170424 global britain main doc [draft formatted] · germany’s gdp will grow by 14% between 2017...

Priorities for trade beyond the European Union

04/2017

Henry Newman, Stephen Booth, Aarti Shankar, Alex Greer and Vincenzo Scarpetta

Global Britain

Stephen BoothDirector of Policy and Research

Aarti ShankarPolicy Analyst

Open Europe is a non-partisan and independent policy

think tank. Our mission is to conduct rigorous analysis

and produce recommendations on which to base the

UK’s new relationship with the EU and its trading

relationships with the rest of the world. We aim to

ensure that Government policy and public debate is

rational and well informed.

In the wake of the UK’s vote to leave the EU, our

programme of research and consultation will focus

particularly on:

• The UK’s new relationship with the EU, including

trade, security and political cooperation.

• The most important opportunities for new trading

relationships with nations outside the EU.

• Productive international cooperation across areas

such as immigration, research and development,

cross-borderinvestmentandinancialservices.

Our starting point is the promotion of democratically

grounded economic, trade and investment policies

which foster growth, employment and freedom under

the rule of law. Guided by these free market and liberal

principles, we are committed to an open Europe and an

open Britain.

Ofices

About the Authors

Alex GreerResearch&CommunicationsOficer

Open Europe

7 Tufton Street

London

SW1P 3QN

+44 (0)20 7197 2333

www.openeurope.org.uk

[email protected]

@OpenEurope

Open Europe Brussels

Rue du Trône 61

B-1050

Brussels

+32 (2) 540 86 25

Open Europe Berlin

Oranienburger Straße 27

10117 Berlin

Germany

+49 (0)30 2758 1365

[email protected]

www.openeuropeberlin.de

This report is released as part of the Prosperity UK 2017

Conference, for which Open Europe is an adviser.

Vincenzo ScarpettaSenior Policy Analyst

Copyright © Open Europe 2017 ISBN: 978-1-907668-51-7

AcknowledgmentsThe gravity model used in this paper was

developed with Ciuriak Consulting. The team

included Dan Ciuriak, Fanny Siaw-Soegiarto,

and Sharon Zhengyang Sun.

Henry NewmanDirector

1 Global Britain: Priorities for trade beyond the EU | Open Europe

Contents

Executive summary ................................................................................................................................................. 2

Introduction ............................................................................................................................................................... 5

1. Recent trends in global and UK trade ...................................................................................................... 8

1.1. Global trade has slowed down, but there are some silver linings ......................................... 8 1.2. An overview of UK trade .................................................................................................................. 10 1.3. A quick glance at UK trade by sector ........................................................................................... 16

2. A ‘gravity model’ of UK exports .............................................................................................................. 18

2.1. General patterns in UK trade revealed by the gravity model ............................................. 19

3. Where do UK exports under and over perform? ............................................................................... 23

3.1. Current UK export performance ................................................................................................... 23 3.2. Looking ahead: Projecting UK export performance to 2030 .............................................. 27

4. How should the UK engage with priority markets? ......................................................................... 30

4.1. How do our results tally with the Government’s stated trade objectives?..................... 30 4.2. Which stand out as the priority markets for UK FTAs? ......................................................... 30 4.3. Other bilateral policy instruments for improving trade relations ..................................... 31 4.4. Unilateral initiatives – Trade promotion and the ‘Britain is GREAT’ campaign ............ 32 4.5. India and the Subcontinent .............................................................................................................. 35 4.6. Canada, US and Mexico .................................................................................................................... 39

4.6.1. Canada ................................................................................................................................................. 39

4.6.2. The US and the ‘Trump effect’...................................................................................................... 40

4.7. Israel ........................................................................................................................................................ 42 4.8. Nigeria .................................................................................................................................................... 43 4.9. China and Hong Kong ........................................................................................................................ 44 4.10. The Gulf .................................................................................................................................................. 46 4.11. South America ...................................................................................................................................... 48 4.12. Other emerging markets: ASEAN and East Africa .................................................................. 50 4.13. Non-EU European markets ............................................................................................................. 55

Annex: Developing the gravity model framework ..................................................................................... 57

1. Data sources ......................................................................................................................................... 57 2. Model specification ............................................................................................................................ 57 3. Estimation results – Final equation .............................................................................................. 59 4. Caveats on interactions .................................................................................................................... 60


Executive summary The UK’s commitment to leave the European Union requires a new international trade and commercial policy. For decades these policies have been decided at the EU level, via the EU institutions, and requiring – in the case of Free Trade Agreements (FTA) – approval by member states and the European Parliament. Soon the UK will be able to determine its own policy. Previous Open Europe research has analysed the potential economic impact of leaving the EU. This paper suggests that there is enough untapped UK trade potential to offset the effects of Brexit on exports to the EU. In this scenario, an ambitious, outward looking UK trade strategy could complement a deep and comprehensive deal with the EU and contribute to delivering increased UK prosperity. What should that policy be? Should the UK liberalise its tariff regime to ensure cheaper imports for consumers and businesses? How does our trade in services differ from that of goods? Should the UK seek to agree FTAs with the world’s biggest economies, including the US, China, and Japan – with which the EU has so far failed to reach agreement? Should the priority instead be emerging markets in Asia, or Latin America? Should the UK focus on the Commonwealth or what some have (offensively) termed Empire 2.0? Should the UK pay special attention to countries with which we share ‘soft power’ assets a common legal system, the English language, a shared history, and a large ‘diaspora’ community? For this report Open Europe has developed a quantitative analysis to help inform the crucial decisions on trade and commercial policy. The framework will allow the UK Government to prioritise the non-EU trading relationships that the UK must seek to upgrade. It will show the implications that these developing relationships could have for improving the UK’s export performance. The gravity model, which we have used to build our framework, predicts how much trade the UK ‘ought’ to be doing with other countries based on various factors, including their economic geography. This model is developed by observing that countries trade more with bigger countries that are closer to them. Other factors, such as diplomatic representation and soft power connections are also considered. By running historic trade data through the model, our framework was tested and improved. There’s little point making policy looking at just today’s world. According to projections, Germany’s GDP will grow by 14% between 2017 and 2030. Over the same period India’s is expected to more than double. So we have modelled how the data will appear in 2030, using predicted growth figures. There are some surprising findings. According to the model, UK exports to India, Canada, and Israel consistently under-perform. By 2030, the UK would, we predict, under trade with those three countries by nearly £10 billion of goods a year. When services are specifically considered, China joins those three countries and together the four have significant untapped potential of over £17 billion of services trade. Other underperforming markets include Nigeria, Bangladesh and Pakistan. The top ten under-performing markets for goods, and those for services, represent together untapped UK export potential of just over £41 billion in 2030. In this paper we only consider export growth – not imports. A holistic UK commercial and trade policy must also consider the UK’s ability unilaterally to liberalise access to its market. This could have significant benefits for UK consumers, business and the economy. And the UK should also take further domestic action to support its economic growth and prosperity, some


of which will be easier outside of the EU. This includes regulatory reform, addressing infrastructure and transport problems, education reform, and supporting – rather than interfering with – UK universities. The UK will not ‘automatically’ realise this untapped potential. There are complex and varied reasons for trade under-performance in each country. In some cases there are simpler fixes but India, for example, remains a difficult prize. There will also be public pressure to consider the moral aspects of trade, and Government cooperation, with countries whose governments pursue repressive and autocratic policies – Bangladesh, or much of the Gulf, are obvious examples. Open Europe recommends that, after the forthcoming General Election, the UK Government: 1. Pursues a careful strategy of intensive engagement with under-performing countries, but

above all India, Canada, Israel, and China. Government must develop a coordinated strategic approach with careful priorities including by considering a combination of the size of the prize and the ease of reaching it. The approach should not exclude any significant economy but must be effectively prioritised. Equally, it will be important to protect UK share of trade in high-growth markets, even if trade levels are already over-performing.

2. Does not focus too much on FTAs. Although FTAs can be important, including because they serve to symbolise governmental commitment to support trade, the EU’s FTAs of which the UK is party have so far proved far less important for facilitating trade than could be expected. The UK already trades effectively with the USA and other major economies without an FTA. There do remain barriers to trade to address, but agreeing an FTA with – say China or USA – will be tough to achieve. In contrast, the UK significantly under-trades on services with the EU, despite the Single Market. The UK should avoid an all or nothing approach. Even if a full FTA remains difficult to achieve, there are various possible agreements including bilateral investment treaties or targeted agreements to address particular trade issues. And, while the UK should ‘grandfather’ existing EU FTAs over once it leaves, those FTAs were often a one-size-fits-all, lowest-common-denominator and there may be a potential for a deeper bilateral agreement after Brexit.

3. Effectively exploits UK soft power assets – the UK’s deep, historic connections with many

countries, the UK’s nationals many of whom have family links with other parts of the world, the reach of UK universities and importance of R&D. It is important that the UK remains open to business travellers and to international students, but also that this openness is promoted abroad, to counter perceptions of any closing including as a result of Brexit or migration limits.

4. Develops deeper connections with priority countries on areas not directly related to trade,

such as on innovation, R&D, higher education, development, defence, and so on. This needs to be a priority for the whole Government. This will require a major, coordinated effort from all Government departments with ministers and officials visiting priority countries, and the appointment of appropriate trade envoys, ambassadors and representatives. Possible projects include new scholarship schemes for students from target countries, jointly-funded university research programmes, defence and security cooperation, development expenditure to support infrastructure, and so on. The more that the UK can work closely with countries across a host of issues, the easier it is to also address barriers to trade.


5. Prioritises UK service exports as, while growth in global goods trade is slowing, service trade is expanding. The UK is already a strong trading nation, but while we run a trade deficit on goods, it’s a surplus for services. Services trade has been poorly supported by the EU, not least because of the limitations of the Single Market, and because of linguistic and legal differences. Some services companies, for example in the insurance industry, have said that EU membership provides them with little advantage, and even that Brexit will be a positive advantage. To support services trade, the UK needs travel regimes for businessmen and women are not overly burdensome – with security checks, as far as possible, carried out in advance of travel.

The UK is already a great trading nation, which exports to well over 200 nations. In recent years, the proportion of UK non-EU trade has grown to be a majority. Our research reveals that the UK’s EU membership cuts against the grain of our overall comparative advantage – which is services industries. All three of our top priority countries share strong historical ties – Canada and India remain in the Commonwealth, Israel looks fondly on the country which allowed it to be created. All share our legal system. And, while Canada speaks English, English is a lingua franca for India, and widely understood in Israel. The task of the Government is to seize the opportunity of Brexit to draw fully on our comparative advantages, the English language, the common law system, the status of the UK judiciary and legal system, the UK’s security, development and defence reach, our world-class universities, our innovation and science.


Introduction

Britain’s departure from the EU allows the UK to formulate a new international trade and commercial policy. Since joining the European Economic Community (EEC) in 1973, the UK’s overall trade policy has been primarily determined by the institutions of the EEC and later EU. As part of the Common External Tariff, each member state levies the same tariffs on all products imported from outside the EU, while removing tariffs on intra-EU trade. The Common Commercial Policy means that negotiations on Free Trade Agreements (FTAs) are conducted at the EU level. Outside the EU, Britain – if it leaves the Customs Union (as Open Europe has recommended in, “Nothing to declare: a plan for UK-EU trade outside the EU”)1 – will be able to determine its own trade and commercial policy. The UK will be free to decide its own tariff regime and seek particular FTAs with priority countries. To make a success of leaving the EU, the UK must develop a comprehensive and ambitious international trade and commercial policy. Open Europe has already recommended that the UK and EU should seek a full and comprehensive FTA, to maintain zero-tariff trade between them. This is in the overwhelming economic interest of both sides in the forthcoming Brexit negotiations. The UK will, however, need to consider its non-EU trade. In recent years, this proportion of trade has grown and now accounts for a majority of overall UK trade. This report is based around a quantitative framework which will help to inform a prioritisation of the key non-EU trading relationships which the UK should now seek to upgrade. It will also suggest the policy instruments which could be most usefully deployed to realise potential trade and investment gains, and outline the implications of those gains for the UK’s economic performance. To identify priority markets, this report has considered the influence of ‘economic geography’ on trade and investment. This model was developed from observing several elements in the patterns of global trade. First, countries typically trade more intensively with partners that are larger (in terms of size of economy) and geographically closer. They also trade more with partners which are more open, with greater economic freedom, and with which they share soft power features such as a common language, cultural characteristics, legal systems, and historical ties. These observed outcomes reflect the effect of trade costs: distance and border frictions increase trade costs, while socio-economic and historic-cultural commonalities reduce trade costs. Second, it is believed that countries also tend to trade more with partners that have differing economic specialisations, reflecting the influence of comparative advantage. The UK has a strong comparative advantage in knowledge-intensive services and high-tech goods sectors such as chemicals, transport equipment and food and drink. Generally, comparative advantage has driven globalisation and the growth in trade between the developed world and the emerging economies, as the former have specialised in high value-added production and the latter in labour-intensive manufacturing.

1 The full report is available here: http://openeurope.org.uk/intelligence/economic-policy-and-trade/nothing-to-declare-a-plan-for-uk-eu-trade-outside-the-customs-union/


Third, it is understood that countries can trade more with partners when they invest in the relationship. Trade and investment has been shown to be deepened by economic diplomacy in the form of embassies, consulates and trade offices, as well as trade missions led by ministers and senior officials. Face-to-face contact is important in doing business. Governments invest heavily in high-level missions that serve directly to introduce businesses with economic decision-makers in partner countries. During his time as Prime Minister, David Cameron led a series of these trips which brought various business leaders (assembled by Number 10 Downing Street) and key senior ministers into contact with businesses, key officials and politicians in a series of target countries. Face-to-face contact is of course facilitated by improved air connections and expedited business travel programmes, including visa waivers. These help reduce the time and hassle costs of business travel. Patterns of trade and investment evolve from a web of forms of interaction. Governments have also appointed Prime Ministerial trade envoys or ‘ambassadors’, from outside of the classic Foreign and Commonwealth Office (FCO) structures, often serving MPs or businessmen and women.2 However, embassies and economic diplomacy may matter more in countries where the government and other state actors exercise a greater role in economic decision-making. In more market-orientated economies, it is expected that economic diplomacy would be less significant – although it can still play a role. Since the Brexit vote, the institutions of the UK’s economic diplomacy have undergone significant reorganisation. In anticipation of the ability to conduct an independent trade policy, there is a new Cabinet position of Secretary of State for International Trade and a new Department for International Trade (DIT). The functions of UK Trade & Investment (UKTI), previously jointly reporting to the FCO and the Department for Business, Innovation & Skills (BIS), have been replaced by the new DIT. Fourth, formal agreements are of course another side of economic diplomacy and ought to help develop trade ties. These agreements can range from fully-fledged Economic Partnership Agreements (EPAs), to FTAs, to issue-specific instruments such as Mutual Recognition Agreements (MRAs), bilateral air transport agreements (ATAs or ‘Blue Skies’ agreements), science and technology cooperation agreements, Memoranda of Understanding (MoUs) and so on. Fifth, political and security relationships also matter for trade and investment. Trading across political fault lines raises risks and business costs. Political and legal uncertainty is likely to deter companies from making investment and other decisions. Conversely, defence cooperation generates commercial procurement opportunities and can reduce concerns about trade in ‘dual-use’ products – e.g. goods, software or technology that may be used for both civilian and military applications. Licensing requirements for dual-use goods in the telecoms, aerospace and security sectors are currently set out in EU regulations.3 Outside the EU, the UK could seek new arrangements with non-EU partners. The goal of this paper is to use a quantitative framework to identify which non-EU trading relationships the UK should look to prioritise and upgrade over the coming years. To do this, we decided to draw on a gravity model of UK trade developed with Ciuriak Consulting. Gravity models have been used for decades across a wide range of social sciences. They are a development of Isaac Newton’s Law of Gravitation which found that every particle was

2 See Clingendael, ‘Discussion papers in diplomacy: Economic diplomacy, the level of development and trade’, 2010: http://www.clingendael.nl/sites/default/files/20101000_cdsp_artikel_%20van%20Veenstra,%20Yakop%20and%20van%20Bergeijk.pdf 3 See HM Government, ‘Controls on dual-use goods’: https://www.gov.uk/guidance/controls-on-dual-use-goods


attracted to another particle in direct proportion to the product of those particles’ masses and in inverse proportion to their mutual distance squared. In the nineteenth century, gravity models were used to examine migration, and by the 1960s they were applied to economics and have become one of the workhorse tools for international trade and investment analysis. As far as international trade is concerned, gravity models aim to predict trade flows based on – primarily, but not exclusively – the size of countries’ economies (which stands as a proxy for the respective trading partners’ supply potential and market demand) and the geographical distance between them (which captures the effect of transportation costs and other transactions costs related to, for example, greater cultural and linguistic differences). These models rely on the observed phenomenon, described above, that larger and closer countries tend to trade more with one another. The gravity model on which this paper is based allows us to calculate a predicted level of UK exports for specific countries, as well as regional trading blocs. We can then compare this prediction to the actual level of UK exports to those markets. We then extrapolate both the trends in predicted and actual UK exports out to 2030 to reflect how changes to the global economy might affect UK trade patterns. Where predicted levels are higher than actual levels, this might indicate that there is untapped trade potential between the UK and those countries or regions. Conversely, where actual levels are higher than predicted levels, it is of interest to investigate what the UK can do to maintain and build on this ‘over-performance’ so that it can safeguard, and potentially further boost, its market share in those countries or regions. Investigating ‘what works’ in over-performing markets may help provide examples of initiatives that could be deployed in markets where UK exports currently under-perform. It is important to emphasise that the gravity model developed in this study only considers UK exports, not goods and services imported by the UK. While this approach is intended to highlight the most significant opportunities to boost UK exports, the development of a wider commercial and strategic engagement policy for the UK after Brexit must necessarily be informed by other factors such as the UK’s ability unilaterally to liberalise access for imports to the benefit of UK consumers and business. Section 1 of this paper will outline recent trends in global and UK trade. Section 2 explains the gravity model framework we use to assess the UK’s trade performance and what it tells us about patterns of UK trade. Section 3 presents the results of the gravity model, ranking the countries in which UK exports most under and over perform, compared to expected levels given the features of economic geography. This includes a projection of the UK’s export performance out to 2030, in order to capture how changes to the global economy should be considered as part of a future UK trade strategy. Section 4 analyses how the UK can maximise its trade potential in particularly interesting country-specific or regional markets. Finally, Section 5 draws conclusions and assesses how the UK’s untapped export potential identified in this report compares to potential losses of exports to the EU as a result of Brexit.


1. Recent trends in global and UK trade

1.1. Global trade has slowed down, but there are some silver linings

The period following the global financial crisis has seen a marked slowdown, but not a collapse, in the growth of global trade. The volume of world trade in goods and services has grown by just over 3% a year since 2012, barely outpacing global GDP growth. This is in stark contrast to the recent era of globalisation in the 1990s and 2000s when world trade growth regularly ran at twice the growth of global GDP.

The recent slowdown in global trade growth has affected developed and developing economies, with few countries escaping the trend, either in absolute terms or relative to GDP growth. Various explanations have been given for the slowdown, ranging from a stalling of trade liberalisation, creeping protectionism, the slowing expansion of global value chains, to weaker demand in emerging economies, particularly in Latin America and China. The World Trade Organisation (WTO) continued to expand during the 2000s – notably welcoming China and Russia in 2001 and 2012 respectively. The WTO currently has 164 members, accounting for about 95% of global trade.4 This essentially means one can no longer expect major boosts to global trade simply from the WTO enlarging its membership – as was the case after China joined the club. In fact, all the world’s largest economies are now WTO members.

4 See WTO, ‘The WTO in brief – The organisation’, page retrieved on 20 April 2017: https://www.wto.org/english/thewto_e/whatis_e/inbrief_e/inbr02_e.htm


The WTO – how does it work? The baseline for international trade is provided by the rules of the World Trade Organisation (WTO), established in 1995. Trade under WTO rules is underpinned by the Most Favoured Nation (MFN) principle. This means that if a country grants one WTO member a lower import duty for a product, it has to extend the same treatment to all other WTO members. The maximum tariffs on individual types of goods are laid out as part of each member’s WTO ‘schedule of commitments’. The MFN principle is not based on strict reciprocity. Countries can benefit from the more favourable MFN duties offered by a fellow WTO member without having to lower their own import tariffs. There are, however, exceptions to the general MFN principle. WTO members are allowed unilaterally to grant developing countries preferential access to their markets. Free Trade Agreements (FTAs) are another major exception to the MFN rule. Two or more countries can agree to apply lower or zero tariffs only among themselves. This means goods originating or sufficiently processed in countries that are party to the FTA qualify for preferential or zero duties. Furthermore, major multilateral trade talks through the WTO have stalled over the past fifteen years. The most recent attempt at deepening trade liberalisation within the WTO framework, the so-called ‘Doha round’ launched in 2001, was shelved in December 2015 – when the WTO declined to re-affirm Doha’s mandate after years of gridlock. The stalemate of the Doha round was largely, albeit not exclusively, caused by divergences over a proposed Special Safeguard Mechanism (SSM) that would have allowed developing countries to raise their tariffs on agricultural products in response to a surge in imports of such products from abroad.5 Notwithstanding the collapse of the Doha round, a number of sectoral multilateral and plurilateral agreements are still being concluded or negotiated. The WTO’s Trade Facilitation Agreement (TFA) entered into force on 22 February 2017 and addresses how to streamline customs procedures to speed up the movement, release and clearance of goods. Cumbersome customs procedures can certainly be included among so-called ‘Non-Tariff Barriers’ (NTBs) – obstacles to trade beyond the basic tariffs on imports of foreign products. New-generation trade deals focus a lot more on tackling NTBs in addition to merely scrapping import tariffs. However, the failure of the Doha round means that progress in the most sensitive areas of international trade must now be made amongst ‘coalitions of the willing’. The revamped Agreement on Government Procurement (GPA) entered into force in April 2014. It is a ‘plurilateral’ agreement within the WTO framework – meaning not all WTO members have signed up to it. The GPA parties have opened procurement activities worth an estimated $1.7 trillion annually to international competition (i.e. to suppliers from GPA parties offering goods, services or construction services).6

5 For a broader discussion, see IMF, ‘The WTO Doha trade round – Unlocking the negotiations and beyond’, paper prepared by the IMF’s Strategy, Policy and Review Department, 16 November 2011: https://www.imf.org/external/np/pp/eng/2011/111611.pdf 6 At the time of writing, the GPA has 19 parties comprising 47 WTO members. Another 29 WTO members participate as observers, with nine of them in the process of joining the agreement. For further details, see WTO, ‘Agreement on Government Procurement’: https://www.wto.org/english/tratop_e/gproc_e/gp_gpa_e.htm


The Trade in Services Agreement (TiSA) is currently under negotiation among 23 members of the WTO, including the EU, with the objective of opening up markets and improving rules in areas such as licensing, financial services, telecoms, e-commerce, maritime transport, and professionals moving abroad temporarily to provide services. TiSA is open to all WTO members who want to open up trade in services and China has asked to join the talks. A draft economic assessment of TiSA’s benefits suggests that the improved legal certainty provided by TiSA might lower the cost of trade in services by 3.4% in OECD markets and 5.8% for low- and middle-income markets.7 Some political trends across the world are also looking relatively less favourable to free trade. In one of his first moves after taking office, US President Donald Trump has pulled his country out of the Trans-Pacific Partnership (TPP) – a trade deal between the US and other eleven nations, including Australia, Canada and Japan. The US has also successfully lobbied to drop a pledge to “resist all forms of protectionism” from the final communiqué of a meeting of G20 finance ministers in Germany earlier this year.8 Furthermore, President Trump has pledged to renegotiate the North American Free Trade Agreement (NAFTA) with Canada and Mexico – although there is no firm timeline for that at the time of writing. However, a narrow focus on the disappointing trends of recent years risks overlooking the strong growth of trade in services, which has been more resilient to the structural factors affecting goods trade. World services trade has increased by 8% per annum over the past decade, around double the rate of growth of goods trade.9 While services’ share of global trade held steadily at 20% from 2000 to 2011, it rose to 23% in 2015 and it is projected that this share will continue expanding to 25% by 2030 due to advances in technology and liberalisation that are making services more tradable.10

1.2. An overview of UK trade

Trade has recently come to play a comparatively greater role in the UK economy. According to the World Bank, the UK’s trade-to-GDP ratio, which is generally also regarded as an indicator of trade openness, has risen from 52.8% in 2000 to 56.9% in 2015. However, it has been on a declining path for the past few years after peaking at 62.7% in 2011.11 The UK is a global trading nation – a highly diversified exporter of goods and services with a global reach of some 220 partner economies worldwide. The global shift towards greater services trade should be an opportunity for the UK, since it is already the world’s second largest exporter of services. In 2015 the UK accounted for 7% of global services trade, behind only the US’s 16% share. While services exports tend to account for only around a fifth of total exports for most countries, in 2016, the UK’s share of services in total exports was 44.6% (and 48.3% of total exports when precious metals and fossil fuels are excluded).12

7 See report prepared by Ecorys for the European Commission, ‘Trade SIA in support of negotiations on a plurilateral Trade in Services Agreement (TiSA)’, December 2016; http://www.trade-sia.com/tisa/wp-content/uploads/sites/7/2014/02/TiSA-draft-Interim-Report.pdf 8 Financial Times, ‘G20 drops vow to resist all forms of protectionism’, 18 March 2017: https://www.ft.com/content/241cdf2a-0be9-11e7-a88c-50ba212dce4d 9 WTO, ‘International trade statistics’, 2015; https://www.wto.org/english/res_e/statis_e/its2015_e/its15_highlights_e.pdf 10 HSBC, ‘Unlocking the growth potential of services trade’, 2016 11 World Bank, ‘Trade as % of GDP’, page retrieved on 20 April 2017: http://data.worldbank.org/indicator/NE.TRD.GNFS.ZS?end=2015&locations=GB&start=2000 12 Value of UK Trade in Goods and Services, Balance of Payments Basis, Office for National Statistics. The adjustment for precious metals is based on HS 71 data for 2016 sourced from the International Trade Centre, Trade Map.


About 54% of goods exports and 44% of services exports are with EU and European Free Trade Association (EFTA) partners. In 2015, less than 44% of UK exports of goods and services went to other EU member states – meaning that over half of UK exports are already outside the bloc. Of the non-EU/EFTA exports, about 80% of total goods exports are accounted for by the UK’s top 20 non-EU export markets.13 The same is true for services. Accordingly, there is a fairly heavy degree of concentration of UK export sales in its major markets. This suggests there is plenty of untapped potential for the UK to exploit by further diversifying its non-EU export markets. Generally, since 2007, the UK’s total exports of goods and services have broadly tracked world exports. However, underlying this average, UK exports to non-EU markets have grown significantly and above the global trend, while exports to the EU have undershot. This is reflected in the growing share of non-EU markets in the UK’s total exports of goods and services, which increased from 49% in 2007 to 56% in 2015.

This is corroborated by the fact that, in 2015, of the UK’s top 20 trading partners in terms of total volume of exchanges (that is, the sum of exports and imports of goods and services), nine were EU member states and eleven were not.

13 Counting the ASEAN Economic Community as a single market.


Given that growth in the EU, and most of the Eurozone in particular, has been poor relative to markets elsewhere, it is not necessarily surprising that UK exports have been diversifying away from the EU. While this process of diversification was most certainly influenced by the Eurozone’s prolonged economic crisis, it also reflects a more general trend in worldwide economic growth. Looking ahead to 2030, it will increasingly be countries outside the EU (and Europe) that are expected to enjoy the highest growth rates – and will therefore offer greater opportunities for UK exporters. According to OECD growth projections, Germany’s GDP will be only 14% higher in 2030 than in 2017. By comparison, India’s GDP is forecast to more than double (+109%) over the same period. Indonesia is also expected to see its GDP almost double by 2030 (+97%), while China’s GDP is foreseen to be 74% higher in 2030 compared to 2017.

Another way to assess the UK’s trade performance is to gauge it against that of its EU counterparts. The following chart illustrates that UK goods exporters have outperformed their EU competitors in non-EU markets (extra-EU trade), whereas they have underperformed relative to EU competitors when trading within the EU’s single market (intra-EU trade).


UK services exporters have also performed well compared with their EU competitors in both intra-EU trade and extra-EU trade, albeit with a less marked difference between performance in EU and non-EU markets. If looked at side-by-side, these two charts also suggest UK exports of services to other EU member states have recently grown more than the EU-28 average – despite the absence of a genuine single market in services in the EU. Conversely, UK exports of goods to other EU member states have performed consistently below the EU-28 average over the past few years. In 2015, UK exports of goods stood at the same level as in 2007.


In other words, UK exports to non-EU countries have grown faster than UK exports to the rest of the EU in recent years – with a much more visible difference in goods than in services. Overall, this is an encouraging indication of the UK’s ability to move into new markets and take advantage of global opportunities. Nonetheless, there clearly is room for improvement. As the chart below shows, only a comparatively small proportion of UK exports currently go to high-growth countries. In 2015, only 3.2% and 1.3% of UK exports of goods and services went to China and India respectively. Only £923 million worth of UK exports (0.002% of the total) went to Indonesia – a country of around 250 million inhabitants and set to be one of the world’s fastest-growing economies.14

The UK’s trade balance – the difference between exports and imports – has been in deficit (with imports higher than exports) since 1998. The UK currently runs a deficit in trade in goods, which is partly offset by a surplus in trade in services. The UK’s deficit in trade in goods stood at over £126 billion in 2015, while trade in services posted a surplus of nearly £88 billion in the same year. The UK’s trade deficit in goods and services with the other 27 EU countries is currently valued at around £69 billion, a 17.9% deterioration compared with 2014.15 Among non-EU countries, the UK has seen rising surpluses in trade with the US in recent years, with a level of over £39 billion in 2015. The UK, however, has experienced a growing trade deficit with China since 1999, although this has broadly stabilised since 2010 and currently stands at £23 billion.16

14 When reading the chart, please note that GDP growth projections for Hong Kong, Singapore, Saudi Arabia and the Residual Gulf Arabian countries were not available in the OECD database – as these countries are not OECD members. The ‘residual Gulf Arabian countries’ item in the ONS Pink Book includes: Bahrain, Iraq, Kuwait, Oman, Qatar, United Arab Emirates, and Yemen. 15 The figure includes a deficit in trade in goods of £89.5 billion and a surplus in trade in services of nearly £21 billion. 16 In 2015, the UK posted a deficit of £25.2 billion in trade in goods with China, and a surplus of £2.3 billion in trade in services.


1.3. A quick glance at UK trade by sector

A more detailed breakdown into sectors shows that, perhaps unsurprisingly, the rise in the share of services in UK exports is largely driven by professional and management consulting services. However, the UK’s strength in services remains driven by financial services.


More generally, the chart below shows the enormous importance of services to wealth creation in the UK. In terms of value added created in the UK economy in 2014, services contributed to the tune of 67% – once the UK’s housing and property market are excluded. Financial and professional services together accounted for 15% of the UK’s total Gross Value Added (GVA) in 2014.


2. A ‘gravity model’ of UK exports

As discussed in the introduction, it can be observed that, generally, countries trade more intensively with other countries that have larger economies and are geographically closer. There are also other factors that are expected to have a positive impact on a trading relationship: greater economic freedom and openness to trade, a common language, stronger historical ties, a shared culture, and so forth. It is also understood that countries tend to trade more intensively with partners that have differing specialisations in global trade, reflecting the influence of comparative advantage, and with partners in whom they invest political capital – including through economic diplomacy and various forms of bilateral agreements. Measures that incentivise face-to-face contact between the respective business communities (high-level trade missions, special visa arrangements, or improved air connections) can play a role too. Gravity models provide a way to assess systemically these effects and interactions. Gravity models are inductive in the first instance: they are used because they help identify observable phenomena, but they do not necessarily explain those phenomena. In other words, by identifying correlation, gravity models allow us to infer and test causal relationships. Such models – as any other economic model – are not infallible. There are, of course, important questions to be asked about the overall accuracy of economic modelling. Ultimately, national trade patterns are determined not by a formula but by a myriad of individual consumers and businesses in the various countries. While trade costs and trade policies do matter, specific cases of under-performance (or over-performance) in specific markets may sometimes simply reflect the accidents of history or the impact of factors not effectively accounted for in the model. However, a number of robustness checks were undertaken in order to ensure the accuracy of our model. These are generally conducted by including/excluding relevant variables in order to assess to what extent the presence/absence of a specific variable changes the results of the model. We tested our model sequentially, adding variables in to identify a structure under which any modification of the variables leads to only minor changes in the results – which is an indicator of a high level of robustness and validity of the model. Furthermore, we consulted economic data going back to the year 2000 – which has also been used to test the robustness of our model in a historical perspective. As a result of testing the model specification, fossil fuels and precious metals were excluded from the analysis. Exports of these commodities are dominated by a few countries and they tend not to follow gravity model patterns.17 This paper develops in the first instance gravity equations for the UK’s exports of goods and services and uses these equations to estimate expected levels of trade. The expected levels by partner country are then compared to actual, recorded levels of trade to provide an indication of unexploited trade potential. In addition, we introduce policy variables such as the existence of FTAs or diplomatic representation into the equation. We also take into account interactions with the socio-economic characteristics of partner countries, to consider how effective these trade policy instruments are.

17 For instance, the UK’s imports of oil are dominated by Norway and the Organisation of Petroleum Exporting Countries (OPEC). Meanwhile, the UK has no commercial-scale gold mines, but London is the centre of the global gold market, which can lead to large fluctuations in flows. These tend to show up as exports to Switzerland, where large gold bars are reprocessed, often for the Asian market. See ONS, ‘UK energy: How much, what type and where from?’, 15 August 2016: http://visual.ons.gov.uk/uk-energy-how-much-what-type-and-where-from/. See also Financial Times, ‘UK gold exports surge tenfold this year’, 19 August 2013: https://www.ft.com/content/876af37c-08dd-11e3-ad07-00144feabdc0


In this paper, we will discuss the country-specific findings of the model at length in the following sections. Further research, based on this data and modelling, will in future Open Europe analysis examine the potential impact of a wider range of trade policy instruments, such as visa waiver programmes, bilateral investment treaties (BITs), or science and technology agreements.

2.1. General patterns in UK trade revealed by the gravity model

The size of the UK’s economy is a significant determinant of the UK’s exports of services. This variable has to be interpreted as a proxy for the UK’s supply potential: the larger the economy, the bigger the potential as a source of exports. Our model suggests that growth of the UK’s economy by 1% is associated with an expansion of all services exports by about 0.8%. However, there is little observable systematic relationship between the UK’s economic growth and its exports of goods. This largely tallies with the country’s pattern of de-industrialisation – as the UK increasingly specialises in services as its major area of comparative advantage and the main driver of its growth. A 2016 Ernst & Young report forecast that the Gross Value Added (GVA) of information and communications, and professional services will grow by 11% and 10% respectively over the next three years. By contrast, manufacturing will only grow by 2% over the same period.18 The size of the partner’s economy, which measures the potential demand for UK exports, is found to be a highly significant determinant of UK exports of all goods and services. For every 1% increase in the size of the partner economy, the UK’s exports of goods and services are about 0.7% larger. Meanwhile, every 1% increase in distance to foreign markets reduces UK exports by about 0.8%. This is consistent with the gravity model literature results for this relationship. To illustrate this, China is 24% further from the UK than the United States according to the distance data used in this study, and its economy was about 61% the size of the US economy in 2015. These figures suggest that, given symmetric but opposite effects of partner size and distance, UK exports to China would be about half the level of exports to the United States (0.61/1.24 = 0.49). The actual ratio was 41% according to the 2015 data for combined UK exports of goods and services. Accordingly, simply knowing the relative size and distance of partner economies serves to roughly calibrate expected levels of trade. Interestingly, distance is about as important for services as it is for goods.19 In other words, our model suggests there is as yet no apparent ‘death of distance’ for UK services exports due to the Internet, for example. The importance of distance to levels of trade in services may be because, despite the growth of digital services that can be provided remotely, many services are still delivered in person. This illustrates the importance of policy instruments such as visa programmes for business people. On the other hand, some would consider the continued importance of distance for UK goods trade as surprising, given that containerisation has reduced the cost of transporting goods. More important could be the ‘economical distance’. For example, research has shown that geographical distance alone does not explain differences in freight costs and that it is a country’s position within global shipping networks, or its distance from trading nodes, that is the more relevant factor for international transport costs.20 In addition, for larger countries such as the US, Russia or China, the cost of internal transport also comes into the picture.

18 E&Y, ‘UK region and city economic forecast’, 2016; http://www.ey.com/uk/en/issues/business-environment/financial-markets-and-economy/rebalancing---ey-uk-region-and-city-economic-forecast 19 Excluding precious metals and fossil fuels. 20 UNCTAD, ‘Freight rates and maritime transport costs’, 2015; http://unctad.org/en/PublicationChapters/rmt2015ch3_en.pdf


For overall UK exports, dealing with countries with common legal systems has a powerful influence on exports. UK exports are 138% higher to markets which have a common legal system with the UK. These commonalities are especially important for services in general. The strength of this factor is probably linked to the fact that a common legal system acts as a proxy for other commonalities such as a common language and historical-political ties. Indeed, they all tend to boost the intensity of bilateral economic relations. In testing the gravity model, though, these other commonalities were tried but discarded – as the common legal system variable had the best performance and all three were highly correlated. For the purposes of the model, a common legal system simply denotes whether a partner’s legal systems shares a common law basis with the UK’s and does not distinguish between the degrees to which legal systems may be compatible. The group of countries which share a common legal system therefore includes countries as diverse as the US and India, which both have legal systems that originate in the common law but have developed quite differently. On the other hand, the vast majority of EU countries’ legal systems have a civil law basis. The model suggests that international trade specialisation plays only a marginal role in shaping the direction of the UK’s exports. Once the influence of trade in precious metals and fossil fuels is stripped out, goods exports are not greater to countries with differing patterns of international trade specialisation than the UK – and the same is true for services. Thus, comparative advantage does not seem very important in determining the pattern of the UK’s global trade according to our model. The Economic Freedom Index (EFI) shows that the UK exports more to countries with a higher degree of economic freedom. This is true across all export categories, but is most important for services market access and least important for agricultural and food trade. This likely reflects that access to services markets is more dependent on the level of domestic non-tariff barriers. The EFI, which is developed by the Fraser Institute, ranks countries based on five areas: size of government; legal structure and security of property rights; access to sound money; freedom to trade internationally; and regulation of credit, labour and business.21 EU membership has an interesting and important effect in shaping the UK’s trade patterns. The UK’s exports of manufactured goods are 36% greater to EU member states than to other economies. Agricultural and food exports are close to 150% greater to EU member states than average. This is not entirely surprising. While the EU has gone a long way in reducing obstacles to trade in goods among its member states within the single market, the EU’s Common External Tariff has historically meant greater barriers in place to trade with non-EU countries (although EU tariffs on manufactured goods are now generally low). Meanwhile, the EU agricultural sector in particular is protected by the Common Agricultural Policy (CAP) and high tariffs or quotas on imports from outside the bloc.22 Conversely, the UK’s services exports do not benefit from EU membership. This outcome might reflect the lack of a genuine single market for services. It is well established that, despite the importance of services to EU economies, there remain many significant barriers to trading services across EU borders. Meanwhile, the UK does not share a common language or legal system with most of the EU, which are further obstacles to economic integration within the EU

21 The Fraser Institute, ‘Economic freedom of the world: 2016 annual report’, 2016; https://www.fraserinstitute.org/sites/default/files/economic-freedom-of-the-world-2016.pdf 22 See Open Europe, ‘Nothing to declare: a plan for UK-EU trade outside the customs union’, March 2017; http://openeurope.org.uk/intelligence/economic-policy-and-trade/nothing-to-declare-a-plan-for-uk-eu-trade-outside-the-customs-union/


single market. For comparison, it has been noted that trade between individual US states accounts for nearly 40% of GDP, whereas in the EU the figure is around 20%. Furthermore, the volume of exchanges of goods and services within a US state is only 2.6 times higher than that between US states, but in the EU it is no less than 7.5 times higher.23 More generally, EU membership appears to run against the grain of the UK’s overall comparative advantage, since it appears that the single market has boosted exports of UK manufactures and agri-food to the EU, but the UK has been unable fully to capitalise on its strength in services. On the other hand, trade outside the EU tends to align more closely with the UK’s growing specialisation in services. For example, Open Europe’s recent report on EU financial services trade, “How the UK’s

financial services sector can continue thriving after Brexit”, concluded that, while the EU has developed a meaningful single market in some banking activities, such as wholesale and investment banking, there is no genuine single market for industries such as asset management and insurance. In fact, Mark Wilson, CEO of Aviva Plc, the UK’s second largest insurance firm, said recently, “In the EU there is not one single insurance market. It’s no easier for me to do business in France than Singapore or China.”24 The presence of diplomatic representation has a very strong positive correlation with UK exports. However, this is for a very straightforward reason: the UK already has diplomatic representation in most countries and territories in the world. Therefore, the model has been further refined by introducing a level of representation variable. This variable reveals that higher levels of diplomatic representation in a country are associated with much higher levels of exports of both goods and services. Identifying causality is not straightforward. The UK’s decision on the level of representation is likely partly based on the existing level of exports, while having diplomatic representation helps address frictions. Therefore, the level of trade and diplomatic representation has causation flowing in both directions. Nevertheless, we can infer from the greater strength of the variable for agricultural products and services, which tend to face greater non-tariff barriers compared to manufactures, that diplomatic representation does have a positive impact on exports. Somewhat counterintuitively, FTAs with non-EU countries to which the UK is a party through its membership of the EU appear to have had no significant impact on UK exports of goods. For services, UK exports are about 20% higher to countries that have an FTA with the EU than to other countries. The services impact is surprising, given that FTAs, and those the EU has signed in particular, tend to do little to liberalise services. This might be explained by the fact that these agreements do improve upon bound commitments under the WTO’s General Agreement on Trade in Services (GATS) and therefore reduce legal uncertainty for service providers to these markets. There is often a gap between what restrictions on services a country imposes in practice and its bound commitments at the WTO. Bound commitments represent ‘ceiling levels’ of restrictions – i.e. the maximum amount to which a country can restrict access, without raising 23 See ECIPE, ‘What is wrong with the single market?’, 2016, p6; http://ecipe.org/app/uploads/2016/02/5Freedoms-012016-paper_fixed_v2.pdf and Open Europe, ‘Kick-starting growth: how to reignite the EU’s services sector and boost growth by €300bn’, May 2013; http://openeurope.org.uk/intelligence/economic-policy-and-trade/single-market-in-services/ 24 See Open Europe, ‘How the UK’s financial services sector can continue thriving after Brexit’, 2016; http://openeurope.org.uk/intelligence/britain-and-the-eu/how-the-uks-financial-services-sector-can-continue-thriving-after-brexit/


the possibility of dispute settlement proceedings. Therefore, an agreement that formalises and consolidates applied restrictions can reassure services providers that their market access will not be reduced in future, by reverting to the upper bound level of restrictiveness. One reason that might explain the small overall impact of EU FTAs is that the UK shares the benefits of these trade deals with the other 27 member states – and therefore does not reap the benefits of trade diversion from its EU partners. Bilateral UK FTAs with these countries would yield larger export gains than the UK stands to make under EU FTAs since the UK would make preferential gains against EU states. Agreements with 27 countries are likely to be at the lowest common denominator level – whereas UK-specific deals could be more intense and more focused on the UK’s specific needs. The UK’s greater flexibility to act speedily could therefore be an advantage. However, it should be noted that the reverse holds true for the UK should the EU-27 strike a deal with these parties before the UK. It would suffer preference erosion in that case, as EU exports would have preferential access over UK exports. It could also be argued that, due to its larger size, the EU could secure greater commitments on market access from trade partners than the UK acting alone. Indeed, the experience of medium-sized economies such as Australia and New Zealand challenges the popular belief that countries only want to conclude trade deals with large states or economic blocs – as both countries have a diversified portfolio of FTAs covering a significant proportion of their international trade.25 In many cases, however, size does play a role in trade negotiations. Switzerland, for instance, has struck an FTA with China under which it committed to opening its market to Chinese exports to a larger extent and at a faster pace than China would do for Swiss exports. The UK is indeed a much larger economy than Switzerland or Australia, but size will not always be on its side in future trade negotiations. One final caveat: a country’s trade balance is affected by a host of different variables. One of these is currency fluctuations. In reality, this correlation can work both ways. The value of the domestic currency can affect the price competitiveness of imports and exports, but a country’s trade balance also affects the exchange rate. For example, a weaker pound would make UK exports more competitive and imports from abroad more expensive – leading to an improvement in the UK’s trade balance. Over time, however, if the UK were to consistently post a trade surplus, this would in turn lead to an appreciation of the pound vis-à-vis other currencies. Furthermore, all currencies are subject to similar fluctuations. This makes it difficult to make firm predictions on the impact that the pound’s exchange rate relative to other major currencies might have on the UK’s trade balance in the coming years.

25 For a broader discussion, see Open Europe, ‘Where next? A liberal, free-market guide to Brexit’, April 2016, pp16-17.


3. Where do UK exports under and over perform?

This section presents a ranking according to our gravity model of the main countries where UK exports are currently either under- or over-performing compared to what we would expect given economic geography considerations and other relevant variables. We also present a projected ranking for the year 2030. There is, of course, a degree of unpredictability of projecting expected medium- to long-term GDP growth. Nonetheless, analysing these trends will help reveal the implications of different GDP growth rates in the UK’s various trading partners and the growing importance of emerging economies to global growth in the decade after Brexit. To construct the rankings, we focus on all goods (excluding precious metals and fossil fuels) and two sub-categories of goods: manufactured goods; agricultural products and agri-foods. The final category we use to rank UK trade partners is services. In constructing the ranking of non-EU markets we have also excluded the European Free Trade Association (EFTA) countries (Norway, Iceland, Lichtenstein and Switzerland). The UK is already deeply economically integrated with these countries either via membership of the single market or via the EU-Switzerland bilateral relationship. Therefore, we have considered the UK’s relationships with these countries separately in Section 4. It is worth stressing again here that it is ultimately firms that trade and individual consumers who determine their products of choice across a range of competing international brands. This means the observed levels of under- and over-performance in bilateral trade can sometimes reflect factors that are not taken into account by the model or are inadequately modelled. It is also important to reiterate that the gravity-model only encompasses UK exports to partner countries, not goods and services imported by the UK. 3.1. Current UK export performance The top ranking under-performing markets represent untapped UK export potential of about £25 billion,26 while the UK’s over-performance in the top-rated markets adds up to a little over £40 billion.27 These figures are relative to the UK’s established level of export capability to all markets. Table 2 shows that the model identifies Canada, India and Israel as three countries where UK exports are currently under-performing across the board. In fact, they top the overall list for goods excluding precious metals and oil, and also for services (joined in the latter category by China). They also rank in the top three in goods sub-categories of manufactures and agricultural products. Nigeria, Bangladesh and Pakistan also rank high among countries where UK goods exports are under-performing. The main under-traded regions for the UK are thus Canada, the Indian sub-continent, Israel and Nigeria. These are very different markets and the factors that account for the under-trading are likely to be very different as well.

26 UNCTAD services data for Saudi Arabia was not available. Using ITC services data, it would make the top ten under-traded services markets and it could therefore represent additional unexploited potential, which needs further investigation. However, we do not believe this data is robust enough to report in these main tables, although these figure are reported in the regional tables in Section 4. 27 UNCTAD services data for Kuwait was not available. Using ITC services data, it would make the top ten over-traded services markets. However, we do not believe this data is robust enough to report in these main tables, although these figure are reported in the regional tables in Section 4.


Table 3 looks at the markets in which the UK exceeds expectations based on the gravity equation. China tops the list in goods and the United States and Japan in services. China leads in manufactured goods and the United States in agriculture. Generally speaking, this table shows the UK has strong positions in the world’s three biggest overseas economies. Apart from the largest economies, the United Arab Emirates, South Korea and South Africa figure prominently in the various over-performing categories. Singapore stands out in goods and Australia in services. Otherwise, the table features a rather heterogeneous mix of markets. We will return to some of the countries more specifically in Section 4, but one immediate takeaway is that the UK performs better than its average when it comes to exporting to major non-EU markets – the US, China and Japan. Incidentally, none of them has an existing FTA with the UK via the EU. The UK could therefore build on these existing strengths, bearing in mind, however, that all three markets represent tough negotiating targets for future FTAs.


3.2. Looking ahead: Projecting UK export performance to 2030

Next we look at the UK’s possible export performance in 2030. In doing so, we examine the implications of differential GDP growth rates in the UK’s partner economies to capture how longer-term trends could affect the UK’s trade performance. For example, if any existing under-performance is left unaddressed, it will become even larger in high-growth markets over time. Conversely, safeguarding the existing over-performance – and therefore a strong market position – in high-growth economies would yield a structural lift to UK exports in the years to come.

As noted earlier, there is a degree of uncertainty and difficulty in predicting economic growth rates to over a decade away. To consider the implications of differential rates of growth in the UK’s partner economies, we project their GDPs forward to 2030 based on two sources:

• For the period to 2021, the IMF’s World Economic Outlook projections of October 2016;28 • For the period to 2030, the long-term economic projections for the world economy by

Jean Fouré et al. (2016) of France’s Centre d'Études Prospectives et d'Informations Internationales (CEPII).

Table 4 shows that cumulative growth to 2030 raises the total level of under-performance of UK exports towards the top-rated markets to about £41 billion.29 As a consequence, the extent of under-trading with several higher-growth developing markets increases and several developing markets have risen in the rankings.

India takes first place from Canada for UK under-trading in goods excluding precious metals and fossil fuels, more than doubling under-performance to -£5.5bn (or 13.4% of the total projected UK under-trade in goods and services). Uganda, Tanzania and Sri Lanka all enter the top ten for goods under-trade, displacing Algeria,30 Kazakhstan and Mexico.

In services, the under-trade with India, China and Israel more than doubles for each country to make a combined -£9.8 billion or 24% of the projected total for goods and services. Turkey surpasses New Zealand to take eighth place in services under-trade at -£1 billion, while Canada retains top place for UK services under-trade, growing by about one-third to £7.4 billion or 18.1% of the total under-trade for goods and services.

Meanwhile, Table 5 illustrates that the top-ranked markets where UK exports are foreseen to over-perform against expectations in 2030 total about £58 billion.31 Within this, China retains the top spot for over-trade in goods excluding precious metals and fossil fuels, increasing more than two-fold to £11.8 billion or 20.4% of the total UK goods and services over-trade. Turkey, Qatar and Australia all rise one place each to account for 8.6% of the total goods and services over-trade, just shy of £5 billion, while the United States remains top for UK services over-trade, increasing by just over one-third to £15.6 billion or 26.9% of total goods and services over-trade.

28 The projection uses the IMF projections for each economy’s GDP in nominal US dollars, deflated to 2016 constant dollar values, using the US GDP deflator for the conversion. This series is extended using the aggregate growth in the CEPII projection for real GDP in each country between 2021 and 2030. This assumption implies constant real exchange rate parities across all currencies. The IMF projections to 2021 incorporate some degree of real exchange rate change as reflected in a narrowing or widening of the gap between a country’s GDP measured in current US dollars and its Purchasing Power Parity (PPP) level. We extend the trend to 2030 where plausible. For the most part, there is only modest adjustment from this factor. 29 UNCTAD services data for Saudi Arabia was not available. Using ITC services data, it would make the top ten under-traded and it could therefore represent additional unexploited potential, which needs further investigation. However, we do not believe this data is robust enough to report in these main tables, although these figures are reported in the regional tables in Section 4. 30 It should be noted that Algeria is not yet a member of the WTO. 31 UNCTAD services data for Kuwait was not available. Using ITC services data, it would make the top ten over-traded services markets. However, we do not believe this data is robust enough to report in these main tables, although these figure are reported in the regional tables in Section 4.


4. How should the UK engage with priority markets?

4.1. How do our results tally with the Government’s stated trade objectives?

In recent evidence to the House of Commons, the Secretary of State for International Trade, Liam Fox, provided some detail of the Government’s post-Brexit trade strategy. He said his second priority, after establishing the UK’s independent schedules of commitments at the WTO, was to ‘grandfather’ the existing trade deals to which the UK is currently party via its membership of the EU. In particular, he specified,

“EU-Korea and EU-Switzerland […] account for about 80% or so of the trade by value – others

are much smaller countries in terms of trade value – and they are clearly the [EU trade deals]

that we would prioritise. But we would like to get them [all] done.”32 The Secretary of State also indicated that, in addition to existing EU trade deals, work was underway to scope the potential for trade agreements with India, Australia, China, New Zealand and “a collection of Gulf states.”33 Another idea reportedly floated within the Civil Service – albeit in a tongue-in-cheek fashion – has been the resurrection of an ‘Empire 2.0’ trade model in relation to Commonwealth trade ties. Importantly, the Secretary of State has rejected this label, calling it an “offensive caricature.”34 Indeed, not only would the political and historic insensitivities of such a strategy fail to foster goodwill among Britain’s potential partners, it also misunderstands the modern economic and governance environment of the Commonwealth. The objective of the government’s ‘Global Britain’ strategy should be to take advantage of mutual opportunities and ensure shared prosperity. The following analysis will lay out potential means of achieving this, including with Commonwealth nations.

4.2. Which stand out as the priority markets for UK FTAs?

The rankings in Section 3 support the Government’s stated objective to prioritise grandfathering existing EU FTAs, as Open Europe also recommended in our recent study, “Nothing to Declare: A plan for UK-EU trade outside the Customs Union.”35 In addition to Switzerland and South Korea, the standout priorities for ensuring the continuation of existing EU FTAs are Canada and Israel, which both rank amongst the most under-performing markets for UK exports. It should be noted that the Canada-EU Comprehensive Economic and Trade Agreement (CETA) is expected to come into force soon, which may help address some elements of under-trade. However, a bilateral Canada-UK deal should go further, particularly in liberalising trade in services. Our model also suggests that Singapore and South Africa are over-performing markets where the UK should prioritise continuation of existing EU FTAs.

32 House of Commons, International Trade Committee, ‘UK trade options beyond 2019’, 1 March 2017, p51: https://www.publications.parliament.uk/pa/cm201617/cmselect/cmintrade/817/817.pdf 33 House of Commons, International Trade Committee, ‘UK trade options beyond 2019’, p56. 34 Politics Home, ‘Liam Fox tells officials not to use 'offensive caricature' term 'Empire 2.0'’, 12 March 2017: https://www.politicshome.com/news/uk/government-and-public-sector/civil-service/news/84165/liam-fox-tells-officials-not-use 35 For a broader discussion, see Open Europe, ‘Nothing to declare: A plan for UK-EU trade outside the Customs Union’, March 2017: http://openeurope.org.uk/daily-shakeup/new-open-europe-report-nothing-declare-plan-uk-eu-trade-outside-customs-union/


Meanwhile, the data also highlights key markets where the UK does not already have an FTA via its EU membership and where it could therefore explore the possibility of a bilateral trade deal post-Brexit. Of the under-performing markets, Nigeria and Indonesia are fast-growing economies where the UK should consider creating deeper formal trade ties. India stands out as the number one priority, while neighbouring Pakistan and Bangladesh are also markets where the UK could improve its export performance. India’s tariffs on imports are high – they average 13.5% and reach 33.4% for agricultural products. India also imposes significant non-tariff barriers in services markets, including tight controls on foreign investment. While a UK-India trade negotiation would not be easy, not least because of India’s historic demand for greater visa liberalisation from the UK, there are clearly barriers that could be lowered through an ambitious bilateral FTA. Furthermore, economic factors are not the only motivation behind concluding FTAs. For example, analysis of the 2006 Australia-US FTA found that the political and symbolic importance of securing close bilateral relations following 9/11 outweighed Australian concerns over asymmetrical economic benefits. Indeed, post-Brexit, there are likely strong political motivations to ensuring deeper formal trade ties with a fast-growing, historic partner such as India. The UK already performs relatively well in the major overseas markets: the United States, Japan and China – although there is still major room for improvement for UK services exports to China. The UK does not currently have an existing FTA with any of these markets through the EU, and all three represent tough negotiating targets. However, tariffs on goods imports to the US (3.5%) and Japan (4.2%) are not particularly high. As such, bilateral FTAs with the US and Japan should focus on addressing non-tariff barriers to trade. For example, provisions on services, customs cooperation and outward investment opportunities could help improve the UK’s export performance to these markets. China’s comparatively high tariffs mean that striking even a basic agreement on goods trade could deliver important cost reductions for UK goods exporters, opening up new avenues of trade. Improving the UK’s performance in services markets should also be a priority, but securing a high-standards agreement on regulatory and intellectual issues is likely to be a significant challenge.36

4.3. Other bilateral policy instruments for improving trade relations

While FTAs can be an important trade policy tool, they are only one instrument that can be used to support trade. The potential economic gains of an FTA also need to be weighed against the political capital required, both at home and abroad, to negotiate a deal. As Open Europe has previously indicated, the UK – while traditionally regarded as open to free trade – is not immune to domestic opposition to FTAs.37 A 2014 YouGov survey conducted during US-EU negotiations on the Transatlantic Trade and Investment Partnership (TTIP) found that 39% of British voters thought TTIP would be bad for the UK, against 13% who believed it would be good.38 As Britain repatriates the power to conduct and conclude trade deals, potential domestic resistance to controversial agreements – particularly with low-cost markets such as India and China – must be borne in mind.

36 See Open Europe, ‘Where next? A liberal, free-market guide to Brexit’, April 2016; http://openeurope.org.uk/intelligence/britain-and-the-eu/guide-to-brexit/ 37 Open Europe, ‘What if…? The consequences, challenges and opportunities facing Britain outside EU’, March 2015, p86. 38 YouGov poll for 38 Degrees, 25-26 August 2014: https://d25d2506sfb94s.cloudfront.net/cumulus_uploads/document/umt71i8wcn/38degrees_results_140826_TTIP_W%28new%20tabs%29.pdf


Furthermore, as Open Europe highlighted in recent research, the existence of preferential trade agreements is not enough to ensure businesses make use of the economic advantages available to them.39 For instance, a high administrative burden to accessing preferences – for example, in certifying the ‘origin’ of the products they are exporting (or importing) – can discourage trade operators from taking advantage of reduced tariffs. It is therefore important to examine other trade instruments beyond FTAs. There is a whole gamut of policy tools that are directly or indirectly related to trade, including:

• Bilateral Investment Treaties (BITs): They set out the conditions under which individuals and private companies of one country are allowed to invest in another, as well as the rights and legal protections for investors.40 The UK is currently a party to over a hundred BITs.41

• Mutual Recognition Agreements (MRAs): They can cover a wide range of issues. As far as

trade in goods is concerned, MRAs ensure that trading partners accept each other’s ‘conformity assessments’ – that is, the testing of products before they can be put on the market – as valid. When it comes to services, MRAs ensure the recognition of professional qualifications – so that nationals of one contracting party can provide their services within the territory of the other contracting party without the need to re-qualify or re-register their qualifications, and vice versa.

• Visa facilitation agreements: They can make it easier for students and businesspeople alike to move across borders, with positive knock-on effects on trading relations as a whole. For example, expanding education exports in the form of increasing numbers of foreign students creates lasting linkages, including personal networks, which can support trade and commerce. Greater numbers of foreign students also drive tourism through family visits.

Cooperation agreements on research, technology and even security can also come into the picture. Indeed, these policy tools can and should be used in combination, rather than as stand-alone initiatives. Generally speaking, while concluding a fully-fledged FTA can sometimes take several years, it can be quicker to wrap up narrower deals that are potentially conducive to broader agreements at a later stage.

4.4. Unilateral initiatives – Trade promotion and the ‘Britain is GREAT’ campaign

Under the Government of Prime Minister David Cameron, there was a renewed emphasis on trade and investment promotion as part of the UK’s broader foreign policy objectives. The FCO was tasked with placing a greater emphasis on trade and investment support, while Chancellor George Osborne used his 2012 budget to set a highly-ambitious target of doubling UK exports to £1 trillion by 2020. Meanwhile, under Prime Minister Theresa May, the functions of UKTI, previously bringing together work of the FCO and Department for Business, Innovation & Skills, have been replaced by the new DIT.

39 For a broader discussion, see Open Europe, ‘Nothing to declare: A plan for UK-EU trade outside the Customs Union’, March 2017: http://openeurope.org.uk/daily-shakeup/new-open-europe-report-nothing-declare-plan-uk-eu-trade-outside-customs-union/ 40 Before the 2009 Lisbon Treaty, the UK was able to independently sign BITs despite membership of the EU. However, with the entry into force of the Lisbon Treaty, Foreign Direct Investment (FDI) was added to the EU’s Common Commercial Policy (Art 3 of the Treaty on the Functioning of the EU) and the agreement of BITs became an EU exclusive competence. 41 UNCTAD, ‘Investment Policy Hub – United Kingdom’, page retrieved on 13 April 2017: http://investmentpolicyhub.unctad.org/IIA/CountryBits/221#iiaInnerMenu


The “GREAT Britain” branding campaign The “GREAT” campaign was and remains a central part of the UK’s trade promotion efforts. It is a major branding initiative to promote the UK as a destination for tourists, trade and investment and students in order to secure economic growth. The campaign was launched in February 2012 with the aim of exploiting the attention generated by the London 2012 Olympics and Paralympics to secure a long-term improvement in how the UK is perceived across the globe. The campaign was managed by the Cabinet Office and allocated £113.5 million funding for the 2012–2015 period to be spent across five organisations, both governmental and non-governmental: UK Trade & Investment (UKTI), the Foreign & Commonwealth Office (FCO), British Council and VisitBritain (UKTI was replaced by the new Department for International Trade in July 2016). Alongside the GREAT campaign, other parts of government use different brands and marketing activity to meet their objectives, such as Department for International Development’s ‘UK Aid’ logo. A June 2015 report by the National Audit Office noted that the Cabinet Office had confirmed “a return of £1.2 billion against a target to bring £1.7 to £1.9 billion to the UK economy by 2019-20” and suggested that “Performance to date indicates that the target of £1.7–£1.9 billion is realistic within a five year timescale.”42 In April 2017, the GREAT campaign’s website claimed to have “already secured confirmed economic returns of £2.7bn for the UK”.43 In 2014, the GREAT campaign’s priority countries were Brazil, China, ‘Emerging Europe’, France, Germany, the Gulf Countries, Hong Kong, India, Indonesia, Mexico, South Korea, Turkey and the US. Many of these countries feature prominently in our rankings of either under- or over-performing UK export markets. While initiatives such as the GREAT campaign should be welcomed, the UK should also seek to learn from competitors such as Germany and France. Since 1970, in constant terms, exports as a share of GDP have doubled in the UK, but trebled in France and the US, and grown four-fold in Germany.44 For example, in March 2012, the Heseltine review noted how Germany, among other competitors, fosters overseas business-to-business support structures to a much greater extent than the UK. 45 The German equivalent of UKTI is Germany Trade & Invest (GTAI) – the federal department for trade and investment promotion. Unlike UKTI, it has a much smaller number of direct employees and the majority of practical export support services are delivered by German chambers of commerce, both at home and overseas, which are the central point of export advice and services.46 Meanwhile, data from the OECD for the period between 2005 and 2014 illustrates how far the UK lags behind competitors, such as Germany, France, Italy and Sweden, in its provision of finance to its exporters. Governments provide export credits either directly or via insurance and guarantees to exporters entering new markets as the private sector can often be reluctant to provide finance to new firms operating in developing and emerging economies.

42 National Audit Office, ‘Exploiting the UK brand overseas’, 5 June 2015; https://www.nao.org.uk/wp-content/uploads/2015/06/Exploiting-UK-brand-overseas.pdf 43 See http://www.greatbritaincampaign.com/#!/about 44 HM Government, ‘Building our industrial strategy: Green Paper’, 2017, p80; https://beisgovuk.citizenspace.com/strategy/industrial-strategy/supporting_documents/buildingourindustrialstrategygreenpaper.pdf 45 See discussion in LCCI, ‘Exporting Britain: trading our way back to growth’, October 2013, p19; http://www.londonchamber.co.uk/docimages/11797.pdf 46 See https://www.ahk.de/en/about-us/ and http://www.gtai.de/GTAI/Navigation/EN/welcome.html#invest


In 2015, the Cole Commission on Exports47 recommended greater coordination between UKTI and UK Export Finance (UKEF), including the co-location of UKTI and UKEF operations across the UK and the rest of the world to ensure a joint approach to supporting export opportunities. The Cole Commission also recommended a “One Stop Shop” be provided by the British Chambers of Commerce to support greater number of small and medium size enterprises (SMEs) to export. Before UKTI was replaced by the DIT in July 2016, several efforts were made to reform UKTI. Lord Maude, Trade Minister between 2015 and 2016, and former Business Secretary Sajid Javid sought to streamline the organisation, reducing staff and reassigning responsibility for specific export sectors to individual departments. Meanwhile, a dozen or so senior MPs were designated as ‘trade envoys’. Maude complained that UKTI had become “an island” in Whitehall, lagging behind best practice in procurement, and set out a plan to address this. 48 The Government appears to be making it easier for potential exporters to access information and support from one integrated source. DIT recently launched the great.gov.uk website – a new digital platform to provide integrated access for exporters and investors to the full range of its services. Meanwhile, the November 2016 Autumn Statement doubled the financial support for UK exporters available through UKEF.49 In the sub-sections below, we delve deeper into the UK’s ties with some of the most promising markets identified by the model. In doing so, we consider the wider diplomatic and cultural ties with these markets on which the UK could seek to build stronger commercial and political relationships. In some cases, we have grouped markets into regional groupings. The UK’s relationships with individual countries within these groupings may differ widely, and therefore

47 The Cole Commission was an independent business-led review of action to promote export commissioned by independent review of British exports was commissioned by the Rt Hon Ed Balls and Chuka Umunna MP, in September 2014. Report available here; https://www.policyforum.labour.org.uk/uploads/editor/files/ColePlan11-23166.pdf 48 See The Financial Times, ‘UK to overhaul trade arm in export drive’, 16 September 2015; https://www.ft.com/content/f8754ab4-5c6d-11e5-a28b-50226830d644 and The Financial Times, ‘Maude leaves ‘stretch target’ as he quits as Trade Minister’, 9 February 2016; https://www.ft.com/content/1d25f0ce-cf33-11e5-92a1-c5e23ef99c77 49 DIT, ‘Department for International Trade’s Autumn Statement settlement’, 24 November 2016; https://www.gov.uk/government/news/department-for-international-trades-autumn-statement-settlement


the appropriate policy will not be one-size-fits-all, but we believe it is useful for the UK to consider its relations with different parts of the globe, particularly in an age of increasing regionalisation.

4.5. India and the Subcontinent

India 2015 estimated population: 1,311,051,000 2030 projected population: 1,527,658,000 GDP per capita (current USD): 1,598 2030 projected GDP per capita (2005 USD PPP): 7,561 Ties with the UK:

• India is a member of the Commonwealth of Nations. • Large Indian diaspora in the UK, with 365,000 Indian nationals, including potential

dual nationals, resident in the UK in 2015. • E-visa facilitation scheme is open to British nationals travelling to India. • UK-India Business Council. Last year, the partners held a UK-India Tech Summit.

Our model suggests that by 2030, India would become the UK’s top under-performing market in goods trade, having overtaken the current most under-traded nation, Canada. It would also remain the UK’s second most important under-performing market in services trade. A comparison of India’s under-trade gap in 2016 and 2030 in real price terms reveals India’s fast-growing untapped potential: by 2030, the unexploited potential in goods trade with India could grow by around £3 billion, and in services by about £2 billion. While this is not a dramatic rise in absolute terms over the 14-year period, it demonstrates that the UK’s current underperformance will be compounded by India’s expected growth. The UK will need to adopt different strategies with different nations in the region. Pakistan’s and Bangladesh’s trade with the UK is currently governed respectively by the EU’s Generalised System of Preferences and Everything But Arms arrangements. While the UK should replicate these, there is no such India-EU agreement to grandfather. In addition, limited regional integration and political sensitivities within the subcontinent make it unprofitable for the UK to attempt a one-size-fits-all approach. For instance, developing trade ties with Pakistan may have an impact on diplomatic relations with India, and vice versa. One way of mitigating such unintended consequences would be to continue to encourage diplomatic dialogue between India and Pakistan. A particular focus on India would be valuable, given it represents a rapidly growing emerging-market: it is projected to become the world’s second-largest economy by 2050,50 overtaking the US, and is expected to surpass China in terms of population within the next ten years.51 As a Commonwealth nation, India also shares the English language and legal system, factors which can boost the intensity of bilateral relations, according to our model.

50 PWC, ‘The Long View - How will the global economic order change by 2050?’, February 2017; https://www.pwc.com/gx/en/world-2050/assets/pwc-world-in-2050-summary-report-feb-2017.pdf 51 United Nations, ‘Probabilistic Population Projections based on the World Population Prospects: The 2015 Revision’, July 2015; https://esa.un.org/unpd/wpp/DVD/Files/2_Indicators%20(Probabilistic%20Projections)/UN_PPP2015_Output_PopTot.xls


Yet, despite its potential, barriers to trade with India remain significant. India ranks 102nd out of 136 in the World Economic Forum’s Global Enabling Trade index in 2016,52 and 130th out of 190 in the World Bank’s ‘Ease of doing business’ rankings – last amongst the BRIC economies in both cases.53 Particular difficulties include acquiring and registering property, enforcing contracts and paying taxes in India.54 In addition, trade with India faces obstacles such as underdeveloped infrastructure, especially transportation capacity constraints;55 a highly-regulated intellectual property regime;56 and interstate tax and regulatory barriers to trade. Above all, India implements high, complex tariff protection to trade, ranking second-last globally in terms of domestic market access.57 The World Bank calculates India’s average applied tariff rate at 6.3%, compared to the UK’s 1%.58 This also masks high tariff peaks in goods such as automobiles and motorcycles (60-100%), coffee (100%), alcoholic beverages (150%).59 Agreeing a basic UK-India FTA to remove tariff barriers is the low-hanging fruit to unlocking India’s trade potential. However, there remain significant political obstacles to an FTA, including competing demands of visa liberalisation from India against domestic UK concerns about controls on migration. Furthermore, discussions for an India-EU FTA have been ongoing for over a decade, so the UK should also look to exploit other opportunities in the near-term. The UK should resurrect the recently expired UK-India Bilateral Investment Treaty (BIT). This eased foreign direct investment restrictions by enshrining commitments to non-discrimination and Most Favoured Nation (MFN) treatment, protection from expropriation by the State, and unrestricted repatriation of revenues and profits from investment.60 Renewing a UK-India BIT will be crucial to lowering restrictions to FDI, at a time when Indian national infrastructure projects present significant opportunities to British investors. UK investment in projects such as ‘Make in India’, ‘Digital India’, and ‘Smart Cities,’ would also help support modernisation of India’s business environment. The Department for International Trade could lead trade delegations to India in direct connection with these projects. Equally, the UK should continue to foster goodwill and cooperation with India separate to trade and investment. For instance, the UK should protect the attractiveness of its universities to Indian students. Despite the competitiveness of UK higher education, the number of Indian students choosing to study in the UK has fallen 44% over the past five years.61 To make itself a

52 World Economic Forum-Global Alliance for Trade Facilitation, ‘The Global Enabling Trade Report 2016’: http://www3.weforum.org/docs/WEF_GETR_2016_report.pdf 53 World Bank, ‘Doing Business 2017: India’, April 2017: http://www.doingbusiness.org/~/media/wbg/doingbusiness/documents/profiles/country/ind.pdf 54 World Bank, Ease of doing business in India: http://www.doingbusiness.org/data/exploreeconomies/india 55 S&P Global, ‘The Missing Piece in India's Economic Growth Story: Robust Infrastructure’, 2 August 2016: https://www.spglobal.com/our-insights/The-Missing-Piece-In-Indias-Economic-Growth-Story-Robust-Infrastructure.html 56 Rashmi Banga, ‘Brexit: Opportunities for India’, p1. 57 World Economic Forum, ‘The Global Enabling Trade report 2016’, p41: http://www3.weforum.org/docs/WEF_GETR_2016_report.pdf 58 World Bank, ‘Tariff rate, applied, weighted mean, all products (%) – India, UK’: http://data.worldbank.org/indicator/TM.TAX.MRCH.WM.AR.ZS?locations=IN-GB 59 Office of the United States Trade Representative, ‘2017 National trade estimate report on foreign trade barriers, p206: https://ustr.gov/sites/default/files/files/reports/2017/NTE/2017%20NTE.pdf 60 See the Agreement between the Government of the United Kingdom of Great Britain and Northern Ireland and the Government of the Republic of India for the Promotion and Protection of Investments, March 1994: http://investmentpolicyhub.unctad.org/Download/TreatyFile/1613 61 UK Council for International Student Affairs, ‘International student statistics: UK higher education’: https://institutions.ukcisa.org.uk/Info-for-universities-colleges--schools/Policy-research--statistics/Research--statistics/International-students-in-UK-HE/


more attractive place to study, the UK could consider the ease with which students can apply for visas. It should also continue to play its part in their bilateral Ease of Doing Business partnership, which aims to offer British expertise to support India’s effort to reduce obstacles to doing business.62 UK Foreign Secretary Boris Johnson has also suggested last year that the UK could help to boost India’s global voice, for instance by formally supporting a permanent seat for India at the UN Security Council.63 However, this should only be considered as part of a coordinated and careful global strategy. A wider look at the Indian subcontinent suggests a similar trend of growing under-performance in Pakistan’s and Bangladesh’s markets. There are, however, differences in the profile of UK trading potential with these other nations. For instance, the scale of the UK’s under-trade with Pakistan and Bangladesh is notably smaller than that with India, with the real-term price of Indian under-trade accounting for roughly three-quarters of the Subcontinent’s total under-performance (in 2016 UK Pound Sterling prices). Also, Britain’s untapped potential in these markets is more concentrated in goods trade.

62 Gov.uk, ‘Joint statement between the governments of the UK and India’, 7 November 2016: https://www.gov.uk/government/news/joint-statement-between-the-governments-of-the-uk-and-india 63 Boris Johnson, ‘Beyond Brexit: a Global Britain’, Chatham House Speech, 2 December 2016: https://www.gov.uk/government/speeches/beyond-brexit-a-global-britain


4.6. Canada, US and Mexico

4.6.1. Canada

Canada 2015 estimated population: 35,940,000 2030 projected population: 40,390,000 GDP per capita (current USD): 43,315 2030 projected GDP per capita (2005 USD PPP): 46,316 Ties with the UK:

• Canada is a member of the Commonwealth of Nations. • 54,000 Canadian nationals resident in the UK in 2015, including potential dual

nationals. • British citizens benefit from a visa waiver when travelling to Canada. • Canada-EU Comprehensive Economic and Trade Agreement (CETA) is expected to be

provisionally applied later this year. • Under the 2011 Canada-UK Joint Agreement, Foreign Ministers meet annually to build

a strategic foreign policy partnership. • UK and Canada are both parties to the ‘Five Eyes’ security alliance.

Canada tops our ranking of countries where UK exports are currently under-performing both in goods and services, emphasising its large untapped potential. Furthermore, our model predicts that, in 2030, Canada will still top the ranking of countries where UK services exports underperform (to the tune of over £7 billion) and will rank second, overtaken by India, among countries where UK goods exports underperform (by over £4 billion).64 This may appear counterintuitive, given that Canada is already a mature, market-orientated economy, whose population and GDP will both continue to rise between now and 2030 – but clearly at a slower pace compared to other fast-growing economies. Canada retains some barriers to trade and investment. Under the Investment Canada Act (ICA), for instance, foreign investors must notify the Canadian government of direct or indirect acquisition of Canadian business above a certain value, and investment must be deemed to be of ‘net benefit’ to Canada in order to be approved. Outside the EU, the UK should prioritise ‘grandfathering’ CETA, the recently agreed EU-Canada trade deal, so that it continues to apply to the UK after Brexit. However, the UK should also look to upgrade it on a bilateral basis, as CETA provides for limited liberalisation of trade in services, and financial services in particular. Beyond trade, other bilateral initiatives could include the government offering more favourable arrangements for Canadian citizens to live and work in the UK, or to travel to the UK for business. At the moment, Canadian citizens do not benefit from any special treatment compared to other non-EEA nationals – with the exception of the two-year Youth Mobility Scheme visa for people aged 18 to 30.65

64 Note that these estimates are based on data prior to the entry into force of the EU-Canada trade deal CETA, to which the UK is a party via its membership of the EU. 65 HM Government, ‘Tier 5 (Youth Mobility Scheme) visa’, page consulted on 11 April 2017: https://www.gov.uk/tier-5-youth-mobility/eligibility


The UK and Canada also cooperate in the domain of intelligence and surveillance, and are both parties to the ‘Five Eyes’ agreement – which also includes the US, Australia and New Zealand. The UK could use this close level of trust as a springboard towards closer cooperation in areas such as defence procurement. 4.6.2. The US and the ‘Trump effect’

United States 2015 estimated population: 321,774,000 2030 projected population: 355,765,000 GDP per capita (current USD): 56,116 2030 projected GDP per capita (2005 USD PPP): 62,022 Ties with the UK:

• There were 162,000 American nationals resident in the UK in 2015. • UK citizens travelling to the US benefit from a Visa Waiver Programme. • The US and the UK both hold permanent seats at the UN Security Council and are both

members of the ‘Five Eyes’ intelligence alliance. According to our model, the US is set to retain its current position as the UK’s top over-performing market for services trade, and its third most over-performing market for goods trade in 2030. This indicates the UK’s strong export performance in this market, despite the lack of preferential trade measures. Indeed, the US is Britain’s number one destination for goods and services exports (19.7% of total exports), its second largest provider of goods and services imports (11.1% of total imports), and its most significant source of inbound foreign direct investment (24.5% in 2014). There remain some barriers to services trade with the US. For instance, America currently imposes capital thresholds requirements on non-US banks to form intermediate holding companies if they wish to operate in US markets.66 Liberalisation of these thresholds would support provision of capital and financial services. A clear opportunity to further develop the US-UK ‘special relationship’ would be to agree an FTA, including coverage of services. Some have argued that US President Trump’s reticence towards free trade and global defence commitments will make it more difficult for the UK to negotiate an FTA with the US. However, it is important to bear in mind that Trump’s concerns appear to relate to the impact of FTAs on the domestic manufacturing sector, rather than the services sector, where the UK has its greatest comparative advantage. The UK should also build on its relationship with the US in non-commercial policy cooperation. Working visa procedures and quotas that limit services trade growth should be discussed, with the existing visa waiver programme serving as a basis for further liberalisation.67

66 OECD, ‘Services Trade Restrictiveness Index (STRI): USA’, December 2016; https://www.oecd.org/tad/services-trade/STRI_USA.pdf 67 Department for International Trade, ‘Exporting to the USA’, November 2016; https://www.gov.uk/guidance/exporting-to-the-usa


More broadly, the UK should build on its current status as the single nation hosting the largest number of US international students in higher education,68 extending support for scholarships, student exchange and research schemes. For example, the Fulbright Programme is state-funded to the tune of £819,056 and £600,000 respectively by the US and UK governments.69 The UK should consider both increasing its share of contributions and securing commitments to enlarge the scheme – and other such schemes – overall.

Considering NAFTA as a whole, President Trump’s trade policy decisions might have repercussions on the UK’s opportunities in North America. Trump has pledged to renegotiate NAFTA, although there is no firm timeline for that at the time of writing. Should the agreement be dismantled or significantly scaled down, Canada and Mexico are likely to be keen to strengthen their ties with other partners.70 The UK could take advantage of this situation and boost its market share particularly in Canada.

68 OECD, ‘Foreign / international students enrolled’, accessed April 2017; https://stats.oecd.org/Index.aspx?DataSetCode=RFOREIGN# 69 US-UK Fulbright Commission, ‘Financial Statement for the Year Ended September 2016’, September 2016; http://www.fulbright.org.uk/media/Commission_signed_2016_Accounts.pdf 70 See also Open Europe, ‘Where next? A liberal, free-market guide to Brexit’, April 2016, p16: http://openeurope.org.uk/intelligence/britain-and-the-eu/guide-to-brexit/


4.7. Israel

Israel 2015 estimated population: 8,064,000 2030 projected population: 9,998,000 GDP per capita (current USD): 35,728 2030 projected GDP per capita (2005 USD PPP): 41,411 Ties with the UK:

• UK citizens are not required to hold a visa in order to travel to Israel for a stay of under three months.

• UK-Israel trade is currently governed by the 2000 EU-Israel Association Agreement. • UK and Israel have established a bilateral Tech Hub, a UK-Israel Business Chamber of

Commerce, and this year they have set up a UK-Israel trade working group. Our model suggests that Israel is set to remain both the UK’s third most important under-traded market in goods and its fourth most under-traded services market in 2030. In real price terms, the value of Israel’s untapped potential is expected to grow by 2030, particularly in services where the data suggests it could more than double. It should be noted that Israel is a relatively small economy, compared with the others on the under-traded list. Its population is small – at around 8 million – yet wealthy and highly-educated. There are also key regulatory constraints to entering the Israeli services market, including restricted rights to foreign acquisition or procurement, strict resident labour market tests for the temporary provision of services, and a requirement for the chair of a board of directors to be Israeli.71 Given the relative difficulty of foreign investors to operate independently in Israel’s services market, the UK’s strategy should be based on collaboration and joint venture. This approach is already being applied in Israel’s valuable digital technology sector, with the creation of the UK-Israel Tech Hub under Ambassador Matthew Gould.72 The Tech Hub was designed to work separately from UKTI and focus particularly on linking together innovative SMEs in Israel and the UK across fields such as digital, cyber, and biotech. Britain should showcase the successes of this collaboration and promote further investment in Israel’s digital sector as part of a joint tech summit, as was achieved with India last year. It should continue to invest political time and official energy in collaborative projects with Israel such as the D5 digital inter-governmental programme. UK-Israel trade relations currently operate under the 2000 EU-Israel Association Agreement, which ensures the free movement of capital, some liberalisation of trade in services, and ongoing economic and social cooperation. The UK should prioritise ‘grandfathering’ this FTA to prevent any new barriers to trade. It should also replicate the EU-Israel conformity assessment agreement in industrial product standards. This will be important given the UK’s top exports to Israel include chemicals, pharmaceuticals, vehicles and general machinery.73 It is promising that the UK and Israel have already established a trade policy working group to ensure a smooth transition of arrangements following Brexit.74

71 OECD, ‘OECD Services Trade Restrictiveness Index (STRI): Israel’, p1. 72 See UK-Israel Tech Hub: http://www.ukisraelhub.com/ 73 Department for International Trade, ‘Doing business in Israel: Israel trade and export guide’, May 2015: https://www.gov.uk/government/publications/exporting-to-israel/exporting-to-israel 74 Gov.uk, ‘UK and Israel set to hold first trade policy working group’, March 2017: https://www.gov.uk/government/news/uk-and-israel-set-to-hold-first-trade-policy-working-group


There are particular political sensitivities within the UK (and more broadly) around trade with Israel, not least because of concerns around the Israeli occupation and annexation of territories conquered since 1967, and the status of Palestinians and Arabs within Israel. The ‘Boycott, Divest, Sanction’ (BDS) Movement seeks to persuade business to desist entirely from any business with Israel, while other groups have sought to boycott Israeli companies working in the West Bank or goods produced in settlements. ‘Lawfare’ has also been used against businesses with presence in Israel. And there has been significant controversy over the labelling of goods and agricultural products from the occupied territories. The UK Government has promised to restrict the use of boycotts by public authorities, including local councils. Despite the strong commitment of the UK Government to furthering trade with Israel, business continues to face perceived risk. Israel has avoided significant inter-state conflict since 2000, but there have been major hostilities in recent years, including in Lebanon, Gaza, and in the West Bank. There are also concerns of terrorism and the return of widespread civil unrest (intifada), or that business will face punitive legal suits including through ‘Lawfare’. Beyond these more directly political concerns, the onerous security regime for all travellers arriving at, and particularly departing from, the Ben Gurion airport, is off-putting to businesspeople. The UK could work with Israel to facilitate travel and security pre-clearance for business.

4.8. Nigeria

Nigeria 2015 estimated population: 182,202,000 2030 projected population: 262,599,000 GDP per capita (current USD): 2,640 2030 projected GDP per capita (2005 USD PPP): Not available Ties with the UK:

• Nigeria is a member of the Commonwealth of Nations. • 106,000 Nigerian nationals resident in the UK in 2015. • Nigeria-UK Bilateral Investment Treaty for the promotion and protection of

investments is in place since 1990. • There also exists a Nigeria-British Chamber of Commerce.

In both 2016 and 2030, our model ranks Nigeria among the top five markets where UK exports of goods are under-performing, and among the top ten where services are under-performing. In 2030, the level of under-trade is projected to be nearly £1.7 billion for goods and around £1 billion for services. It is therefore a country the UK should prioritise within its post-Brexit trade strategy, contrary to the recent trend that has seen the UK actually lose part of its market share in Nigeria – both in terms of volume of exchanges and stock of FDI.75 However, this is easier said than done. Barriers to doing business in Nigeria include both infrastructure and governance constraints. Under-developed utilities, power, transport, and telecommunications facilities restrict companies’ ability to set up local operations in the country. Governance concerns include security threats, as well as bribery and corruption – all of which hinder Nigeria’s business potential and ability to compete globally. For all these

75 PwC, ‘Seizing the opportunity: An economic assessment of key sectors of opportunity for UK businesses in Nigeria’, p4.


reasons, stablishing a comprehensive FTA with Nigeria is not expected to be a near-term strategy.76 Nonetheless, the UK should continue to support the country’s efforts to improve its infrastructure and governance. The UK’s Department for International Development (DfID) allocated over £1 billion in resources to its operational programme for Nigeria between 2011 and 2016.77 The UK could pursue a more targeted funding programme looking specifically at supporting key infrastructure projects. The UK could also consider extending the Youth Mobility Scheme visa to Nigerian nationals, so that they can live and work in the UK in larger numbers for limited periods and then return to their country with increased know-how and a developed connection with the UK. This form of strategic cooperation could help pave the way for more wide-reaching trade agreements in the coming years. A richer and better educated middle class would presumably generate larger demand for financial and business services over time.

4.9. China and Hong Kong

China 2015 estimated population: 1,376,049,000 2030 projected population: 1,415,545,000 GDP per capita (current USD): 8,028 2030 projected GDP per capita (2005 USD PPP): 18,102 Ties with the UK:

• 140,000 Chinese national residents in the UK in 2015. • The largest group of international students in the UK in 2015 were Chinese. • UK citizens travelling to China benefit from a Mutual Visa Exemption agreement. • UK and China benefit from a Bilateral Investment Treaty, in force since 1986, and a

China-Britain Business Council. According to our model, UK exports of goods to China are expected to over-perform by nearly £12 billion (69%) in 2030, while services exports are foreseen to under-perform by around £1.4 billion (27%). The UK should aim to safeguard, and ideally further improve, the over-performance of its goods exports to China, on the one hand, and exploit the untapped potential in terms of services exports, on the other hand. While China was among the top ten markets for UK exports in 2015, it only accounted for 3.2% of total UK exports of goods and services. Considering that China accounts for almost one fifth of the world’s population and is the second largest global economy, this is a comparatively small proportion of UK exports. There is clearly a large margin for improvement. High import tariffs represent a key constraint to trade with China. China applies an average tariff of 9.6% on imports of goods, rising to an average of 15.2% for imports of agricultural

76 Nigeria is a signatory of the Economic Partnership Agreement (EPA) between the EU and West Africa, to which the UK is currently a party via its EU membership. However, the Agreement is quite narrow in scope – as it only covers trade in goods and development cooperation. The UK and Nigeria also have a bilateral investment treaty in force since December 1990. The full text of the treaty is available here: http://investmentpolicyhub.unctad.org/Download/TreatyFile/2110 77 Department for International Development, ‘Operational Plan 2011-2016: DFID Nigeria’, December 2014, p13.


goods.78 While a basic trade deal covering only goods could deliver gains for the UK, negotiating an FTA with China will be a challenging exercise. Aside from import tariffs, the significant economic role still played by the Chinese state is itself a constraint on the ease of doing business in the country – along with the costly administrative import procedures, arduous technical specification standards, capital restrictions, and local currency requirements. Encouragingly, the bilateral economic relationship between the UK and China does currently benefit from other preferential arrangements, including the 1986 Bilateral Investment Treaty. In addition, due to schemes encouraging cooperation and exchanges in higher education, China provides the single most foreign students for courses at UK universities, although growth rates declined from 10% to 8% in 2016 compared to the previous year.79 David Cameron’s government also put a lot of diplomatic effort into strengthening ties with China: Chinese energy company China General Nuclear took a 33% stake in the UK’s Hinkley Point nuclear power station; the UK became the first major Western founding member of the Asian Infrastructure Investment Bank;80 and the British government organised a state visit of Chinese President Xi Jinping to the UK in October 2015. Last year, the Home Office launched a new two-year visitor visa for Chinese nationals allowing for multiple trips to the UK for a longer period – for the purposes of tourism or business.81 Diplomatic initiatives are important as part of a coordinated strategic approach, not least as a way to prepare the ground for a future FTA with China. The UK should also be active in providing pathways and guidance for domestic firms and investors to take advantage of Free Trade Zones as routes into the Chinese market. According to our model, Hong Kong is forecast to feature in the top ten countries where UK services exports under-perform in 2030. While Hong Kong is well-established as a major global financial services hub, less than 1% of UK exports of all services went to Hong Kong in 2015. There is clearly a case for looking to boost this bilateral trade relationship. For instance, the UK could engage further with Hong Kong and other global financial centres as part of a four-way ‘alliance’ comprised of UK, Switzerland, Hong Kong and Singapore. In the short-term, this could help negotiate greater access to the EU financial services market, while in the longer term it would provide participants with a louder voice on the international stage. Such an alliance need not represent a formal international institution – the concept of an ‘F4’ strategic association was previously floated by the Swiss Bankers’ Association. 82

78 See also Open Europe, ‘Where next? A liberal, free-market guide to Brexit’, p24. 79 British Council, ‘Student mobility: UK markets continued to shrink in 2016’, March 2017; https://siem.britishcouncil.org/insights-blog/student-mobility-uk-markets-continued-shrink-2016 80 See Asian Infrastructure Investment Bank, ‘Members and prospective members of the bank’: https://www.aiib.org/en/about-aiib/governance/members-of-bank/index.html 81 HM Government, ‘Home Office launches new two-year Chinese visa pilot’, 6 January 2016: https://www.gov.uk/government/news/the-home-office-launches-new-two-year-chinese-visa-pilot 82 Financial Times, ‘Swiss bankers propose alliance with London to negotiate EU terms’, 7 July 2016: https://www.ft.com/content/b2d07188-441f-11e6-b22f-79eb4891c97d


4.10. The Gulf

Our model suggests that UK exports of both goods and services are currently over-performing in the Persian Gulf region, and will continue to do so in 2030 by over £10 billion in goods and over £11 billion in services. The UK should look at ways to further improve this performance over the coming years. Of the countries in Table 8, Saudi Arabia, Qatar, the United Arab Emirates (UAE), Oman, Bahrain and Kuwait are all members of the Gulf Cooperation Council (GCC). The GCC is a customs union and has become an increasingly dynamic actor when it comes to concluding trade deals – which it negotiates as a bloc. The GCC has an FTA in force with EFTA countries since July 2014.83 It concluded an FTA with New Zealand in October 2009, although the deal has yet to come into force,84 and is currently also in trade talks with China. Strong growth prospects and a fast-expanding middle class are valid reasons why the UK should aim for a comprehensive FTA with the GCC – which it currently does not have via the EU. Indeed, the strategic and geopolitical importance of these countries for the UK goes beyond just trade links. It should therefore come as no surprise that Theresa May met with the GCC within her first six months as Prime Minister, and visited Saudi Arabia in April this year to strengthen the UK’s partnership with the Middle East. In her speech to the GCC, she rightly stressed the importance of Gulf countries’ investment in the UK – as well as London’s growing role as one of the capitals of Islamic finance in the world.85 This is broadly the right track. Nonetheless, the UK’s relationship with the GCC also has some politically more controversial aspects – for example arms sales to Saudi Arabia – which are unlikely to be easily resolved.86 Although not directly a Gulf country, Jordan is another Arab country with which the UK has important ties on a number of levels. It has also sought to join the GCC since 2011. In her visit to Jordan earlier this year, Theresa May announced that the UK would be sending military trainers to support Jordan’s air force in the fight against Islamic State.87

83 For further details, see EFTA, ‘Free Trade Agreements – Gulf Cooperation Council (GCC)’, page retrieved on 12 April 2017: http://www.efta.int/free-trade/free-trade-agreements/gcc 84 Ministry of Foreign Affairs of New Zealand, ‘NZ-Gulf Cooperation Council FTA’, page retrieved on 12 April 2017: https://www.mfat.govt.nz/en/trade/free-trade-agreements/free-trade-agreements-concluded-but-not-in-force/gcc/ 85 HM Government, ‘The Prime Minister’s speech to the Gulf Cooperation Council 2016’, 7 December 2016: https://www.gov.uk/government/speeches/prime-ministers-speech-to-the-gulf-co-operation-council-2016 86 See, for instance, The Independent, ‘If we don’t sell arms to Saudi Arabia, someone else will, says Boris Johnson’, 26 October 2016: http://www.independent.co.uk/news/uk/politics/if-we-dont-sell-arms-to-saudi-arabia-someone-else-will-says-boris-johnson-a7382126.html 87 Agence France-Presse, ‘UK to train Jordan air force fighting Daesh’, 3 April 2017: http://gulfnews.com/news/mena/jordan/uk-to-train-jordan-air-force-fighting-daesh-1.2005320


4.11. South America

Overall, our model suggests that the UK performs relatively close to what is expected in the main South American markets. This reflects a comparatively good outturn in Brazil, offset by weaker performance elsewhere. More generally, Latin America does not immediately stand out as an obvious target market for the UK to boost its exports. Just like the UK starts from a privileged position when discussing trading arrangements with nations to which it is bound by historic and cultural ties, countries such as Spain and Portugal find it easier to make headways into Latin American markets. For instance, the latest available data shows that only around 5,000 people of Argentinian nationality are estimated to be living in the UK – compared to nearly 72,000 in Spain. Similar gaps show up when looking at figures for Brazilians, Uruguayans, Paraguayans and Chileans in the UK.88

This is not to say the UK should not put any effort at all into strengthening ties with Latin America after Brexit. Clearly issues surrounding the interests of the Falkland Islands during and after Brexit negotiations, for instance, will require close cooperation with Argentina. However, given that the UK – as any other country – has finite capacity to engage into trade talks across the world, it should be prepared to prioritise other countries and regions over Latin America.

88 Figures from both statistics offices are updated to end-2015.


4.12. Other emerging markets: ASEAN and East Africa

The UK’s export performance to ASEAN markets presents a diverse picture, according to our model. Overall, the UK achieves its expected level in this market, but this is the product of substantial over-performance in goods and under-performance in services. Furthermore, the UK’s export performance with Singapore largely masks underlying trends in other ASEAN economies. For instance, the UK’s significant over-performance in goods exports to Singapore overshadows its under-performance with six ASEAN markets – most notably Indonesia. Singapore ranks in the UK’s top five over-performing markets for goods in 2030, and in the top ten for services. Given that the UK currently holds no trade agreement with Singapore, an FTA offers the possibility to boost this performance further. However, if the recently approved Singapore-EU FTA serves as a model, a trade deal is unlikely to provide comprehensive liberalisation of services markets, an area of key UK interest. The UK should therefore look for other means of cooperation in services trade, including the previously suggested ‘F4’ financial services alliance with Zurich, London, and Hong Kong.89 Equally, the Chancellor’s UK-Singapore FinTech bridge initiative would boost trade in services by encouraging private investment and expansion of the UK tech industry in Singapore.90 Indonesia is another important market to pull out of this regional bloc, as it features in our model’s top ten under-traded markets for both goods and services in 2030. This is perhaps not surprising given Indonesia represented just 0.2% of total UK total trade in 2015, with UK exports to Indonesia of non-oil and gas goods declining by 10% in the years 2011-2015.91 The untapped potential for the UK is compounded by Indonesia’s significant growth potential: currently the world’s sixteenth largest economy, it is projected to rise to the seventh largest by 2030.92 Equally, the ASEAN bloc collectively ranks as the seventh largest global economy at present, set to rise to the fourth largest by 2030.93 The EU and Indonesia have not yet established an FTA, although talks began last year. However, striking a UK-Indonesia trade deal post-Brexit is unlikely to unlock Indonesia’s market potential in the near-term. Rather than tariff barriers (according to the World Bank, Indonesia’s average tariff rate is 2.3%, although this masks higher tariffs for certain goods, such as vehicles)94, obstacles to entering the Indonesian market include underdeveloped infrastructure,95 as well as a highly-regulated foreign investment market.96

89 Financial Times, ‘Swiss bankers propose an alliance with London to negotiate EU terms’, 7 July 2016. 90 Philip Hammond, ‘FinTech will transform the way we live and do business, says the Chancellor’, 12 April 2017: https://www.gov.uk/government/speeches/fintech-will-transform-the-way-we-live-and-do-business-says-the-chancellor 91 Kementerian Perdagangan Republik Indonesia Ministry of Trade, ‘Growth of non-oil and gas imports (origin countries) Period: 2011-2016’: http://www.kemendag.go.id/en/economic-profile/indonesia-export-import/growth-of-non-oil-and-gas-import-origins-country 92 Department for International Trade, ‘Doing business in Indonesia: Indonesia trade and export’, April 2016: https://www.gov.uk/government/publications/exporting-to-indonesia/exporting-to-indonesia 93 Gov.uk, ‘Building prosperity and supporting security in South East Asia’, January 2016: https://www.gov.uk/guidance/building-prosperity-and-supporting-security-in-south-east-asia 94 World Bank, ‘Tariff rate, applied, weighted mean, all products (%) – Indonesia’: http://data.worldbank.org/indicator/TM.TAX.MRCH.WM.AR.ZS?locations=ID 95 Oxford Economics and PricewaterhouseCoopers, Building Indonesia’s future: unblocking the pipeline of infrastructure’, 2015, p1. 96 OECD, ‘Services Trade Restrictiveness Index (STRI): ‘Indonesia’, December 2015.


The UK could support Indonesia’s strategy97 to develop its infrastructure in the medium-term through funding programmes. The UK could fund or invest in Indonesia’s modernisation projects, primarily in transport, utilities and manufacturing sectors.98 The UK should also establish itself as an ASEAN Dialogue Partner after it leaves the EU, having previously participated in this role as a member state. Achieving an independent Dialogue Partner status would allow the UK to continue engaging with the ASEAN nations on issues such as economic, political and security cooperation.99

97 Oxford Economics and PricewaterhouseCoopers, Building Indonesia’s future: unblocking the pipeline of infrastructure’, 2015, p1. 98 Ibid., p2. 99 See Overview of ASEAN-European Union Dialogue Relations: http://asean.org/?static_post=overview-of-asean-eu-dialogue-relations


East Africa will also be worth watching as an area where the UK could improve its export performance in future. Our model suggests that, by 2030, Uganda and Tanzania will enter the top ten ranking of markets where UK exports of goods under-perform. Both countries are members of the East African Community (EAC).100 The bloc enjoyed strong economic growth over the past decade, and its growth prospects are seen as healthy – albeit potentially slower – for the years to come too. Furthermore, the EAC has been diversifying its economy away from agriculture. The share of agriculture in the region’s total economic output fell from almost half in 1970 to less than a third (28%) in 2010.101 Over time, the increase in GDP per capita is also likely to boost demand for more sophisticated services across the region – presenting the UK with clear trading opportunities. The EAC did conclude an Economic Partnership Agreement (EPA), covering only trade in goods and development cooperation, with the EU in October 2014. However, the deal is not yet in force at the time of writing. EAC members were all supposed to sign it by 1 October 2016, but in fact only Kenya and Rwanda did so. Tanzania, in particular, refused to sign citing “the uncertainty in [the] EU after the exit of [the] UK”, as well as concerns over the impact the EPA might have on the region’s manufacturing industries.102 Incidentally, this appears to suggest EAC countries would be keen for the UK to ‘grandfather’ the EPA and remain a party to it after Brexit.

100 The EAC is comprised of Burundi, Kenya, Rwanda, South Sudan, Tanzania and Uganda. It established a customs union in 2005, which became fully operational in 2010. EAC countries also signed a Protocol for the establishment of a common market in November 2009, and a Protocol for the establishment of a monetary union in November 2013: http://www.eac.int/about/EAC-quick-facts 101 For a broader discussion, see Gigineishvili et al., ‘How solid is economic growth in the East African Community?’, IMF Working Paper 14/150, August 2014: https://www.imf.org/en/Publications/WP/Issues/2016/12/31/How-Solid-Is-Economic-Growth-in-the-East-African-Community-41840 102 See, for instance, Financial Times, ‘Kenya feels Brexit effect as UK vote threatens Africa trade deal’, 28 July 2016: https://www.ft.com/content/01beeb54-5347-11e6-9664-e0bdc13c3bef


4.13. Non-EU European markets

Overall, our model suggests that the UK will perform slightly above its expected level in these markets, largely due to a strong services export to Switzerland, which helps to offset weaker performance in services to Norway and Turkey, and in goods exports to Switzerland. Although non-EU European markets – with the exception of Turkey – do not present the same high-growth potential as emerging market economies, they are likely to remain important trade partners for the UK. International Trade Secretary Liam Fox has already outlined the government’s commitment to establishing an early trade deal with Switzerland, for example. The UK Government is right to prioritise maintaining free trade with Switzerland. After China, Switzerland represents the highest growth market for UK exports over the last decade, with UK service exports to Switzerland increasing by 130% over the last five years.103 However, grandfathering the existing Swiss-EU arrangements will raise some questions for the UK. Switzerland is not party to the European Economic Area (EEA), but is a member of the European Free Trade Area (EFTA) along with Norway, Liechtenstein and Iceland. Its trade relationship with the UK is currently governed by a wide-ranging series of Swiss-EU bilateral agreements. When seeking to secure a new agreement post-Brexit, the UK will have to consider whether to strike separate bilateral deals with Switzerland, Norway and others, or with the EFTA bloc as a whole. While an FTA with Switzerland will be important to preventing the imposition of new trade barriers with an important export market, it is unlikely dramatically to boost the UK’s trade performance. Indeed, the UK should not focus on correcting its under-performance in goods exports to Switzerland. Its competitive advantage in advanced manufactured goods will face heavy competition from other EU countries, in particular Germany. The UK should instead seek additional means of cooperation with Switzerland and other non-EU European markets further to improve its performance in services. As we have suggested earlier, Switzerland and the EU could form an ‘F4’ alliance along with Singapore and Hong Kong.104 An informal association could be simple to establish, and could focus on coordinating positions on global financial regulation, setting common definitions and establishing new international standards. In addition, the UK and Switzerland should capitalise on their shared status as global leaders in innovation.105 Beyond Swiss membership of the UK Science and Innovation Network, they could establish a UK-Swiss tech hub to accelerate collaboration and joint investment in the digital technology economy. Turkey also looks set to remain an important non-EU European partner. It features within the top ten over-performing markets for goods trade in both models. It is also set to rise one place to become the UK’s eighth most under-traded economy for services in 2030.

103 Department for International Trade, ‘Doing business in Switzerland: Switzerland trade and export guide’, October 2016: https://www.gov.uk/government/publications/exporting-to-switzerland/doing-business-in-switzerland-switzerland-trade-and-export-guide 104 Financial Times, ‘Swiss bankers propose an alliance with London to negotiate EU terms’, 7 July 2016. 105 See the Global Innovation Index 2016: https://www.globalinnovationindex.org/analysis-indicator


Current trade between Turkey and the UK is governed by a customs union. UK-EU trade facilitation measures put in place once the UK withdraws from the EU Customs Union should also take into account relations with Turkey in order to minimise disruption. The newly established Turkey-UK trade working group provides a strong foundation for this.106 Future Turkey-UK cooperation could focus on a stronger defence and security partnership, particularly following the 2017 agreement between Turkish Aerospace Industries Inc. (TAI) and the British business BAE SystemsOne for collaboration on the design of a new fighter jet. Equally, the UK could improve investment relations, with particular emphasis on high-demand infrastructure projects such as energy development.107

106 Gov.uk, ‘PM press conference with Turkish Prime Minister Yildirim’, 28 January 2017: https://www.gov.uk/government/speeches/pm-press-conference-with-turkish-pm-yildirim-28-january-2017 107 UK Trade and Investment, ‘UK Trade & Investment in Turkey Helping your Business grow Internationally’, August 2012: http://turkey1stedition.doingbusinessguide.co.uk/media/154336/ukti_turkey_services_for_online.pdf


Annex: Developing the gravity model framework The following gravity model framework was developed for this report by Ciuriak Consulting.

1. Data sources The table below identifies the main data sources used to construct the gravity model presented in this report.

2. Model specification UK exports are explained by the conventional gravity model variables capturing the size of the UK economy (which indicates supply potential), the size and distance of the partner economies, and indicators of trade costs and openness. In addition, the model includes a number of variables that are amenable to policy treatment – the foreign partner’s tariff regime facing the UK, free trade agreements (which are dummy variables for the countries with which the UK currently has an FTA through its Membership in the EU, and a dummy variable for the UK’s EU partners), and diplomatic representation. Thus:

• Xj denotes UK exports to country j • GDPUK denotes the GDP of the UK (since varies over time)

• GDPj denotes the GDP of country j

�� = �� + �� + �� + �� + �� + �� + �!"# �+ �$�� %� + �&'��(�)"*+ + �,��-.�-� + ��"*_#�0� + 1


• DistUKj denotes the distance of country j from the UK

• ComLeggij stands for a dummy variable that indicates whether the UK and country j share a common legal system.

• TSIUK-j is the correlation between the trade specialisation indexes (TSIs) of the UK and

country j; this takes into account the similarity of the UK’s pattern of comparative advantage with that of the partner country

• EFIj is an index measuring economic freedom in the destination market • GDPCHj is the real GDP growth rate of the partner economy • EUj denotes whether the trade partner is an EU member state • DipRepj denotes whether the UK has an active diplomatic presence in country j

• EU_FTAj denotes whether the trade partner has an in-force FTA with the EU Contiguity, which is often used in regression, captures only the UK’s relationship with Ireland and thus acts as a fixed effect dummy in that regard. In preliminary trials, it was found to matter only for food exports. As it otherwise added no explanatory power to the analysis, it was dropped. The dummy variables for common legal systems, common language and common cultural ties are highly correlated for the UK, reflecting the lingering effects on the UK’s trade of its imperial past and commonwealth relationships. The dummy for common legal systems worked best in initial trials and was chosen for the ongoing analysis, but it captures the effects of all these commonalities. As an alternative to using an FTA dummy to capture the effect of trade agreements, it is possible to use tariffs, or broader measures of trade costs that attempt to capture comprehensively bilateral trade costs. A variety of such measures were tried in initial trials but were dropped because they were not readily amenable to interpretation for policy analysis compared to the FTA dummies. The TSI variable is of particular interest since it captures the extent to which comparative advantage leverages trade. The UK should have greater exports to countries that import intensively the products that the UK exports intensively. Following Ciuriak and Kinjo (2006), a country's Trade Specialisation Index (TSI) score is calculated for each sector defined at the 2-digit HS code level. �� − '�� + '�

This yields a vector of 97 values for each country. The correlation between the UK’s vector and its partner’s vector then captures the degree to which the UK and the partner specialise in the same exports.

�� = 3�))4 56� − '� + '7�4 , 6� − '

� + '7�49

Where:

• �� is the correlation between the Trade Specialisation Index (TSI) of countries i and j

• X is exports, and • M is imports


For goods, the correlation is over all 97 HS-02 level industry classifications. In the case of services, there are far fewer categories using the Extended Balance of Payments Services (EBOPS) classification system. Annual correlations were calculated for over 170 countries in the latest data (2015) with more than 70 countries traced back all the way to 1993 using UN COMTRADE data. This variable can take values that range from 1 if the TSIs are identically distributed over the various sectors, to –1 if the TSIs are perfectly negatively correlated. A positive TSI correlation would indicate the partner is a natural competitor to the UK in international trade. A negative value would identify a natural trading partner. Note that ranking by this index alone would yield qualitative data concerning the underlying basis for the trade potential identified with the broader gravity model. As regards the dependent variable – UK exports – for goods we use HS-2 level industry codes to construct alternative goods trade variables based on the following groupings: all goods; all goods excluding precious metals and fuels (HS 71 and 27, which do not tend to follow gravity model patterns); manufactured goods (HS codes 84 to 96); and agri-food goods (primary and processed agricultural products excluding non-food agricultural products). As for services exports, COMTRADE uses the 2002 EBOPS (Extended Balance of Payments Services) classification system. Regressions for all services have been run, using the services-based TSI that also excludes non-commercial services. Commercial services have not been included as a dependent variable because of the poor quality of the data available. The quality of trade data in services in general is still far below the quality of trade data for merchandise goods that have been collected with high precision for tariff revenue purposes. The three data sources from ITC Trade Map, UN COMTRADE and the World Bank Trade Services Database (TSD) used to triangulate the trade in services data have a relatively small number of observations and the regressions of commercial services using the three different data sets yield coefficients with varying signs and magnitudes. Hence, given data issues and limited time, we did not continue with commercial services as a dependent variable. Finally, DipRep is a binary variable where 1 indicates presence of diplomatic representation in the country or territory and 0 if otherwise.

3. Estimation results – Final equation

When both the diplomatic representation and free trade agreements are included in the equation, diplomatic representation the coefficient values are similar. GDP growth is also added in to capture the role of dynamism in the partner economy attracting exporters’ attention. The latter variable suggests that UK services exports are concentrated on slower-growing mature economies, rather than on higher-growth developing economies. This equation is used for further analysis of the UK’s trade performance by partner.


4. Caveats on interactions Interactions are often important in gravity equations. The impact of a policy variable may be conditional on the conditions in place in the destination economy. For example, diplomats are likely to have more ability to influence trade outcomes in jurisdictions in which the government is more heavily involved in economic decision making. By the same token, the estimated effect of diplomatic representation on exports on average across all destination economies will overstate the effect in jurisdictions that feature a high degree of economic freedom and understate the impact in jurisdictions with more government direction of economic decision-making. Such interactions were explored by introducing interaction variables. However, while there is a strong interaction between the DipRep and EFI, and between the FTA and EFI variables, a stable relationship could not be pinned down in the time available. This is an area for further research.

Ofices

Open Europe

7 Tufton Street

London

SW1P 3QN

+44 (0)20 7197 2333

www.openeurope.org.uk

[email protected]

@OpenEurope

Open Europe Brussels

Rue du Trône 61

B-1050

Brussels

+32 (2) 540 86 25

Open Europe Berlin

Oranienburger Straße 27

10117 Berlin

Germany

+49 (0)30 2758 1365

[email protected]

www.openeuropeberlin.de

Open EuropeStaying ahead

of the game

www.openeurope.org.uk@openeurope

170424 global britain main doc [draft formatted] · germany’s gdp will grow by 14% between 2017...

Documents