EU debate - in or out?

As previously highlighted the debate on the UK's membership of the EU is becoming a major issue. In recent days there have been lots of contributions to the debate in anticipation of the Prime Ministers speech on Europe due on Friday.

One thing most people say is that Britain is a trading nation and they hope the UK can remain a member. However they then go on to make various conditions, saying it must be in the UK's interests to remain and depending on their viewpoints these conditions vary in strictness.

For economists the question is about the gains from trade. The lower the barriers to trade the more everyone benefits. There are various grades of economic integration and how far a country goes along this path determines what benefits they get. In order these steps are:

Free Trade Area  - free trade in manufactured goods only as a rule
Customs Union  - common external barriers with free trade inside the union
Common Market - Customs union plus freedom of movement for labour and capital within the Common Market
Economic and Monetary union - Common Market with one currency, eliminating the need for exchange rates
Political Union - One country

There are variations on these. The important point is that as countries allow greater integration they gain more benefits, but there are also some costs which include loss of domestic political control and in some cases the loss of the ability to pursue independent economic policy.

It would be useful to review the economic costs and benefits of EU membership now so that you can tell the political from the economics points that will be made in the next week or so.

A BBC article is here - there are many others

Economic nationalism is still there

Virtually any economist will tell you that free trade is the best thing for the welfare of all. Some will tell you that it has to be be free and 'fair' trade.

What is certainly true is that consumers benefit from the lower prices due to competition caused by free trade. European consumers have certainly benefited massively from cheaper goods made in China in recent years.

Of course there are losers as well as winners in this process. Many of those who made goods now supplied by the Chinese have lost their jobs and some firms have closed down. The knowledge that these resources are now released to be used in more profitable areas of the EU economy is of little consolation to the unemployed.

Governments are not good at practising what they preach. While a government claims to support free trade they are nervous about the votes of those adversely affected in the declining industries. They act to protect them and slow the transition, or even stop it.

One way of defying free trade is to claim a competitor is 'dumping' goods on the market. That technically means they are selling the goods at a price below the cost of production. The motives for a country doing this would be to raise domestic employment or to destroy the industry of another country in order to then monopolise that market.

The EU has just announced a tax (called a tariff or duty) on Chinese ceramics. Around half the cups, plates etc sold in the UK are made in China. The duty can be as much as 58.8%!

The EU is allowed to do this as an interim measure while the matter is investigated. The World Trade Organisation (WTO) can intervene but that takes a couple of years. Sadly the EU is quick to suspect dumping, usually due to complaints from EU firms and it is rarely true. The Chinese, in this case, are simply cheaper.

The attached article reveals a surprising number of cases where the EU has acted to restrict trade. In this case there seems to be more opposition that support for the move within the EU itself.

The Yahoo article is here

Who won the banana war?

The EU is well known for its protection of agriculture. Farmers in the EU have benefited from taxes on agricultural imports that have made more efficient farmers from outside the EU uncompetitive within the EU.

So perhaps it is surprising to learn that the EU has also protected farmers in the Caribbean. They did this by putting a tax on bananas grown in countries that were not former colonies of EU countries benefiting mainly former UK and French dependencies in the West Indies.

Other countries, such as Costa Rica and Venezuela complained to the World Trade Organisation that this was unfair. Their plantation grown bananas were, according to them, bigger and better quality than the small Caribbean bananas and were being unfairly disadvantaged in the EU market.

For more than twenty years this dispute raged on and now the EU has agreed to lower the tariffs on bananas. (Details are in the linked Daily Telegraph article.)

So who has 'won'. Well the non-EU colonies have greater access to the EU market, so they have a victory. The other big winner is the EU consumer who will now be able to buy bananas more cheaply as tariffs fall and competition in the market will increase.

However the tariff is not abolished, just reduced. So EU consumers will still be paying more than they could do for  bananas and so there is a continued welfare loss due to the tariff that remains.

The clear losers are Caribbean banana growers. They are high cost, small producers who operate in conditions that produced lower quality and smaller bananas than other countries. They will probably find their incomes will fall. Fortunately sugar cane is the best crop to use for making bio-fuel and the Caribbean is ideally suited to produce that leading to a rapid expansion of that industry.

A victory for partial free trade anyway.

The Daily Telegraph covers the story here

The sharp end of international trade and specialisation

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Ford have announced the closure of the Transit van factory in Southampton. The last 500 jobs will be lost from a plant that has produced over two million vans since 1972.

This was not a surprise. A Belgian Ford factory is also to close as the vehicle maker can produce far more cheaply elsewhere.

The closure reflects the continuing decline of Britain’s comparative advantage in basic manufacturing. Turkey will benefit as all production is transferred there.

The move illustrates one of the important effects of specialisation and exchange. We know that specialising allows more goods and services to be produced overall and through trade everyone can consume more and so be better off.

While overall welfare rises somebody bears a cost during the 'adjustment period'. This must occur as an industry grows in one trading partner through specialisation another, somewhere else, must decline. Where an industry declines workers lose their jobs and must seek new ones.

Those who lose their jobs are structurally unemployed. They are in need of retraining and because so many are losing their jobs at the same time it may be difficult to clear the local labour market for some time. The costs will fall particularly heavily on the over 40’s who will find it most difficult to find work.

A point to consider is why BMW (the Mini) and Honda are growing in the UK. Is it because of their product?

The local paper reports this move here

Fixed exchange rates - pros and cons

Before Hong Kong returned to China it was a small but vibrant trading economy. It dealt primarily with the West and a huge proportion of its activity was traded. 'Made in Hong Kong' was as common a sight as 'Made in China' is today.

Fixed exchange rates were the norm from 1945 to 1971. Hong Kong was too small an economy to maintain its own stable currency and so after the collapse of the world fixed exchange rate system they pegged the HK$ it to the US$.

The Hong Kong economy needed a stable exchange rate so that its firms could trade with certainty, knowing what prices to set and what money would be received. But the maintenance of a fixed exchange rate in turbulent times is difficult and imposes costs as well as benefits on the economy concerned.

Hong Kong's problem is that it chose the US$ to fix to. A perfectly sensible choice at the time, but now the US is pumping money into their economy (Quantitative Easing) this is destabilising the US$.

The BBC article below talks about the recent experience and discusses some of the issues.

The BBC article is here

The complex issue of trade

Japan has seen a fall of over 10% in exports in September compared to a year ago. This is pretty exceptional under any circumstances and threatens the Japanese economy.

The causes are varied and add up to an overall drop. They are:
A boycott of Japanese goods in China
The weakening of European markets
The strong Yen

The unfortunate combination of factors means that japan will see Aggregate Demand falling as net exports (X - M) is a significant influence on the Japanese economy. Japan has run a trade surplus for many years and this has helped raise the rate of growth in Japan. Now a return to recession is a real possibility.

Interdependence of modern economies is a fact of life.

The BBC report the story here

The debate of EU membership is really coming back

In 1975 the UK held its first ever referendum on whether it should stay in the EU (then the EEC) which it had only joined in 1973. 67.5% of people voted to stay and the Home Secretary of the day, Roy Jenkins, said that it had 'put the uncertainty behind us'.

While there have been people who have called for withdraw, such as UKIP, no mainstream politician has given it serious consideration. Today it appears that the inept and intellectually challenged Education Secretary Michael Gove believes the UK should leave (with support from, among others,  the giant brain of Iain Duncan-Smith).

I have a balanced and tolerant view of Mr Gove, but there is an economic argument for leaving the EU and that debate must now be had. The result will determine nothing less than the economic future of the UK.

The argument for joining the EEC in 1973 was that of trade creation. Barriers to trade would be eliminated between the UK and the other members and the amount of trade and specialisation would increase making everyone better off. This is classic stuff and exactly the sort of thing economists advise countries to do if they want to grow up to be big and strong.

Along with the lowering of trade barriers came political co-operation. This has included a European Parliament and a European Court. EU law supersedes UK law. This is what people like Michael Gove and UKIP object to, it restricts the ability of the UK government to act.

So is there a case for leaving the EU? Well actually yes. The result will depend on the terms of leaving. The ideal solution for the UK would be to get the same deal as Greenland when it left. That put Greenland in the same position as Norway - a part of the single EU market, but not a member.

Norway gets all the benefits of specialisation and trade, but pays nothing towards the running of the EU, has no say in the rules and gets none of the political benefits of a single European voice.

The Greenland option is going to be very hard to stop politically. The question to be decided is 'Do you want Britain to be a simple economic partner of Europe, or a political partner in Europe?'

Under starters orders.  This is going to run longer than the debt crisis!

The Mail (who else?) report Gove's views here

Why we joined the European Union

When Britain joined the European Union (called the 'Common Market' in the UK at the time) it did so because it wanted to be a member of a free trading area.

It turned out not to be as free as we thought, but in 1993, thanks in large part to an initiative by the Blessed Margaret, a 'Single European Market' was created. Here labour, goods and services and capital had complete freedom of movement.

So anyone who is an EU citizen can work anywhere in the EU, a firm can sell their services anywhere in the EU and the people can put their money in any EU bank they like.

This encourages specialisation and trade, as a result everyone is better off. It is also encourages competition and will drive down prices because barriers to entry in the market have been reduced, benefiting consumers.

The Premier League at last lost a case where they had prosecuted a pub in Portsmouth for using a foreign decoder to watch football matches. It took the European Court to rule on this matter and today the High Court had to agree that the pub landlady should get her money back. The ruling - the exclusive deal with Sky contravenes Single Market legislation.

So the EU is not all bad!

The BBC covers the story here

The UK experienced an unwelcome fall in exports in the latest figures reported by the ONS. The trade gap widened as a result.

Perhaps the more surprising thing is that exports had been rising at all. Europe, the UK's biggest trading partner, has been experiencing such problems it would not have been a shock if they had bought less.

The concern for Britain is that, in a time when the UK desperately needs growth, a rise in net exports is an important factor in increasing Aggregate Demand. These figures mean that net exports is effectively reducing AD and so will reduce growth not boost it.

On the bright side imports have risen slightly. While bad for net exports now this can indicate returning consumer confidence and possibly improving disposable income.

The Guardian reports the trade situation here

Welcome to a future built in BRIC

Please read the attached article by Jim O'Neill. It is a follow up to his original paper 10 years ago about his prediction of the potential growth of the BRIC Economies (Brazil, Russia, India and China). He makes us question the role of the G7, with China now the second biggest economy in the world and Brazil set to surpass France and Britain to become the 5th largest economy. Also Russia and India are bigger than Canada. The world order is changing as he states that by 2020 the GDP of the 8 Growth Nations will equal that of the G7. Whilst the European crisis is important for the future of the United Kingdom it is important not to neglect other parts of the world as O'Neill argues this may be where the future lies.

The Telegraph Article Here

Free trade makes a comeback

The leaders of the Asia-Pacific region are meeting in Hawaii. Might sound insignificant but together the member nations account for over 40% of the worlds trade and population.

Unlike the EU trade agreements in the area are fairly rudementary. They consist of a series of bilateral agreements and a few small Free Trade Areas - FTA's (although NAFTA is an obvious exception). Now nine members of APEC are talking about extending the TPP - a small free trade association set up in 2006 - to include the USA and Japan among others.

Economists like free trade. They don't see trade as a 'zero-sum' game, where losers and winners cancel each other out. Rather everyone gains from trade, the buyer and the seller both think they are better off as a result of an exchange, otherwise they wouldn't do it. And so it follows that the more trades that take place the more people that are better off.

At the most fundamental level trade allows specialisation and exchange. As everyone already knows that is the basis on which the economy of the world has been able to improve the standard of living of everyone since before the industrial revolution.

But free trade meets significant opposition. In the recession there were fears that 'economic nationalism' would lead to a new round of protectionism in the misguided belief that it would help keep jobs in countries experiencing difficulties. Despite the lessons of history some countries continue to have strong protectionist lobbies that value short-term protection over long-term prosperity and a political system that rewards such views (such as Australia).

The move to a nine-member Pacific FTA is therefore to be welcomed. In theory FTA's are the lowest rung on a ladder towards full economic integration. The next rung up is a customs union and then a common market and above that the EU style 'monetary union'. The aim is to increase the well being of all members by allowing more trade and so more specialistion. FTA's tend to be about trade in goods only, but represent a significant advance and the new TPP will include some non-goods trade provisions.

The NDTV article explains some of the advantages here.

 The Wikipedia page on Free Trade Areas is here

The protection of agriculture in the EU at what cost?

As an Australian who has seen our farmers locked out of the European markets through the Common Agricultural Policy it is difficult to understand why Europe continues with protection of this industry. The latest reform includes handing out €435bn of taxpayers' money over the next 10 years. This is during a time when many other Europeans can not find work. The CAP is the EU's single largest expense, making up nearly half of the EU budget (38.5% now, but down from 72% in 1985).

Whilst the protection for farmers is what the EU desires, it neglects the impact this will have on every other industry.


The Guardian Report

Dr Death suggests Greece default on its' debts

Dr Roubini (Dr Death) is renowned as one of the world's most pessimist Economists and has been credited with predicting the Global Financial Crisis in 2008. He has suggested that Greece default on their debt and leave the Euro.

His justification for this is because of advantage of floating exchange rates. He states that if Greece leaves the Euro and returns to the Drachma then they would be in a stronger position to recover. This is because a return to the Drachma would lead to a dramatic depreciation of the currency. This depreciation would improve competitiveness and growth.

A depreciation of a currency will make exports cheaper and imports more expensive therefore improving conditions for local producers. He also examines the success of Argentina and Iceland after they defaulted in 2001 and 2008 respectively to successfully recover.

His article is here

EuroZone

The inability of Greece to meet the required targets and the rising expectation that Greece will default has brought about a huge amount of speculation of what will happen next. The Daily Mail expects the "EU to be torn apart", the Telegraph views it as an opportunity to start again and design an EU that Britain would like to join and the Guardian warns Great Britain that this is going to hurt.

The last prediction is why these developments are so important. This is because over half of Great Britain's trade is with to Europe. Economically the relationship between the EuroZone and the United Kingdom is extremely close. The attached graph further justifies the close relationship between the two economies.

Watch the following connections to get a full understanding of the issues revolving around a Greek default.

http://www.youtube.com/watch?v=rrsGSvuBAi4&feature=player_embedded

http://www.youtube.com/watch?v=m-fWgT26rzs&feature=player_embedded#!

US economy will affect UK recovery

It was once said that if America sneezed then Europe caught a cold. The phrase was based on the power of the US economy as a buyer of European goods.

If America goes into recession their demand for imports falls. That means European exports fall and so demand falls and jobs are lost here. The UK's biggest trading partner is the USA and so the fact that the US created no jobs last month is worrying. It suggests the US economy is very much weaker than thought and could return to recession.

This is more of a cause for concern for the UK than for other EU countries as the business cycle of the UK is much more closely aligned to the US than it is to the EU. While that is changing (60% of the balance of trade is accounted for by EU trade) America remains a key power in the world economy, roughly equal in size to the whole of the EU in GDP terms.

External factors are more and more important to the way economies behave. No government can fool itself that it has all the policy answers to its own economic problems.

The Guardian cover the US jobs crisis here

The trade war within

The article attached below is perfectly timed for the 585 stimulus (extract 4). It examines the complexity of European trade relations especially when dealing with developing countries. The article correctly preaches reciprocity is desirable when adopting openness but not when it includes raising barriers. The other interesting point is that whilst open trade would greatly benefit Europe with price stability and competitiveness it would only further expose the southern nations desperately sinking in debt.

http://www.economist.com/node/18586846?story_id=18586846