Why consumers, not producers, are the key to post-brexit trade
The arguments over the effects of Brexit on our trade are difficult to follow. If not agreement, I want to bring some clarity. To begin with, though, I need to establish two principles. First, the objective of economic activity is consumption. The things that economists obsess about – GDP, productivity, investment – are important solely because of their direct or indirect, immediate or eventual, impact on consumption. We work to live and not the other way round (although this is yet to dawn on many in the German economic establishment).
Most people are both producers (through their employment) and consumers. But the producer interest is more strongly represented in debates. The reason is partly because some people do not accept my first principle but, more importantly, because production is more concentrated than consumption. You could imagine an Association of Car Purchasers campaigning for tariff-free imports of cars. But cars are just one of umpteen things that people buy, and only every few years. By contrast, car manufacturers, on the whole, produce only cars and they produce them all the time.
Second, the economy is constantly changing. If external circumstances demand an adjustment but the existing structure of production and jobs is preserved in aspic, the result will be a loss of welfare. Yet lobbying groups reflect the perceived interests of existing producers. Accordingly, there is an innate bias towards defending the status quo.
Now to post-brexit trade. In an ideal world, our trade negotiations would push us towards free trade. Tariff-free and interference-free trade between the UK and the EU would continue. Meanwhile, restrictions that the UK is obliged by our EU membership to impose on imports from the rest of the world would be dropped. And, simultaneously, non-eu countries would drop their restrictions on our exports.
Freer trade equals more trade which equals increased real incomes. If this were the end result, then surely even remainers would embrace it. So what are the grounds for dispute?
There are three. First, remainers doubt that the UK will be able to forge a relationship with the EU that would maintain trade between us on an equivalent basis to now. Second, they doubt the UK’S ability to forge advantageous free trade agreements with other countries. Third, they believe that if we don’t manage this, we will be unable to boost our non-eu exports sufficiently to offset a reduction in exports to the EU.
Suppose the pessimists are right. Although, in my view, it is not the first-best outcome, the option of unilaterally reducing our barriers against imports from the rest of the world while opting not to impose them on the EU has a good deal to commend it.
This is counter-intuitive to many people, not least because they obsess about the producer interest and forget about consumers. If we reduced our trade barriers against the rest of the world then the UK price of non-eu imports would fall. This would pose stiffer competition for domestic producers who would lose out, in the short term at least, unless and until they could raise productivity to compensate. Note, though, that their loss would be consumers’ gain.
Admittedly, if that is all that happened then the economy overall would take a hit because imports would increase and that would weaken UK aggregate demand which, other things equal, would reduce employment. This is the substance behind Philip Hammond’s jibe that consumers need to have jobs to be able to benefit from lower import prices.
But other things would not be equal. Since we send 80pc of our tariff revenues to the EU, the bulk of the gain to consumers from lower tariffs would not be offset by losses to other parts of the UK economy. Moreover, because the UK would only be reducing barriers on the half of our imports that come from outside the EU, a good deal of the competitive pressure induced by lower prices to UK consumers would fall not on British producers, but rather on European exporters to the UK.
Take imports of wine, for instance. If, as a result of us dropping the 32pc tariff on imports of non-eu wine, the price to UK consumers fell, EU producers would be obliged to cut their UK prices. Here is a gain to UK consumers that does not come mainly at the expense of our producers. And if consumers had more real income as a result of tariff reductions, they would spend more.
Because of these opposing effects it is not inevitable that UK aggregate demand would fall in reaction to lower tariffs. If it didn’t then there would be no net adverse impact on jobs – although some jobs would disappear and new ones would be created. Back to the second principle.
If aggregate demand did fall, then to sustain employment, demand would have to be boosted by other means. The most obvious route is a fall of the pound which would tend to boost net exports (while, also, of course, reducing the gain to consumers from lower tariffs). In practice, we do not know whether the pound would have to fall further or whether the major fall that has already occurred effectively reflects the market assuming an outcome roughly similar to this.
The upshot is that current disputes about post-brexit trade revolve around what happens if we don’t secure the first-best result. The optimists argue that we would still be better off without the EU’S protectionism; the pessimists not. In principle this issue could be settled empirically. But we do not necessarily have to live through the experiment.
The tactics of how best to negotiate with the EU, and how much to reveal the possibility that we could unilaterally decide not to impose tariffs on imports from the EU, should perhaps be left to our negotiators. But the more they share the optimistic view, the stronger they can be – and the more likely it is that something like the first-best outcome can be achieved.
Roger Bootle is chairman of Capital Economics roger.bootle@capitaleconomics.com
‘The more our negotiators share the optimistic view, the more likely a first-best outcome can be achieved’