The Problem With Post-Brexit Trade Deals

17/07/2017 11:57
Yongyuan Dai via Getty Images

They say history repeats itself but never in the same way. In 1839, a Chinese scholar-official called Lin Zexu launched a campaign against British opium imports, which had made addicts of between four and twelve million Chinese people. The British responded with barbaric force, sending gunboats up the Yellow and Yangtze rivers and - at gunpoint - forcing "free" trade on the country.

Nearly 180 years later, the balance of power has shifted dramatically. Imports of cheap Chinese steel have emasculated the UK's oldest industrial communities, British gunboats carry no guns and China holds all the cards. The parallels are striking, if somewhat less severe. History can be deliciously ironic.

The bitter reality of international relations does not appear to have filtered down into domestic British politics. Indeed, since the EU referendum it has become "unpatriotic" to raise legitimate questions about the capacity of Britain to survive and thrive outside the EU. This is silly in all contexts, but particularly with regard to international trade.The UK is undoubtedly a wealthy and influential country - China, the USA and others do want to trade with it. But it does not follow that Britain will be able to sign good trade deals.

The messy world of international trade
When the UK leaves the European Union, it will default to trading under World Trade Organisation (WTO) rules and regain the capacity to sign free trade agreements (FTAs) with other countries around the world. This was also much touted by Michael Gove in the referendum campaign, who argued that Britain unchained could become a global trading entrepot in the mould of Singapore.

Assuming that the UK pursues this path - rather than creating a "customs unions" with Europe, which would prevent it from concluding its own trade deals - it will most likely copy the EU's "schedules," which set tariffs on goods imported from elsewhere. Once complete, the UK will not be allowed to increase tariffs beyond this level.

But here's the catch. Countries like China joined the WTO with relatively high tariffs - around 15% on average, though they have dropped to 10%. The UK will join the WTO in 2019 with relatively low tariffs - around 2%, based on those currently applied by the EU. China will be able to trade with the UK on these terms, giving it a significant advantage, which may obstruct the creation of a bilateral trade agreement.

You can't have your cake and eat it
Signing a trade agreement is rather like starting a romantic relationship: each party has to convince the other that they are better than the alternatives. For Chinese businesses trading with the UK, there is a clear and attractive alternative to signing an FTA: continue trading under WTO rules.

This is most obvious in the goods trade. China exports a wide range of products into the UK, with most of its major exports receiving an applied tariff of no higher than 2%. The UK charges 12% on sweaters, pullovers and vests, but these make up only 2% of China's overall exports into the UK. By contrast, UK exports into China are heavily dependent on the automotive industry. Unfortunately, these receive some of the highest tariffs in China: 8.26% for internal combustion engines and 25% for completed motor vehicles. If China can already easily sell its goods into Britain, it has no reason to give Britain a beneficial trade deal.

The same is true of investment. Indeed, the UK is one of the most welcoming countries in the world to foreign investors, much to the chagrin of left-wing populists like Jeremy Corbyn. On the OECD openness scale, the UK scores 0.1 (where 0 is completely open), significantly below the OECD average; China scores 0.4.

In both goods and investment, China already has significant access to UK markets. But despite this, the UK attracts a small fraction of Chinese exports - 2.7%, to be precise. This raises a more fundamental question. If the British market remains relatively insignificant under extremely liberal trading conditions, what need is there for China to conclude an FTA?

Buying political support
Some Western commentators have suggested that an FTA would beneficial to China for non-economic reasons. Vince Cable, for example, argues that the UK could support China's bid for "market economy" status, a designation bestowed on countries whose domestic prices are deemed to have been set by the market, rather than the government. Based on past evidence, China is willing to give generous concessions to receive this. In 2008, New Zealand recognised China as a market economy, which helped conclude an extremely beneficial trade deal with the country.

However, China has already launched a case to gain market economy status at the WTO, arguing that the EU and the US pledged to grant it to the country 15 years after it joined the the organisation. To quote the Financial Times: "the weight of legal opinion holds that China's case is valid." A WTO ruling on the matter is expected in under two years, but trade deals can take much longer to conclude, so by the time the UK leaves the EU, it will have lost the opportunity to leverage this to its own advantage.

Vince Cable also suggests that the UK could offer China political support against the threat of American protectionism. Ironically, the US recently concluded a minor deal with China which contained a significant political element. In return for limited market access, the US officially recognised China's "One Belt One Road" strategy for extending its influence in central Asia. The UK might be able to ape this approach, but the spoils will be small. If the UK were to offer greater political support - for example, by dropping its objection to human rights abuses - it would have to justify this to an increasingly xenophobic domestic audience and risk jeopardising relations with the EU and US, both of which are far more important to UK trade.

In the absence of real economic or political gains, China has little reason to agree to a trade deal with the UK, let alone offer serious concessions. The reason is clear. Having a liberal market economy is a blessing. But it also enables foreign businesses to trade with relative ease, stripping the liberal country of bargaining power. If Brexit Britain wishes to retain the liberal attitude to trade espoused by Michael Gove, it will have to accept that good free trade agreements might be difficult to find.