Trade Deals Alone Won't Make Brexit a Success
Theresa May has a clear plan to buttress Britain after it leaves the European Union: trade, trade, trade. As if your life depended on it. She’s hoping, as she travels to Washington today, that President Trump will help make that possible.
Some might note the obvious tension between pushing the deglobalization button -- as the U.K. has in leaving the European Union -- while claiming you are going global. But there is another less glaring but equally important problem with her agenda: Betting that trade will be enough to drive economic growth is risky at best. At worst, it’s folly.
It would be difficult to find a successful modern-day economy that is not big on trade; but there are plenty of economies throughout history which faltered despite being highly open. In the 16th century, Spain led Europe in Atlantic trade. A century later, it was the Netherlands, and by 1656 its exports and imports represented a remarkable 85 percent of gross domestic product. However, unlike Britain, the experiences of Spain and the Netherlands eventually amounted to nothing but stagnation for the centuries that followed.
In theory, of course, trade can improve efficiency, encourage specialization, enable the exploitation of economies of scale, and promote innovation and technological diffusion. But as I argued in a book on the subject, while markets and trade are common to many economies past and present, growth and prosperity don’t always follow.
Unpicking the two-way interactions between trade and growth -- and actually proving them -- has been tricky for economists. In a 1999 paper for the American Economic Review, professors Jeffrey Fankel and David Romer famously showed that every one percentage point increase in the share of trade in output can raise income per person by up to two percentage points, but that, statistically speaking, the result is barely significant. Later work struggled to find any statistically significant relationship, suggesting that it is growth that most likely drives trade rather than the reverse.
Once the factors for growth are in place, it’s likely that trade will continue to fuel them, creating a virtuous circle. However, according to World Bank economists Tatiana Didier and Magali Pinat, the maximum effect of trade on growth appears to be felt when engaging with developed economies, when there are high levels of intra-industry (as opposed to inter-industry) trade and when part of value chains. Replacing trade with European economies with trade with less-developed economies may, therefore, reduce the impact of British trade on growth. And research published by David Autor, David Dorn and Gordon Hanson last month found that trade with China has in fact reduced not increased American industrial innovation.
New trade deals will not be enough to deliver rising levels of income if not underpinned by growth-promoting policies at home. And there it is worrying that the government’s main domestic policy tool to boost economic growth is a new industrial strategy, outlined in a green paper Monday. The government’s 10-point plan is a vague grab-bag, ranging from the promising (policies such as expanding digital infrastructure and providing “a proper system of technical education”) to the perplexing (“cultivating world-leading sectors”). History has not been kind to such attempts in the past, particularly when they involve picking winners, whether explicitly or implicitly. To be convincing, May needs to persuade us that her industrial policy is distinct from previous such attempts.
Brexit itself represents a serious blow to two of the key forces that drive growth -- science and immigration. More money won’t easily compensate for lost cross-border collaborations between researchers and universities. And the tougher stance towards immigration is likely to hurt entrepreneurial and innovative activity. Immigrants are, for example, 70 percent more likely than natives to set up their own business; 25 percent of all British Nobel Prize winners are foreign-born. And it’s not only skilled migrants that help; the “unskilled” have also played an important and often neglected role in supporting the wider economy.
While May likes to talk up Britain’s past as a great trading nation, such trade was as much the product of growth as it was the driver. The Industrial Revolution of the 18th and 19th centuries, which moved Britain from global backwater to global leader, was rooted in technological improvements which pushed down costs and, through resultant lower prices, brought millions of international customers to Britain’s doors.
Britain’s export strength came not because of trade deals but as a result of innovation and underlying economic growth. In the words of Deidre McCloskey and Robert Thomas “trade was the child of industry.” To gauge how successful May’s new trade policy will be, watch her domestic policy.
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