Daniel Hannan is one of those dangerous Brexiteers who goes around spouting all sorts of rubbish as if it was received wisdom and sounding plausible at the same time. He has a piece again on Conservative Home (HERE) about trade liberalisation being the true prize rather than trade deals. Like many of his arguments it contains a few grains of truth. He is not an economist but claims sufficient expertise to expound at length on the subject.
He says trade deficits don't matter and we shouldn't worry about them, saying:
"He [Sir John Cowperthwaite] understood, as most economists do, that the balance of trade doesn’t matter, because any deficit must be matched by inward investment, any surplus by outgoing capital".
Hannan simplifies a bit too much. If I look at a more balanced picture:
"As usual in economics, there are several different views of trade deficits. Depending on who you talk to, they are bad, good, both (depending on the situation), or immaterial. However, few economists argue that trade deficits are always good (HERE), And, "So as long as the trade deficits are financed by foreign investment and the dollar is not overly weakened by them, then GDP will be fine"
Many countries operate with a trade and current account surplus – good examples are China, Germany, Japan, Norway and several emerging market countries with strong export sectors.
A country with a surplus on the current account sees capital outflows of the same amount. This capital is either deposited in banks overseas or used to purchase foreign assets, from government bonds to companies, leading to an increase in the surplus nation's ownership of foreign assets (HERE) and:
Countries that run a deficit on trade that is NOT financed by foreign investment (and FDI dropped by 92% last year - HERE) are at risk of a Balance of Payments crisis:
A BoP crisis occurs when a country cannot pay for essential imports or service its debt (i.e. pay interest), often as a result of currency devaluation; usually preceded by large capital inflows in order to boost growth but then investors get worried about their debt and remove their capital.
Key Dangers from running Persistent Trade Deficits
A deficit leads to lower aggregate demand and therefore slower growth
In the long run, persistent trade deficits undermine the standard of living
Trade deficit can lead to loss of jobs in home-based industries
Deficit countries need to import financial capital to achieve balance
A trade deficit can lead to currency weakness and higher imported inflation
Countries may run short of vital foreign currency reserves
A trade deficit is a reflection of lack of price / non-price competitiveness
Currency weakness can lead to capital flight / loss of investor confidence
So, it's true that as long as Russian Oligarchs buy London property and there is a healthy flow of Foreign Direct Investment (FDI) to match the deficit everything is fine. This is the "kindness of friends" that the governor of the Bank of England talks about. But remember foreign companies slowly begin to own a lot of the wealth creating base with profits either being repatriated or used to acquire more of your industrial capacity. If the flow of funds stop we might be in trouble because "any negative effects of trade deficits will correct themselves over time through exchange rate adjustments and through competition leading to a change in what a country produces (HERE)".
Exchange rate adjustments is a euphemism for devaluation, the kind that causes people to lose confidence in your economy and pull more money out leading to a run on the currency and higher and higher interest rates. Not good. This is why Brexit is so dangerous. FDI fell 92% last year, if this doesn't reverse the pound will begin to suffer.
And free trade is mostly all good he claims, with a just few small caveats buried in the article:
"It is true that, within an economy that is growing overall, free trade might accelerate certain sectoral shifts. Some industries decline while others grow, though that process is primarily driven by technology rather than trade".
What Hannan calls "sectoral shifts" is job losses, suddenly and on a huge scale. Cheap food is good but if you have no job, it probably doesn't matter how cheap it is, you still can't afford it. And it's all OK when the economy is "growing overall" - you can go out and get another job. What if it isn't? He doesn't say.
And farming would be devastated by cheap food imports from the US or low cost countries outside the EU. One of the founding principles of the EEC was to ensure Europe was self sufficient in food production. Would we be confident if we rely on even more of our food coming from overseas? And what about our farmers? They struggle now and couldn't compete without tariffs. Who would be the custodians of the countryside then?
Free trade sounds good in principle and for men like Hannan it might be good. But for ordinary people struggling to manage, it may would not be the Utopia he claims.
