April 8th, 2016
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The possible Brexit scenarios
The market for goods
The principle of non-discrimination requires WTO members not to treat any member less advantageously than any other; grant one country preferential treatment, and the same must be done for all others. There are exceptions for regional free trade areas and customs unions like the EU, but the principle implies that, outside of these, the tariff that applies to the ‘most-favoured nation’ (MFN) must similarly apply to all.
In practice, this would prevent discriminatory or punitive tariffs being levied by either the EU on the UK, or vice versa. The maximum tariff would be that applied to the MFN. The EU’s MFN tar- iff has fallen over time, meaning that in this particular context the ‘advantage’ of membership has declined. On a trade weighted basis the MFN is 1.5% (please view this as an average).
However, given that MFN tariffs would be imposed on around 90% of the UK’s goods exports to the EU by value, it would necessarily mean many exporters becoming less price competitive, to varying degrees, than their counterparts operating within the remaining EU, and those within countries with which the EU has preferential trading relationships.
Similarly, because the UK has negotiated as part of the EU at the WTO, it is likely that it would inherit the EU’s tariff regime at the time of leaving, meaning, at least initially, higher prices would be faced by consumers buying imports from the EU and those countries with which the EU has a trade agreement.
Without any change, a 32% tariff would be levied on imports of wine (surely this is a reason to vote in!), and a 9.8% tariff on motor vehicles. The implications of a move to an MFN trading ar- rangement for exporters and domestic consumers would vary considerably by sector.
For instance, without a trade agreement, a tariff of 4.1% would be applied to liquefied natural gas exports from the UK to the EU; a tariff of 12.8% to wheat and meslin (a type of flour), and a tariff of 6% to unwrought aluminium, all items which the UK currently runs a trade surplus with the EU. There would be a 12.1% tariff on goods vehicles, and 3.8% on car components. In all, 1200 types of goods would be affected to varying degree.
The market for services
Obstructions to services trade are usually in the form of non-tariff barriers, such as domestic laws and regulations, also known as ‘behind the border’ measures. In general, services markets are more highly regulated than the market for goods. Often, regulation is intended to meet so- cial objectives, or to correct failures in supply, rather than to directly restrict foreign suppliers, but the effect on market access for foreign companies can in some cases be highly restrictive.
EU Member States retain considerable national discretion over services regulation and supervi- sion. Just as a fully level playing field in services trade does not exist within the EU, so exporters from outside the EU face different levels of market access in individual Member States.
However, the level of market access would generally be far more limited for UK exporters under a General Agreement of Trade and Tariffs (GATS ) arrangement than it is currently for a number of reasons:
1) Many restrictions that are forbidden within the EU remain applicable to firms outside the EU because Member States have made no commitments under the GATS schedules in those areas.
2) The EU (unlike the GATS) has pursued the harmonisation of regulation and supervision in several large services sectors, thereby taking away the justification of Member States to insist on national regulation in this respect.3) The right of commercial establishment is guaranteed under EU treaties, significantly fa- cilitating trade in services provided via the commercial presence of a foreign firm. Simil- arly, the free movement of labour facilitates trade in those services provided through the presence of people in the territory of another economy.
4) EU competition policy prevents, to an extent, barriers to services trade arising from in- cumbent firms benefitting from excessive market power.
5) The Treaty rights with respect to free movement of services, freedom of establishment, and free movement of labour are enforced supranationally by the Court of Justice of the European Union, underpinned by extensive case law on services exchange.
Under GATS, an independent panel can be appointed to settle and enforce disputes, but there is no presumed right of market access; the job of the panel is merely to assess whether the barrier in question is non-discriminatory. As well as affecting cross-border trade in services, these re- strictions could also have implications for UK companies providing services through a commercial presence (effectively outward direct investment) in other Member States.
The EU treaties require that a service provider from one Member State be legally free to estab- lish in another, while continuing to regulated by the authorities of its home country. A UK com- pany that provides services through establishments in other Member States may find, if Britain is no longer a member of the EU, that it has to comply with the requirements of a foreign regulat- ory authority.
The Transatlantic Trade and Investment Partnership (TTIP)
This is a trade deal between the USA and the EU which has been conducted in secret. The ongo- ing discussions are about market access, specific regulation, and broader rules for cooperation. The biggest concern which has gained much publicity is the proposed Investor-state dispute set- tlement (ISDS). This is an instrument that allows an investor to bring a case directly against the country hosting its investment, without the intervention of the government of the investor’s country of origin. The fear is a US health services company could be awarded a contract to sup- ply e.g. the NHS, and then the US investors claim the return is less than promised and so sue the NHS, or indeed the government, with any fees payable by taxpayers. But as so much of the deal is still confidential, this cannot be proved.
What will happen if Britain votes to leave?
The following scenario is my opinion based on history and current institutional arrangements. It is not written to be deliberately alarming, rather it is designed to be a reasonable economic analysis with some political consequences. But as you know economists are famous for getting things wrong!
As soon as the vote is announced and it is to leave, the forex dealers will sell sterling (they may well have been doing this in the weeks before the vote). The hedge funds will see the decline as a one way bet and very quickly sterling could hit $1.25 and €1.08.
In July the Government will fail to sell £10Bn of gilts at 2% (in January the gilts sale was only 1.1 x oversubscribed – normally it is covered up to 6 times). This will raise the long run interest rate to around 4%. The mortgage rate will respond immediately and mortgages will increase by 2% overnight. The housing market will shudder to a halt and prices will stop rising. It is possible but unlikely that prices will crash.
Assuming sterling does not recover from the rates predicted above, the UK inflation rate will rise to 3% by Jan 2017. The Bank of England will raise base rate to 2% by March 2017.
Cameron will resign. Boris, Gove and Duncan-Smith will claim the moral high ground, and one supposes a bid for the leadership.
By September 2016, retail sales will have stopped dead and the papers will be full of misery. Finance directors will begin to conserve cash as a recession begins. As government revenues col- lapse there will be an emergency budget in November with much deeper cuts in public spending than anyone expected, due to the soaring interest bill on the national debt.
As the Balance of Payments deficit continues to widen to 5% of GDP (due to a weak currency) the Treasury will argue that domestic demand must fall further as exports are not responding to lower prices.
In May 2017 unemployment will begin to rise and there will be a mass exodus of EU workers to a strongly recovering Europe.
This recession lasts three years. By the end of 2017 the Tories lose their working majority. Scot- land demands another referendum and in 2019 they vote to leave the UK and apply to join the EU.
Out of desperation, the UK is forced to do deals with the EU which are against its long term in- terest, but access to the market is regained (with the abolition of controls on EU workers). The Conservatives lose the 2020 election, the incoming Labour government has a majority of 5 with the SNP holding the balance of power. Yvette Cooper, the first female Labour UK PM, causes con- cern by appointing her husband as Chancellor of the Exchequer.
Points to bear in mind
It is companies not countries which trade with each other. Almost all countries have at least one world class local company, but it is like to be small and selling into global niches.
British companies prefer to trade with the old colonies or where culture and language is com- mon. We have only a few large manufacturing businesses which possess a comparative advant- age. We have many smaller companies with price premium niches (but whose owner-managers often avoid countries where the food is poor, or there is no sailing or skiing which they can com-
bine with a business trip). These companies depend on highly skilled engineers, designers and IT specialists from around the world.
British exports are mostly premium priced, a lower exchange rate does not increase volumes by much if at all. It does however increase the profit margin.
We have significant comparative advantages in services. After the US, Europe is the biggest global market for services.
It takes a long time to establish a presence in new markets unless you are selling clearly differ- entiated goods on the internet.
So what should you do if you run a UK based business? If you are exposed to currency risk, buy forward now.
As a precaution make sure you have banking arrangements which will allow you to survive a cash shortfall. Or begin to build a cash position.
Distribute this paper to all your employees; do not tell them how to vote but emphasise how im- portant the vote is.
Try and avoid getting angry with the political debate (that is unless the quality improves). If you find that you disagree with this paper then do your own research and see if you can refute its content. The first place to start is fullfact.org.
The House of Commons Library The FT The Economist The Bank of England
The ONS https://fullfact.org/ I fully recommend this site. It checks the veracity of political utterances.
Published March 17 2016
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