First things first: start with a trade strategy

Key Points

·       There is increasing acceptance and legitimacy of government policy intervention across a range of spheres, which includes trade policy. Government policy involves making trade-offs between efficiency, equity and security.
·       A sensible trade strategy should be one that seeks to support and contribute to domestic policy objectives, and thus these need to be clearly articulated as well as the extent of the contribution of trade policy to those objectives.
·       A key feature of trade policy is that it directly impacts the economic relations between countries, and therefore it almost always involves negotiation between countries as opposed to being unilaterally determined.
·       Given the gains from international trade it is tempting to see the desire to sign free trade agreements as a step in the right direction. However, this risks: focusing overly on efficiency, a lack of coherence across agreements, and pays too little attention to what can be achieved plurilaterally or multilaterally.
·       Trade and investment are closely linked, and in turn are important for long-run economic growth, leading to technical progress and increases in productivity, but which, in turn, requires clarity, certainty and stability in policy.
·       Trade policy is not just about free trade agreements but also working with and through the multilateral institutions and plurilateral initiatives which help to underpin the rules-based international economic environment.
·       Unilateral trade policy measures should be taken based on evidence, with transparency and consultation otherwise they are open to capture by interest groups, as well as political interference.
·       Trade liberalisation, including signing free trade agreements, needs to be done selectively, coherently and consistently across agreements. In order to achieve this, there should be greater clarity regarding the UK’s objectives across the wide range of issues increasingly included in free trade agreements.

In a recent blog, following another change of UK prime minister, and Secretary of State for International Trade, I commented: ‘Ask not which free trade agreements to sign but why you want them in the first place‘. The message was that it is important to first have a clear trade strategy and then to consider the different ways in which free trade agreements may contribute to that trade strategy. For the UK this has particular resonance and importance because having left the EU, the UK is now in a position to create an independent trade policy.

The 2019 Conservative Party manifesto lacked substance in this regard other than freeports, and the desire for striking new trade deals, aiming for 80% of UK trade to be covered by free trade agreements by December 2022 (the current figure is just over 62%). More recently, in November 2021, the Government published its “Export Strategy: Made in the UK, Sold to the World" which perceives trade strategy to be focused almost entirely on exports and the desire to open up opportunities for UK businesses. The Labour Party also published its approach to trade policy in September 2021 which identified the objectives of a worker-centred trade policy. Neither pays much attention to wider domestic policy objectives, the range of domestic constituents, nor the wide range of issues increasingly covered in modern trade agreements.

Two elements of contextualisation are worth mentioning here. The first is that in the UK, the Brexit referendum and subsequent debate have been often rancorous with polarised views, not just concerning the UK relationship with the EU, but more broadly with regard to international trade and trade policy. Sometimes it has felt like listening to a fairy story – with twists and turns, unicorns, magical outcomes and of course villains. This has made it more difficult to have a clear and rational debate about a UK trade strategy.

The second is that it is clear that many countries around the world are becoming more interventionist with regard to what can be loosely described as industrial policy and trade policy. This has been justified in part by geopolitical concerns notably with regard to China, but also as a response to two major shocks - Covid-19, and the Russian invasion of Ukraine -  which have required government action and intervention, and in the process of doing so have given increased legitimacy to intervention.

This Briefing Paper sets out some key considerations in the making of a trade strategy and a framework for considering the elements of policy that contribute to achieving that strategy. Possibly the most important point to make here is that a trade strategy, and thus policy to achieve that strategy does not exist independently of other policies. Trade policy is primarily about domestic outcomes and, therefore, also domestic politics, and thus has to be thought of in the context of the government’s wider economic and social policy objectives. A government’s trade strategy then becomes about how to support those objectives through trade policy with other countries. This is why you need to ask why you want trade agreements in the first place.

The aim of government policy is to maximise welfare. This includes both specific economic concerns (output, GDP) as well as non-economic concerns, such as inclusiveness, which often need to be balanced against each other. Inevitably, therefore, policymakers, face trade-offs in the policy choices that they make. A key element in good policymaking is to understand those trade-offs, and to be frank about them.

Conceptually, the typical trade-off which economists consider, and which appears in many an undergraduate textbook is that between “efficiency” and “equity”. Increasingly, however, there is a third aspect which needs to be considered: “security”.

Let me use import tariffs to illustrate the point: It is not difficult to show that from the perspective of economic efficiency (and under certain conditions), removing import tariffs is the most efficient trade policy for an economy. Efficient here means the policy that maximises real income. Take tariffs on food and agriculture as an example. While importing agricultural goods more cheaply may lead to a more efficient allocation of resources and benefit consumers, and firms buying intermediate inputs, it may also entail the contraction of some of the agricultural industry and the decline of some producers that may have been protected by the tariffs. Hence, the reduction in tariffs results in winners and losers and thus has equity implications

Note that typically equity may have a broader remit than simply jobs and income. There may be a legitimate public policy preference for maintaining a given domestic sector – food production and agriculture, fishing, cultural goods are frequently cited in this regard. For example, the government may care about the availability of food supplies and the domestic capacity to provide food for its population, or there may be preferences regarding the regional distribution of economic activity across a country.

Closely related to the preceding is the justification for government intervention (policy) where there may be, what economists call ‘market failure’. Market failure may occur when the actions of private agents and the market lead to spill-over effects onto others, which have not been taken into account. These spill-overs may be negative – for example concerning the environment; or they could be positive, for example, with regard to Research and Development (R&D). Market failure may also occur where there are information asymmetries. For example, where potential exporting firms do not have sufficient information regarding the policies and procedures in an export market. Where there is market failure, and a public policy preference for addressing that failure, such as minimising negative environmental impacts, or facilitating beneficial exports then government policy may be needed.

Simply because there may be equity concerns does not necessarily mean that the policy should not be introduced. It might, for example, mean that there need to be further policies to mitigate the negative consequences, or to attain those broader equity concerns. To stay with the example of agricultural trade, there may be a need for policies to support agricultural producers from the loss in income, or encourage diversification, or facilitate re-training. But equally, it may be that the broader public policy concerns dominate and/or it is hard to implement the flanking policies, such that the policy is not introduced.

There is however a third element in these trade-offs which is increasingly on the minds of policymakers, and which is concerned with security. Where efficiency is concerned with the best way of economically achieving a given outcome, equity is concerned with the impact on a particular section of society or on a particular outcome, security is concerned more with systemic risk which may impact across a range of outcomes and sections of society. As with efficiency and equity, security has a number of possible dimensions. The key dimensions are to do with national security and economic security. It is clear, that in recent years there have been growing concerns with national security related to military and ICT technologies, and economic security be this food security, energy security, or supply chain resilience in perceived ‘critical’ sectors.

Such security issues and the related geopolitical concerns have led to the emergence of policies with a more explicit assertive geopolitical focus ranging from the Inflation Reduction Act in the US, the EU’s Open Strategic Autonomy initiative, China’s dual circulation strategy, as well as the various initiatives in many countries to promote a domestic semi-conductor industry. These issues have also led to the emergence of new fora and dialogues such as the Trade and Technology Council between the US and the EU, or the Trilateral Initiative between the US, Japan and the EU.

Note that just because there may be equity or security objectives does not obviate the need for efficiency considerations. Suppose policymakers want output in a certain sector to be higher on equity or security grounds. This might well be achievable through protectionist tariffs, but it is unlikely that this is the most efficient way of achieving that outcome. Generally, policy is more efficient the more it is targeted at the problem / distortion it is trying to address. Hence a tariff may well increase production - and so addresses the problem of production being too low – but at the same time tariffs raise the prices paid by consumers - introducing its own distortion - which is inefficient. Hence, it is important to find efficient ways of achieving equity or security objectives.

With regard to domestic policy objectives, some fairly obvious ones come to mind - and the list is not intended to be exhaustive nor in any order of importance: higher economic growth; more inclusive economic growth across a range of dimensions; national security and economic security; increased environmental sustainability, minimise the impact of climate change; improved working conditions, digital competitiveness and digital security.

Of course, each of these needs more detailed analysis and discussion. For example, it is not enough to simply state a desire for higher economic growth. Almost anybody would want this as an objective. It is important to state how this is to be achieved, be this via incentives for investment and R&D, training and skill upgrading, worker mobility both national and international; the structure and access to finance; the physical, institutional and ICT infrastructure in the country and across the regions of the country; the extent and quality of investment in people be this through health care, education provision, or protection of workers’ rights.

As indicated earlier there is an increase in the acceptance and desire among policymakers for policy intervention. This appears to have gained ground with concerns about, what is often loosely referred to as, supply chain resilience, which is in turn linked closely to the earlier discussions regarding both national and economic security. This does not necessarily imply a desire for self-sufficiency, but it does mean reducing reliance on certain suppliers and countries. Those issues of ‘supply chain resilience’ are typically discussed in terms of their direct and immediate impacts, such as access to grain, energy, or semi-conductor chips. But they are, and should also be, related to longer-run concerns and objectives about the evolution and future structure of the economy, and how trade policy and what sort of trade policy can help in this regard. Policymakers should be concerned about that longer-run perspective and how policy can be used to facilitate longer-run objectives and to nudge the economy in given directions. Arguably this may be more important in a country, such as the UK, where firms typically have a shorter investment time horizon than appears to be the case in other countries such as Germany, Korea or Japan.

All this suggests that what is needed is a coherent industrial strategy, and then a clear understanding of how trade policy and the trade agreements that are signed contribute to that strategy. Two notes of caution here. First, the articulation of an industrial strategy does not necessarily entail a highly interventionist approach, nor does it entail picking winners. It entails the need for government to be clear about the medium and long-run objectives of the economy and the evolving structure of economic activity, and how policy is designed to help achieve this. This has many dimensions. In part, for example, this is concerned with the distribution of activity across sectors. In the UK economic activity is increasingly heavily dominated by services (which comprises over 80% of GDP), and manufacturing tends to be concentrated in capital-intensive, R&D-intensive and high-skill industries. We have also seen a rise in the use of services, and delivery of services by manufacturing.  In part, for example, this is concerned with who is engaged in that economic activity be this by firm size, worker composition, or across the regions and devolved administrations. Trade can then become part of that broader strategy as opposed to a, hoped-for helpful, add-on. It is perhaps telling to note that the last UK industrial strategy document was published in 2017, four Prime Ministers ago.

Whatever one’s views are regarding the political merits or demerits of leaving the EU, it is very hard to provide a convincing case that economically this is or will be beneficial to the UK. Almost universally all the empirical evidence both prior to the exit of the UK from the EU, and since its exit point to the negative economic consequences. Broadly speaking this is for three reasons:

1.     The direct effects of the increase in barriers to trade in goods and services, investment, and labour mobility.
2.     The increase in uncertainty regarding policy and outcome in the UK leading to an impact on investment.

In the longer-run these negative economic consequences may be substantial, and it is worth noting that economic history suggests that adjustment to large shocks for workers and regions can take a long time because of strong elements of path dependency leading to spirals of decline. In addition, and together with other countries the UK, has been hit by Covid-19, and by the disruptions caused by the Russian invasion of Ukraine. Nevertheless, even taking these factors into account we can see the negative impacts on trade and GDP from leaving the EU.