Brexit is passé: Trade, non-trade barriers and the distance of trade matters

Those who are writing obituaries about Great Britain also wrote similar epitaphs when the EU was formed; the habit of over-simplification continues. The world has moved on and we must.

If you were a property developer in Central London and had you invested in assets that assumed certainties of the future, you are obviously in the wrong side of risks; with three banks already having announced their intentions to leave London as the base, the financial center of Europe may be up for some serious re-evaluation. That follows suit for the realty sector.

If you were running a tourist business, you could be more than happy that the exchange rate attracts more visitors into U.K. now than before.

If you were running a business that is remotely connected to manufacturing or financial services, you would be wary, to say the least. These are first reactions, only to be expected, but never the end of the story.

EU membership is all about trade and U.K. has a 55% linkage with EU as a trading block. But wait a minute two fifth of that is in services and it is very difficult to say what holds there. Of the rest of the three-fifth, it is only with Germany and Netherlands that U.K. has a trade deficit, with all the rest U.K. has trade surplus.

So it may seem evenly poised, if one is thinking about the free-trade negotiations that U.K. would have to do. But not quite, there are other things in store.

To be part of the EU is like not having to sign 100 trade deals with twenty seven other countries each of which could be having its own paraphernalia in terms of ‘product attributes’, that could be unique for trade to happen. You do not have to negotiate these over several rounds of strategic posturing. More than that the non-tariff trade barriers, which are more venomous to deal with are put in the back burner.

Japan has no import tariff on cars but could you export a car into Japan?

Imagine if you wanted to export a car into Japan you would have to strategize for decades to be able to make any headway. Why, because of non-tariff barriers. The story goes that when the first cars were exported into Japan from U.S., the cars had to be parked in front of the government inspector’s office in Imports and the inspector would take several days to even turn up for inspection.

Well, we have progressed from those days but the scepter of non-tariff barriers is so very sharp that it would cut you off before you could even think of any defense. The goods which are now flowing freely between U.K. and the EU would now have to formally move through barriers that would have both the tariffs to be fixed and the non-tariff stipulations to be overcome.

One data is very interesting as the Dutch economist Jan Tinbergen discovered that there is a close analogy between Newtonian physics and trade flows (gravitational force between two objects is proportional to their mass and the distance between them). Tinbergen found that trade flows between two countries are proportional to their GDP and the distance between them. Great Britain’s maximum trade is between the close borders of Netherlands and Germany. It is here that the maximum focus must shift and it is here that the maximum is going to be gained and lost.

There is a rising rhetoric that Great Britain should be less bothered about the EU and should shift focus to the rest of the world as its trading partner. Nothing can be more wrong as Jan Tinbergen has proved that adequately and it would need a significant comparative advantage to make large distances pay off where trade is concerned. U.K. will remain strongly tied to Germany, U.S. and Netherlands as its major trading partners.

The negotiations will take two more years to happen. But the process need not be rugged with battle lines drawn. Rather, it should be that the signaling from both sides must have the right mix of diplomacy. U.K. cannot keep referring to the rest of the world as its free-trade partner while trying to get attention from the EU. And EU cannot forget the importance of U.K. as its trading partner as well.

Much will depend on what signals we raise and what messaging we do. The financial world has been fast to over-react but the dust will settle shortly. To find an alternative to London as a business center will also not be that easy.

The speculators in the meantime had a field day and may be more is in store for this week. From Oil to S&P 500 we have seen gyrations of all kind. These are about bets that went sour or about new speculations in the making. These will pass, while more important deliberations have to be made on how to forge new alliances and this will not only be harrowing time for countries but also for corporates who have deeply entrenched businesses head quartered in London.

The bigger ramifications of this will take its toll on globalization itself. But I am hopeful there that the process by and large is irreversible. The Brexit only confirms that the preparedness to deal with such tendencies should be more profound. It better not be left to campaigns that talk about headlines that do not touch the common people. After all it is the common people who come out to vote and on that day those who voted for exit may not have known the full implications of their consent had they been made part of a debate that was more comprehensive in its analytics of causes and effects.

The world will move on and we better reorient to stop further damaging propensities that come in the way of trade and globalization.