures.  Fully implemented, it could increase global GDP by almost $1 trillion. 
  • A video tweeted by Maersk (a major global shopping & container corporation) explains how trade facilitation will boost global trade especially for developing nations and is well worth a view here.

Technical barriers to Trade

But the biggest barriers to trade, particularly for trade with the EU and other developed nations, are so-called Technical Barriers to Trade (TBTs).
  • These barriers occur where nations have differing regulatory regimes (i.e. technical product standards and regulations to protect consumers and natural resources).  Exporters face difficulties and cost in adapting their products to meet the regulations of a foreign market.  Furthermore, nations often seek to protect domestic markets by introducing regulations that effectively discriminate against foreign competitors.
  • The rationale for the Single Market is that a common "harmonised" set of regulations are established, so removing these technical barriers between member states. Which is why the introduction of Single Market introduced a flood of new regulations.
  • The need for harmonised standards and regulations has grown as globalisation has increased. Finished products are now often assembled from components sourced around the globe.  In simplistic terms, using imperial size bolts with metric size nuts is not going to work ! The need for common standards extends beyond the EU.
  • The Single Market also provides a regulatory barrier to exporters outside the Single Market. The EU is negotiating so-called "2nd generation" trade agreements with foreign countries. These include tariff reductions, but also focus on harmonising regulations, including recognising where each others regulations are equivalent or achieve the same objective, (termed "mutual recognition").
  • The EU's "bi-lateral" agreements are painfully slow - typically 5-10 years. The "big-bang" approach of harmonising all regulations is further complicated by taking into consideration the protectionist interests of all 28 EU member states. The EU-US TTIP agreement appears to have stalled completely on attempts at regulatory harmonisation.

Globalisation and Multi-lateralism

The process of regional integration and bi-lateral trade agreements has hit a brick wall. A patchwork of bi-lateral agreements also complicate world trade, leading to what is termed the "Spaghetti bowl effect". A global, multi-lateral approach is needed. Fortunately, in the same way that GATT worked to lower tariff barriers globally, the WTO is paving the way for global action on barriers to trade via a series of agreements:
  • The WTO Technical Barriers to Trade (TBT) Agreement covers trade in all goods (both agricultural and industrial) and requires that technical regulations, standards, and conformity assessment procedures are non-discriminatory and do not create unnecessary obstacles to trade. In particular, article 2.4 states that members SHALL use international standards where they exist. Article 6.3 encourages members to enter into agreements to mutually recognise each others conformity assessments (so that products tested in the home market are accepted as meeting required standards in foreign export markets).
  • The WTO Sanitary and Phytosanitary (SPS) Agreement allows Governments to implement national food safety and animal and plant health measures, but not for protection of domestic producers. Measures should be based as far as possible on the analysis and assessment of objective scientific data. Governments “harmonise” or base their national measures on the international standards developed in the "3 sisters" :  FAO/WHO Codex Alimentarius Commission (food safety); World Organisation for Animal Health, formerly the Office International des Epizooties (OIE); International Plant Protection Convention (IPPC) (plant safety).
  • The General Agreement on Trade in Services (GATS) is the first and only set of multilateral rules governing international trade in services. Ranging from architecture to voice-mail telecommunications and to space transport. Covering Banks, insurance firms, telecommunications companies, tour operators, hotel chains and transport companies. Individual countries choose to open markets in specific sectors but can also choose to reserve certain sectors for national treatment (e.g. Health services).  Since January 2000, services have become the subject of multilateral trade negotiations, the so-called DOHA round of negotiations.
  • The WTO Intellectual Property Agreement covers trade and investment in ideas. Internationally-agreed rules state how copyrights, patents, trademarks, geographical names used to identify products, industrial designs, integrated circuit layout-designs and undisclosed information such as trade secrets – “intellectual property” – should be protected when trade is involved.
These can be seen to provide a framework for a "Global Single Market".  As I discussed in a previous post on rules adopted by EFTA EEA states, the standards and regulations that govern this emerging Global Single Market are defined in a myriad of international organisations. Organisations based on an inter-governmental approach of consensus, voluntary opt-in, right of reservation, best scientific knowledge and best working practices. Regulations can be proposed by any member state who want to initiate harmonisation efforts to reduce trade barriers.  The best example of this is the "International model" of regulation developed by the UNECE WP.6 working party. In short, these various international forums foster international co-operation to reduce trade barriers.

The contrast with the supra-national EU is telling.  The EU commission holds sole power to propose and amend legislation.  The EU council and parliament make decisions by qualified majority voting, the UK can and is regularly outvoted. Moreover, the bulk of the European Single Market regulations are approved by committees (chaired by the EU Commission) and are not even subject to EU Council and Parliament votes. Increasingly, the EU are simply "rubber-stamping" international regulations, although it does not prevent the EU from "gold-plating" some regulations, particularly when big corporate interests lobby for a complex implementation to stifle their small business competitors.

And the most damning point is that within international organisations, the UK is relegated to the role of an EU proxy.  A Global Single Market is being forged and we have surrendered our voice, vote and opportunity to take part in shaping its creation. We are not at the "top table". Fellow blogger LostLeonardo has produced a number of excellent posts on this topic, notably on Article 34 ,  the fallacy of "clout" in trade negotiations and "embracing-a-global-role"


Britain, more than most nations, relies on international trade for its prosperity.  The EU is barely growing and its many economic problems, not least the Euro, are not going to be resolved any time soon. Fundamentally, being locked into the EU's custom union, behind the EU's common external tariff, with trade policy surrendered to Brussels, is very much against our long-term interests.  It is clear Britain has to look to free trade and wider horizons to prosper.

But it also has to be understood that trade has moved on in recent decades.  Non-tariff barriers are now dominate concerns over tariffs.  An independent Brtiain wishing to forge trade links with developing nations, will face non-tariff barriers. As an independent nation, Britain could choose to direct overseas development aid and its diplomatic and military resources to addressing these problems particularly for developing Commonwealth countries in Africa. Coupled with a progressive approach to tariffs for developed nations, Britain would have a tremendous opportunity to assist developing nations in international trade, with long term benefits for all.

The most important and least understood barrier is technical barriers to trade and how "harmonised" regulations are needed to break down these barriers. The Single Market provides our current regulatory regime and simply walking away from the single market would leave the UK open to technical barriers equivalent to an average tariff of 20% or more.  Fortunately, it is possible to Leave the EU, but keep the Single Market. The EFTA EEA option provides a route out of the EU while maintaining current Single Market access. It provides political and judicial independence without risking trade and hence risking our economy. The UK would regain it's voice and vote in international organisations and play a full part in shaping the emerging Global Single Market.

Ultimately, the emerging Global Single Market provides an escape route from the EU's control of the Single Market. Increasingly, the EU is a redundant middleman, simply rubber-stamping international regulations.  Most importantly, the WTO TBT Agreement article 2.4 states that compliance with international standards shall allow market access. In time, it will be possible to forge a trade relationship with Europe based entirely on international regulations, without the unwanted and unwarranted involvement of the EU's political institutions.

The EFTA EEA option means it is safe for us to Leave and provides a first step in our journey away from the EU. Remain means we miss out on the global opportunity of a lifetime.