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Why There Will Be a UK-EU Trade Deal By New Year’s Eve---and What the US Can Learn From It

December 14, 2020

By Jeff Ferry, CPA Chief Economist

If you’re not following the UK-EU trade deal negotiations, this is Europe’s greatest current cliffhanger, pushing even the COVID crisis off the front pages in Britain and many EU nations. The European Union is no stranger to last-minute, through-the-night negotiations, but the stakes are very high in this one, as Britain is only days away from spinning out of its temporary transition period with the 27-nation EU and into a new world of mutual 10 percent tariffs, with the likelihood of chaos at all the ports and airports in the United Kingdom as flustered Customs officials try to figure out how to levy new tariffs on truckers who will be furiously impatient, having spent a week or more sitting in lengthy queues at ports like Dover and Calais. British consumers are reportedly stocking up on household goods this week and the phrase “panic buying” is on everyone’s lips.

But this weekend it suddenly became clear how this negotiation ends. The EU will compromise, and will agree to terms that British PM Boris Johnson can accept. A German newspaper editor gave the game away. I predict this will all become clear before the deadline of New Year’s Day. And the moves in this particular chess game hold important lessons for the US and for incoming president Joe Biden.

From the moment Britain voted to leave the European Union in June 2016, political leaders all over Europe began to debate the terms by which the EU would agree to trade with Britain. The French government wanted to take a tough line and make it painful for the British economy and the British people, largely to act as a warning to other nations that might consider leaving the Union. The campaign has been highly effective. After all, exports and imports each represent just over 30 percent of UK GDP (double the comparable shares in the US economy), and trade with the EU accounts for 47 percent of UK trade. Some 234,000 UK businesses are exporters, or 9.6 percent of the total number of businesses (the comparable figure in the US is less than 1 percent). On top of the fears of all these exporters of lost business are consumer fears that thousands of essential and non-essential goods would rise in price once 10 percent tariffs were imposed on all UK imports from the EU.

But then on Sunday, like that famous Turner painting of the sun breaking through over storm-tossed boats at Calais pier, all suddenly became clear. German editor Alexander von Schoenburg published an article in British newspaper the Daily Mail entitled “Why my fellow Germans DO want a Brexit deal.”

Von Schoenburg explained that the chief EU negotiator, Michel Barnier, a Frenchman, has been pushing the French hard line, but now the German government has put its foot down. On Friday, German Foreign Minister Heiko Maas said publicly that the EU must find a “political solution,” while Chancellor Angela Merkel was quoted that same day saying that “everything” must be done to reach a mutually acceptable deal. Von Schoenburg is in no doubt, as am I, that Merkel’s wishes will be heeded and a deal will be struck. In the EU, France leads the marching band but Germany calls the tune.

Why the sudden change of EU heart? Britain, Von Schoenburg explained, is just too important an export market for German industry for Germany to allow political grandstanding over a UK-EU trade deal. Von Schoenburg accused the French government and its man Barnier of trying to enforce a deal in which Britain would be visibly “punished.” In contrast, Von Schoenburg argued:

“Germany, of course, has much more to lose from a No Deal conclusion than France. Last year we exported 80 billion euros ($96 billion) of goods and services to the UK—which is the world’s biggest buyer of German cars, accounting for almost one in five of our motoring exports. Volkswagen alone sold 200,000 cars in Britain last year. You [the UK] are also big buyers of German pharmaceuticals, chemicals, and petroleum products….Future generations will judge us harshly if we walk away from the talks now.”

The strong language, especially the mocking critique of the intransigent Barnier, suggests that Von Schoenburg was likely reflecting a briefing from a German cabinet minister—possibly even Merkel herself.

Since Boris Johnson won election a year ago on a Brexit-full-speed-ahead platform, the British people have been beset by growing fear and trepidation over the possibility of no UK-EU deal. But the signal from Von Schoenburg shows that a deficit country almost always holds an advantage in such negotiations, because the export surplus nation has more to lose. Britain has been a trade deficit nation for 22 consecutive years.

There are four fundamental insights to draw from this episode:

  • First, the international trading system, which British politicians like to call the rules-based international order, is fundamentally defective. It puts no obligation on surplus nations to reduce their surpluses. This allows persistent surplus nations like Germany (and China and many others) to game the system by overproducing, underconsuming, and exporting unemployment and deindustrialization to nations that can’t or won’t game the system. The British take pride in their own role in building this so-called system in the 1940s. But in fact, the most important point of economist John Maynard Keynes’s plan for a post-World War II international economic system was to place an obligation on surplus nations to reduce their surpluses. Keynes’s plan was not only rejected at Bretton Woods by the Americans who dominated the 1944 conference, but the leader of the US delegation mocked Keynes, referring to him as “Your Majesty,” because of his eccentric Bloomsbury speaking voice, which sounded haughty and pompous to American ears. The Americans were determined not to be locked into agreements by debtor nations, because they could not foresee that they would one day become one themselves. Keynes was 100 percent correct that the system cannot work if many nations take unfair advantage and if debtor nations have their backs against a wall.

 

  • However, deficit nations have a powerful weapon: surplus nations are more desperate to keep markets open for their exports than deficit nations are to buy those goods. That’s because there are almost always substitutes for the goods in question and also because tariffs on such goods will only raise their prices, typically by a small amount. That’s less painful for the buyer than the loss of market share, revenue, and jobs is for the exporter. So deficit nations have more power than they often think.

 

  • Third, the economics profession is guilty for what amounts to malpractice in not pointing out the weaknesses of the free trading system for deficit nations. This is why the great “populist” revolts came in the two most persistent deficit nations, the UK and the US. Note that two of the greatest economists of the 20th century did not fall for the overselling of free trade: American economist Paul Samuelson broke the silence of his retirement in 2004 to publish an article stating clearly that it is “dead wrong” to claim that free trade always benefits both nations. And Keynes advocated tariffs as part of a solution to Great Depression unemployment. In a beautiful 1933 article in the Yale Review, Keynes wrote: “economic internationalism embracing the free movement of capital and of loanable funds as well as of traded goods may condemn my own country for a generation to come to a much lower degree of material prosperity than could be attained under a different system.” (He was right about a full generation but he got the start date wrong; it started with modern globalization, Britain’s entry into the EEC in 1973, followed by the entry of Asia and eastern Europe into the world trading system in the 1990-2001 period.)

 

  • Fourth, if free trade involves a tradeoff of lower consumer prices in exchange for higher unemployment and deindustrialization (the loss of high-wage, high-growth industries), then it follows that the reverse is also true. Less free trade can reduce unemployment and stimulate the high-growth, high-wage industries in exchange for slightly higher consumer prices. The net benefit of either solution, or of a compromise solution somewhere in the middle, cannot be found in logic; all the alternatives must be objectively examined, analyzed and compared. Each nation must find its own optimal solution.

 

Boris Johnson will likely get his UK deal. But if he were truly visionary and truly focused on converting the so-called Red Wall of formerly left-wing districts he won in the last election into permanent Conservative voters, he would go much further. He would make a speech announcing Britain’s “withdrawal” from the so-called rules-based system. He would publicly put Angela Merkel, Ursula von der Leyen, Joe Biden, and Xi Jinping on notice that the system had failed the UK by converting it into a permanent deficit, constantly-deindustrializing nation. He would erect tariffs on selected growth industries, especially automobiles, and he would set targets for growth of those industries. He would then watch as wages and employment rose. He would tell the other leaders that the UK stood ready to rejoin the international system as soon as it was revised to put debtor and creditor nations on an equal footing.

Unfortunately, he won’t do that. There is precious little new thinking on the economy in the UK today—with the possible exception of Will Tanner’s intriguing new think tank, Onward. Similarly in the US, there is not enough new thinking on the desperate plight of our economy. The recent book Deaths of Despair brings home the ravages of US deindustrialization, which have been concentrated in a shorter time period than in the UK.  We have had persistent deficits for exactly twice as long as Britain, 44 years, but British industrial decline started under the gold standard before deficits were possible.

Think how powerful it would be if two deficit nations joined forces and said they would trade with surplus nations either not at all or only under penalizing terms. We might actually find our way to a genuinely equitable rules-based system that would encourage international prosperity instead of enabling the exploitation of the misguided by the manipulators.


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