Brexit, is there light at the end of the tunnel?

Brexit

 

As the inevitable approaches, we are still in a quandary. What does the future hold? Is the grass really greener on the other side, or is it just an optical illusion?

Questions, questions, questions but still, no answers!

What was inevitable? Brexit means the UK will leave the single market and customs union without a deal. All in the belief that Europe was bound to giving us a deal that allowed us to carry on as before, without contributing to Europe in any way shape or form, because they are dependent on us. Simply an illusion.

It is best if we put Nigel Farage and Boris Johnson out to pasture and let them live in their dreams! Perhaps we could also send Jacob Rees-Mogg back to the 17th or 18th Century where he belongs.

 

What is the EU?

 

It is the biggest partnership of nations ever created, with totally unrestricted trade between the members. No other ‘free trade’ agreement allows companies from one country to trade freely with the population of another. All other free trade agreements allow company to company trade across borders, but require that the ultimate trade with the consumer is carried out by an entity that is registered and taxed in the country where that trade takes place.

 

To achieve this there has to be a set of rules and regulations in place that ensures a level playing field in markets of all member countries. Hence the term single market. Every person within that market has a right to sell his services (labour) in any member state, on the same terms as applicable to the population of that member state, hence free movement of labour.

 

In no other free trade agreement, would you be allowed to go into another country, pitch your tent and start trading with the population without registering as a business in that country and paying tax in that country.

 

Mature people in any partnership, be it marriage or business, work out their differences through discussion rather than attempt to break things.

 

It should be clear that there very little possibility of us ever making a free trade agreement with any country that replicates or even comes close to what we have with Europe.

 

Free Trade Agreements.

 

When we consider free trade agreements we must see that no country enters into an agreement unless it will get tangible benefits from that agreement. It does not simply open it’s market without a clear benefit to itself. For example the USA, produces a large food surplus, which is supported by Government buying of grain surpluses, which are largely distributed as aid, but the USA would rather receive money for these surpluses.

 

The USA would, therefore, want your markets fully open to it’s agricultural sector. As they have different regulations, would you want your agricultural sector to have to face competition where genetically modified crops and hormone reared animals are allowed? Now these might not be bad for us, but, could our farmers withstand competition of this kind without our regulations being downgraded to their standards? If we downgrade our standards would we still have a market in Europe?

 

There might be little damage if there was clear labelling as that would give the consumer the right of choice. However, the USA would resist labelling unless this could be fudged.

 

Now consider our ability to enter into free trade agreements.

In probability because of historical reasons we might stand well with the Commonwealth, but we would need to understand that they would also want their quid pro quo. For example easier visa and migration rules. In any event, some of our past misdeeds in our colonies are also likely to raise their ugly heads.

 

If we consider other countries we need to ask ourselves the question. Which would they prefer to do a deal with, Europe or the UK? A market of 500 million people or a market with 65 million? I think, if we delude ourselves that other people can’t count, then we are in a sad place, probably populated by the Boris Johnsons, Nigel Farages and Donald Trumps of this world.

 

A look at our own economy will show that we, in fact, have little to offer. While we say our economy is 80% services not all of these are trade-able. The largest portion of our services sector is made up of the NHS, Retail Trade, Hospitality and Care Sectors. Now, the USA would like us to open up the NHS by moving toward an insurance based system in which they would be able to compete. There might in fact be a case for this, as it is the system most used throughout Europe, though in Europe, this is done by a state run insurance system (ring fenced contributions) rather than private enterprise.

 

Of the services sector we are left to Financial Services, Transport and Consulting.

 

Consulting includes Accounting, Advertising, Architectural, Digital, Engineering, Legal and Management. If we look at these we will see that if we have the skills required, very few countries, even those where there is no trade deal, preclude us provided we register and pay tax in that country, for the services we render there!

 

Our Transport sector is mainly Trucking across Europe and is not therefore applicable to any trade deal in distant places, where only shipping and airfreight is of importance.

 

At last our strength Financial Services. I wonder how many countries are going to allow us the absolute freedom given by Europe and let us just pitch our tent and sell to the general public, without requiring us to be capitalised within that country, and complying with its regulatory environment. Certainly, if they do, they would require a minimum of an absolute guarantee from the British Government for any default. Most of our major Financial Services companies already have subsidiaries in the countries where they consider there is viable market for them.

 

I think that most in this sector already have subsidiaries in Europe. For the companies to escape the worst effects of Brexit they would only need to capitalise and staff those subsidiaries properly, while also adhering to the European regulatory regime. No different from what they would have to do in any other country with whom we might do a trade deal. Life will be little different, for the companies, although costs might be slightly higher as Europe will undoubtedly introduce their financial transactions tax that was opposed by the UK. To the exchequer, however, the impact might be quite big.

 

The remainder of the economy.

 

Major exports: Oil, Bulk and specialist Chemicals, Arms and Munitions, Motor Vehicles (mainly to Europe), Agricultural produce (mainly to Europe) and Alcoholic beverages.

 

How come oil? Thought we were running out?

You may ask.

Simply because we import oil from Saudi and the Arab Emirates as a quid pro quo for selling them arms, and therefore have oil available to export.

 

Very little of our Motor Car industry is locally owned, and most of the players in the industry have plants in China, South America, USA, Mexico, Europe and Africa. The general rule has been to manufacture as near to your market as possible to cut out shipping and transportation costs. It is unlikely that any deal will vastly expand this sector.

 

Bulk and specialist Chemicals are mainly derived from oil or other forms of mining and we will be manufacturing close to our capacity in these products. Possibly investment could expand that capacity, but don’t hold your breath, there is significant competition from other oil producers.

 

So we are down to Arms and munitions. As the USA is in a similar situation, do you wonder that the Middle East is kept in a state of unrest. It also explains the rhetoric on Russia, trying to bring back a cold war situation, so that countries spend more on armaments. That is largely the reason behind Trump’s drive for NASA to be upping their expenditure and importing weapons from USA. He would be most upset if they increased their proportion of spending by expanding their armies!

 

Trade deals do not expand the market for Armaments, unrest and insecurity do! If we consider Theresa May’s announcement of the deal by BAE systems to build warships for Australia as an indication of the potential of future trade deals, and then learn that the ships will be built in Australia, we see that deals are not all they are cracked up to be! Our only real gain will be the fees for design (provided BAE can manage the build within budget) and the armaments we export for them. The bulk of these armaments will undoubtedly come from the USA as BAE is basically 75% USA and 25% UK owned.

 

Still think that the grass is greener?

 

Yes there are benefits, the cost of foods might decrease as we import cheaper Chicken, Beef and Grains from the USA. However, that might mean the demise of our own Agricultural Industry!

 

Quantifying the cost.

 

It is nearly impossible to quantify the cost as it is still difficult to see what is possible. As far as I can see the best we can hope for will be a free trade area but subject to border checks aimed at verifying the country of origin, and dealing with VAT payments, This might mainly be done electronically but without Customs being able to physically stop shipments and inspect it will never work.

 

Under this scenario we would see the smallest impact beyond disruption in the flow of goods, meaning manufacturers will face holding bigger inventories. This increases the administrative burden and risks, particularly the risk of facing substantial fines in the face of erroneous customs and origin declarations. The European Union has shown that it is not adverse to imposing fines.

 

WTO rules

 

The duties in terms of WTO rules are aimed at preventing unfair competition in the market from foreign countries. In the main these are fairly minimal and should not affect trade to any marked degree. In certain areas like Agriculture and the Motor industry countries are allowed to give a bigger level of protection, there might be a bigger impact. Food Security and Vehicle manufacture are deemed strategic allowing better protection of local industry.

 

The duty is not a cost to the exporter, but rather to the importer, unless the exporter chooses to absorb the cost by discounting the price. The true effect is to raise prices in the internal market. In the round this is simply a tax on the population resulting in a transfer from the population to the government.

 

The impact is therefore a squeeze on the ability of the population to spend because of the increase in prices. In some cases this price increase may result in in the consumer preferring to choose an alternative product or perhaps desist from buying. You can see a more detailed analysis of the effect of tariffs in my article on Donald Trump and Trumpism.

Depending on the fiscal strength of a country, it might be able to mitigate against this price increase, in it’s market, by reducing other taxes, to counter balance the tax earned from the duties, for example VAT.

 

In the case of food or agricultural produce the impact could be a lot greater. For example, because of duties, importing beef from Argentina is currently marginally more expensive than beef in the markets of Europe and the UK. The rise in prices by mutually applied import duties will make beef from Argentina cheaper than locally produced beef. Our own beef producers will therefore not have the full benefit of being able to increase prices by the amount of the import duty, but will suffer on their exports to Europe as our beef would now be substantially more expensive than Argentinian beef. This might have been a bad example as both Argentina and Brazil (the countries with the lowest cost of beef production) export their full surplus production to China in return for inward investment in their economies from China.

 

My own assessment of trade with Europe after switching to WTO rules is that trade in goods, with the exception of agricultural produce, will not be affected by more than three or four percent. See also my previous article on Brexit written before the referendum!

 

In the longer term there might well be a bigger impact, as Vehicle manufacturers (who all have production facilities both in Europe and the UK and are not UK owned) choose to tailor their production to the demand in each of the two markets. In other words they will produce in the UK to service the UK market and in Europe to service the European market. The effect of this is, that over the long term the real UK economy will shrink while the real European economy will continue to grow.

 

I think the grass on the other side is looking decidedly dull and lifeless the same as most of my neighbours lawns during this heatwave.

 

Conclusions.

 

1. There will be a reduction in UK tax revenues as a result of the slight reduction in trading activity as well as the Financial Services Sector having to pay it’s taxes in Europe on the income it earns out of Europe.

 

2. EU migration might abate, but, there will be increased migration pressure from the Commonwealth countries, particularly the poorer ones: India, Pakistan and Africa.

 

3. There might be reduction in government costs, from not paying into the EU, but, in probability this will be counter balanced by the loss of tax revenue from the Financial Services Sector and it’s staff, coupled with the loss of money flowing back into the UK from the EU (I doubt that our farming sector will survive if we fail to pay them the £3 billion they receive from the EU.).

 

4. All other participation in EU science initiatives, security and health will cost.

 

5. Finally to stand on our own feet we will need to be able to defend the value of Sterling which currently relies on EU rules accepting it as an reserve currency with no less importance than it’s own. (All member States are treated equally). The amounts paid to the EU are effectively not cashed and simply held as a reserve.

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