5.1 Trade

Section contents

 

  • About 3/4 of global trade is in goods and 1/4 is in services
    • Goods and services are interlinked
    • Exports and imports are interlinked
    • EU, US and China dominate world trade
    • UK ranks 7th for trade after Germany, Japan and France
    • UK ranks 10th for goods exports and 2nd for services exports
  • The new EU-UK trade agreement is inferior to EU membership and creates new trade barriers
    • Brexit trade barriers reduce UK-EU trade volumes and profitability
    • Impact of tariffs on goods trade should be small
    • Non-tariff barriers (such as rules of origin) have much bigger impact than tariffs
    • New infrastructure will take time to implement – extra trade admin and costs for government and business

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World trade


The world trade section covers:

  • Global trends
  • Impact of Covid-19
  • Main players
  • Trade share trends
  • Trade openness trends

Global trends

International trade is critical to the economic health of developed nations and growing the prosperity of developing nations. In 2019, after a decade of growth, global trade in goods declined in value by 3% according to the World Trade Organisation. This was a result of the trade war between the US and China, US hostility to the WTO and fears of a disorderly Brexit. The value of services trade continued to grow at 2% in 2019, but more slowly than previously.

China has been the driver of the recovery in trade in the second half of 2020, following the global declines due to Covid-19.

Goods and services

The bulk of international trade concerns physical goods: $18.9 trillion in 2019 (about 76% of total), while services accounted for just over $6.0 trillion (about 24% of total).
See Figure 5.1 from the United Nations Conference on Trade and Development (UNCTAD) for some global trade trends from 2006 to 2018.

  • World trade in goods has increased markedly over the last decade, rising from about $10 trillion in 2005 to over $19.4 trillion in 2018.
    • Global trade in goods declined substantially in 2015 and 2016, before recovering in 2017.
  • Trade in services doubled between 2005 and 2018 from about $2.5 trillion to $5.5 trillion.
    • Growth in services trade has been steadier and less volatile than growth in goods trade.
    • Goods and services trade are often related (for example, servicing contracts on manufactured goods).

Developed (north) countries’ relative importance as suppliers in international markets is declining. However:

  • Value of trade in goods is virtually equal in developing and developed countries.
  • About two thirds of trade in services originated from developed countries.

The World Trade Organisation (WTO) assesses that 57% of world trade in goods and services took place in global value chains in 2015. Global value chains accounted for over 41% of global exports in goods and services.

South and North

World goods trade grew during the last decade mainly due to the rise in trade between developing countries (South–South). See Figure 5.1 (right panel).

By 2018 the value of South-South goods trade was $4.9 trillion, slightly less than trade between developed countries (North-North).

  • Regional trade agreements partly drive this. For example, trade between Commonwealth countries belonging to a regional trade agreement is more than three times higher than when they do not.
  • South–South trade flows are more than half the trade of developing regions.
  • Much South–South trade is intra-regional:
    • South–South trade share varies by region, from about 40% in Latin America to almost 70% in South Asia and East Asia.
    • An important part involves trade with China, which has become an important partner for all developing country regions.

Impact of COVID-19

International trade fell below 2019 for 2020, but is expected to recover in 2021. The fall of 15% in the first half of 2020 was followed by recovery, mainly in goods, in the second half. The estimates for 2021 global trade are uncertain.

For global trade in 2020 compared with 2019:

  • UNCTAD expects a decline of around 7 – 9%:
    • Goods decline of around 6%
    • Services decline of around 16.5%
  • WTO expects a decline of around 9% for goods trade

For 2021:

  • WTO expects a rise of 7.2% over 2020 for goods
  • For Europe, WTO expects:
    • Goods exports to rise by 8.2% (following a fall of 11.7% in 2020)
    • Goods imports to rise by 10.3% (following a fall of 8.7%)
Sources:
UNCTAD, Key Statistics and Trends in International Trade 2019, March 2020
UNCTAD, Global Trade Update, February 2021
Commonwealth Secretariat, Commonwealth Trade Review 2018, February 2018
World Trade Organisation, World Trade Statistical Review 2020
World Trade Organisation, Trade shows signs of rebound from COVID-19, recovery still uncertain, October 2020

Main players

The EU27, US and China dominate world trade in goods and services (see Figure 5.2 and Table 5.1 below) – trade is the sum of exports and imports. In 2019, the EU27 had an external trade surplus (€300bn), the US a deficit (€543 billion) and China a surplus (€160bn).

  • In 2019, the value of the EU27’s external trade was €5.98 trillion (excluding intra-EU trade), US trade was €4.98 trillion and China €4.75 trillion (excluding Hong Kong – €1.16 trillion).
  • EU27, US, China and 18 other countries account for about 84% of the world’s trade (see Table 5.1).
  • As a consequence of their trade dominance, the EU27 and the US (and increasingly China) have a major influence over the standards that regulate world trade in goods and services.
  • UK goods and services trade was €1.66 trillion (including its EU27 trade), ranking 5th just behind Japan and accounting for 4.6% of world trade. However, both Germany and France, if shown as separate countries, would rank above the UK.
  • In terms of national rankings, the UK ranked:
    • 10th for goods exports and 5th for imports;
    • 2nd for services exports and 5th for imports.

 

Figure 5.2: Main players in world trade of goods and services (2019 – €bn)

Table 5.1: Main players in world trade of goods and services (2019)

Figure 5.3 shows the first trade partner in 2019 for trade of goods for each country. Some important points to note:

  • EU27 is the first trade partner for US, China, UK, Russia, India and about half of Africa.
  • US is the first trade partner for the EU27, Mexico, Canada, Central America and Colombia.
  • China is the first trade partner for Japan, Australasia, Indonesia, Saudi Arabia, Iran, about half of Africa, Brazil, Chile and Peru.
  • Brazil is the first trade partner for Argentina, Bolivia and Paraguay.

 

Figure 5.3: First trade partner for trade in goods (2019)

Source: European Commission, DG Trade Statistical Guide, August 2020

Trade share trends

Figure 5.4 shows trends in share of world trade from 2009 to 2019.

  • The EU27 has had the top share in each year but its share over the last four years has been flat and is now 16.4%.
  • The US increased its share between 2011 and 2016, but since then has declined to 13.7%.
  • China grew strongly through to 2015 but its growth flattened until 2017 at 12.8% before finishing in 2019 at 13.0%.  Note that the figures for China exclude Hong Kong (sixth in Table 5.1), which, if included, would put China on a par with the EU27 in 2019.
  • Japan gradually declined from a 5.5% share in 2009 to 4.5% in 2015 and has since plateaued at 4.6% in 2018 and 2019.

 

Figure 5.4: Trends in share of world trade for EU27, US, China and Japan.

The UK’s share was 5.2% in 2009 (slightly below Japan), 4.5% in 2014, 4.4% in 2017, 4.3% in 2018 and 4.6% in 2019 (same as Japan).

Source: European Commission, DG Trade Statistical Guide, August 2020

Trade openness trends

Most economies depend on trade with other nations. To assess ‘trade openness’ (or ‘trade intensity’) economists use the ratio of trade (the sum of exports and imports) to GDP. By including imports and exports, the measure indicates the level of integration of a country with the world economy. The global average ratio of trade to GDP for 2019 was 60%. Trade openness tends to be higher in developing nations and lower for larger economies.

The EU’s trade openness ratio in 2019 was 43% (excluding intra-EU trade), ahead of the US (26%), Japan (36%) and China (38%). If intra-EU trade is added, EU trade openness was 91%.

The UK’s trade openness ratio in 2019 was 64%, behind most of the UK’s EU27 partners apart from Italy (60%): France (65%), Spain (67%) Norway (72%), Germany (88%), Switzerland (119%) Netherlands (154%) and Ireland (239%).

The European Commission provided Figure 5.5 which shows the trend in trade openness over the last decade. China’s trade openness has declined as its economy has grown and domestic consumption of domestic products has increased. The EU27’s trade openness is growing slowly after faster growth in the first part of the decade, whereas the US has been declining slowly in the second half of the decade.

The UK was at 54% in 2009, rising to 62% in 2011 before falling to 57% in 2015. It then rose to 64% by 2019.

Figure 5.5: Trend in trade openness 2009-19

Sources:
World Bank, Trade as % of GDP
European Commission, DG Trade Statistical Guide, August 2020

 

Trade arrangements


Overview

This section looks at different trade arrangements (or models) and their implications for trade barriers, principally in relation to UK trade with the EU. It covers:

 

Trade barriers

There are two types of trade barrier: tariff barriers and non-tariff barriers. Tariffs only apply to goods and may be related to quota thresholds. Services carry no tariffs. Non-tariff barriers apply to both goods and services. Figure 5.6 compares the frictions due to trade barriers in the main types of potential UK-EU trade agreement for goods and services.

The most basic trade arrangement is WTO terms with no preferential arrangement nor bilateral agreements. The most sophisticated is EU membership, which minimises trade barriers for member states for goods and services. A Free Trade Agreement (FTA) removes tariffs and quotas for goods. Under an FTA, most non-tariff barriers remain for goods and these barriers are usually more important than tariffs.

Non-tariff barriers (NTBs) apply to both goods and services and for most sectors.

  • There are two types of NTB:
    • Customs barriers (such as certificates of origin and rules of origin);
    • Regulatory barriers (technical standards, regulatory standards etc).
  • Non-tariff barriers, for most goods, are costlier and impede trade more than tariffs and quotas (for details, please see the section on ‘No deal/end of transition’)
    • UK government estimates that the cost of NTBs is comparable to a tariff ranging from below 5% to over 20% depending on industry sector (source: EU Exit Analysis, Cross-Whitehall Briefing, page 9).
    • By contrast, the Institute for Fiscal Studies estimates the UK pays an average tariff on goods imports of 2.8%.
  • For goods, EU trade arrangements with third countries often eliminate most tariffs but only partially reduce NTBs. None eliminates them to the extent that EU membership does.
  • For services, most EU trade agreements with third countries do little to reduce trade barriers apart from EEA membership.
    • The Comprehensive Economic and Trade Agreement with Canada is the most advanced EU FTA. However, even it includes limited liberalisation of services trade.
    • Even within the Single Market, the EU recognises that there is further work to do to remove frictions in services trade.

Figure 5.6: Trade barriers in UK-EU trade arrangements

Source: RBAS analysis (updated 4 April 2022)
Institute for Fiscal Studies, The EU Single Market: The Value of Membership versus Access to the UK, August 2016

 

WTO terms

The World Trade Organisation sets minimal, common-denominator rules among 164 countries in the world accounting for 98% of world trade (in 2017). All members conduct some of their trade through trade agreements with other members (customs unions, FTAs etc).

Trading under WTO terms with the EU has no preferential features, but may be enhanced by bilateral agreements relating to specific sectors or product standards. For example, the EU has bilateral agreements with the US and China. For a more detailed discussion of UK trade, the WTO and the main Brexit options please see the briefing for non-experts: UK Trade and the Word Trade Organisation.

The UK is a member in its own right, but the EU acts at the WTO on behalf of EU member states.

Each member has its own ‘schedules’, WTO-speak for the list of tariffs and quotas that it applies to imports from other countries. The schedules also include ceilings on agricultural subsidies and commitments on opening markets for services. There can also be commitments on opening government procurement markets for this sub-set of members (which would include the EU and the UK.) For a helpful summary of what’s included in WTO schedules, please see Peter Ungphakorn’s blog: 12 years on, EU’s certified WTO goods commitments now up to date to 2004.

The UK has submitted its proposed schedule for tariffs and quotas to WTO members for certification. Subsequently the UK submitted its schedule for services.  The tariffs for approval are called ‘bound tariffs’. These are the maximum that the UK can levy on imports. In May 2020, the UK published its applied tariffs which it calls the UK Global Tariff (UKGT). These tariff rates are sometimes lower than the bound rates.

WTO members take decisions by consensus, supported by the WTO Secretariat. For the UK’s proposed schedules to be certified, there must be no objection by any of the other163 WTO members. The UK would be able to trade under its proposed schedules while the certification process proceeds. Note that the Secretariat has no executive power.

WTO members do not delegate decision-making power. This means that the WTO processes for negotiating schedules require careful navigation. As an example, on 5th October 2017, the US and other countries, including Argentina, Brazil and New Zealand objected to a proposed deal between the UK and EU to divide agricultural import quotas between themselves. As any one WTO member may veto a proposed deal, the UK could be at the mercy of countries playing politics, say by Argentina over the Falklands or by Spain over Gibraltar.

Customs unions

A customs union is only relevant for trade in goods. Its purpose is to eliminate customs duties in bilateral trade and establish common import tariffs. Although CUs relate only to goods, some have parallel economic partnership agreements that cover some services.

All members of a CU apply the same set of tariffs, which vary by sector, to goods imported from outside the union. A common external tariff (CET) means that:

  • Imported goods from third countries are subject to the same tariffs irrespective of which member country imports them.
  • Once inside the CU, goods move tariff-free between members without costly checks on the origin of goods (this is particularly valuable for manufacturing sectors, such as automotive, that import components from within the CU).
  • Members must have border checks with countries outside the CU. Imports from countries outside the CU are still subject to rules of origin checks – even with an FTA. For example, there are border checks between Canada and the US, and Mexico and the US, even though they are all members of NAFTA.
  • Members are usually prevented from pursuing bilateral FTAs with other countries (because these affect tariffs and quotas).
    • As a member of the EU Customs Union, the UK cannot negotiate and sign independent trade deals that affect import tariffs.
    • However, the UK is free to agree bilateral trade deals with third countries that facilitate market access for UK goods and trade in services.

Not all CUs prevent members from conducting individual trade negotiations. For example, Turkey is in a customs union with the EU but can agree trade deals with other countries in some sectors, because the Turkey-EU CU is not as extensive as the EU Customs Union (it does not cover all goods and also involves quotas). However, Turkey is not consulted on EU trade negotiations.

There are 16 CUs around the world, including:

  • Gulf Cooperation Council (GCC)
  • West African Economic and Monetary Union (WAEMU)
  • Central American Common Market (CACM)
  • Caribbean Community (CARICOM)
  • Andean Community (CAN)
  • Southern Cone Common Market (Mercosur).

A CU has a very limited impact on customs controls. It removes a few checks but does not remove the need for checks for compliance with regulatory and technical standards. Other trade agreements are necessary to remove the other trade barriers.

The European Commission published Table 5.2  to demonstrate that a CU with the EU removes just two checks on imports from third countries to the EU. To remove all the other controls at the border requires membership of the Single Market and the EU VAT area.

Table 5.2: Limited impact of a customs union on EU customs controls

Sources:
World Bank, Customs Unions, (Soamiely Andriamananjara)
Centre for European Reform, Is Labour selling the UK a Turkey?, April 2018
European Commission, 22 May 2018

 

Free trade agreements

A free trade agreement (FTA) is a reciprocal agreement between at least two parties, which aims to liberalise trade by significantly reducing or eliminating tariffs and quotas on goods trade between its members. WTO rules govern FTAs.

These preferential agreements must be between at least two countries but may involve more – for example regional deals. Unlike a customs union, an FTA does not require its members to set the same tariffs on trade with countries outside the FTA. Modern FTAs try to remove a few NTBs but most remain in place. Modern FTAs may also address some services trade (for example, the FTA between Canada and the EU) but in a limited way.

FTAs that deal only with tariffs, quotas and customs arrangements, are called “shallow” agreements. Those that include rules on other relevant domestic policies that affect trade are referred to as “deep” agreements. These might include policies on, for example, competition, intellectual property rights, investment and movement of capital. Some FTAs go further and cover issues such as environmental laws, labour market regulations and measures on visa and asylum. There is a trend towards deeper FTAs.

Four examples of well-known regional FTAs and their members:

  • EFTA FTA – Norway, Iceland, Switzerland and Liechtenstein
  • NAFTA – US, Canada, Mexico
  • ASEAN FTA – Brunei Darussalam, Indonesia, Malaysia, Philippines, Singapore, Thailand plus Cambodia, Laos, Myanmar, Viet Nam
  • Dominican Republic-Central America Free Trade Area (CAFTA-DR) – US, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, Dominican Republic.

 

EEA-EFTA

The European Free Trade Association (EFTA) is an intergovernmental organisation set up for the promotion of free trade and economic integration to the benefit of its four Member States (Iceland, Norway, Liechtenstein and Switzerland). Note that EFTA does not act on behalf of its members like the EU. Instead, the EFTA members themselves negotiate and sign the agreements.

The European Economic Area (EEA) provides for the free movement of persons, goods, services and capital within the Single Market of the EU between its 28 member states, as well as three member states of EFTA: Iceland, Liechtenstein and Norway (see Figure 5.7). The context for the four freedoms for the EFTA states is slightly different than for EU members. The EEA Agreement makes it clear that they are means to achieve trade goals rather than political ends in themselves.

EEA-EFTA members contribute to the EU programmes in which they choose to participate, but do not contribute to general EU budget.

The EEA agreement is limited compared to EU membership. For example, the EEA agreement does not include:

  • EU Customs Union
  • EU Common Trade Policy (and EU trade agreements with third countries)
  • Common Agricultural Policy
  • Common Fisheries Policy.

To ensure unified application of EEA rules, the three EEA-EFTA States established the EFTA Surveillance Authority and the EFTA Court, which mirror the surveillance functions of the European Commission and the competences of the ECJ.

For more detail on EFTA and differences with EEA and EU, see http://www.efta.int/faq

Figure 5.7: EEA and EFTA members (before UK departure from EEA)

 

EU membership

Economic cooperation between member states is a core objective of the EU.  As a result, one of the major benefits of EU membership is near-frictionless trade of goods and services.

Four EU frameworks remove trade barriers between member states to make trade easier and to reduce the cost of doing business. Some barriers, such as transport costs, culture and language remain, but the powerful EU combination eliminates tariffs (border taxes) and customs checks. It also reduces (but does not eliminate) regulatory NTBs, which are particularly important for services trade.

Non-members may have preferential trade arrangements with the EU including Mutual Recognition Agreements (MRAs). An MRA means two countries recognise the results of one another’s conformity assessments (a set of processes that confirm whether a product meets specified legal requirements – these may include testing, inspection, and certification).

Unilaterally, the EU may grant a third country regulatory equivalence (for example on financial services regulation) or adequacy (for example on data protection), where it believes it meets the required EU standard. The EU has the power to remove these at short notice, and it may use its leverage to achieve other trade goals.

Single Market

Membership of the Single Market reduces NTBs for goods and services in a way that no other existing trade deal or free trade area does. It means that goods and many services in member states meet the same standards and can be freely traded with other member states. A car manufactured in Sunderland or Bavaria can be sold anywhere in the EU.

All non-EU countries have ‘access’ to the EU Single Market as an export destination. A non-EU country may also be a member of the Single Market under the EEA agreement if it is a member of EFTA.

Union Customs Code

The Union Customs Code sets out the framework for strong customs cooperation between member states. It also defines the formalities for the movement of goods between EU member states and third countries, including:

  • Import–export procedures
  • Data requirements
  • Tariff classifications
  • Common risk criteria

Common interpretation of these rules is necessary to avoid, for example, differences in tariffs charged as a result of different tariff classifications of the same goods. The Union Customs Code also mandates greater use of information technology between member states’ customs authorities to allow real-time information sharing. Many of these features are included in the recent WTO Trade Facilitation Agreement.

Preferential trade agreements

Non-members may have preferential trade arrangements with the EU. There are three main types with different purposes:

  • Customs unions: eliminate customs duties in bilateral trade and establish common import tariffs (like Turkey);
  • Association Agreements, Stabilisation Agreements, Free Trade Agreements and Economic Partnership Agreements: remove or reduce customs tariffs and some NTBs (like Canada or Japan);
  • Partnership and Cooperation Agreements: provide a general framework for bilateral economic relations but leave customs tariffs as they are (like Russia). Often partnership and cooperation agreements precede a deeper trade agreement.

See Appendix H for a list of all UK trade partners and the types of agreements they have with the EU.

 

Summary of EU models

Table 5.3 summarises the five common models for trading with the EU. The UK initially sought a bespoke deal which would be different to the existing models. However, it seems likely to settle for a basic FTA (model 3) or ‘no deal’ (model 5 without the bilateral agreements).

Without membership of a customs union, border controls will be required between Great Britain and the EU, including between Northern Ireland and Great Britain. For a fuller discussion of international trade and trade models, please see the briefing paper: UK trade and the World Trade Organisation.

Table 5.3: EU trade models

Source: RBAS analysis

 

EU VAT area


The EU VAT area is separate from the EU Customs Union and Single Market. It is a key enabler of trade between member states. If the UK leaves the VAT area as a result of Brexit, important consequences follow.

Tax is a complex area. Please note that the comments below aim to highlight the main considerations and are not comprehensive.

Pre-Brexit situation

The UK introduced VAT as a condition of joining the EEC in 1973. As a member state, the UK is part of the EU VAT area designed to facilitate trade between its members. When the UK leaves the EU, it is likely to leave the EU VAT area.

For EU members, being registered for VAT in one member state is sufficient to trade in all. At the moment, VAT is generally not charged on the supply of goods, nor certain services, between businesses from another EU country. VAT becomes chargeable when sold to the final customer.

Under the EU rules, the minimum standard rate of VAT is 15% and the maximum 25%. The current UK standard rate is 20%. Member states cannot levy a rate of VAT higher than their standard rate. So the UK could not, for example, have a luxury goods rate at, say, 30%. There is a prescribed list of goods and services to which EU member states can apply reduced rates of VAT. These are set at a minimum of 5% with only two reduced rates allowed.

The UK enjoys an opt-out to maintain zero rates on items such as food, children’s shoes, clothes and books. The UK cannot create new zero-rated items (for example for tampons or child seats) and, if it moves an item out of the zero-rate band, it cannot move it back.

Future developments

The EU has recently issued proposals for more flexible VAT rates, but these would still inevitably leave constraints for members. The EU is concerned that intra-EU VAT-free trade has become a major source of fraud. This has led to a big shortfall in VAT receipts – the so-called ‘VAT gap’. The EU  is planning to move to a single EU VAT area.

This would result in a fundamental shift to VAT being payable in the country where goods and services are consumed. The seller in the country of origin will need to register, account and pay VAT – unless the customer in the destination country is certified to be a ‘reliable taxpayer’ (allowing deferred VAT accounting to continue). This new system is due to be fully operational by 2022.

Impact of leaving EU VAT area

VAT accounts for 18% of UK tax receipts – the third largest source of tax revenue after income tax (25%) and national insurance (19%). So, any press reports that VAT could be abolished with Brexit are fanciful. The government has said that it aims to minimise changes to VAT processes after Brexit.

VAT chargeable at the border

A big change after Brexit will be how VAT is charged on trade with the remaining EU 27 member states. If the UK leaves the EU VAT area, a UK importer will have to pay import VAT at the border. This means payments will occur earlier leading to potential cash flow consequences, unless the government finds a way of mitigating them.

British companies trading across the EU in services would be hit as well. They would need to become VAT-registered in each member state where they operate.

Import declarations

Importers will have to make import declarations for the first time – a change that will affect around 130,000 businesses. The European Commission has warned of other potential complications for those engaging in cross-border trade. An example is the potential need to employ a VAT representative in the country to which they are sending goods, though long-term arrangements will depend on the final agreement between the UK and the EU.

Border infrastructure

Brexit will also lead to huge new infrastructure to impose VAT at the UK border, including with Ireland. New controls will be needed to check packages coming into the UK from the EU (in the same way that packages from non-EU countries are currently inspected). The alternative would be to accept a loss of control of VAT revenue and an increase in fraud. The EU will be keen to make sure that the UK operates on a level playing field for tax with the EU.

Some UK officials say that infrastructure can be avoided if the EU lets the UK remain in the current information exchange system. The system ensures governments know which goods have crossed EU frontiers. UK officials are seeking this access without being subject to European courts or common VAT rules. They argue that if the UK aligns its product standards with the EU, information sharing is only a small extra step to keep the cross-border trade flowing freely.

Damage to small businesses

British businesses fear that leaving the EU VAT area would damage EU-UK trade.  If the UK leaves the EU VAT regime with no other agreement in place, companies could suddenly be required to pay VAT upfront on goods imported from the EU (and vice versa). For around 130,000 British companies, mostly small and medium-sized enterprises, it would be their first time to pay upfront import VAT.

This would create both cash-flow and time burdens, which would be particularly costly for small businesses. HMRC would need to increase its staff and resources even further. Goods would be held at the border until VAT was paid. This is also likely to inconvenience consumers buying products from the EU over internet marketplaces.

Sources:
What Brexit means for VAT, Prospect Magazine, April 2018
VAT: Brexit’s hidden border dilemma, Chris Giles, Financial Times, 30 May 2018
 

Last updated on 17th April 2022 by Richard Barfield