Misconceptions abound when it comes to trade. Perhaps the most common is that somehow exports are good and imports bad. The reverse is the case. Exports are useful because we need the money to pay for the imports we want. There is no intrinsic benefit in spending our time producing stuff for other people.
There are related misconceptions about the exchange rate. While it can be necessary at times, a falling exchange rate is not good in itself. It makes the imports we want more expensive and means that others can get the fruits of our labour on the cheap.
Another misconception arises because when you think of trade you probably are thinking of firms in one country selling cars or wine or fridges to consumers in another. In fact, the majority of the UK’s imports and exports are not like that at all. They are transactions between, or even within, companies.
That’s most obviously the case with raw materials. We don’t import iron ore to go straight to consumers, but rather to be used by steelmakers and other manufacturers. But a lot of manufactured goods are like that, too. Car assembly tends to involve components being exported from one country to be assembled in another. The same components may cross borders several times before the car rolls off the production line.
The same is true of services. A lot of cross-border trade in legal, business and financial services is trade between companies; firms in London providing services to other firms in Paris, Rome, wherever.
Indeed, more than half of the UK’s imports of goods and services from the European Union are of this intermediate type. In the other direction, the numbers are even more striking. Seventy per cent of our exports to the EU are of intermediate goods and services; that is they are exported for use by companies, not for purchase by consumers.
These proportions have been rising over time. This sort of trade is most important for the manufacturing sector and within that for manufacturers of motor vehicles, pharmaceuticals, electronics and chemicals. Not only are they especially dependent on imports from the EU to run their businesses, they are among the biggest exporters back to the EU.
All of this matters when it comes to thinking about trade deals and the kind of agreements we will need in a post-Brexit world.
First, we can’t think of imports and exports independently. Nearly a quarter of the value added embedded in UK gross exports is produced abroad. We can only export effectively if we can import. A successful trading nation needs low barriers to imports and to exports.
Second, because the EU is an important export market for the UK, and because a majority of those exports are themselves inputs into things produced in the EU, we will continue to be dependent on trade deals that the EU strikes with the rest of the world, as well as, of course, on the trade deals we have with the EU. Better trade deals between the EU and third parties will continue to be good for the UK economy.
Third, this complexity of international trade means that multilateral trade deals are much more valuable than a series of bilateral deals. Hence the value of the European single market, the North American Free Trade Agreement and the Trans Pacific Partnership, for example.
One reason for this is the importance of rules of origin requirements. These can create real complexity for firms involved in international supply chains having to navigate a series of overlapping agreements. The EU-South Korea free trade agreement is a good example. A good exported from the EU is deemed to have “originated” in the EU only if less than 45 per cent of the value of inputs has been imported from outside South Korea or the EU. At present EU firms can freely use components manufactured in the UK. Outside the EU, the UK may well be considered a third party in such trade agreements and hence EU firms may not be able to use so many UK components in exports to South Korea.
More generally, since foreign components are an important input for British manufacturers, many firms may not be able to benefit from bilateral deals that the UK signs unless the UK can get its partners to agree to less restrictive rules of origin requirements.
Finally, perhaps most importantly, it is this complexity of international supply chains that makes so-called non-tariff barriers so important. Both distance and the minimisation of customs and other delays are important determinants of whether companies form cross-national supply relationships. Regional value chains are of considerable, and growing, importance in world trade. Distance matters. And deep trade agreements such as common markets and customs unions have been much more fruitful than shallow free trade agreements that simply remove tariffs.
All this means that the UK can only very partially mitigate the risks Brexit poses for firm costs and supply relationships through tariff reductions, a deal on tariff-free trade with the EU and by striking new trade deals with other countries. Tariffs are not the biggest issue. EU tariffs on intermediate goods from third countries are already lower than they are for other goods. The trouble is that agreements between countries on non-tariff barriers, while hugely valuable, are difficult to strike.
All of which helps to explain why any decision to leave the single market and customs union is such a big and potentially costly one, and why so many companies are concerned about a future outside of either. And while it has always been true that we can’t have imports without exporting stuff to pay for them, it is increasingly the case that we can’t have the exports without importing stuff to make them.