GY Formative Essay - Grade: 2.1 PDF

Preview

Summary

Essay on how brexit will affect UK trade policy...

Description

Word Count: 977

GY209 Formative Essay In this essay I will be addressing the potential impact that Brexit will have on Britain’s trade policy and the consequences this will have upon the British economy. Also, I will be commenting on the validity of the argument that leaving the EU would allow the UK to conduct its own trade deals with commonwealth and non-EU countries which would reap benefits for the British economy. One of the main benefits the UK could have by opening to the global economy is the increase in consumption through lowering the cost of goods whilst also providing a greater variety to consumers. This is achieved by capitalising on their comparative advantage which is when they can produce goods at a lower opportunity cost to their rival nations. Based on Ricardo’s theorem, which is proven by Bernhofen’s. and Brown’s paper, Britain is comparatively more productive in the service sector giving them an advantage when trading abroad. This will allow Britain to achieve potentially lower prices than if remained in the single market as can form trade deals to import goods that it isn’t as comparatively productive in. However, Ricardo’s model is simplistic in nature and only accounts for one factor of production (Labour) and assumes no transport costs which is inaccurate especially in this context since to trade outside the EU transport costs would most likely increase as would have to trade further afield. Moreover, services are more challenging to trade over borders so this effect may be limited. Building on this theorem, the Heckscher-Ohlin model gives us a more realistic framework to see the effect of the UK opening to trade. They use factor endowments (Labour and Capital) to observe patterns of trade with abundancy in a factor that is intensive in a good giving a nation a comparative advantage in that good. Britain can be seen to be more capital abundant relative to emerging economies for example those in Southern Africa (South Africa, Botswana etc). This would allow them to specialise and trade in capital intensive goods such as machinery and motor vehicles which contributed to £9.7 billion in exports to the region last year. Conversely, these economies in Southern Africa have labour abundancy in relative terms giving them comparative advantage in labour intensive goods such as fruits and nuts which alone contributed to £547 million worth of imports to Britain. 1 A post Brexit trade deal has already been agreed for this region to continue and potentially increase this trade to capitalise on aggregate gains of trade. However, a further extension of the H-O model with the Stolper-Samuelson theory allows us to better understand the consequences to Britain’s economy, specifically the winners and losers. (Stolper and Samuelson, 1941) They theorised that an increase in the price of the factor intensive good would increase the price of the abundant factor itself due to a rise in demand. The converse is true for falling prices in factor scarce goods. This implies that the benefits of trade, in Britain’s case, will fall to the capital owners as their purchasing power increase and as such losers will be those in labour intensive industries e.g. farming in the form of falling wages. However, in theory there are still aggerate gains for workers can

1

Word Count: 977

retrain making this a short-term adjustment due to labour market frictions and the gains from the winners can be used to help compensate these losers. Another extension to the H-O model shows how differentiated labour can also be a source of abundancy and scarcity. The UK possess a high skilled labour force compared to for say India who are relatively more abundant in low skilled labour. So, although Britain may be labour scarce overall if focus on their high skilled industry when exporting they can still maintain a comparative advantage which can help boost wages in this segment of the labour force. Overall the biggest losers to trade will ultimately be low skilled workers due to fierce competition from most developing economies. This can be empirically seen in Dorn and Hanson’s paper where they observe how the rise of cheap Chinese manufacturing (due to low skilled labour abundancy) accounted for a 25% decline in the US manufacturing sector. As a result of this they further observed how labour market frictions could absorb 66% of the gains of trade between China and the USA as people retrain, seek benefits etc. Currently the UK trades with the EU with 45% exports and 53% imports which is all done within the single market.2 All this is done with no barriers to trade including tariffs and quotas. Once we leave the single market however this will have dire consequences for Britain if a new unilateral FTA is not agreed. By being subject to tariffs it will have the opposite effect of trade creation by increasing costs of imports thus reducing consumer surplus and a reduction in overall trade. Even with countries such as the USA negotiating current trade deals with Britain it will still not be enough to make up for the lost trade between Britain and the EU. Moreover, given Britain’s economy is relatively small to the EU (a sixth of the size) it will suffer from lack of bargaining power and may be subject to unfavourable terms when trying to negotiate FTA’s both with the EU and larger superpowers such as the USA. In conclusion, although the opportunity to trade with nations outside the EU could bring benefits to the economy due to the positive economic effects both globalisation and free trade could bring to the economy, the significant loss to existing trading relations I believe will outweigh this. Especially if in due course there was a no deal Brexit, leaving the UK on WTO rules whereby it would be a long and arduous process to renegotiate all new trade deals with no guarantee of more favourable terms than we have already.

References: 2

Word Count: 977

Bernhofen D.M. and Brown J.C. (2004). A Direct Test of the Theory of Comparative Advantage: The Case of Japan Autor D. Dorn D. and Hanson G. (2013). The China Syndrome: Local Labor Market Effects of Import Competition in the US. https://uk.reuters.com/article/uk-britain-africa-trade/britain-agrees-post-brexit-trade-deal-withsouthern-africa-idUKKCN1VW1N5 1 https://www.pwc.co.uk/economic-services/ukeo/ukeo-nov16-trade-prospects-after-brexit.pdf 2

Ito T., Rotunno L. and Vézina P. (2017). Heckscher–Ohlin: Evidence from Virtual Trade in Value Added Stolper, W.F. & Samuelson, P.A., 1941. Protection and real wages, London.

Word Count: 977...