Deepak Lal: Trade policy and Brexit

The UK must acknowledge that foreign trade is a positive-sum game, and the correct policy is a unilateral adoption of free trade

The weeks after the ‘Leave’ camp won the United Kingdom’s Brexit referendum, the ‘Remain’ camp has been suffering from post-traumatic stress. They are still hoping for some way to stay in the European Union. This centres on the trade deal with the EU, which allows continuing access to the single market. Various models – the Norway model, the Swiss model, and even an Albanian model – are being bandied about.

Theresa May — a Remainer who became the new UK Prime Minister after a Shakespearean denouement to the Tory leadership contest. Amongst the Leavers, Michael Gove like Brutus stabbed the Caesarian frontrunner Boris Johnson a few hours before he was to announce his candidacy for the leadership. But, within a week Mr Gove, like Brutus, had met his Philippi. With the remaining Leaver Angela Leadsom ending her candidacy in tears, Ms May won. She has emphasised ‘Brexit means Brexit’, and has put three Leavers – David Davis, Liam Fox and Boris Johnson – in charge of departments to bring this about.

The single market with its harmonisation of laws and regulations and free movement of persons is not in the UK’s interests. The referendum result makes it impossible any longer to accept free movement of EU nationals into the UK. Moreover, as Martin Howe, a barrister specialising in EU law, has shown at length (“How to leave the EU”, www.politeia.co.uk), the single market and the European Court of Justice which enforces it, are protectionist by nature, imposing high costs on British producers and consumers. “Though only 15 per cent of the UK’s economy is involved in exports to the EU but 100 per cent of the economy consisting of sales to the domestic market and non-EU export sales are subject to the single market regulatory burden.” As the UK has the lowest share of exports to other EU states than any other member state, these regulatory costs “spread out more widely to impose costs on economic activities outside those which gain any benefit from freer trade into the single market”.  

The UK should therefore aim for free trade with the EU outside the common market, and if that fails it should trade with the EU under the existing low tariff WTO rules. Its focus should be on forging free trade deals with non-EU countries, making use of the deals it is already party to through the EU, by replacing the EU with the UK as co-signatory without any further elaborate negotiations, and creating new free trade deals with the US, India, China, Australia et al. It can now do so without having to go through the EU, which has to get 27 countries with different objectives to agree to free trade deals with non-EU countries, as witness the failure to conclude the free trade deal with Canada because of Romanian disputes about visas!

Concentrating on its own free trade deals, instead of a future trading regime with a protectionist and increasingly economically dysfunctional EU, will also allow Britain to reclaim its pioneering role and the mechanism it used in the 19th century for free trade on the correct economic principles that the UK had accepted. Following Adam Smith, since the Repeal of the Corn Laws the UK acknowledged that foreign trade is not like warfare – a zero-sum game, as mercantilists believe – but a positive-sum game with mutual benefits for participants. In fact, for any single country, despite the protectionism of other countries the correct trade policy is a unilateral adoption of free trade. This gives rise to consumption gains, as the country obtains its consumption bundle at the lowest cost. It also leads to production gains, as the country specialises in the goods in which it has a comparative advantage. Furthermore, there will also be “dynamic” indirect gains through transfer of foreign technology, and by promoting competition less productive firms are forced to contract and more productive ones to expand. For both reasons there will be dynamic gains that will raise the economy’s productivity and thence rate of growth.

Thus, a country will benefit from removing its own tariffs and import restrictions even if all its trading partners maintain theirs. For, these trade restrictions only damage the protectionist country’s welfare, and it would be senseless not to improve one’s own welfare just because someone else is damaging theirs. Hence, there is an incontrovertible case for every country to unilaterally adopt free trade, irrespective of the protectionist policies of other countries. The major contemporary example of the adoption of this policy is China since its Open Door Policy in 1982.

Britain followed this advice throughout the 19th century. The US by contrast has from its inception never accepted the principle of a unilateral move to free trade. It has believed in reciprocity: it would only cut its tariffs in exchange for cuts by its trading partners. This is based on the erroneous assumption that trade like warfare is a zero-sum game, and one should not unilaterally disarm, but only if one’s enemies do so too. With the end of the British imperium and its replacement by the US after the World War II, its mercantilist view of foreign trade became the basis of GATT. The interwar tariff barriers were to be reduced by mutual disarmament through GATT.

It would take me too far afield to examine the consequences for the world economy. But, see my Reviving the Invisible Hand for how it has moved from the 19th century liberal international economic order where the British unilateral adoption of free trade by the Repeal of the Corn Laws in 1832 was imitated by others. Not least, by the French who through the Cobden-Chevalier treaty of 1860 (incorporating the MFN, or most favoured nation, principle), and the string of treaties they signed with other European countries led to virtual free trade in Europe. UK trade policy after Brexit could lead to a similar outcome: overcoming the resistance the WTO is facing to promote further freeing of trade based on its erroneous mercantilist principles, and more importantly to the unravelling of the “spaghetti bowl” of preferential trading arrangements (PTA’s) – of which the EU was the earliest – and which are destroying the multilateral trading system.

Ironically, the denouncing of the existing PTA’s (like NAFTA) and the new ones proposed, by both the candidates in the US presidential elections, might lead it to instead sign individual free trade agreements with many of its trading partners, whilst destroying its current and planned PTA’s. If the UK adopts a future trade policy with the EU eschewing the single market, but offering reciprocal free trade, and failing that of trading under WTO rules with an external tariff equal to the EU’s, this could begin a process similar to that it initiated in the 19th century of ending mercantilism. This could at last provide for the adoption of the intellectually honest case for unilateral free trade.