The UK needs to tap into its strengths in services including design and engineering
In the aftermath of the UK’s vote to leave the European Union, much of the immediate focus was on ‘why’: why people voted for Brexit, why the Remain campaign could not make the economic arguments stick, why ‘Take Back Control’ trumped ‘Project Fear’.
Quickly, though, the focus has shifted to ‘how’: how to make Brexit work. Faced with the reality of having to figure out where to go next, the UK has some big choices to make as it looks to the future.
On the trade side, at least, there are two places to start. The UK needs to look beyond its traditional trading partners to the world’s fastest-growing economies, and it also needs to play to its strengths – and that means growing exports not only of goods but also of its world-class service industries.
Demand from China and other faster-growing markets is likely to pivot towards professional, legal and financial services
For the most part, Britain’s economy has performed well within the European Union. Since the beginning of the '80s, British living standards have risen more quickly than those in Germany, France, Italy and Spain.
Unemployment has been up and down but, on average, has been lower in the UK than in its main European counterparts.
And investors elsewhere in the world have preferred to invest in the UK: Britain’s car industry has been transformed thanks to Japanese (and German) involvement while, since 2000, the Chinese have made more direct investments in the UK than in any other EU country.
Yet there is one clear and troubling area in which the UK has persistently underperformed. UK exporters have struggled to make waves in the emerging world. Of Britain’s total exports of goods, the share heading to faster-growing economies is now lower than it was in 1980.
For Germany, Italy and France, it’s either the same or higher. Recent trends suggest the UK is beginning to catch up but, nevertheless, the historical evidence suggests that Britain’s ability to compete on the world stage has not exactly been ‘best in class’.
If the UK is to thrive outside the EU, this needs to change. At around 7 per cent of gross domestic product, the UK has a huge balance of payments current account deficit.
That’s going to be a lot more difficult to finance in the years ahead given the uncertainty around Britain’s relationship with the EU Single Market and the UK as a destination for Chinese investment following the Hinkley Point delay.
A sterling decline will be helpful in the short term. However, longer term, the UK can’t rely on devaluation alone. The country needs to strengthen its fundamental economic connections with the rest of the world.
Economic developments in emerging markets have, until now, been more suited to, and beneficial for, the world’s major capital goods exporters than for the UK.
The German economy has flourished partly because of China’s seemingly insatiable demand for capital goods over the past three decades. With per capita incomes now a lot higher, however, demand from China and other faster-growing markets is likely to pivot towards professional, legal and financial services. That’s where the UK has an advantage.
Over the past 10 years, the UK’s services exports have been heavily focused on the EU and the US. In 2015 more than three-quarters of services exports went to those two destinations. Even though much of Asia enjoyed rapid growth, its importance to UK exporters of services actually diminished.
In 2005, more than 17 per cent of UK exports of services went to Asia and the Middle East. Last year, the equivalent figure was less than 14 per cent. That compares with a figure of more than 21 per cent for goods. The declining relative importance of services reflects not so much China’s economic resurgence but, instead, Japan’s persistent economic weakness. For many of the UK’s world-class service providers, Asia has simply offered the wrong mix of growth.
In the years ahead, however, there’s every chance that Asia will deliver the right mix of growth. Parts of China – including the Pearl River Delta, a megacity with a population bigger than Australia, Canada or Argentina – have living standards fast approaching those in the West.
Trade and investment within the emerging world’s borders is likely to lift off. There will be strong demand for the services in which Britain is truly world-class.
This suggests that the British government should be working not only to create trade deals for Britain’s goods producers. It should also be building on Britain’s comparative advantage in services, not only to safeguard its future trading relationship with the EU, but also to support the emerging markets’ growing needs.
That means reaching out to China’s Belt and Road initiatives, particularly through the Asian Infrastructure Investment Bank; sponsoring services trade fairs in far-flung places under the auspices of, for example, the UK-India Business Council; and working with the EU to ensure that the UK is a major beneficiary of the upcoming Trade in Services Agreement (TISA).
It also means ensuring the UK has a world-class education and skills system and delivering a regulatory framework at home that ensures UK companies don’t find themselves at a competitive disadvantage.
That includes an immigration policy that enables companies to recruit the best and brightest worldwide. And, if for whatever reason the EU Single Market in services remains incomplete, the UK government’s avowed willingness to engage globally could allow it to steal a march on its European competitors.
The UK may have decided to leave the EU but the UK’s strengths in services are considerable. Recognising those strengths and acting upon them will help Britain flourish in a post-Brexit world.
A version of this article first appeared in The Daily Telegraph on 1 September 2016.