By Patrick Minford
In his blog Alan Winters makes various claims about the work Edgar Miller and I recently published on behalf of Economists for Free Trade (Minford and Miller, 2017):
–that under our free trade option (1) there would be a ‘race to the bottom’ on standards and
— (2) we would become ‘more integrated with the EU’ — (3) that our trade model is odd and non-standard.
–(4) that if one allowed for the effects on input prices due to the Brexit devaluation and other frictions in ‘exchange rate pass through’ manufacturers would not gain much in profit
These claims are all wrong! Here is why:
On (1) we only make price comparisons on manufactures with other OECD countries and assess the average price difference between EU and the most competitive OECD suppliers for broad product categories such as ‘electrical machinery’ and ‘transport equipment’. The price data that is averaged is of the highest quality and adjusted by national statistical offices for all the usual issues. Other OECD countries are subject to the same international standards as we are.
Our estimates of total EU protection tally approximately with known tariff rates plus others’ estimates of non-tariff barriers.
On food we simply use the OECD’s estimate of price support to producers- which is quite standard.
(2) is not so because we assume explicitly that the EU treats us under an FTA as it does now- so no change. Under our model if they do not and levy tariffs on us, it makes no difference to the world prices we have access to and therefore causes us no national welfare losses.
(3) our world trade model is general, inclusive of all factor markets, and quite standard in terms of general competitive equilibrium. It is the models that Alan Winters embraces with their unsustainable assumptions of limited entry and widely dispersed monopoly power that cannot match known world competitive conditions in which companies such as Blackberry and Nokia can be destroyed rapidly.
(4) if we were to allow for the effects of input costs, our estimates of manufacturing profits would be higher since we are eliminating protection on these also and this typically exceeds the devaluation effect. As for devaluation pass-through, for a ‘small economy’ like the UK with a supply only 3% of world output it is logical to assume that over 5 years or so it obtains world prices in dollars, implying sterling prices fully raised by the devaluation.
Let me expand on these short points.
What is strange is that Prof. Winters, an experienced applied trade economist, has so completely either misunderstood or misrepresented my work which has been around in one form or another for over ten years- see my book ‘Should Britain leave the EU?-, first edition 2005, second edition 2015 (Minford et al, 2015) in which this same world trade model is both explained and used, together with the price comparison method suing detailed OECD CPI data.
The world trade model, which is also described again in my paper with Edgar Miller, traces the way that trade barriers, whether tariffs or non-tariff barriers, work their way through to consumer prices and different sectoral costs and prices, so reallocating resources between sectors of the economy. It assumes full competition and free entry in world markets for the products of these sectors- food, manufacturing and traded services. In each country there is a non-traded sector. The model solves under full general competitive equilibrium, as is standard with trade models.
It is elementary to show that, once the UK has left the EU and eliminated EU protection so that it faces world prices on both imports and exports, the EU’s trade policies towards the UK are simply irrelevant to the UK. They leave world prices unchanged so that UK welfare, outputs and prices are unaltered. So Winters’ remarks about ‘deeper integration with the EU’ are incomprehensible.
The measurement of EU protection is again standard and widely agreed, at around 20% on food and about the same on manufacturing, about three quarters of the latter being non-tariff barriers. I made this point before when the LSE group raised similar issues- see my ‘Reply to LSE’ Minford, 2016 c, on www.economistsforfreetrade.com. The food measure comes from the OECD. The manufactures one comes from detailed OECD consumer price comparisons and is consistent with separate measures of known tariffs and estimated non-tariff barriers. The facts of high EU protection are embarrassing to EU apologists but are a well-known fact: the EU is nearly three times as protectionist as the US in manufactures and about twice as protectionist in food. In our model we assumed that international pressure would reduce it to around half of the latest measures as indeed has been happening over a long time period.
If the UK abolishes these trade barriers would this imply a ‘race to the bottom’ on standards? Not at all. The non-tariff barriers are such because they use standards and anti-dumping duties in a way that acts to raise prices above going international standards used generally around the developed world. Our data is for the OECD where these standards apply. In abolishing the EU’s non-tariff barriers we would simply apply these standards appropriately without an attempt to use them as an excuse to raise prices.
Winters is confused by our discussion of FTAs, suggesting that somehow we are using FTAs to create unilateral free trade. We make it perfectly clear that ‘free trade’, interpreted as our abolition of existing trade barriers put up by the EU on UK imports, can be achieved by two main routes: either unilateral abolition or abolition as part of a general negotiation of FTAs. The gains to the UK from reaching ‘free trade’ come from the abolition of these trade barriers, via an 8% fall in consumer prices and the resulting 4% rise in consumer welfare and GDP. The calculations, as well as variants where less than free trade is achieved, are set out in Appendix B of the Minford-Miller paper. As noted there and explained again above, these gains are totally unaffected by what the EU levies in the way of trade barriers against the UK.
Hence our remark that ‘no trade agreement with the EU’ whereby we institute free trade either unilaterally or by comprehensive FTAs with the rest of the world, ultimately accompanied by abolishing any barriers against the EU , is better than a ‘bad trade agreement’ with the EU which prevents us abolishing these barriers.
The Independent lauds the Winters analysis as debunking the ‘one study supporting the Brexit WTO strategy’. It does no such thing, as the Independent could easily have established had it not rushed into print about this muddled blog. The disgraceful truth is the opposite: our study is the ONLY one that analyses the WTO option under the free trade assumption. As Winters well knows and as the Independent ought to be aware, all the other studies that purported to examine this option were fraudulent in that they assumed no elimination of the EU’s protection: thus they calculated the outcome under continued UK protection against the world at large, including against the EU (Minford, 2016b). Some ‘WTO free trade option’ that! Furthermore most of them used the notorious ‘gravity’ model under which attempts to trade further afield than our neighbours in the EU is supposedly most handicapped by increasing costs of distance; this model hugely underestimates the gains from global free trade and is at variance with the far-flung nature of UK trade (thus our biggest country export market by a mile is the US, nearly three times as large as Germany, yet hugely more distant). Yet interestingly even this model produces some small gains from the WTO free trade option, as exemplified by an exercise of the LSE group: based on their calculations of the effect of a 3% tariff cut by the UK one reaches a gain of 1% of GDP from levying the full 10% assumed trade barrier and 2% from levying the current 20% barrier.
It is time for the Independent and other Remain supporters in the media and academia to use standard trade models as we have to evaluate the policy of HMG to Brexit free trade. While gravity models are all the rage among trade academics at present they are essentially untested- they have merely been ‘calibrated’ to reproduce trade regressions-, and their assumptions of limited entry and competition in world markets violate the known facts of world trade competition. Furthermore the pretence that the UK cannot pursue free trade policies under the WTO should be abandoned now that it is government policy to do so.
Finally, a word about manufacturing prospects. In the Minford-Miller paper we showed that near- term profits are likely to be much higher due to the Brexit devaluation, giving the sector a long time window in which to raise productivity over the long term to face the greater competition under free trade. The sector has shown itself highly competent in the past in ‘going up the value chain’, raising productivity annually by nearly 3% by increasingly hi-tech operation. It needs only a fraction of this growth to rise to the challenge of world competition outside the EU. While no doubt we can further refine these detailed calculations, this basic productivity calculation is clear enough: in the long term, say the next ten years, competition will lower prices by 10%, so productivity must rise to compensate, and this is much facilitated by the enlarged profits the sector will enjoy while sterling remains depressed over the short to medium term.
UK government policy today is pro-free trade and pro-competition, which benefit consumers and the economy. Economists like Winters should applaud this and stop being apologists for busted Remain prejudices.