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Friday, May 20, 2022

Unpacking the deal Down Under

The Australia – United Kingdom (UK) “in-principle” Free Trade Agreement (FTA) has been hailed by the UK government on two post-Brexit counts: the first free trade agreement that has been negotiated from scratch, as well as the first major trade deal. These statements echo one of the main arguments for Brexit – reclaiming the sovereignty of the UK and being able to chart the UK’s own course, especially on the world stage.

Australia’s historical and cultural connection to the UK, coupled with the timing of the trade deal seem to have worked in Australia’s favour where analysts on both sides claim that Australia receives the better end of the deal.

However, if we are to assume that both players – the UK and Australia are rational agents – who aim to maximise their welfare, there certainly must be more to be explored and understood about the supposed benefits and costs of this trade deal, and the time frame to be considered in analysing those benefits and costs.

Time-past and time-future provide lenses for unpacking the dynamic and long-term benefits of this trade deal, to both parties.

While Australia has a history dating back thousands of years, modern Australia was heavily influenced by the colonisation of the UK from 1788 to 1901. When the 6 former colonies became Australia’s 6 states and formed a federation – modern Australia in 1901 – Australia kept some of its ties to the UK, and to date, Australia remains a Realm of the Commonwealth. Before the UK entered the European Common Market in 1973, it is not surprising that the UK was Australia’s largest trading market.

In joining the European Common Market and progressively becoming more engrained in the European Union (EU), the UK created trade barriers between itself and Australia, via the EU – tariffs, quotas, and standards-based barriers – that prevented Australian exporters from trading freely with the UK. By 2018, the UK had moved to being Australia’s eighth-largest trading market.

This history is an important context to understand the benefits that Australia is set to gain from the recent FTA, because this agreement will begin to undo the trade barriers that the UK effectively had against Australia via the EU for many decades. On the other hand, in the last four decades, the Australian economy has liberalised rapidly, and compared to the UK, has far less barriers towards UK firms and industries to begin with.

While both countries are set to gain compared to the status quo on a macro-economic level – the UK’s gains in this trade deal will be less because the UK will experience diminishing marginal returns, given that the Australian economy is already very open to the UK to begin with. At present, the gain to Australia is greater, as Australia is only at the beginning of the road to free trade with the UK, as the UK has far more barriers to lift – and hence the seemingly large potential gain to Australia.

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One could argue that the UK has benefited from Australia’s more liberalised approach to UK exports for decades, well before this FTA, while the UK has harmed Australia during that same period – via its trade barriers towards Australia. Analysing the situation from a different starting point – that is pre-Brexit and right to the point where the UK joined the European Common Market – shows that the UK reciprocating free trade towards Australia has been decades in the making. The UK’s second and reciprocated move has just come very late for Australia.

In general, a bi-lateral FTA would benefit both nations on a macro-economic level – the total surplus, the size of the pie, gets larger – production and consumption increases on both sides of the deal. This assumes mobility of goods, mobility of services, and mobility of labour. On this latter point, the mobility of labour, the FTA will be drastically different to the pre-Brexit UK-EU experience. The EU is an economic and political union. Citizens are free to move and work across EU nations, which further enhances the gains from trade to all parties.

On the subject of labour mobility, the current Australia-UK free FTA simply has a new provision increasing the maximum age for working holiday visas from 30 years to 35 years, and extending the period of this visa from 2 years to 3 years – hardly the labour mobility of the pre-Brexit days.

Professionals on both sides of the deal are set to benefit via an agreement to mutually recognise each others’ professional qualifications – but for anyone over 35 years of age, one would have to permanently migrate, rather than go on a working holiday, to experience this benefit of increased labour mobility.

Thus, when comparing the benefit to the UK of the EU-UK deal, versus the Australia-UK deal, the extent to how far the pie can be grown is limited by virtue of the lack of labour mobility – which is also of course hindered by the lack of geographical proximity of Australia compared to the EU.

The two countries are not only geographically distant but also in different hemispheres – experiencing the opposite seasons all-year-round. Free mobility of labour would be a sort after proposition. Seasonal goods and services such as agriculture, clothing, and tourism would benefit both Australians UK citizens – year-round employment in the same sector for fruit harvesters, swimwear designers, and ski instructors, amongst others, would be a novel concept, and perhaps economies of scale to benefit both countries. However, geographical distance eats into any potential benefits from free trade due to the increase in transportation and other transaction costs.

Without even considering geography or history – Australia will gain more from any trade deal with the UK because the UK has a larger population – 68 million versus Australia’s 26 million. A larger population in the UK means a larger market for Australian exporters. A larger population in the UK also means economies of scale for British industries that Australia can only dream of, or has tried and failed at, miserably.

Economies of scale reduce the cost of production, which can make or break the commercial viability of an industry. Take the car production industry in Australia for example, which is all but non-existent, where several players have ceased production in recent years. Effectively, Australia doesn’t have large manufacturing industries and products to sell to the UK, FTA or otherwise, while the UK does. Hence why much has been discussed in the media about UK-manufactured cars expanding their market into Australia – benefitting British manufacturers and benefitting Australian consumers.

As with any bi-lateral FTA, while the net macro-economic gain is positive, there will be short-term micro-economic losses, depending on the sector. While British manufacturers of cars may gain under the FTA, British farmers may lose in the short run. This would explain the UK farming sector’s displeasure in the in-principle Australia-UK free trade agreement.

Australia’s agricultural sector has not experienced the protectionist policies that EU countries have enjoyed for decades. Pre-Brexit, the UK benefited from the EU’s Common Agricultural Policy (CAP) which at €54 billion per annum is approximately a third of the EU budget. As Australian farmers are not as protected as EU farmers, they have had incentives to innovate, and reduce their costs of production. Agriculture is a sector that Australia does have economies of scale and a comparative advantage in, in part, due to Australia’s abundance of arable land. Unsurprisingly, Australia is a net exporter of agricultural products. Thus, on balance, under this FTA, Australia’s agricultural sector is set to benefit more than the UK agricultural sector, as a new market opens for cheaper Australian produce.

This imbalance would explain why the terms negotiated in the deal, even at the early in-principle stage, outline a staggered and staged removal of agricultural trade barriers – even to minute details of how quotas are gradually increased, and tariffs are gradually reduced, up to periods of 10 to 15 years (depending on the product), as well specific details about the safety nets in place for British farmers when certain thresholds of import volumes are exceeded. The UK government is aware about the short-term negative impact to UK farmers, and they have ensured that the sector experiences the shock gradually and thus has time to adapt in the long run.

With free trade, even the short-term negative impact on certain sectors will disappear in the long run, provided the conditions of a free market and free labour mobility are met. As the UK agricultural sector opens to cheaper imports, the sector will be incentivised to innovate and adapt. Non-productive resources, including labour, would move out of the sector into more productive sectors, thereby increasing the size of the macro-economy, and the total size of the pie in the long run. In a post-Brexit world however, labour mobility is limited, and the Australia-UK trade deal does not go anywhere near to replicating the EU’s labour mobility.

On balance, due to the unique historical, geographical, and economical background of the Australia-UK relationship – the short-term gain to Australia seems to outweigh the short-term gain to the UK. But perhaps, there is another angle to analyse this free trade deal on, when looking beyond the past and the present, and into the future. The political angle needs to be considered for the UK government, which may help explain why this rational agent has wilfully entered such a deal.

The UK government is not looking at this free trade agreement in isolation, this deal is a signal to the UK of the free trade deals to come, as the UK can freely enter into its own agreements as a sovereign nation. The current government needs to provide evidence to their population of the very benefit that was highlighted as the advantage of Brexit. This free trade deal is that signal.

Given that Australia has a historical affinity to the UK, and the Australian economy was already very open to the UK to begin with – this would have been one of the easiest free trade agreements to negotiate. Only one player had their guard up, and this was the same player who needed to make the deal happen. The timing of the G7 summit after more than a year of lockdown, when G7 leaders could meet face-to-face, where the UK was the host and could extend an invitation to Australia as a guest – was the perfect photo opportunity to signal a new economic paradigm – to the UK, and to the world, of what is to come – more bi-lateral free trade agreements, non-EU multi-lateral agreements such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP)…and beyond.

Dr Prashan S M Karunaratne,
Senior Lecturer, Department of Actuarial Studies & Business Analytics
Macquarie Business School, Sydney

Prashan is a teacher at Sydney’s Macquarie University who has inspired and engaged tens of thousands of students over more than a decade. He has been invited, this year, to present his work in the UK and European Union which showcases his latest innovations in the teaching and learning of economics and business.

 

 

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