A UK-US free trade deal could boost national output by £80 billion and cut UK prices by 8 per cent

A UK-US free trade deal could boost national output by £80 billion and cut UK prices by 8 per cent

The key promise of Brexit is free trade with the world, while we continue to trade freely via a trade agreement with the EU.

In the internal Brexit debate, attention has been monopolised so far by our talks with the EU over how we can go on trading with them without hindrance. Since we start from an initial state of doing so, many of us have argued that reaching a mutually beneficial continuation should not, in fact, be a problem. That it has been suggests we and the EU need to try harder – or think smarter. For example, we (and EU President Tusk) have suggested agreeing a standard free trade agreement, such as Canada+ or the recently concluded EU FTA with Japan, as a promising avenue, together with agreement on using existing customs procedures as a solution to the Irish border question, as currently practised at borders around the world.

But in this article, I want to concentrate on how we can achieve free trade gains with the rest of the world. My key point is that there is single trade agreement that promises to be both (1) quick to agree and (2) can also deliver, on its own, virtually all the free trade gains that we hope to receive from the non-EU world. This is agreeing an FTA with the US, which could deliver virtually all the economic benefits we are seeking.

Of course, there might be some subsequent sweeping up to deliver additional economic benefits that might still be missing and there would be other benefits accruing from achieving FTAs with our Commonwealth friends and with such multilateral agreements as the recently agreed Trans-Pacific Partnership (CPTPP).

To gain a grip on this free trade aspect, we need to recap how the UK gains from free trade. It is by removing trade barriers against suppliers from the rest of the world so that our consumers can buy from them at world prices. This in turn lowers home UK prices and forces home producers to raise productivity to compete. Any jobs squeezed out by higher productivity are replaced by jobs in expanding sectors, with domestic demand being supported through fiscal and monetary policy so that it is equal to available supply. Rising productivity raises wages, which increases the supply of people wishing to work and so raises employment.

These gains can be achieved via unilateral free trade, or otherwise by numerous free trade agreements (FTAs) around the world, which, between them, open up our markets to world suppliers – equivalent to implementing unilateral free trade. In practice, the FTA approach is what the UK Government plans, since – politically – it is easier to offer opening our markets in return for other countries opening their markets to us.

In addition, there can be economic gains from other countries lowering their trade barriers against the UK. However, even though substantial gains may accrue to individual UK producers, the macroeconomic gains to the UK in aggregate are likely to be small because of the way world competition works.

For example, suppose a new market is opened up by country Y letting in £X million of a UK product tariff-free, while keeping tariffs on other countries. Increased UK sales in this market will displace other countries’ sales there, driving these sales into other world markets where the UK also competes. The balance of world supply and demand for this product does not change, therefore, and nor does the world price. So, overall UK production, which is sold around the world at the average world price, will not expand. Nevertheless, there are gains to individual firms due to the widening market access, which keeps politicians happy, even if the macroeconomic gains to the economy are small or negligible.

In sum, then, the main macroeconomic gains we realise from many bilateral trade agreements result from removal of our trade barriers on foreign suppliers. This means we can estimate the major gains from many FTAs as approximately equal to those from unilateral free trade. In addition, we have the microeconomic gains to individual producers from wider access to world markets, plus some small macroeconomic gains from this that we cannot easily estimate.

Now consider the possible gains from a UK-US free trade agreement. Suppose we give the US full tariff-free access to our food and manufactures markets in return for them giving us tariff-free access to their markets – eg, services. The US, as a very large economy, can easily provide all our import demands. Therefore the US price will be the dominant supply price for UK consumers and home producers will have to match this US price. To the extent that US prices are the same as world prices, our consumers will have access to world prices so that the gains we make will be equal to the gains we would have made by doing a whole raft of FTAs with world producers – i.e. approximately the full gains we would make from implementing unilateral free trade.

Therefore, the gains we make from a US FTA boil down to a calculation of how close US export prices are to world prices. Let us begin with food. The US exports about 10 per cent of total world food exports. Plainly the US could not do so unless it matched world prices, food being a commodity in perfect competition.

Turning to manufactures, how competitive are US producers? On this we have extensive data, a summary of which is shown in the Table below that shows global prices of manufactured goods. The Table is based on very detailed price data collected for each country on exactly comparable products (so avoiding issues of quality) in order to carry out international purchasing power comparisons.

What this Table shows is how US export prices at the border compare with the major world suppliers, Korea and the EU weighted average supply. The EU is generally more expensive than Korea, which can be thought of as the default OECD manufacturing source of competitive supply.

When we add international transport margins, we find that the US matches or nearly matches these competing world prices in all categories of manufactures, except textiles and transport equipment.

While these price figures are from 1992, they are consistent with later data from tariffs and non-tariff barriers, which provide an alternative way of estimating price differences due to trade policy.

So, when we compare a UK-US FTA with a full-range of global FTAs that between them drive UK prices fully to world prices, in practice there is little difference. Thus, achieving a US FTA effectively – in one bound – would bring to the UK gains equal to those from unilateral free trade.

We estimate the benefit of the UK implementing unilateral free trade to be an increase in long-term GDP of 4 per cent, or an ongoing and increasing boost to the UK economy of £80 billion. Furthermore, average consumer process would drop by 8 per cent. We can easily envisage that a UK-US FTA would reduce protection against US food and manufactures by enough to achieve similar trade gains.

It might be asked whether the US has sufficient product availability to supply the UK’s import needs. This is overwhelmingly probable since the US economy is some seven times the size of the UK’s. Furthermore, an analysis of 100 product categories (i.e. all HS 2-digit product codes) found none where the US was not a substantial exporter to the UK. Furthermore, an analysis of the more detailed HS 4 digit level (10,000 product categories) found only a handful where the UK does not already import from the US – and these were primarily food products with high EU tariffs or that have been excluded by the EU’s Precautionary Principle of food safety, most notably GM vegetables.

In spite of the oft-repeated comments about President Trump being a ‘protectionist’, it is evident that he – backed up by his Trade and State Department officials, as well as frequent commentary from himself and the American Ambassador to the UK – is eager to proceed with a UK-US FTA. The Office of the US Trade Representative has recommended doing so, the US Congress has passed enabling legislation, and UK-US Working Parties have been meeting for the past two years in ‘scoping’ exercises to prepare for the day (30th March 2019) when the UK can legally begin formal negotiations.

Consequently, we potentially could achieve a UK-US FTA relatively quickly and therefore the major trade gains of Brexit very rapidly and in full on leaving the EU; for example, under a WTO-rules exit. In one bound we would have achieved the gains from the free trade agenda, leaving further FTAs to consolidate these gains with other good world supply sources, and also to bring with them any further macro and micro gains from wider world market access.