Never mind what others do: Cut your own tariffs

Following Mrs May’s famous dinner with Jean-Claude Juncker, EU politicians and officials have expressed astonishment that she doesn’t grasp how unlikely it is that she will be able to do a trade deal with the EU – and the disaster this portends for the UK. The Prime Minister is right not to be too concerned.

Our detailed analysis at Economists for Free Trade shows not only that no trade deal is better than a bad deal, but that it can actually be better than the deal the UK has at the moment.

To understand this, we first must deal with the myths surrounding what is misleadingly called the “WTO Option”. It’s a misleading term because every option for the UK in its new trading arrangement will be a WTO option. In practice, there is no other way the UK can leave, regardless of whether Britain has done a deal with the European Union.

There are clear economic benefits to embracing free trade, irrespective of how negotiations with Brussels turn out. 

Once the UK leaves the Single Market, it will take up its full (founding) membership of the WTO and trade under its rules. Contrary to another myth, these only set the rules of engagement, but do not dictate tariff levels. 

The UK would adopt the EU’s Most-Favoured-Nation (MFN) tariff schedules as its WTO tariff schedule upon leaving because the UK has been a member of the EU Customs Union. If the UK has agreed a trade deal with the EU, its terms would govern the UK’s trading relationship with Europe – but the MFN tariff schedule would govern the larger part of British trade with the rest of the world. If the UK has not agreed a deal, then MFN rules would apply to the EU as well.

Crucially, these schedules dictate only the maximum tariff levels the UK can impose. Importantly – and to bust another myth – the UK can elect to reduce those tariffs, possibly eliminating them altogether. There is no obligation to maintain them: the only obligation is to treat all countries the same (except for those countries with whom the UK has concluded a trade agreement).

So what happens if we remove tariffs against the EU and the rest of the world? In summary, a standard world trade model shows that unilaterally removing tariffs creates a long-term GDP gain of four per cent, a fall of eight per cent in consumer prices, and an increase in Treasury revenue of more than seven per cent, compared to the status quo. Contrary to yet another myth, the UK would gain these benefits even if the EU and the rest of the world do not reciprocate.  

It will be up to Britain to decide what level of tariffs it sets against the EU and consequently the rest of the world. This single decision will decide whether we prosper.

About half of this gain comes from eliminating our tariffs on goods imported from non-EU countries, abolishing the UK’s relatively few non-trade-barriers, and eliminating the CAP and its associated levies. The other part of the gain comes from not raising tariffs on manufactured goods imported from the EU after leaving – even if Brussels decides to raise tariffs against us.

Clearly, this will be a better situation than we have today – a massive gain for the consumer.

However, problems arise if the UK engages in a tit-for-tat tariff policy against the EU in response to their levying import tariffs against it. If the UK retains goods and agricultural tariffs against the EU (and consequently against the rest of the world, as WTO rules would require), GDP drops four per cent from today’s levels, virtually no decrease in consumer prices is obtained, and the Treasury loses about two per cent of its revenue. This represents a massive eight per cent negative swing in GDP, compared to removing all import tariffs. Furthermore, such a policy would disrupt manufacturing supply chains. This, in fact, was the very scenario the Treasury and others used in Project Fear to discredit the WTO option.

It will be up to Britain to decide what level of tariffs it sets against the EU and consequently the rest of the world. This single decision will decide whether the UK prospers in its new trading environment.

Some argue that unilateral free trade is complicated or even “politically impossible”. However, this argument should be seen for what it is: the modern resurrection of the age-old producer vs consumer conflict that Cobden and Bright so notably turned on its head when the Corn Laws were repealed. This set the British economy on a course of global trade expansion for the better part of a century. 

Producers need not suffer in order that consumers benefit. Our research shows that manufacturing – aided by sterling’s lower exchange rate (likely to last for several years) – can prosper without protection. Even without the benefit of a lower currency, a modicum of productivity improvement, coupled with new opportunities to re-source supply chains at better value from both the UK and the rest of the world, will allow manufacturers to compete successfully.     

Nevertheless, some politicians prefer an alternative approach – i.e., negotiating a series of free trade agreements with the rest of the world. Under this approach, the UK would not unilaterally eliminate import barriers but would attempt to achieve the same objective via such agreements.  

The absence of a trade deal really can be better than the status quo – and certainly better than a bad trade deal. 

While perfectly valid, this approach has some disadvantages: it will take time, may miss some important countries and risks stalling. Therefore, if Britain decides to go down this road, it must spare no effort in preparing for signature as many free trade agreements as possible with major like-minded countries before the end of the two-year Article 50 negotiation period. 

Thus, the lack of an EU trade agreement will not be calamitous, the WTO option is not to be dreaded, and there are clear economic benefits to embracing free trade, irrespective of how negotiations with Brussels turn out.  

The absence of a trade deal really can be better than the status quo – and certainly better than a bad trade deal. But perhaps Mrs May already recognises this.