Brexit and the risks of economic nationalism

In talking about their future relationship with the UK, EU leaders may want to mind their language.

Though the British premier, Boris Johnson, says he ‘got Brexit done’ last month, the United Kingdom’s future economic relationship with the European Union remains undefined. Officials are ramping up to negotiate but reaching an agreement will be difficult. From a continental point of view, the UK is approaching the negotiations as if from another planet, as the chair of the European Parliament’s Brexit steering group,  Guy Verhofstadt, has put it.

The negotiations present EU leaders with an under-appreciated, big-picture dilemma. At their heart will be the question of a ‘level playing field’. European officials say that the UK will have to adhere to the EU’s social, environmental, competition, and possibly even tax standards as a condition for broad and smooth access to the single market. But the British government completely rejects that demand. Its chief negotiator says ‘the point of the whole project’ is freedom for the UK to set its own (potentially lower) standards.

Nationalist thinking

The dilemma confronting the EU is that conditioning market access on UK agreement to this level playing field risks reinforcing nationalist economic thinking. And more such thinking is the last thing any EU leader, from the far left to the centre-right, wants to see.

If too many more people come to believe that gains for other countries mean losses for their own, or that international markets force nations to race to the bottom on social standards, the European project—and even many other international economic institutions—will be in serious trouble. Nationalist instincts gave rise to the headache of Brexit in the first place, along with the victory in the United States of 2016’s other great free trade disruptor, Donald Trump.

The president’s approach to the renegotiation of his country’s North American Free Trade Agreement with Canada and Mexico is telling about the sort of ideas that lead to demands for a level playing field. Trump, an avowed nationalist, criticised NAFTA for years as an unfair deal on which the US was purportedly out-negotiated. Now he promotes his new, more protectionist US-Mexico-Canada Agreement as including ‘unprecedented labor standards that will help level the playing field for [American] workers’.

Trump seems to believe that weak labour laws (at least hitherto) have been giving Mexico an advantage in a zero-sum competition with the US. This is strikingly similar to the advantage European officials are suggesting the UK could gain outside the EU—hence their demands that it not drop below European standards.

Across the English Channel, Johnson and many of the people around him are so confident about the prospects for a leaner-and-meaner, post-Brexit UK that they want to expand opportunities for more trade with economies outside of Europe. (No small irony, given that research suggests Brexit would never have been so popular with voters but for the prior dislocations of globalisation.)

In a variety of ways, then, British, European and Trump administration officials all believe that—or at least are talking as though—high wages, taxes and strong environmental protections are burdensome costs, hindering their countries’ abilities to compete with others in world markets.

Mercantilist notion

These beliefs are not a given. In fact, they make little if any sense from the perspective of mainstream economics. The notion of trade as a mercantilist, win-lose competition among nations has no place in modern economic theory.

Drawing on the famously counterintuitive reasoning about trade which is nonetheless central to their discipline, economists say that imports, exports, and tradeable industries adjust to whatever labour, tax, and environmental policies governments choose—no matter whether they are good or bad. Otherwise, the social-democratic and relatively affluent Nordic nations, with their high taxes, strong labour laws and world-leading environmental policies, would be economic catastrophes.

It is true that international markets can lead industries to shrink (or expand) and the social costs of adjusting to new economic realities are real. Domestic conditions influence the distribution of income and can give some industries advantages vis-à-vis others. But while companies and industries compete, whole nations do not. Though lower standards in foreign countries might seem unfair, they are not, and there is no strong economic case for a level playing field.

In that sense, EU leaders who care about workers and the environment should think carefully about the pros and cons of demanding that Britain adhere to the EU’s standards as a condition for access. These demands could backfire, by reinforcing the damaging misconceptions that nations compete and that cutting as much regulatory ‘fat’ as possible is somehow the key to victory.

Such ideas, which for economists were deftly put to the sword by Adam Smith and David Ricardo, could exert downwards pressure on important policies in the longer run. If British voters have elected a government that wants to gut their country’s social standards, that is a tragedy—but a tragedy for Britain, not the EU.