Written evidence submitted by Volga Trader (BAT0006)

Submission by Volga Trader,

Bridgend, Wales and Saratov, Russia

Brexit and Trade: The impact on Wales

What this submission discusses

This submission discusses the “Opportunities for trade agreements with non EU countries” and how to access them. The submission is justified by the novelty of the numerical analysis presented, in particular the Gravity Model of Trade. The model compares the potential for trade with actual trade figures. As a result it is particularly good at revealing unmet trade opportunities by country.

The large unmet opportunities are in order, Russia, Turkey and Indonesia. The lost trade relative to normal UK performance on the Gravity Model is £27Bn, £12Bn and £26Bn respectively.

So the submission is also justified by the experience of the author, Philip Owen, with his trade consultancy Volga Trader in Russia. Part of 45 years experience in innovation and international trade. Practical experience is usually accompanied by vested interest. This case is no different.

The document concludes with a list of recommendations for practical actions.

What the committee asked for

The committee asked for evidence on the following topics. Links to the sidepapers are repeated during the relevant discussion and at the end of the submission for those who prefer to read straight through. Links to documents written as part of this submission are in Blue. Links to data available on the wider web are in Green.

●        Priorities for UK trade relations with European Union.

○        As the discussion in the section “Forms of Brexit” indicates, the author assumes Total Brexit so there is no scope for discussing trade relations.

○        The Welsh Subregions side paper looks at the importance of trade with the EU by the unusual measure of number of businesses (thus voters) involved.

●       Opportunities for trade agreements with non EU countries

○        The side papers  Engage with Russia, Fractured nature of the USA discuss specific opportunities for trade agreements.

●        Impact of revisions to NI protocol.

○        The author has no expertise in NI matters. There is no discussion.

●        New roles for Welsh Ports is focussed on opportunities rather than adjustments to existing services to Ireland about which the author knows little.

●        The effect on agriculture

○        The Protected Industries section deals with high tariff walls.

○        Opening up the Japanese market to UK shellfish to compensate for losses to the US-EU trade deal demands immediate action, See Protected Industries!

●        Actions to be taken by devolved administrations

○        Processes always matter.  Changes to limits on state aid may allow improved processes. Small improvements to Trade Support Processes at UK and devolved government level have as much potential for increasing UK trade as major trade deals.

Contents

What this submission discusses

What the committee asked for

Contents

Brexits still to come

Consequences

Trade Frictions in all cases

Tariffs

Welsh regional exposure to EU goods trade

The Gravity Model

It’s not a long way to Tipperary

Most of world trade potential is here

Export or Import?

Do services count?

Planes and passports

Gravity Model of Trade data table

Results - The Gravity Model of Trade for the UK

20x magnification, easy gains or the dust in the corner?

1000x magnification, seeing the whole picture

Where trade does not meet performance

Trade Support Processes

Recommendations

Very urgent

Other recommendations for action in order of impact

Brexits still to come

The Secretary of State for Wales has said plainly that all forms of Brexit under consideration exclude the Customs Union and Single Market. There seem to be three remaining options for the future relationship with the EU,

●        A treaty not dissimilar to the Withdrawal Agreement negotiated by the previous Johnson administration. The government now appears to be unhappy with this agreement.

●        a World Trade Organization, Article XXIV Brexit which is not under the control of the UK thus cannot be planned for. The WTO court, inquorate due to US refusal to appoint a judge, would have to decide. A Biden influenced judge might swap UK compliance on Northern Ireland in exchange for an Article XXIV Brexit lasting up to 10 years.

●        The only current option, a Total Brexit which would lead to substantial tariffs on exports to the EU by the Protected Industries and vice versa.

Consequences

Trade Frictions in all cases

All forms of Brexit in all industries will require customs documentation. This will produce trade frictions such as; inability or lack of confidence to process the forms in SMEs, cost, document creation delay, lack of freight forwarding capacity, delay at borders,

Wales can add ferry routes to shift some customs processing load from overloaded French customs at Calais to other French ports and even to Spain. Similarly North Sea ports can divert Dover-Calais trade to Belgium, the Netherlands and Germany.

Even with minimal customs support, these new ferry routes can deal with returning empty trucks in both directions thus reducing congestion at Dover-Calais.

See the side paper new roles for Welsh Ports for more discussion.

Tariffs

Most UK trade is in manufactured goods. The relevant WTO tariffs against UK goods are generally low. The UK’s inherited tariffs from the EU against imports will be some of the world’s lowest. So a Total Brexit would not have a huge impact on manufactured goods. Normal variations in exchange rate are bigger than WTO/EU tariffs.

In a Total Brexit, inherited EU tariffs in the Protected Industries would be very large for both Export and Import. Sales to the  EU will collapse.

There would also be large tariffs on food imported from the EU. There has already been a trial run of Brexit. In 2014, Russia imposed sanctions on the EU that amounted to a Total Brexit by Russia. Food price inflation reached 30%. Overall inflation reached 15.5% from a previous 8% base.

Welsh regional exposure to EU goods trade

This section is a summary of a side paper Welsh Subregions.

Subregions can give some hint as to the standing of individual members constituencies and thus the constituency’s claim on priority attention.

25,266 Welsh businesses, 76% of all those with a connection with International Trade supply chains depend strongly on trade with the EU. At 5 voters per business (owners, managers, relatives) this is 125 thousand voters, roughly 8% of the 1.5m of those who voted in Wales at the 2019 General Election. At the next election their assessment of Brexit will be based on events, not hopes. It is clearly important for the government to understand what might happen to them.

The Gravity Model

The Gravity Model of Trade is one of the more robust models in economics. It observes that trade between countries depends on the size of the economies and the inverse square of the distance between them.  (Keep going! The simple explanation follows).

The Gravity Model is easiest to explain by thinking about the buyer of goods or services.

Consider buying groceries. There may be only one supermarket within 2 miles of your home, an area of 3,1 miles. Look 20 miles from your home and the area is 314 square miles. Enough room for 101 supermarkets. You can easily see that the buyer’s options multiply with the square of the distance.

Members may have seen signs in shops saying

“you can have it cheap, fast or good, choose two”.

Distance turns cheap into expensive and fast becomes slow. Only quality is unaffected.

Distant suppliers must offer outstanding quality or have exceptional price advantages to attract the buyer’s attention. As distance increases, sellers feed against greater competition so their advantages fade with distance.

It’s not a long way to Tipperary

For example,

●       LHR to  Stuttgart (more or less the EU’s economic centre) 580 miles

●        Distance to Sydney - 10500. Sydney is 18.1 x further.

●        So £1 Bn of GDP in Stuttgart is worth £328 Bn of GDP in Sydney.

This can seem shocking to those who see the actual numbers for the first time. It is real. It can be seen in the real life figures of inputs to the model. So distance has a strang impact on trade potential. Distance is persistent. Good relations with near neighbours is strategy.

Growth rates in GDP come and go. Chasing GDP growth is tactical.

The impact of distance explains why This is why regional trade blocs such as the EU, the EaEU, the GCC or Mercosur work. Distances are short. Long distances subverted the attempts of the 1931 Ottawa Conference to form a Commonwealth Free Trade Area despite 25 subsequent years of negotiation.

Most of world trade potential is here

The G20 is a grouping of the world’s largest economies. It claims 75% of world trade takes place between its members.

This model looks at trade with the G20. However, where a G20 member is part of a trade bloc, the whole trade block has been included as it is the trading entity for purposes of agreement on tariffs and regulations, not the individual country. The trade bloc EFTA has also been included. Although small in GDP terms, it is close to the UK so trade potential (and performance) is proportionately high.

Thus, the Volga Trader model accounts for about 85% of the world’s trading economies by value.

Export or Import?

An 18th-century economist would value exporting and thus the accumulation of gold over importing.

A modern economist would note that imports are other people’s added value sent to the UK and thus enhancements to UK prosperity. Exports on the other hand are UK value sent away. They are a means of paying for imports but by no means not the only one.

Imports tend to benefit the whole community but few notice because the benefits are spread widely; exports tend to benefit just the exporters which creates a concentration of interest. Thus exporters promote the false 18th-century view.

This report considers total trade, imports and exports.

The ONS publishes good quality figures for Welsh export of goods and experimental figures for Welsh export of services. However, Welsh imports are harder to determine. For that reason, this paper has used a UK wide gravity model.

Do services count?

Some assert that service exports do not depend on distance. That the UK’s strength in services will cross the oceans without impediment. This is not true.

There are four “Modes” of service trade  defined by the WTO.

●        Mode 1              cross-border services (online transactions, sales by call centre)

●        Mode 2              Services purchased while abroad (tourism, education)

●        Mode 3               Setting up a commercial presence abroad (data centre, law office)

●        Mode 4               a worker crosses the border temporarily (service technician, manager)

Some are important in vulnerable rural areas and support Welsh language communities.

Planes and passports

Even downloadable software involves selling expense. The website must promote to the buyer in the local language. SEO terms that work in English may not work in Arabic. They must be found and tested.

The site must comply with differing local laws and tax collection requirements.The further away, often the more different the law and the language, the more expensive the lawyers and tax consultants.

Intellectual property may weigh nothing but there are copyright and patent protection issues. Somebody must fly out to sell it and someone is needed to support technology transfer. The marginal production costs of the Intellectual Property may be zero but the sales costs are not.

Services matter in Wales, Services in Wales but not as much as for London in either import or export. Welsh interests diverge from UK interests in the relative importance of goods and services trade.

Gravity Model of Trade data table

The table below is worth a brief review but the results will be presented graphically. It is available so that calculations can be checked by researchers as required.

The trade blocs are presented in order of potential according to the gravity model.

Members may be more familiar with the figures in US $ but in deference to the Leader of the House, British Pounds and miles have been used.

Sources: Real GDP from IMF WEO average GBP exchange rate; Distance; Google maps, UK Trade from ONS.

Continue reading to see the results graphically

Results - The Gravity Model of Trade for the UK

This is the first of three charts presenting the results of the Gravity Model for the UK. It is the first of three because the EU utterly dominates other potential trade partners in both measures of potential and of actual results. Thus, magnification Is required.

An academic would use a log scale to map such large differences in values. Most MPs are not economists, scientists or engineers. To ensure that the proper relations are evident to such non specialists, a linear scale has been used for the first two charts.

The vertical scale shows actual trade performance in £Bn. The horizontal scale shows potential normalized to the EU at 100. Other potential of trade partners can be read as a percentage of the EU.

The trend line represents average trade performance. The R2 for the trend line is 0.924, a strong confirmation of the validity of the gravity model.

The EU is so dominant in both potential and actual performance that all countries other than the US are as dust in the corner.

The message is clear. The overwhelming focus for maintaining UK trade levels improvement should be the EU. Small percentage losses in EU trade will require substantial percentage gains elsewhere to compensate.

Equally clear, the USA is by far and away the next most important partner and requires discussion in a side paper: USA internally fractured and fracturing the world economy.

Attention to other countries is a 2nd order problem by comparison with the USA but some easy gains are available in less saturated markets.

20x magnification, easy gains or the dust in the corner?

This chart leaves out the EU in order to provide a clearer visualisation of countries that might be considered to have potential for easy gains in trade. The trend line is the same as in the previous chart.

In population terms the countries of EFTA are small. They are also some of the richest countries on the planet and close to the UK. This explains their high potential. UK performance is at the average level and comparable with the EU. All EFTA members are closely associated with the EU.

The Eurasian Economic Union, mostly Russia, is a middle sized economy quite close to the UK. The UK underperforms with the EaEU by £26Bn compared to potential.

For Turkey, another middle sized economy quite close to the UK, the underperformance is £15Bn.

There is a notable over performance in trade with China. China has grown so quickly in recent years that it has sucked in enormous imports of goods from across the world.

The Chinese working population peaked in 2011. The raw materials cycle started its downward trend. Oil propped up by a cartel held out until 2014. Raw materials vary on a 30 year cycle and are now stable.

By 2016 the net oil producers on this chart had lost purchasing power. This affected the gravity model. The oil producers were fast growing economies outside the EU. Now they tend to be laggards.

Growth is not shown on this version of the model but could be with substantial work.

1000x magnification, seeing the whole picture

This is the whole model but on a logarithmic scale so that the less consequential countries can be seen. It is the same trend line as before but the log-log scale changes its shape.

Countries with significant potential for trade are in the range 1 to 10 on the horizontal axis. Note the vertical scale is also a log scale.

Japan, India and Canada are all similar in potential and performance so even a logarithmic chart does not separate them.

Given its English-speaking status and high level of development, Canada might be seen as a disappointment. However Canada is an oil economy.

Canada was also a member of the North America Free Trade Association along with Mexico. So competition from the US may have depressed the U.K.’s opportunities for trade in Canada (and Mexico). Canada is making substantial efforts to diversify trade.

India’s growth continued even when oil prices were high. In the medium term it will be one of the few countries which will improve its relative potential for UK trade.

The UK’s extreme underperformance in Indonesia is now visible and is £27Bn a year. However, given the history of previous good performance, the EaEU is advised as a better prospect.

Australia and South Africa are sentimentally important in the Brexit debate but at the bottom for potential.

Where trade does not meet performance

The EU and US are included for reference.

*Average Trade Weighted Duty 2017, World Bank

The UK is underachieving by £68 million of trade a year with the greatest underperformers. This is about a 10th of trade with the EU and equivalent to trade with EFTA. It is 3 ½ times the value of the U.K.’s trade with Australia (£18.1Bn).

All three countries have modest to severe problems with accommodating human rights. All three countries occupy disputed territory. In this they are not unique and there are many examples of the UK ignoring human rights and territorial issues when arranging trade. Indeed trade outside the Triad would be largely impossible without doing so.

The EaEU was strongly dependent on oil exports as was Indonesia. The EaEU has coped far better than most oil exporters due to the large manufacturing sector in Russia. Arguably it coped better than Canada. Indonesia has lost some of its bounce.

Turkey along with India was unusual among oil importers in that it continued growing strongly between 2007 and 2014. It can be expected to grow even more quickly now.

Volga Trader has direct experience with clients from Turkey and Indonesia. However Volga Trader’s outstanding strength is in discussion of the EaEU and Russia. There was a time not so long ago when UK trade with Russia outperformed even Germany. So there is no deep-seated industrial reason why such levels of performance may not return. The Welsh and UK prospects in Russia are discussed in Engage with Russia.

Trade Support Processes

While individual trade deals can make a substantial difference, small improvements to export support processes can actually make a bigger difference as they take effect across the whole of UK trade without a single new deal being signed. So can removing impediments to imports.

In the present circumstances, improving documentation skills and identifying existing language skills perhaps offer good prospects.

However the fastest return, certainly in Wales, might be using the opportunity of escaping EU state aid limits to focus more on the outputs of trade support processes rather than the inputs, Escaping state aid limitations for supporting fast growing firms with outputs as well as inputs may be a bigger an opportunity resulting from Brexit than any single trade deal.

UK Worldwide trade is about £2.8 Trn. Improving UK processes to increase that by 1% can deliver £28Bn. This is comparable to closing the trade gap with the EaEU or Indonesia and far in excess of potential increases in trade from other proposed FTAs by orders of magnitude.

Recommendations

Very urgent

●        Ask the Secretary of State for Trade to review the FTA with Japan for shellfish concessions as a matter of urgency. Protected Industries

• Fund plan to reorient UK shellfish exports to Japan and China (to fill gap left by US).
• Fund necessary infrastructure and working capital to launch sales in Japan and China before the fishing community goes bankrupt..

●        Immediately assign UK government Brexit preparation funds to dredge the channel to the Swansea RoRo ferry berth. See new roles for Welsh Ports

• Commission a feasibility study to set up liner schedules to Ro-Ro ferry ports in Northern France and Northern Spain.

●        Provide funds for 10,400 firms in Wales to receive training in customs documentation from Chambers of Commerce, Institute of Export and other qualified providers

• Develop (with Chambers of Commerce &/or Institute of Export) free/refundable, on line, self-taught courses in customs documentation with completion certificates. These should be promoted to the currently unemployed to build the skills base.
• Add all sources of information on customs documentation and supporting training courses to a specific page on the Welsh Government website.
• Retain access to the EU’s Market Access Database either at UK or Welsh levels.

Other recommendations for action in order of impact

1. Review Trade Support processes to enhance focus on outputs by firms. This is high impact. Improving the success rate of existing processes will deliver more than most potential FTAs.
1. Introduce country by country export benchmarking groups for peer to peer exchange of experiences.
2. Engage with Russia. The prize is £26Bn extra trade a year for the UK in 5 years, most of it in high added value goods and services saleable to few other countries.
1. End the visa war! There is a particular problem with the difficulty, delay and expense of getting visas to travel to Russia. Doing this is simple and opens up or cheapens many service industry possibilities.
2. Feasibility study looking at cooperation with the United Aircraft Company on various world wide support services for the SSJ100 and future projects.
3. Top down, winner picking promotion of other potential fields of industrial cooperation with Russia including all Welsh Government Industry Fora plus insurance, nuclear and space industries.
4. Use angel investment networks to promote investment in Welsh venture capital start-ups as a Tier 1 visa route for Russian nationals. Particularly focus on creative industries to restart animation links.
5. Feasibility study on UK/Welsh participation in the Russian agricultural revival. Storage, transport, ports, processing, finance, insurance. Start by discussion with the agricultural attache.
6. Formally invite Russian and all other agricultural attaches in London to the Royal Welsh Show at least once in their UK tour.
7. Review funding arrangements for bearing the risk of wafer samples between the Welsh Compound Semiconductor Catapult (UK funded) and opto-electronics clusters (WG funded) and the Russian optoelectronic industry as a pilot.
8. Commission a wider range of political views about Russia than currently in frame. British analysis particularly in the media seems to be informed solely by sources with an anti-Putin agenda, sometimes justified, often not.
9. Prepare an agenda of economic possibilities for tentative discussion and brainstorming with the Russian Embassy as informally as possible (Trade Delegation perhaps).
10. Open discussion with the EaEU about a skeleton FTA. Do this quickly so that an option is available to put pressure on the USA when discussing matters of food. It should be subject to withdrawal in event of Russian human rights or territorial infringements.
11. Russia-Wales cultural/business event(s) held in Wales to bring together the Welsh community of interest in Russia. Repeat for Turkey, Indonesia and other key trading targets.
3. Repeat item 2 with Turkey in mind. Volga Trader is unable to assist.
4. Review the UK-Japan FTA to identify opportunities for services in Wales specifically Mode 3 Japanese service companies investing in Wales. Identify barriers to trade with the EU.
5. Develop funded conversion courses for Russian, Turkish and Bahasa (The UK has a Malay population) speaking immigrants to become employable in sales and marketing posts.
1. Include paid for sponsorship for them to acquire certification from Chambers of Commerce or Institute of Export to enhance their immediate employability.
2. Take other active steps to get them employed – e.g. first 6 months salary paid by the government.
6. Commission a legal review of halfway house opportunities for UK data centres accessing Europe for Japanese and potentially US Mode 3  investors. This is a foundation stone for many IT businesses. An opportunity for services in Wales but UK government action required to avoid GDPR safe haven issues.
7. Seek non EU markets for Welsh lamb as a hard target for the Welsh meat marketing board. Profits will not grow but there will be greater industry stability with more diverse markets.
8. Continue the negotiations begun by Liam Fox as Secretary of State for Trade on service industry issues in the fractured USA.
9. Continue the Fox initiative in Indonesia.
10. Feasibility studies on longer term new roles for Welsh ports looking at grain, meat, fruit import container terminals at Milford Haven, Swansea or Cardiff.
1. Include options to develop fodder mill, chicken industry and pig farming.
2. Repeat with a. but with Liverpool as the only Atlantic import terminal.

October 2020