How much is a Free Trade Agreement with the US worth to the UK economy?

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12 December 2019

Michael Gasiorek is Professor of Economics at the University of Sussex and a Fellow of the UK Trade Policy Observatory. Nicolo Tamberi is a Research Assistant in Economics for the UK Trade Policy Observatory. 

Following Brexit, and assuming the UK is no longer part of a customs union with the EU, the UK will be able to sign free trade agreements (FTAs) with third countries. Indeed, the Conservative manifesto aims to have 80% of UK trade covered by FTAs within three years. This is clearly unrealistic, because it would require signing agreements with more than 12 countries within a time-scale which has rarely been achieved for a single agreement.  The objective, however,  highlights that, post-Brexit, there will be a lot of focus on trying to sign FTAs. Other than the somewhat significant matter of signing an agreement with the EU, top of the UK’s FTA wish list is an agreement with the US.

Much has been written about the difficulties of negotiating a deal with the US, and the seeming incompatibilities between what the US would want from such an agreement, and what the UK might be prepared to concede. In a recent UKTPO Briefing Paper, Emily Lydgate et. al. also outlined the risks to the Union which such an FTA might pose.

These are significant challenges, so it is worth putting them in context by considering what might be the economic implications of a UK-US free trade agreement. To do this we have compiled almost all the traded sectors in the UK economy, for which data was available. This includes 28 agriculture and food processing sectors, 104 manufacturing sectors, and 16 services sectors. This level of disaggregation means that we can model changes in tariffs and other trade costs in much more detail than other comparable work.  We have then simulated the impact of signing a free trade agreement with the EU, and then the additional impact of also signing an agreement with the US.

Leaving the EU leads to a simulated decline in both imports (by 7%) and exports (by 12%) which in turn leads to an overall reduction in output of 1.8%.  This is a relatively modest fall, which is in part driven by our cautious assumptions as to the size of the underlying trade costs, and in part because there are longer term consequences of leaving the EU such as on supply chains, investment flows, firms’ location decisions, and productivity which we do not capture. The full effect is therefore likely to be considerably higher.

If the UK managed to simultaneously sign an agreement with the US and the EU, how much difference could this make? It turns out that the difference is small. There is a slightly smaller decline in both exports and imports (as the UK trades more with the US), but there is still a net loss of UK output of 1.3%. The key message is that signing a deal with the US does yield benefits to the UK, but compared to the loss from leaving the EU these are much smaller. It is also worth noting that while there is a gain to the UK as a whole from signing a trade agreement with the US, this does not mean that all sectors in all regions gain. Agriculture and food processing production decline by more as a result of an agreement with the US in all the regions of the UK; there are five regions where manufacturing output sees a further decline. In contrast, services expand in all regions and, most of all, in the South East, London and Scotland. Perhaps not surprisingly, therefore, these are the regions who have most to gain from an agreement with the US.

If the additional gain from an agreement with the US is relatively small, how is this to be reconciled with the oft-made promises about the gains to be had from such an agreement? It turns out that there are two really quite simple reasons for this. The first is that with regard to goods trade the UK already has, on the whole, low tariff access to the US. US (Most Favoured Nation) tariffs are already zero on 50% of UK exports to the EU, and are less than 5% on a further 38%. Only 12% of UK exports therefore face tariffs greater than 5% – so the scope for increasing trade substantially through tariff reductions is low.

There is also some scope for reducing non-tariff barriers to trade, such as differences in regulations and standards, which we have allowed for. However, the reductions in these barriers will be much harder to achieve and will still involve considerably higher barriers in comparison to the EU’s Single Market, which the UK will be leaving.[1]. The second reason is that nearly 43% of UK trade is currently with the EU, while under 12% is with the US. Reducing barriers on 12% of trade simply cannot compensate for increasing barriers on 43% of trade! For every 1% reduction in trade with the EU, in order to compensate for this, a deal with the US would have to increase trade by 3-4 times as much. This is not feasible.

This does not mean that a deal with the US is not worth pursuing. But it does mean that politicians should be much clearer about to how much could be achieved, the timescales and challenges involved, and the distributions of the gains and losses across industries, sectors, and regions. They should also be prepared to introduce clear consultation mechanisms for setting the rationale, and the priorities in negotiating free trade agreements.

Footnotes

[1] See also Berden et.al, https://www.gtap.agecon.purdue.edu/resources/download/5177.pdf

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