Tag Archives: UK

June – Trade Outlook

Article 50: time to take a strategic look at trade

Almost as soon as the dust settles after the UK election, the Article 50 process to negotiate the UK’s exit from the EU will start. The UK so far has relied on a conciliatory Europe led by a Germany that was genuinely saddened by the loss of its like-minded Anglo-Saxon ally and therefore more likely to drive the bloc towards compromise. The G7 and NATO summits at the end of May, and the inauguration of President Macron have changed all that. Europe is finding a new assertiveness on the global stage. This was articulated by Chancellor Merkel in her Munich speech; she argued that the US and the UK could no longer be relied upon and that Europe must find its own voice to promote its own interests. And while much of the rhetorical anger in the speech may simply be attributed to electioneering, it serves as a wake-up call to the UK. Europe will have its own strategic interests when it starts the negotiations and the UK would do well to be aware of what these are.

Trade is political and this makes it strategic – that is, something that can be used as a tool to promote national or regional interests in economic or foreign policy terms. In this, EU negotiators will be keen to protect Europe’s economic and energy security as well as increasingly focused foreign policy interests.

The EU’s top ten export and import trade flows by sector with the UK are automotives, machinery (including computers), pharmaceuticals, electrical equipment and oil and gas (Figure 1). The top fifteen trade flows by sector add optical, photographic and medical equipment, plastics and aerospace. These are not just the top trade sectors for the EU as a whole; they are also among the top sectors for Germany, France, the Netherlands, Italy, Belgium and the UK.

Given that Europe exports to the UK some 85% more than it imports from the UK, it has been assumed that the cards are stacked in the UK’s favour. However, trade “wars” are reciprocal: one side imposes tougher arrangements and the other retaliates. As these are the top sectors for the UK as well, and as Europe is the UK’s largest export destination for each of these sectors, it will be important to bear in mind that the symbiotic relationship in these sectors are because of Europe-wide supply chains. Everyone will lose without some compromise.

 

Figure 1: Top 15 trade flows by sector between EU and UK (exports and imports, 2016, US$ bn)
Source: Equant Analytics, 2017

The second thing to note is just how concentrated this trade is. The top ten flows account for 53% of Europe’s trade with the UK. Add in plastics, optical and medical equipment and aerospace (the 11th and 12th largest flows and in the top five for Germany, France and Italy) and the top flows account for over 60% of Europe’s trade with the UK (Figure 2).

Again, the dominance of exports to the UK is clear – the top four sectors are all exports to the UK and constitute over 31% of Europe’s trade with the UK. Again, however, the importance of Europe-wide supply chains is critical. The UK is a large export market for German cars and automotive components, but this is because the UK is a major location within Europe for the manufacture of German cars. While this may appear that Germany is more dependent on the UK than the other way around, the UK’s exports of cars to the US has grown at an annualized rate of 9% and to China at an annualized rate of 13% over the past five years. This is not all attributable to German manufacturers, but there is no doubt that this has had an influence.

 

Figure 2:  Share of EU trade with the UK, top fifteen sectors, 2016 (%)
Source: Equant Analytics, 2017

Finally, the EU 27’s trade is 73% correlated with the value of the euro since 1998 suggesting that it is a trade-based currency rather than a speculative one. Its trade with the UK is slightly weaker at 70% but this is still substantial. (Figure 3). The euro is the world’s second largest trade finance currency and its position and strength can therefore be seen as a function of the strength of Europe’s trade. This is a quite distinct function for the euro and explains why Germany in particular has been keen to hold the Eurozone together: the euro’s economic importance is in trade and as supply chains develop across the region, this becomes more rather than less important. Just as is the case for Europe, a stable euro for the UK ensures that prices within the supply chains into which UK businesses are woven are also stable.

 

Figure 3:  EU 27 exports to UK vs euro-usd spot price, 1998-2016
Source:  Equant Analytics, 2017

Elections distort rhetoric and there is anger in Europe about the UK’s bellicose tone which, along with Trump’s visits at the end of May provoked the response from Angela Merkel that former allies could no longer be trusted and that Europe would have to go it alone. The danger is that rhetoric becomes entrenched on both sides after the election in the UK because there is still a long way to go before the German election. This would be a negotiating mistake on the part of the UK. Europe’s and the UK’s trade is almost symbiotic because of the importance of supply chains. Policy makers on both sides would do well to remember this.

March – Trade Outlook

The stage looks set for the UK to trigger Article 50 as planned by the end of March 2017. This will start the process of negotiating the UK’s way out of the European Union, a process which will be at best difficult. As no-one at this stage knows precisely what the trade arrangements will be after Brexit, and as these arrangements won’t come into place for at least eighteen months, it is a good idea to take a snapshot of where we are now in trade terms  and, indeed, to look at what the future looks like if nothing changes. At the very least, this provides a reference point for that point in the future when we are, well, where we will be.

Figure 1:          Projected annualized average growth of UK trade with global regions, 2016-2020
Source:            Equant Analytics 2017

NOTE:     The projected growth between 2016 and 2020 is based on a momentum forecast only. The momentum forecast is taken from all available data for the UK between 1996 and 2016 (inclusive) to capture cyclical changes in trade and from the last ten years and the last three years to create the forward momentum. The projections are based entirely on the data series and not on assumptions about policy changes or their impact. This note applies to Figures 2 and 3

At first glance the chart shows that although UK exports to the EU 27 and the EU currency area are projected to fall, export growth to the Asia Pacific region (APTA) may be as high as 7.4% annually to 2020. This is a pattern that has been gaining some momentum for the past few years, particularly since the investment of BMW in the UK, which has boosted car exports to China for example. Export trade to the Middle East and North Africa is also projected to grow and much of this is in aerospace and engineering-related supply chains. Trade with North America seems set on a downward path – clearly Theresa May’s recent visit to the US has yet to show through in the projections!

However, two key points about this chart need to be considered before a universally positive conclusion is drawn. First, generally speaking, imports look set to grow faster than exports. Some of this may simply be due to the weakness of sterling making imports more expensive but it does suggest that even on current conditions our exports are not growing fast enough to cater for increases in imports. Imports from the Asia-Pacific region (notably China) are the notable exception but as we export just over half to the Asia Pacific region compared to what we import ($46.6bn compared to $87.5bn) this explains why growth of imports might be slower.

Second, exports to Europe, both the EU27 and the Eurozone are set to decline and the increase in export trade with Asia Pacific, even on current trends, is insufficient to make up for this loss. We project exports to the EU27 to be worth $197.6bn by 2020 while exports to the Asia-Pacific region to be worth around $57.6bn, or just under 30% of the value of European exports by 2020.

The picture of UK trade by sector shows just how integrated into global supply chains our businesses are. For example, the top ten sectors (shown in Figure 2 from left to right by size), also show that generally imports are set to grow more quickly than exports. This may not in itself be a bad thing, because where imports are growing in components, for example, the UK is able to add value through its exports of cars. Certainly for pharmaceuticals the projected annual growth to 2020 of 2.8% is substantially higher than the annualized growth between 2010 and 2015 of 1.2%.

 

Figure 2:          Projected annualized growth for the UK’s top trade sectors, 2016-20 (%)
Source:            Equant Analytics, 2017

However, UK export growth is fragile, even on the basis of current conditions. Projected export growth to 2020 for computing is close to zero, while export growth for automotives is one third of the rate it was in the 2010-2015 period of 6.0%. Exports in electronics, organic chemicals and oil and gas look likely to decline. The obvious exceptions are gold and precious metals and works of art where exports will grow more quickly than imports.

Figure 3:          Projected annualized growth, 2016-2020, for key UK services (%)
Source:            Equant Analytics 2017

The UK runs a trade surplus in services and exports overall look set to grow faster than imports over the next five years. However, the picture is mixed. Travel, transport, intellectual property and insurance are the four service sectors where exports are growing particularly compared to imports but cultural and creative, franchising and licensing and financial services exports are likely to decline on current trends over the next five years. Financial services in particular is an iconic sector for the UK because of its links with employment and the regional economy of London and this negative outlook ahead of Brexit negotiations is important for policy makers to bear in mind.

What this overview shows is the fragility of UK trade generally and exports in particular. Trade is growing quickly with Asia, and some of our top sectors and services look strongly placed ahead of Brexit negotiations. However, the fact that imports are growing quickly has to be seen in a context of an area of globalization. If globalization is thrown into reverse during the course of the next two years, not just because of Brexit but also because of increased protectionism in the rest of the world, especially in the US, this position is increasingly untenable as we return to an era where export strength is equated with national economic strength. While nobody really knows what will happen, any uncertainty will increase the downside risks in the current outlook.

February – Graph of the Month

6th February 2017

Where will the biggest impact of President Trump’s Executive Actions be? The Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TPP) look to be things of the past. The North America Free Trade Area (NATFA) will be undermined by the ongoing diplomatic and trade disputes with Mexico.

Yet US trade openness, that is trade as a percentage of GDP, was, on average between 1980 and 2013, 18.6%. Compared to a global average over the same period of around 45%, this just demonstrates the size of the US domestic economy – US jobs are created domestically to a greater extent than they are from trade. It follows that it will be global trade, the flows and patterns of trade around the world that will be transformed if the decisions translate into real action.

Figure 1:          Annualised growth in US trade with top ten partners and regions, 2015-2020 (%)
Source:            Equant Analytics, 2017

However, the US will not necessarily be the main beneficiary of the “bilateralism” of its trade policy. Longer term growth to 2020 presents US trade policy with several issues (Figure 1) irrespective of the intent behind recent changes:

  • Imports from Asia Pacific will grow at over 1.5 times the rate of exports to Asia Pacific. China is the exception, where exports will grow more quickly than imports. But as the US imports from China at nearly five times the rate that it exports to China, the faster rate of export growth is unlikely to have much long term impact on US net trade.
  • Exports to NAFTA look likely to increase more rapidly than imports. NAFTA works well for the US and any trade war with Mexico or disintegration of the regional trade area could damage US exports as much as it hurts Mexico.
  • Germany argues that the ECB keeps interest rates low which keeps the Euro low; President Trump argues that Germany benefits from the low value of the Euro and certainly the US will be importing from Germany at nearly twice the rate of growth that it exports to Germany. We expect faster growth in US imports from both the EU27 and the Eurozone as well.
  • Howsoever great the desire may be to create a bi-lateral trade partnership between the UK and the US, the UK is the US’s sixth largest country trading partner and, as an export destination less than half as important as either China or Mexico. The momentum of trade to 2020 suggests that nothing between the two countries will change.

If the policy is to support US jobs, then the sectors that China and Mexico trade with the US are important indicators of how effective this policy will be.

China’s imports into the US are predominantly in electrical equipment (cameras, audio-recording equipment etc) and the levels are substantially higher than they are for US exports to China in the same sector. However, within the broad grouping of “electrical equipment” are a range of products and the US exports to China in products that are higher at the value chain in both computing and machinery and electrical equipment.

 

Figure 2:          US trade with China by top import sectors, 2016 (USD bn)
Source:            Equant Analytics 2017

The other two top sectors for Chinese imports include furniture and bedding, toys and clothing, and potentially this reinforces the economic nationalism that is now reflected in US trade policy.

On one level there is truth in the statement that the US has exported many of its low and middle skilled jobs to China. This has been deliberate policy and was the product of the “globalization” which drove company performance and which is now likely to be thrown into reverse.

Yet, China is the USA’s third largest export partner by country and its exports are worth $150.6bn to the US economy a year. Most of this export trade is at the high end of the value chain (semi-conductors, aerospace, pharmaceuticals, biopharmaceuticals and automotives) and as such, reflects the strongly research and skills intensive nature of US trade that has evolved through the process of globalization.

Mexico, in contrast, is a key part of a North American value chain in oil and gas, electronics, computing and machinery and automotives in particular. These are the top four import and export sectors between the US and Mexico (Figure 3).

 

Figure 3:          Top four traded sectors between the US and Mexico, annualized growth, 2015-2020 (%)
Source:            Equant Analytics, 2017

Other things being equal, the trade momentum on the face of it at present looks positive for the US: export growth is higher than import growth in electrical equipment and oil and gas, and while import growth is faster in computing and automotives, against the backdrop of a considerable deficit with Mexico, the US itself is exporting equipment to fuel Mexican infrastructure development at a rate of nearly twenty times the rate that it imports. This is again the process of globalization and has been the case since the mid 1990’s.

The drop in oil and gas imports from Mexico presents a double-edged sword potentially. The US has not exported its crude oil historically and although this changed under President Obama, there is still no recorded data in United Nation databased to confirm that it now exports crude to Mexico.  However, it exports refined oil back to Mexico at four times the level that it imports it. Mexico has been accelerating its oil refining capacity over the last 2-3 years and the drop in imports potentially reflects both an increased self-sufficiency in the country and a loss of export revenue to US oil and gas companies.

The implications for global trade that are emerging as a consequence of the way in which US trade policy has been articulated since the inauguration of President Trump are not all about avocados, although even here there is an expected slowing momentum from 7.5% growth in 2016-17 to just over 4% by 2019-20! What is at risk, however, is that already the momentum of trade between the US and its key partners appears to be slowing.

The slowdown reflects flatter global trade growth and the increasing localization/regionalization of global supply chains. Any policy that seeks to disturb what is already a fragile equilibrium, may well cause the tectonic plates of trade to shift permanently.