Underneath the bonnet of Brexit Britain

There are many barometers of health for the world economy. However, none is more important than trade, writes Richard Jeffrey, Chief Economist


Richard Jeffrey

Richard Jeffrey

Chief Economist

At one level, trade and the exploitation of comparative advantage enhance global growth and wealth; however, at another level, trade also exposes weaknesses in economic architecture, both in the international framework and in a more local context.

Improving growth through creating a level playing field for trade flows within the free trade area has been and remains a core objective of the European Union. However, the EU has always had a slightly schizophrenic attitude towards free trade, in that it often behaves in a highly protectionist fashion with countries outside the area. The EU also uses the objective of enhancing the free trade area as a way of pursuing more political objectives. So, it is widely believed that the common currency – the euro – was introduced solely in order to improve the operation of the single market. However, the words of Tommaso Padoa-Schioppa, one of the founding fathers of the EU, create a different context for the creation of the single currency: “Our new currency unites not only economies, but also the people of Europe”.

A free trade area is very different to a common currency area. Whereas the former normally benefits all participants (so long as there is no cheating), the latter can actually prove permanently debilitating to weaker economies. But that is another debate. Of more immediate concern is the impact that Brexit may have on the UK’s trading position, not just with the EU but with the wider international economy. My view is that companies confronted with less easy access to EU markets (although ‘less easy’ is as yet undefined) will meet the challenge by trying to develop other markets. ‘Challenge’ is a key part of the capitalist system; it is the challenge of competition that tests companies and encourages growth; and it is the challenge to attract capital that ensures it is allocated in the most effective ways.

A helping hand with regard to meeting the challenge to the UK of leaving the European Union was provided by the immediate depreciation in the pound following the referendum. There have been adverse consequences from this loss of value – the most obvious being the increase in inflation resulting from higher import prices. Nonetheless, even after allowing for the jump in costs arising from higher prices of imported materials and fuels, companies based in the UK benefited from a substantial improvement in competitiveness. When thinking about the impact of currency depreciation on trade, economists normally focus on the benefit to exporters. However, UK-based companies competing with imports have also gained from an enhanced competitive position.

The impact of improved competitiveness on trade volumes can take considerable time to show through. Moreover, the most immediate effect is that the cost of imports rises. Hence, a currency depreciation normally leads to an initial deterioration in the trading position of a country (it should be noted that this may be partially offset if exporters raise base-currency prices). The hoped-for volume benefits that should eventually reverse that deterioration are more nebulous, but potentially more powerful. The whole process is often referred to as the ‘J’ curve.

Before looking at the UK’s post-referendum experience, it is important to highlight a problem: trade data are notoriously volatile and unreliable and are often very heavily revised. But we work with the materials to hand… during the six quarters prior to the referendum, the trade deficit (in goods) averaged £30.2bn per quarter. Since the referendum, the average has been £34.8bn. This would seem to confirm the normal and expected initial deterioration. But the flows data are quite hard to interpret. There is clear evidence of a post-referendum increase in import prices, especially in imports from the EU. On the other hand, it would also seem that exporters also raised prices quite aggressively. Disentangling the various effects is a somewhat arcane exercise; what is more important is whether we can now begin to discern any longer-term volume improvements in trade flows.

In real or volume terms, the UK’s trade position has deteriorated significantly since the short-lived improvement during and in the immediate aftermath of the ‘great’ recession. Thus, in the five years to, and including, 2016, net trade made a negative contribution to GDP growth averaging a substantial 0.6% per annum. However, 2017 has seen the early signs that this situation is reversing. Indeed, on the basis of my forecasts for the fourth quarter, the positive contribution to growth could be as much as 0.4% during the year. From quarter to quarter, the pattern has been quite erratic, as is often the case with trade. Nonetheless, during each of the three quarters for which we have official data, there has been a positive year-on-year impact from net exports on the overall growth rate of the economy.

So, should we conclude that this is the consequence of improved competitiveness and a positive corporate response to the Brexit challenge? probably, yes. But with a trade deficit that is likely to be some 2.1% of GDP in real terms in 2017, we still have some way to go before we can conclude that we are close to containing the excess consumption, which has beset the economy since we last had a sustained positive contribution to growth from trade (and consistent annual trade surpluses) during the period up to 1997/8. But, for the moment, our tankard is half full.


Richard Jeffrey

Richard Jeffrey

Chief Economist

Richard Jeffrey was Chief Economist at Cazenove Capital until he retired in January 2018. 

This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. 

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