The Challenge – Is to vote with my head and not my heart and as Danial Boysten eloquently stated “The greatest impediment to discovery is not ignorance but the illusion of knowledge”. So in the interests of reducing my own ignorance and improving my overall subject knowledge I’ll attempt anyway to keep an expansive and open mind.

Why this article?

The UK European Union membership referendum is scheduled to take place on 23 June 2016.

As the outcome of this election in particular has the potential to have an impact on the prosperity of my immediate family, I feel the responsibility to vote in an informed responsible manner. That means listening as much as opportunity allows to the debate and assimilating all the available information and voting with my head and not necessarily my heart. It would be all too easy to wave the bull dog flag only to find that any exaggerated or suggested benefits dematerialised after the vote.

The Brexit (Short for British Exit) debate for me is a largely unanalysed or has been to date an unconsidered topic and the following are a few thoughts on just one parochial aspect of the debate. That focus is the UK trade deficit and how it may be affected by the outcome of the EU referendum vote.

So the narrow question is will we be better off from a balance of trade point of view if the UK leaves the EU?

By definition the UK trade balance is a measurement of Britain’s trade with other countries. The headline figure is the value of exports minus the value of imports from the same countries, and is expressed in billions of Pounds. A positive value indicates a trade surplus while a negative value indicates a trade deficit.

As the graph below shows we have more recently imported more than we export so we have a trade deficit with the rest of the world:

One consequence of a persistent trade deficit is that UK jobs are put at risk if exports in particular decrease. Debt then increases and this can lead to speculative attacks on a countries currency. With a weakening sterling for example foreign buyers get more ‘bang for their bucks’ and there is the potential for exports to grow again independent of imports. In this economic situation the trade deficit has the potential to reduce as long as imports are normalised and an equalisation effect then comes into play.

So who do we do trade with?

The following table shows that we export more to non-EU countries in contrast to imports from those same countries. In effect our trade balance deficit is smaller with non-EC countries and in terms of trade we fair marginally better. I also note that the value of Great Britain’s non-EU trade is about 30% less than that of its intra-EU trade. So if we want to reduce the UK trade deficit then we would do better focusing on those relationships where the deficit is smallest or already in credit.

So in broad terms we do more trade currently within the EU than outside of it. This latter point is certainly understandable given we have a custom union with other EU countries.

This custom union ensures that trade tariffs and quotas are non-existent between EU countries. In effect those countries within the EU that can produce goods and services more cheaply will be more able to sell their products in an equalised EU market place. The downside of being in the EU in trade terms is that we are not at liberty to negotiate trade agreements bilaterally with countries outside of the EU.

In more practical economic terms as the UK is not in the single currency the position of sterling against the Euro also has an effect on our trading position with our EU partners.

So if we do more trade currently with the EU then how does the value of Sterling against the Euro affect things?

The graphic below shows the 5 year trending of Sterling against the Euro:

The forecast running up to the EU Referendum at least is for sterling to weaken given the level of uncertainty that has been generated. This will vary in line with the swinging pollster’s predictions on the eventual outcome of the vote. For example if the UK is predicted to stay in then sterling generally rises against the Euro. There’s also strong speculation that this same uncertainty principal will cause sterling to drop further, at least in the short term, should the UK vote to leave the EU.

With Sterling falling as predicted this could stimulate exports which will reflect favourably on the trade deficit. However if we are out of the EU then we will need to negotiate a trade agreement with the EU. Tariffs and quotas will consequently follow in relation to trade with the EU and our export position will reduce on a basket of tradeable goods and services. Consequently there’s the potential for exports with the EU to decrease given imposed post EU membership trade restrictions.

Depending on the position of Sterling against the Euro if there’s a downward turn imports from EU countries may well then decrease as well, given the reduced buying power of Sterling against the Euro. This presupposes that the Euro does not come under trading pressure for other reasons.

So just in relation to the EU, exports may decrease (due to newly implemented trade restrictions) and imports have the potential to decrease (as sterling fails against the Euro). If they are on par then the trade deficit could remain broadly static. As more trade is currently undertaken with the EU, then given our exports may reduce, jobs will be put at risk. Put jobs at risk and there’s the potential to import less because we have less individually to spend and we have an economic downturn. The only benefit that I have derived personally from an economic downturn is low interest rates. As they are as low as they are going to get then future benefits will be minimal to say the least.

Trade deficits however can be good or bad and that largely depends on the degree of that deficit and that countries position in the economic cycle. A small manageable deficit, where we import more than we export, could mean that we can buy in goods and raw materials at lower prices.  Lower priced bought in commodities translates into less debt and more jobs.

What does our trading position look like more specifically?

The following table shows our top nine trading partners April (£m) 2015 figures. What’s significant is that 2 out of 3 of our top 9 trading partners are EU countries.

In the final Analyses…

1. Our top 6 out of 9 trading partners are EU countries and in relation to those we import more than we export. Consequently we have a trade balance deficit with these 6 top trading partner countries. This trade deficit is more marked with our EU trading partners than with non-EU trading partners. If we left the EU then we would need to negotiate a trade agreement with the EU which would attract tariffs and quotas. Our exports into the EU would reduce as the cost of our sold in goods and services would go up. This would lead to a growing trade deficit with our main trading partners in the EU. One opportunistic strategy to reduce costs is to cut wage inflation. Another way is to invest in technology and to provide goods in particular more cheaply. In effect the cost per widget is reduced. So where is this cheap labour in particular coming from if not from the EU worker pool?
2. We would need to negotiate trade deals with other countries alone or join another trading block. Being part of a trade block like the EU or NAFTA (North American Free Trade Association) would yield economic strength in numbers. Any trade agreement negotiations and implementations would take time and the hope is that as the EU market diminished the slack is taken up in trade terms by non-EU markets. But it seems obvious that as trade barriers are imposed between the UK and the EU there will be the same level of trade tariffs and quotas between the UK and non-EU countries. There appears to be no economic advantage in relation to the terms of trade between the UK and those be seek to trade with.
3. If exports by the UK into the EU dropped and non-EU market trade did not compensate then an economic downturn would follow.
4. Only 2 out of 9 trading partners leave the UK in a trade balance credit situation and these are non-EU countries. We are in particular reliant on the USA to bolster the trade balance figures should be leave the EU trading partnership.
5. China is in economic dire straits so we would not derive much benefit as a non-EU trading partner. It’s entirely possible that our trading position with China could get worse as our non-EU trading advantage diminishes.
6. On balance coming out of the EU has the potential to weaken our trading position even more with EU countries.
7. Non-EU countries, which account for less trade anyway, show little immediate opportunity for improving the advantage in the trade balance figures. This is particularly pertinent as outside the EU we could not rely on the economies of bargaining scale than we could otherwise rely on if we remained in the EU.

All in all being of an economic novice mind set I’m not sure I’m any more certain whether the trade balance will improve or not if we stay in or come out of the EU. However the above does suggest that we would be immediately better off economically staying in the EU.

For better or for worse…

So the question was will we be better off from a balance of trade point of view if the UK leaves the EU? I find that on the basis of this narrow question the UK would be better placed economically, in the short term, if we stayed in the EU.

One thing I’m sure of and that is the debate and the EU referendum has caused a lot of uncertainty and that in itself has the potential to cause economic uncertainty. That said the EU in-out debate is certainly one worth having and other issues may have more emotional and economic traction to other voters.

To end I’m must say that I’m certainly not an economist but rather a layman trying to make some sense of the Brexit debate. However Economics appears to the layman to be more about predicting an outcome after the fact rather than before. High insight is a wonderful thing and this in itself leads in economic terms to the illusion of predictability and knowledge before the fact.

So there’s nothing predictable about the unpredictable…Caveat Emptor!