Lessons in Brexit economics – the chimera of frictionless trade

Lessons in Brexit economics – the chimera of frictionless trade

by Eben Wilson
article from Thursday 29, November, 2018

AMONG MANY other myths and oddities about Brexit is the declaration that our government is seeking “frictionless trade” with the EU. 

No trade is frictionless. And economics has a specific “theory of the firm” that examines this issue under the banner of what are called transaction costs.  We should be aware that politicians who seek this chimera are deluding themselves.  Let me explain.

I have some business in Australia at the moment. This involves building relationships with partners and customers. This creates an overhead, and we accept that. There are custom arrangements, finance arrangements, shared communications, the learning of shared methods and other things that need to get done.  That’s business at work; refining contractual arrangements for mutual benefit. 

It’s always costly to start with but that’s beside the point, what matters is whether through time we can commoditise those costs; that is, refine our shared methods to make things happen more easily and cheaply. That’s the job of management.  It’s also the key to profitable growth, by making transactions less costly through time for each pound of earned revenue. Crucially, when any such trade begins it is not known how much any relationship might offer the potential to commoditise transactions costs; that’s what we have to find out, while avoiding unanticipated costs affecting our trades. 

Now let’s put that in the context of Brexit and the forecasts of its impact. Yes, there are transaction costs that differ between EU single market rules and WTO rules.  But the differences between these formal rules – tariffs and required technical standards – are minor or, with respect to standards, known because we trade to them today. 

But what happens as our new business develops? Let’s look at that in the context of the way the EU operates. Within hours of Mrs Day’s deal, the EU was telling us what really lies at the end of her cul-de-sac.  Our fishermen will have to “swallow a link between access to products and fisheries”; and there will be “the necessity to maintain ambitious level playing field conditions and to protect fishing enterprises and coastal communities”.

Whether in fishing, or any other industrial sector, these outrageous interferences are red flags to any business seeking to manage and minimise its own future transaction costs. They are being told that the power to contract freely is constrained by central planners allocating rights to trade. 

Immediately, the process of commoditisation of transaction costs that allows business to enhance profitable trade is compromised. Centralised totalitarian methods infringe on market competition where some lose and some win by innovating and reducing transaction costs.  Business turns instead to cozying-up to the powerful in politics and the bureaucracy, free riding on legislation and regulation that protects specific positions; with larger players in particular using the idea of a level-playing field as a short cut to fixing transaction costs in their favour.  When they win favour, unanticipated costs affect others. Trade growth fades, trade barriers are reinforced, and consumers get costlier less innovative products. 

These micro-economic factors are at the core of the Brexit debate, but are rarely mentioned. It’s much easier to attach a prejudice to macro-economic conjectures based on false statistical projections; choosing the forecast that suits your political beliefs. 

But those forecasts are by definition bunkum. The dynamics of developing trade and its adjusting transaction costs are not forecastable. It is crystal ball gazing to suggest such futures can be known; when these future streamlined businesses haven’t started work on this yet!

It’s important to recognise too that we are talking here about tens of thousands of businesses whittling away at hundreds of millions of transactions costs in a process that market economists call the “spontaneous discoveries of the extended order”.  That spontaneity is important because different companies find different ways of constraining their costs – promoting the consumer interest by holding prices down. That in turn inevitably leads to competitive divergence. But hold up, this is precisely the divergence that the EU says it does not want to see. Why? Because it disrupts its tidy regulatory regimes and digs up its level playing field rolled flat by free-riding big business. The combined need for control of corporates and bureaucrats makes all consumers poorer as a result.  

The economic realities of the political management of trade are discarded by those demanding a new negotiation or other negotiated softer exit from the EU. They miss something very important; the EU does not negotiate in good faith, it cannot and never has. It negotiates only for the advance of its own control because it is based on the core of a totalitarian federalist idea that it must defend to exist. Attempting to get it to negotiate some of its accreting power through negotiation is fruitless.   

Brexit makes us outsiders, and we must act like outsiders at whatever cost they impose. How often do remainers need to be told that they cannot cherry-pick before they accept that this is an absolute and primary condition of the EU? Their playing field is not available to us anymore and it was never going to be. 

Even more disturbing is the expansive nature of the EU’s ambitions. They think that they can grab access to our fisheries and control Northern Irish agri-trade with rules that they set and administer. Yet, this demand is from the same team who declare that the present Withdrawal Agreement cannot be changed by the UK and is immutable. We cannot negotiate with them for a better deal, but they can negotiate with us to take our assets. Jings! 

Have people gone blind? This is how the EU works; it builds level playing fields for its own players, but only so that it can become the controller of the stadium.

For those of us who welcomed Brexit on the grounds that it would allow a clean break to adopt free trade policies and discard European mercantilism, (see www.economistsforfreetrade.com) the starting position of the government should have been an immediate declaration that we would move to WTO rules.  Arguments in favour would have been in relation to making life cheaper for the less well-off and an innovative future for UK business, arguments against would have been transparently from the big corporates seeking to preserve profits alongside euro-romantics blind to an unaccountable, unaudited and dysfunctional centralising entity. 

Instead, a corporatist Conservative Party aligned to a mercantilist civil service has taken us up a creek with no paddle. Worse than this, and laughably, it seems Mrs May is still waving a long and useless stick trying to paddle her canoe to nowhere. The transaction costs of starting to trade to WTO rules are not that different from those of today; the transaction costs that develop through time operating in a mercantilist regime are huge; while under the WTO we can have the freedom to work on those costs.  

If we want our firms to compete with the world, Britain can learn from the world by buying imports, exporting to the world to buy those imports, and so serve consumers better. We need a clean break from EU control to promote competition and free-up our options on transaction costs; the real frictions that constrain real trade growth. 

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