Europe: An Estimate. The Gains from Freer Trade with

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1 The Gains from Freer Trade with Europe: An Estimate Aside from possible effects in stimulating competition and the spirit of enterprise, which are difficult to define, let alone measure, the main gains to be expected from freer trade between the United Kingdom and other European countries are those arising from its effects in increasing the incomeproducing efficiency of the country s resources. Such increases may accrue in three ways : through economies of scale in production made possible by enlargement of the market; through economies of specialization and division of labour resulting from freer trade ; and through better terms of trade with the outside world. Of these, the first is unlikely to be very important for this country given the size of the market to which British industry already has access, and is in any case difficult to quantify. The third is unlikely to be significant for a Free Trade Area confined to manufactures, since Britain s dependence on imported food and materials would not be much reduced and a small reduction in her exports of manufactures to non-member countries would not have much effect in permitting higher prices. The substantial source of gain for the United Kingdom is therefore likely to be in the second direction, specialization and division of labour. A rough idea of the magnitude of the gain from participation (or loss from non-participation) in the Common Market due to this cause can be derived from figures contained in the Economist ntelligence Unit s study, Britain and Europe. This volume gives estimates of the values of trade between this country and Europe in 1970 in the presence and the absence of a Free Trade Area, for eight major industries. These industries produced 55% of the net value of British manufacturing output in n addition, estimates of trade quantities are given for another five major manufactured products, accounting for something under 18.5% of net value of manufacturing output in 1950 ; these quantities can be translated into trade values by assuming The Economist ntelligence Unit Limited, Britain and Europe. London

2 an appropriate unit value, though the result is obviously less satisfactory than the figures for the other eight industries.l Together, these thirteen industries accounted for about 50% of U.K. exports to, and 25% of imports from the Continent in From the estimates of trade values in 1970 on the two alternative assumptions, the effects of the Free Trade Area in increashg trade with Europe above what it would be if only the Common Market is established, can be estimated (su Table Cduwrn 4, and Table 11eohm 2).r The increase in the values of trade with the continent so derived do not, however, measure the gains that would result from the Free Trade Area, since exports use resources which could be devoted to other purposes, and imports must be paid for by exports. To obtain such measurements, it is necessary to begin by defining more precisely the nature of the economies of specialization permitted by freer trade. On the export side, the gain arises from the opportunity to sell the products of the country's resources on better terms than would be possible otherwise, and could be measured by the loss of income that would result if the productive factors employed in meeting the additional demand created by the Free Trade Area had to be diverted to producing for the domestic or other foreign markets. Unfortunately this loss is not estimable on the available information-it is arguable that it would not be great, since manufactures are fairly close substitutes on world markets. But it is possible to fix a maximum for the loss, since at the very worst the prices of the products concerned could be lowered enough to overcome the disadvantage of the Common Market tariff and permit their disposal in Europe. 'The unit values used below were derived as rough approximations from data contained in the industry chapters of Bribin and Europe; they are stated in notes to the Tables, for the convenience of readers inter4 in rdculating the estimates on other assumptions. m e figures are not altogether satisfactory for the present purpose. since they include the effect of the assumption made by the Economist ntelhgence Unit that the Free Trade Area will mean a greater increase (45% as against 41% )in G.N.P. by 1970 than would otherwise occur. This tends to make the following calculations produce an overestimate of the gain from Free Trade.

3 The Gains from Free Trade with Ewropc : An EstimcrLs 249 This consideration actually leads to two estimates, according to what is assumed about the nature of the market and the price reductions necessary to offset the W. f the prices of all exports to Europe had to be reduced to the same extent, the m9rcimum-10~~ estimate would be the value of exports to Europe under a Free Trade Area, multiplied by the proportion in the ihal price of the Common Market tariff rate which had to be of set.l This estimate, however, would be unrealistically large, Since prices of some products, or to some markets, could be maintained while others were lowered. At the opposite extreme, price reductions might be confined to the minimum necessary to promote the particular transactions which would not take place in the absence of a Free Trade Area. n this case, the maximum-loss estimate would be (approximately) the value of the difference in exports to Europe due to the Free Trade Area, multiplied by half the proportion of the relevant tariff rate in the final price (since the price reductions required would have to offset the full weight of the tariff only in extreme cases). Either estimate requires an assumption about the level of the Common Market tariffs, which in most cases can only be a reasoned approximation. The rates assumed,* and the two alternative estimates to which they lead, are presented in Table. On the first assumption, the maximum possible total loss on the industries represented would be of the order of k192 millions per year, while on the second, it would be only of the order of 462 millions per year. t should be stressed that these are maximum estimates, which assume that the goods concerned are useless outside the Continental market. The theory underlying this calculation can be illustrated by reference to Figure 1. n the Figure, SS is the export supply curve of the products of a particular industry, measured in pounds' worth of domestic resources; DD is the European demand me. With a tariff of SS' the quautity erported is OX,, with free trade it is OX,. What has to be done to export OX, in spite of the tariff depends on the nature of the industry's products. f these are perfect substitutes, the prias of all will 1l-h popartroo. m rahbsd to ths t.ria Rta by tbe samd8) =t/l-t. rh.pmtbeppatum *.d lw in tb d d r r b s d dmty mipparts 'm 8-w 0 d.t. h rl E e. u*

4 250 Th8 Manchester Schoot ndustry TABLE ESTMATED MAXMUM GAN ON EXPORTS FROM F.T.A. 1 Assumed C.M. Tariff Rate (% Total Exports to F.T.A Value Maximum Loss Estimate ( 4 Additional Exports under F.T.A. as Against C.M Value (fm) Maximum Loss Estimate (Cm) ron and Steel... Non-ferrous metals.. Metal manufactures.. Generrl engineering.. Electrical engineering.. C hem iuls... Hosiery... Clothing... Passenger can... Commercial vehicles.. Cotton fabrics... Wool fabrics... Man-made fibre fabrics Totals $9 Assumed unit nlum : passenger and commercial vehicles MW ; cotton fabrics 12s. per b. ; wool fabrics 25s. per b. ; man-made fibre fabrics 1%. per yd. have to be reduced until the new price plus the tariff is equal to 0s : the supply curve becomes S"S" and the loss incurred in selling OX, is SS"P"P = SOX,P - SS"/OS, i.e. the total value of free trade exports multiplied by the proportion of the tariff in the final price. f the demand for each successive pound's worth of output is separate and independent, either because discrimination between buyers is possible or because

5 The Gairrs from Freer Trade with Europe : An Estimate 251 the products are distinct, only the prices of the marginal exports will have to be reduced : the supply curve becomes SP'P, and the loss incurred is P'PP', which is approximately equal to 4P'P * SS" = + P'X,X,P - SS'lOS, i.e. half the value of the increase in exports under free trade, multiplied by the proportion of the tariff in the fmal price. Y : a fl Q i X, i x, VALUE OF EXPORTS Fig. On the import side, the gain from freer trade arises from the opportunity provided to consume imported goods in place of more expensive domestically-produced goods to which the purchaser has previously been directed by the tariff. This gain can be measured by the additional tariff revenue the Government could have collected if it had reduced the tariff on each individual item of the additional imports resulting from Free Trade just sufficiently to induce the purchaser to buy it X

6 252 TAG ddamchtstm School (whether the t d reduction is assumed to apply to the previous volume of imports doesn't matter, since this merely affects the distribution of income between purchasers of goods and the Government). t will be approximately equal to the change in the value of imports from the Free Trade Area, multiplied by half the tarifl rate previously levied, Estimates of the gains from this source based on the E..U. figures and assumed tariff rates are presented in the left half of Table 1 ; the total is of the order of l28 millions per year. n addition to the gains from greater imports from Europe, however, it is necessary to take into account the fact that elimination of tariffs on trade with Europe will affect the value of trade with the rest of the world and so alter the amount of tariff revenue coflected on that trade. Estimates of the difference that a Free Trade Area as against a Common Market only would make to British imports from outside Europe can be derived from the E..U. study and are presented in the right half of Table 11, together with the value of the difference on the assumed tariff rates. The resulting figure, a gain of L3.5 million per year, is admittedly rather suspect, and is largely attributable to the study's assumption that Gross National Product will be higher in 1970 with a Free Trade Area than without one. The theory underlying the calculation on the import side is illustrated in Figure 2, where SS is the European supply curve of imports, measured in pounds' worth, S'S' is that supply curve including the British tariff, and DD is the British demand curve. Elimination of the tariff increases imports from Europe from OM, to OM,, resulting in a transfer from tar8 revenue to consumers' surplus of SS'P'P'' and an increase in consumers' surplus (which could have beem captured by... dmmmmatory lowering of tariffs on marginal imports) of PP'P, approximately equal to 4 P'P'' - PP= 4 P"M,M,P - SS/OS, i.e. half the value of the increase in imports multiplied by the tariff rate. To finance the extra imports, however, expenditure elsewhere has to be reduced by P'M,M,P, of which some part, say P'QQP, represents a reduction in government tax revenue. f it is expenditure on

7 Tb Gains from F7m T7d with Eu7opC : An Estimate 253 ndustry TABLE ESTMATED GAN ON MPORTS FROM F.T.A. -mod Brkbh Tarlll nlm (% Addirknd mports from F.T.A., 1970 Vduo (W Addlthd mports from orhv buntrios Total Gain or LOSS ron and Sml... Non-forrour mods... Metal manuhcrura... Gomd onginrrlng... Eloctrial enginoaring... Chemicrk... Hosiery... Clothlng... Plllengor M... Commercial vehicles... Cotton fabrics... Wool fabrics t t ) m ~ a ~ * o * l-0 +0* On8 +2*4 +a * O-7 Man-made fibre fabrics d. per b * Assumed unit nlum : passangor and commercial vehicles L#)o ; cotton fabrics 10s. por b. from F.T.A., 5s. per b. from rest ; wool fabrics 15s. por b. : man-mdo fibm fabria 3s. por yd. and 5 oz por Yd. home-produced goods which is reduced, the re-absorption of the QM,M,Q' worth of resources in export production will generate new-tax revenue which may be expected to replace the loss : but if it is expenditure on imports from non-european sources which is reduced, the loss of tariff revenue is not made good and must be deducted from the increase in consumers'

8 254 The Manchestcr School surplus. Conversely, if imports from non-european countries are complementary with imports from (or exports to) Europe and so increase, the country benefits from the associated increase in tariff revenue. The loss (gain) is measured by the increase (decrease) in the value of imports, multiplied by the applicable tariff rate. fl Fig. 2 Putting the two sides of the picture together, we arrive at a maximum possible gain on the export side of millions per year, and a gain on the import side of 431 millions

9 The Gains from Freer Trade with Europe : An Estimate 255 a year, for the industries represented. These figures suggest orders of magnitude for the economy as a whole of, say,, millions as the maximum gain on the export side, and,6100 millions as the gain on the import side (bearing in mind that these industries are more important in exports than in imports). f the minimum figure for the maximum export gain is taken as a (probably excessive) approximation to the likely gain on that side, this would imply a total gain of the order of,6225 millions-a difference of about 1% on what the Economist ntelligence Unit estimates the Gross National Product is likely to be in This figure is very roughmore of a "guesstimate" than an estimate-but because of the way it is arrived at the order of magnitude is unlikely to be altered much by quite substantial changes in the assumed unit values or tariff rates on which it is based. University of Manchester. HARRY C. JOHNSON.