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Brexit Commentary
BREXIT COMMENTARY
03 Aug 2020 by Dr Frank Eich

Britain’s future trade relationships - distance will still matter

For the British government one attraction of leaving the European Union is to be able to pivot trade flows away from Europe towards the rest of the world. A key motivation is that by shifting exports from slow-growing mature economies to fast-growing emerging countries the UK can “future proof” itself and enjoy faster growth in return. But is this realistic?

The following chart (please see below) nicely illustrates the importance of distance in trade relationships. The vertical axis depicts the distance from London to the country’s capital city - the higher the dot, the further away the capital city in question - while the horizontal axis shows the value of goods and services imported from the UK as a share of the country’s gross domestic product (GDP). The picture would be similar for other countries too.

Despite being culturally close and sharing the same language, imports from the UK only account for a very small fraction of Australia’s and New Zealand’s GDP for example. Being at the other end of the world, distance clearly matters. In general, the closer you are geographically to another country, the more you are likely to trade with it. Indeed, the relationship is so strong that economists think about this phenomenon in terms of gravity: economic size (the market) and distance to market can explain a large part of bilateral trade flows. Of course, trade agreements matter too but their benefits generally take a long time to fully materialise.

It should come as no surprise then that European countries trade relatively more with the UK than, say, the US despite not being part of the Anglosphere. They have benefited from proximity and an established trade agreement.

Against this backdrop and the limited progress on the vexed issue of the future relationship between the UK and the European Union (German Chancellor Angela Merkel recently called the progress überschaubar - best translated as negligible), most trade experts continue to be puzzled by the British government’s relaxed attitude towards the prospect of a “no-deal” Brexit. Instead of seeking a close economic relationship with its largest trading partner, the British government has shifted its attention to signing free trade agreements (FTAs) with the rest of the world.

Australia and New Zealand have been identified as top priorities among developed countries. According to the Department for International Trade (DIT): “A free trade agreement...with Australia is part of delivering the government’s top strategic trade priority of using our voice as a new independent trading nation to champion free trade, fight protectionism and remove barriers at every opportunity. The government’s ambition is to secure FTAs covering 80% of UK trade within the next three years, to become a truly Global Britain.” (DIT, 19 June 2020).

So, how beneficial could these agreements be for the UK economy? DIT answers this using two scenarios. The first scenario assumes substantial tariff liberalisation by the UK, full tariff liberalisation by Australia, and some lowering of non-tariff barriers affecting goods and regulatory restrictions affecting services. The second scenario is more ambitious, with full tariff liberalisation on both sides, and more significant reductions in non-tariff barriers affecting goods and regulations affecting services. These would be pretty solid trade agreements. DIT’s scenarios for a New Zealand trade agreement are similar.

DIT finds that a trade agreement with Australia could increase UK GDP by around 0.01% under scenario 1 and 0.02% under scenario 2 over the next 15 years. This is within the margin of error of any forecast or projection. Reflecting the much smaller New Zealand market, DIT estimates that there would be no impact on UK GDP from a FTA with the country.

These results are not really surprising: the Australian economy is about a quarter of the size of the German economy and similar to that of the economies of North Rhine-Westphalia and Hesse combined. Meanwhile, New Zealand’s economy is more or less the size of Berlin’s. No assessment has yet been published on the benefits of a future FTA with the United States, already the UK’s largest export market. Hopefully the DIT will find larger benefits given the size of the US economy.

But it is not only size that matters. In addition to the exact specification of a future agreement (there will be winners and losers), there is empirical evidence that trade agreements are the more beneficial the closer the participating countries are. This is because international supply chains - which drive intermediate goods trade - generally require short distances. Whichever way a future UK-Australia or UK-New Zealand FTA might look like, the UK is unlikely to establish complex supply chains with them. And the same will probably be true for China, Japan or the United States.

What does this mean for UK-German trade in the future? Chances are that the UK’s closest European neighbours, including Germany, will remain the most important trading partners for many years to come. Given the importance of distance, European supply chains will also remain highly relevant.

Whatever the British government’s ambitions, it won’t be able to shrink the planet.

***

Dr Frank Eich, economicsense Ltd, London
www.economicsense.co.uk


References and data sources:
- UK-Australia Free Trade Agreement The UK's Strategic Approach, Department for International Trade (2020)
- UK-New Zealand Free Trade Agreement The UK’s Strategic Approach, Department for International Trade (2020)
- Are all trade agreements equal?, Rebecca Freeman (2018)
- UK total trade: all countries, non-seasonally adjusted, Office for National Statistics
- Country GDPs 2018 in US Dollar, World Bank Data Bank




Chart: The importance of distance in trade relationships
Download: Dr Frank Eich Brexit Commentary

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