This is an excellent video from the FT about Brexit. It goes into detail about the costs of leaving a free trade area and how Brexit has impacted small business and investment in the UK. Below are some quotes from the video – useful for the barriers to trade topic.
A French company will buy from Germany because they’ll probably be able to get the same product easier and without any of the extra costs that we’re having to apply to get it out of the UK
We couldn’t ship anything to the EU, nothing. It’s 27 countries, they all have different borders, they all have different rules.
Signing a free trade agreement with New Zealand or Australia has ups and downs of the UK economy, and is probably very, very marginally positive. But it’s nothing like losing a free trade agreement and losing the frictionless trade you had with your biggest trading partner that’s only 20 miles away across the channel.
We lose 4 per cent of our GDP by Brexit. We gain 0.08 per cent by the government’s own estimate through this trade deal with Australia.
The topic Barriers to Trade on elearneconomics has fully integrated flash (cue) cards linked back to the key notes that assist students to understand economic vocabulary, improve their skills, develop knowledge and build their confidence.
After 47 years the UK has now left the EU and with it the Common Agricultural Policy (CAP). At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector.
The economics behind CAP intervention price An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:
It encourages an increase in European production. Consequently, output is raised to 0Qs1.
At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
There is a contraction in domestic consumption to 0Qd1Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.
Figure 1: The effect of an intervention price on the income of EU farmers.
The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.
CAP and the UK
At considerable cost to the taxpayer the CAP has subsidised intensive farming methods that have impacted the British countryside and also increased the price of land making it harder to get into farming – since 2003 the price of land has risen from £4,500per hectare to £16,500 today. Subsidies also encourage farmers to develop land which is not suitable for farming and thus supports unproductive farms. The average English farm made a profit of just £6,200 in the tax year 2018-19 and being propped up by the subsidies has led to inertia and little or no innovation. Sheep farmers have especially struggled, in particular the 30% that are located in areas that are not conducive to farming – the Lake District, the Peak District, Exmoor and Dartmoor – but are seen by the public as picturesque walking areas. The issue being that farm income for grazing livestock in 2018-19 was approximately -£5,000 (lowland) and -£19,000 (upland) – see graph below.
Source: FT
New Zealand experience
New Zealand went through the process of removing the subsidies for farmers and in 1984 the Labour government ended all farm subsidies under the Lange Government and by 1990 the agricultural industry became the most deregulated sector in New Zealand. In the short-term there was considerable pain amongst the farming community and land values collapsed, inefficient farms went bust and the service sector that supports the industry. However to stay competitive in the heavily subsidised European and US markets New Zealand farmers had to increase efficiency, became more innovative and export-orientated – 95% of Fonterra’s produce (dairy) is exported. Compared to the UK, New Zealand does have a lower population density, weaker environmental standards and a different climate.
Post-CAP and the UK
In the Post-Brexit environment the UK government have pledged to keep overall subsidy levels although they will be replaced by the Environmentally Land Management Scheme (Elms) which is expected to be rolled out nationally by 2024 – the old subsidies will end in 2027. The Elms focuses on environmental benefits, such as flood mitigation and fostering wildflowers. Payments under Elms will initially be calculated on the basis of so-called “income foregone”, or what farmers could have otherwise made from farming on the same land, plus the estimated costs of the environmental work. The issue here is that a lot of this subsidy with go to the farmers who are already well off.
Agricultural support from the UK government is now focused on ‘public goods’ such as better air and water quality, thriving wildlife, soil health, or measures to reduce flooding and tackle climate change.
With the UK having now left the European Union here is a very amusing clip from the BBC series “Yes Minister” (1982) in which Sir Humphrey and Jim Hacker discuss Brussels and the notion of the UK trying to pretend that they are European. Also discusses why other European nations joined the common market in the first place.
As COVID-19 absorbs most of the headlines worldwide there are other concerns in the UK like Brexit. The farming industry has been impacted by both:
COVID-19 – shutdown of the service that serves the farming industry – 1/3 of the lamb market has gone.
Brexit – a deal needs to be negotiated with the EU.
Brexit and lamb exports to the EU – when the UK was part of the EU it was part of a custom union where there was no tariff between member states but there was a Common External Tariff (CET) which meant that countries outside the EU have to pay the same tariff when they export into any EU member state. For Britain leaving the EU without a deal has serious consequences for the farming sector. Over 90% of lamb exports in the UK have gone to the EU but with no longer being a member state the industry will no have to pay a CET which will undoubtedly make UK exports more expensive in the EU market. The FT visit a farm in Wales to look at the importance of the Brexit negotiations – a lamb is valued around £80 but if the EU charges the going rate of tariff between 40-80% that would bring up the price of lamb to between £112 – £144 in EU countries. This would make it very hard for farmers to remain financially viable. Furthermore it is not just the farming sector as the UK’s overall trade with the the EU is significant:
2018 – 45% of all UK exports go to the EU – $291bn 2018 – 53% of all UK imports from the EU – $357bn
The UK produces approximately 60% of what is required to feed its population with the remainder being imported. The UK’s £110bn-a-year agriculture and food sector is deeply integrated with Europe relying on the bloc for agricultural subsidies of £3.1bn ($4bn) under the CAP – Common Agricultural Policy (explained later in the post). The government has promised to pay the equivalent of the CAP subsidies up to 2022, no one is certain what will happen after that. There lies ahead some major challenges in the UK and not just for the farming sector. The video from the FT below is very useful for explaining the impact of trade barriers and CET.
What is CAP?
At the outset of the EU, one of the main objectives was the system of
intervention in agricultural markets and protection of the farming
sector has been known as the common agricultural policy – CAP. The CAP
was established under Article Thirty Nine of the Treaty of Rome, and its
objectives – the justification for the CAP – are as follows:
1. Raise and maintain farm incomes, through the establishment of high
prices for food. Such prices are often in excess of the free market
equilibrium. This necessarily means support buying of surpluses and
raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide flutuations that often occur in the price of agriculutural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the
efficiency of all units. To reduce the number of farms and farmers
especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self
sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.
CAP Intervention Price
An intervention price is the price at which the CAP would be ready to
come into the market and to buy the surpluses, thus preventing the
price from falling below the intervention price. This is illustrated
below in Figure 1. Here the European supply of lamb drives the price
down to the equilibrium 0Pfm – the free market price, where supply and
demand curves intersect and quantity demanded and quantity supplied
equal 0Qm. However, the intervention price (0Pint) is located above the
equilibrium and it has the following effects:
1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the
horizontal distance AB which is the excess of supply above demand at the
intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to
the area ABCD. It will then incur the cost of storing the surplus or of
destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.
Figure 1: The effect of an intervention price on the income of EU farmers.
The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.
Throughout most of its four decades of existence, the CAP has had a
very poor public relations image. It is extremely unpopular among
consumers, and on a number of occasions it has all but bankrupted the
EU.
No doubt you are aware of the what is happening in the UK with regard to leaving the European Union – Brexit. Below is a very informative video from CNBC which explains the history of the UK when it entered the EEC (as it was formerly known) in 1973 under Ted Heath’s government to today where there is chaos as to the process of leaving the EU.
Below is a funny clip by Seamus O’Rouke that was on RTE Radio 1 (Irish National Broadcaster). He has his own unique reflections on the benefits of having a hard border for the people of Leitrim.
The introduction of a hard border would have massive implications for business and personal travel between Northern Ireland. There has been an understanding between Britain and Ireland for decades that has led to this de facto agreement which has served both countries well for years. The other option is for the current situation to endure soft border, whereby vehicles, goods and people can freely pass through a porous border.
A hard border would see the reintroduction of cameras at checkpoints, and all vehicles being stopped as they approach the numerous crossing points. As it stands, there is complete freedom of movement between Northern Ireland and the Irish Republic. The border is barely recognised, with minor road markings being the only sign that you are moving between nation states.
Seamus O’Rouke tends to disagree with the soft border.
The impact of Brexit on New Zealand depends on what kind of exit agreements are reached between the UK and the European Union. The published provisional deal includes a transition period which runs until the end of 2020. During this time, existing trade conditions for third parties (such as New Zealand) will continue. Below are tables showing the trade relationship between New Zealand and both the EU and the UK. The benefits of two way trade with the EU outweigh those of the UK – US$23,273m against that of the US$5,640m
March 2018 – New Zealand’s total trade balance was a surplus of $4.0 billion in the year – this surplus is up $1.3 billion from the trade surplus in the year ended March 2017.
Total exports of goods and services were $78.0 billion, while total imports were $73.9 billion.
China ($15.3 billion) and Australia ($13.9 billion) were the top export destinations.
The European Union ($13.4 billion) and Australia ($12.1 billion) were the top import sources.
Dairy products and logs to China were New Zealand’s top two export commodities by destination, earning $4.0 billion and $2.6 billion, respectively. This was followed closely by spending by visitors from the European Union ($2.2 billion) and Australia ($2.1 billion).
New Zealand’s negotiations
New Zealand is in negotiations with the UK over a FTA. According to New Zealand Foreign Affairs and Trade NZ wants the following from a FTA:
Removing tariffs and other barriers that restrict the free flow of goods between our two countries
Making it easier for traders of all sizes to do business in the UK, including services exporters Strengthening cooperation and dialogue with the UK in a variety of trade and economic fields
Reflecting our goals including progress on gender equality, indigenous rights, climate change, and improved environmental outcomes.
Some key areas in which we will be seeking even closer cooperation with the UK under the FTA include:
High quality primary sector and goods access to the UK’s market, such as for meat, mechanical machinery and equipment, fruit, pharmaceuticals, forestry, dairy and wine
Helpful conditions for investment and services providers who operate between the two countries
Commitments on progressive trade issues including environmental and labour protections, indigenous rights and gender equality.
Sources:
Parliamentary Library Monthly Economic Review – December 2018.
Another very informative clip from the FT. Some of the salient points include:
Since the global financial crisis the Bank of England, US Fed, Bank of Japan and European Central Bank have bought assets and printed US$12 trillion.
Can interest rates return to what has been normal in the past – say 5% instead of close to 0%.
US Fed plans to shrink its balance sheet later this year – monthly reduction US$6bn in its assets. But this is a very small amount when you consider that the Fed holds US$4.5 trillion
But this is not happening elsewhere. Bank of Japan and European Central Bank are still printing money and buying assets. With Brexit the Bank of England faces huge uncertainties regarding their balance sheets.
Interest rates will remain low partly due to: ageing population, low productivity growth and a savings glut. This has reduced the attractiveness of capital spending.
With the departure of the UK from the EU there have been many questions asked about the future of UK trade. No longer having the free access to EU markets both with imports and exports does mean increasing costs for consumer and producer.
New Zealand’s Experience
A similar situation arose in 1973 when the UK joined the then called European Economic Community (EEC). As part of the Commonwealth New Zealand had relied on the UK market for many years but after 1973 50% of New Zealand exports had to find a new destination. However with the impending loss of export revenue New Zealand had to make significant changes to its trade policy. In 1973 the EEC took 25% of New Zealand exports and today takes only 3%. Add to this the oil crisis years of 1973 (400% increase) and 1979 (200% increase) and protectionist policies in other countries and the New Zealand economy was really up against it.
What did New Zealand do?
1. It negotiated a transitional deal in 1971 with agreed quotas for New Zealand butter, cheese and lamb over a five-year period, which helped to ease the shift away from Britain.
2. New Zealand was very active in signing trade deals of which Closer Economic Relations with Australia was the most important in 1983. The other significant free trade deal was with China in 2008. Below is a list of New Zealand’s current free trade deals and a graph showing the changing pattern of New Zealand trade:
With brexit around the corner it will be imperative that the UK starts to develop trade links with non-EU countries of which New Zealand might be one. The UK is the second largest foreign investor in New Zealand and its fifth largest bilateral trading partner.
Another good video from Paul Solman of PBS ‘Making Sense of Financial News’.
In his new book, “The End of Alchemy,” Mervyn King still worries that the world banking system hasn’t reformed itself, eight years after its excesses led to collapse. He states that it’s easy with hindsight to look back and say that regulations turned out to be inadequate as mortgage lending was riskier than was thought. Furthermore, you are of the belief that the system works and it takes an event like the GFC to discover that it actually doesn’t.
Paul Solman asks the question that a large part of the problem that caused the GFC was the Bank of England and the US Fed were not able to keep up with the financial innovation that was going on in both of these countries. King refutes this by saying that there were two issues that were prevalent before the GFC:
Low interest rates around the world led to rising asset prices and trading looked very profitable.
Leverage of the banking system rose very sharply – Leverage, meaning the ratio of the bank’s own money to the money it borrows in the form deposits or short-term loans.
Central banks exist to be lenders of last resort. Problem: Too big to fail. And that’s what began happening in England, just like America, in the ’80s and ’90s. There needs to be something much more robust and much more simple to prevent the same problem from happening again. King makes two proposals:
Banks insure themselves against catastrophe by making enough safe, secure loans so they have assets of real value to pledge to the Central Bank if they need a cash infusion in a hurry.
Force the banks to keep enough cash on hand to cover loans gone bad as during the crisis banks didn’t have enough equity finance to absorb losses without defaulting on the loans which banks have taken out, whether from other bits of the financial sector or from you and I as depositors.
He finally states that the Brexit vote doesn’t make any significant difference to the risks facing the global banking system. There were and are significant risks in that system because of the potential fragility of our banks, and because of the state of the world economy.
Below is a very good summary of events in the UK over the last week. A major point is how the advice of leading economists and organizations was ignored with regard to the remain campaign. It seems that the electorate were driven by emotion and therefore the thought of independence and sovereignty become very powerful. This is the first time that any nation has decided to leave the bloc, and questions about other countries participating in similar referendums have already been posed.
But what does the leave campaign’s victory actually mean for the global markets? How will the United Kingdom re-form itself, especially in light of Scotland’s likely call for independence?
The impact of Brexit on the New Zealand economy should be limited when you consider the following statistics:
3.5% of total exports from NZ go to the UK – mainly sheep and wine.
2.7% of total imports from the UK to NZ – mainly transport goods
6.7% of all short-term visitor arrivals come from the UK
When the UK joined the EEC (as it was then know as) in 1973 there was a major shift away from trade with the Commonwealth. However New Zealand has been able to move away from the traditional dependency of the Commonwealth to become increasingly integrated to the Asia Pacific region.
Reserve Bank of New Zealand
The RBNZ is a good position even with a record low OCR of 2.25% which paradoxically is among the highest in the developed world. By not being aggressive with OCR cuts the RBNZ has the ammunition to stimulate aggregate demand further which is in contrast to the European Central Bank and the Bank of Japan who are in negative territory. With the turmoil in Europe over Brexit the US Fed will most likely hold off on a rate hike to ease the pressure on markets – it may even cut the US Fed rate.
Gold and Sterling – US$ rate
The graph below shows the reaction to the Brexit – GBP drops significantly against the US$ and gold, as a safe investment, appreciates in value. The uncertainty that surrounds Brexit saw more investors buy gold, which rose to about $1,315 an ounce on June 24th, up by 4.7% on the previous day. This was the largest increase since the global financial crisis in 2008. The rise was in stark contrast to the plunging pound, which tumbled to its lowest level in 30 years.
Below is video from the FT looking at Five Consequences of the UK’s exit form the EU.
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