Brexit flexit: Britain hopes EMs will be at front of trade deal queue
Britain has made striking free trade deals one of its signature policies following the Brexit vote. Emerging markets will no doubt be keen to sign up but the reality is that such deals will take years to sign off
From the combative exploits of Sir Francis Drake in the sixteenth century to the more pacific overtures by modern entrepreneurs such as Sir James Dyson, Britain has seen herself as a premier trading nation. But the shock vote on June 23 that started the process for the UK to leave the European Union has left trading partners in emerging and developing worlds unclear about where the UK stands.
The role of smaller and poorer nations has become more important in the wake of a warning in September by US president Barack Obama, who said that US/UK trade relationships could “unravel”.
The Japanese government made an even more specific and stark threat, using a 15-page open memo to the UK government to warn that its firms could pull out of the country if they no longer had access to EU markets.
The idea that freedom from the constraints of a Brussels-led trade negotiation system would free Britain up to strike deals with emerging markets — and perhaps revive that buccaneering tradition — were central to the victorious pro-Brexit campaign.
Prime minister Theresa May used her first major event in the public arena last month to hail Britain’s proud history as a trading nation. Speaking ahead of her meeting with Chinese president Xi Jinping at the meeting of G20 leaders in Hangzhou, she said: “As the UK leaves the EU I’ve set out our ambition to be the global leader in free trade.”
But like her clarion call that “Brexit means Brexit”, that statement of intent over Britain’s future status as the world’s premier trading nation asked more questions than it answered.
May has sought to seize the initiative, holding informal discussions about future free trade deals after Brexit with the US, Australia and India at the G20 summit, the first major global policy meeting since the June 23 vote by Britons to leave the EU.
But now that three months have passed since the vote, many analysts say turning that vision into reality will be a different matter. “So much of what the UK and the rest of the world are going to have to go through, particularly in terms of trade, is yet to be decided and it is this uncertainty that will prove to be the biggest problem in the next couple of years,” says David Lea, senior analyst for western Europe at Control Risks, a global consultancy.
“There is a lot of negotiating to be done and while people are apparently quite confident about how that is going to go and expressing their opinion in very strident and confident terms, really nobody knows.”
Some of the larger emerging economies and particularly those that are fellow members with the UK of the Commonwealth have made equally positive noises.
Australia has emerged at the front of the queue. Its prime minister Malcolm Turnbull said in Hangzhou that his government had already been engaged in discussions with the UK about what the free trade arrangements may look like after Brexit.
“Australia is determined to provide Britain with all the support and assistance that we can,” he said. “We are such great friends, such strong allies. [There] couldn’t be two countries with closer bonds.”
One of New Zealand’s top trade negotiators is flying to London to support officials in the newly minted Department for International Trade headed by Liam Fox. Singapore, Mexico and South Korea seem keen.
However, analysts such as Andrew Kenningham, senior emerging markets economist at Capital Economics, are not convinced that verbal promises will be followed by hard negotiation any time soon. Australia’s trade minister has since put a timeline of 2.5 years after the UK leaves the EU.
“These things go very, very slowly and many emerging markets have a big backlog of other things they are working on in terms of trade policy, so their thinking on this issue will be almost minimal in somewhere like India,” says Kenningham.
While there is nothing to stop Britain and emerging countries starting to negotiate a trade deal while the UK is still a member of the EU, it will be hard to strike any meaningful deals until it is clear what relationship Britain will have with the rest of Europe.
However, it is clear that — Brexit or not — there is huge potential to exploit and expand the UK’s trade network.
Although the share of UK exports to non-EU countries has risen in the last two decades, sales to the rest of Europe, which has enjoyed anaemic growth for the last eight years, still make up 44% of all exports. Eight of the top 10 markets for UK exports are in the EU (and the eurozone) with Switzerland and China completing the list.
But while the US (17%) and Germany (8%) make up a quarter of exports, outside the top 10 no country is the source of more than 2% of exports.
And many of those countries sell many times that share to the EU as a whole — the UK may make up 4% of Hungary’s trade but the EU is worth almost 60%. Other than China, the largest emerging markets are India with 1.6% and Russia with 1.5%.
CHINA: 'MUTUAL TRUST'
Among those emerging economies likely to see benefits from a new free trade deal, the largest and most interesting is China, which is the UK’s sixth largest trading partner with 3.5% of British exports and which sends 2.6% of its exports to Britain.
Premier Xi told May in Hangzhou that China wanted to continue to promote “even more stable, better” relations with Britain’s new government.
While the two countries should continue to promote co-operation in the areas of investment, energy, infrastructure and finance, Xi added: “Both sides should increase political mutual trust, expand common interests and appropriately handle disputes.”
This was widely seen as a reference to May’s surprise delay to a decision on whether to back a $24bn nuclear project at Hinkley Point in the west of England, to be built by French firm EDF with the help of $8bn from China, which would then go on to build further plants.
Kenningham at Capital Economics says it highlights the tensions that both emerging markets and the UK will encounter as they look to strike third-nation trade deals outside the EU.
“The UK may want to offer even freer access to foreign direct investment. But you run into issues as we’ve seen with the Hinkley Point nuclear plant,” he says.
“The agenda that one part of the government has advocated is absolute free trade, but I think in reality that will run into all sorts of objections within the UK government before you can get around to negotiating with other countries.”
Lea at Control Risks points out that the UK will be in a weaker bargaining position than some major emerging market powers. “The pressure will be on the UK to agree trade deals and agree them quickly,” he says.
“So I suspect they will not be driving too hard a bargain, and the rebalancing of power in the global economy will make emerging markets think now is a good time to do a trade deal with the UK in terms of getting markets for primary products and semi-manufactures.”
He says the major Asian powers such as China and Japan will have the resources to negotiate a wide ranging deal but it will be of such a size and scope that it might take years to sign off. The trade deal between Canada and the EU took six years to negotiate and has still not been ratified after two years.
He says it is more likely the UK will target some of the smaller emerging economies such as Mexico, Singapore and Sri Lanka that have already voiced their interest.
“There will be pressure on the UK to show progress early and I think it will want to demonstrate a few early successes,” says Lea at Control Risks. “They may look to some relatively friendly countries who have a commitment and try to seal those early.”
Smaller emerging markets will not be in such a strong position. “It will be an additional burden for many EMs, especially smaller ones,” Kenningham says. “Their capacity to negotiate trade agreements is quite limited.”
And according to Richard Baldwin, professor of international economics at the Graduate Institute of International and Development Studies in Geneva, there is less to play for. “For emerging markets exporting mostly manufactured goods, there’ll be little change,” he says.
However, a lot will come down to what type of trading relationship Britain can agree with the rest of the EU. Negotiations on that can only start when the UK triggers Article 50 of the Lisbon Treaty and can take up to — but not longer than — two years.
Given that, Kenningham says emerging markets simply will not have the option of negotiating a deal until that process ends. “These things go very, very slowly and many EMs have a big backlog of other things they are working on in terms of trade policy so their thinking on this issue will be almost minimal in somewhere like India.
“Certainly I think it will be difficult for them to achieve very much even in the long term and impossible to achieve anything in the short term.”
The key issue will be the precise legal relationship between the UK and the EU and what access that gives traders and investors to use Britain as an entrepot for the rest of Europe.
Those talks will be tied up in the poisonous issue — for domestic UK politics — of finding a trade-off between the UK’s desire to maintain access to EU markets and its need to satisfy its citizens’ demand to control immigration.
According to Malcolm Barr, an economist at JP Morgan, there are good reasons why the UK’s interests may be best served by setting out a goal to remain within the European Economic Area (EEA) — known as the “Norway option” as that is what the Nordic non-EU country has done.
“Leaving the single market implies an enormous step change in the UK’s trading relationships with the EU,” he says. “Starting from the standpoint of staying in the EEA at least has a pre-existing legal form which can be drawn upon.”
This would enable the UK to either use the flexibility over migration already allowed for in the EEA, or negotiate additional protocols to make additional UK controls over migration more explicit.
However, David Davis, head of the UK Department for Exiting the EU, appears to favour an exit based on a new set of bilateral agreements with the EU — sometimes referred to as the “Swiss option”.
Liam Fox has said he would prefer a free trade agreement with the EU rather than be part of the EU custom union, which he says could restrict the UK’s ability to negotiate lower tariffs with other trading partners.
Quite how seriously he will be taken by UK exporters and potential trading partners remains to be seen, however. In early September the international trade secretary told activists that Britain was “not the free-trading nation it once was. We have become too lazy, and too fat on our successes in previous generations.”
He added: “Companies who could be contributing to our national prosperity — but choose not to because it might be too difficult or too time-consuming or because they can’t play golf on a Friday afternoon — we’ve got to be saying to them if you want to share in the prosperity of our country you have a duty to contribute to the prosperity of our country.”
His remarks did not go down well with British businesses, with Richard Reed,
co-founder of Innocent Drinks (and a high-profile Remainer), calling Fox “a complete fraud” while Chuka Umunna, a Labour member of parliament, branded him a “complete disgrace”.
But away from the mud-slinging of UK politics and the long negotiations in dark Brussels’ committee rooms, the outcome will make a big difference for emerging markets, says Baldwin at the Graduate Institute. “For nations like India, which use the UK as an entry way into the EU market Brexit is a problem,” he says. “If the exit option chosen involves Single Market access, then all is well, if not, the UK-India agreement won’t help.”
Tata Motors, the Indian giant, owns Jaguar Land Rover (JLR), one of the UK’s biggest car brands. Outside the EU trading system, UK-based carmakers could lose preferential tariffs and customs treatment that could make conducting business in Britain more costly.
In a statement issued immediately after the Brexit vote, JLR said: “There will be a significant negotiating period, and we look forward to understanding more about that as details emerge.”
However, Baldwin says that for most emerging markets, which export mostly manufactured goods, there will be minimal impact. “If UK agrees an EEA-like agreement, there’ll be little change for EMs.”
Since all existing trade agreements become void the moment the UK leaves, poor countries in particular will be anxious to know that the preferential treatment they have under the EU’s Everything But Arms (EBA) programme will be maintained. Under EBA, 49 least-developed countries (LDC) gain full duty-free and quota-free access to the EU for all their exports with the exception of weapons.
Kimberly Elliott, a senior fellow at the Center for Global Development in the US, says the UK’s parliament will need to pass legislation to replicate this. The UK will also need to come up with its version of the EU’s Generalised System of Preferences (GSP), lowering tariffs for the least developed countries without also lowering tariffs for rich countries. Change needs checking
But it will be the countries above the LDC threshold with bilateral deals with the EU that may be worried. “The UK will have to renegotiate these and I suspect the problem for developing countries is that these will be well behind in the queue behind the EU, US and Canada,” she says.
“The best outcome in the short run would be if the UK early on passes EBA and GSP with reasonable rules of origins and as broad a coverage as possible, so low income countries are covered from day one and they can then negotiate beyond that.”
Given the timescales involved in trade deals, it may take years if not decades to see clearly whether Britain has used its freedom from the joint EU trade bloc to recreate the network of trade deals it once enjoyed.
Given the political imperative it is likely that the UK will push for deals and emerging markets will seize the opportunity to get a deal on better terms with one of the major economies.
But it is hard to predict the nature of that relationship even 10 years ahead. As David Lea says: “The most important influencing factor is not going to be the UK’s attitude but the overall tone, flavour and mood music of the international trade regime that is in place then.”