Brian Easton says there are lessons about international trade to be learned from Brexit, especially as it is very unusual for an economy to break so completely from its major trading partner

This is a re-post of an article originally published on pundit.co.nz. It is here with permission.

Whether Britain leaving the European Union was right or wrong, good or bad is for the Brits to decide. But there are lessons about international trade to be learned from Brexit, especially as it is very unusual for an economy to break so completely from its major trading partner.

In Econ101 we are taught Ricardo’s theory of comparative advantage. In summary it says that specialisation makes economic sense; that it is a good idea for you (or a country) to do what you do best and trade the surplus for something you want from someone else who (or other country which) does it comparatively better. An economist then spends the rest of her or his life exploring the caveats and subtleties of the theory when it applies to the real world. It’s not logically wrong – it’s just that the real world is more complex.

For example, there are transaction costs in trade. I wrote a book, Globalisation and the Wealth of Nations, which explored the consequences of the costs of distance – transport, inventory, information ... Standard trade theory was not a lot of help. It is a static account of the economy and when we measure the allocative gains from trade we get a small percentage increase. (Which, not incidentally, is why is was so hard to find the promised gains from Rogernomics.)

Yet the evidence points to economies thriving with international trade (although not necessarily everyone in each country). In the end I concluded that the growth came not just from the specialisation but was reinforced by economies of scale and economies of agglomeration, and by competition which stimulates innovation and competitive advantage.

This conclusion is orthodox. The book’s twist was to highlight the costs of distance. Think of them analytically as a natural tariff. As these barriers to trade decline, economic growth is stimulated. (The same happens between regions within a country.) The distance costs have fallen dramatically over the last two centuries and driven globalisation – increasing interconnection between economies. (Since they wont fall as much in the future, we are likely to see some slowing down – even stagnation – of the globalisation of the markets for goods. However, service trade is likely to continue to grow as information technology transfers becomes more efficient.)

So it is no surprise that the British economy has suffered from the rise in the barriers which resulted from the withdrawal from the European Union. The UK government's Office of Budget Responsibility calculated that Brexit is costing 4 percent of GDP over the long term – that adds about three years of stagnation to the British economy. That is probably an underestimate because the dynamic effects are almost certainly greater. (Both investment and skilled labour have moved to the continent to avoid the barriers.)

Many of the barriers come from the fact that the two regimes no longer have the same regulations. The difference has resulted in increased documentation and phytosanitary requirements (measures to eliminate the spread of diseases transferred through livestock, plants and such like). Part of the point of the withdrawal, as far as the Brits were concerned, was to allow them to pursue their own regulatory regime because, it was argued, Brussels was too intrusive. (Some of the alleged rules, like how bent bananas could be, were very funny and entirely fictitious.)

The move to common regulation was the result of the 1992 Maastricht Agreement which aimed to convert the European Community (as it was then) of a multitude of markets into the single market of today’s European Union. (Just as we do not have different regulations between the North and South Islands.) There is a sense that the Brexit vote was a rejection of the transformation of the EC (which they joined in 1973) to the EU which they left in 2020. (I am not discussing here how badly the withdrawal was handled.)

What surprised me was how onerous and complex the regulatory barriers have been – how damaging they have been to trade and economic growth. It has not just been the queues of lorries awaiting documentation clearance at ports like Dover – vivid illustrations that they are. The delays have resulted in some British producers of fresh products where time is critical – like fish and flowers –giving up exporting to the EU altogether.

Sometimes the amount of documentation – pages and pages of it – has been extraordinary. I don’t think the EU is being bloody minded, although Brussels can be clumsy. Perhaps over time they will simplify their requirements and so will the Brits. Which means that there will be increasing regulatory alignment, which Brexit was trying break away from.

There is a lesson here which the Brits may yet learn. While one may yearn for sovereign independence, whatever the de jure situation once there is an international relationship – in trade as well as a host of other areas like human rights and defence – de facto sovereignty is compromised.

The problem of these regulatory barriers arising from misalignment and documentation apply elsewhere in world trade; an exporter to multiple markets may have to meet quite differing requirements. There have been attempts to reduce the barriers, but multilateral efforts have been half-hearted. Free trade agreements increasingly pay attention to them.

There cannot be total regulatory alignment. Our negotiating partners know that our bottom lines include the provision that Te Tiriti o Waitangi is sacrosanct; it protects the Māori broadcasting regime from international investors.

One place where we can do better is moving the trade documentation onto an electronic basis. I do not know just how much that will facilitate our exporters and trade generally. But the lessons from Brexit suggest that it will, probably more than one thinks.

Were I a Brit, I’d favour measures which reduced these transaction costs even if the resulting regulatory alignment reduced the country’s economic sovereignty.

Footnote: A new area of regulatory alignment is likely to be about carbon emissions. The EU is already moving towards requiring those who export products to it from the ‘heavy’ industries – such as aluminium, cement, chemicals and steel – to meet the EU’s domestic carbon emission standards.

They have not yet begun addressing farm emissions of methane and nitrous oxide. But they will. Our farm sector needs to be preparing for that. Rather than the government imposing an emissions regime, it might tell them:

‘Over to you. If you don’t get on with developing your own strategy you will be one day be excluded from some of your valuable export markets. The government’s advice is to get onto it as fast as you can. Biological change takes time. Inconvenient regulatory can change a lot faster. The government will give you all the reasonable support you require.’

*Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.