Brexit: UK the most globalized big economy chooses isolation

Brexit: The UK is the most globalized big economy in the world and despite the disastrous general election results for the Conservative Party, it's unlikely that exit negotiations with the European Union will result in unimpeded access to the world's biggest trading market — John Redwood, a Eurosceptic Tory MP, said last Friday that both Labour and the Conservatives had ruled out staying in the single market. "We were honest with the British people and there is no option to stay in the single market without accepting all of the European laws, the superiority of the European Court of Justice, the freedom of movement and the budget contributions,” he said.

Finfacts article: Ireland should have realistic long-term strategy to deal with both Brexit and changing Foreign Direct Investment model

Angela Merkel, the German chancellor, and Emmanuel Macron, the French president, have both made clear that Britain cannot have the same privileges as continuing members of the EU.

Access to the single market requires acceptance of all four EU freedoms — of movement of goods, capital, services, and people. Suggestions of requiring a minimum salary of £35,000 for EU migrants to the UK have been demolished by Prof Jonathan Portes of Kings College, London.

With a high UK reliance on foreign-owned firms, Brexit supporters expect new export markets to be opened in far away places. However, it's a delusion and conceit sold to the smug, and believers in the tooth fairy.

According to a post Brexit referendum poll, a majority of those working full-time or part-time voted to remain in the EU; most of those not working voted to leave. More than half of those retired on a private pension voted to leave, as did two-thirds of those retired on a state pension.

A study by KPMG, the professional services firm, published last February found that a third of UK manufacturing companies were considering relocating aspects of their plant or operations to another country in order to boost productivity or reduce costs, with China and India the most attractive locations for moving jobs to — rather than generating exports from Britain.

Triple deficits, the Bank of England and "kindness of strangers"

In January 2016 Mark Carney, governor of the Bank of England, warned of financial instability, higher interest rates, and capital flight if Britain voted to leave the EU, saying the country could not depend on “the kindness of strangers” to fund the country’s deficits — "I have always depended on the kindness of strangers," is a line from Tennessee Williams' 'A Streetcar Named Desire' (1947).

Then in December 2016, the governor told an audience in Liverpool, the once thriving port city of North-West England, that Britain has suffered its “first lost decade since the 1860s” when “Karl Marx was scribbling in the British Library.” Mark Carney said that "Over the past decade real earnings have grown at the slowest rate since the mid-19th century." Two weeks before Paul Johnson, the chief of the Institute for Fiscal Studies, said average real earnings in 2021 will be below the 2008 level — "One cannot stress enough how dreadful that is, without real earnings growth. We have certainly not seen a period remotely like it in the last 70 years."

This week it was reported that UK consumer inflation is at a 4-year high adding to the gloom that the UK and Greece have had the worst wage outcomes of mainly rich countries since 2007 - real wages in the UK fell to 2015 and inflation is set to outpace wage rises again.

Britain has had an annual budget deficit (government spending exceeding income) for all but 8 years since 1945 while the UK has also recorded a current account (Balance of Payments) deficit in every year since 1984 and a trade deficit every year since 1998.

The last annual budget surplus was in 2001/2.

The Office for National Statistics (ONS) says that the current budget has remained in deficit, with the exception of two periods from 1987 to 1991 and from 1998 to 2002. The deficit increased considerably during and following the 1990-91 and 2008-09 economic downturns — and reached 7% of GDP in Q1 2010, the highest since the Second World War.

The current account deficit has been mainly related to the persistent excess of imports over exports but in recent times the earnings of foreign-owned assets in the UK have exceeded the foreign earnings of UK residents (mainly corporates). 

In 2016 the value of UK exports was £542.9bn (goods £301.7bn and services £241.2bn) and the ONS said in February that "the EU countries are hugely important trade partners for the UK. In 2016, the EU accounted for 48% of goods exports from the UK, while goods imports from the EU were worth more than imports from the rest of the world combined. For exports, trade in goods and services with the EU has declined in proportion, from 55% of UK exports in 2000 to 44% of UK exports in 2016. Most of the decline in the EU’s share of UK exports is due to goods, not services."

Between 2015 and 2016, the total trade deficit widened by £9.6bn to £39.4bn as imports increased more than exports. There was a £29.3bn rise in imports of goods, with 61.2% of this rise coming from EU countries.

The trade deficit of £39.4bn comprises a services surplus of £95.5bn and a goods deficit of £134.9bn — the UK has had a total trade deficit every year since 1998.

The UK current account (Balance of Payments — a country's trade balance, plus net income, and direct payments between it and other countries) improved to about 2% of gross domestic product (GDP) in the fourth quarter of 2016 but that was partly due to the lower level of sterling boosting the value of foreign earnings.

The Financial Times says that half of the UK’s trade surplus in financial services — worth some £18.5bn in 2014 — comes from exports to the EU. London dominates across multiple niche areas of finance. It does 78% of the EU’s foreign exchange business and 74% of over-the-counter interest rate derivatives; 59% of international insurance premiums are written in London, and 85% of the EU’s hedge fund assets and 64% of private equity assets are managed in the city.

The FT reports that a quarter of firms in the sector expects to move staff.

Hands-up for soft power © Under licence from CC Creative Commons

UK and globalization  

Last April the latest KOF Index of Globalization was published by KOF Swiss Economic Institute at ETH Zurich — one of the world's leading science and technology universities.

Covering up to 207 countries from 1970 to 2014, the Economic Globalization Sub-index is led by Singapore and Ireland and the first big economy is the United Kingdom at a rank of 20 with France at 30, Germany 34 and the United States at 54.   

In 2016 ARM Holdings, the UK electronic chip designer and Britain's biggest high tech firm, that has it technology in billions of devices including the Apple iPhone, was sold for £24bn to a Japanese telco, and in March 2017 Softbank offloaded 25% of ARM to a fund backed by Saudi Arabian and United Arab Emirate investors — foreign acquisition has been the typical route for British companies with long-term potential.

Today a majority of the shares listed on the London Stock Exchange are owned by overseas interests and the ease of buying British businesses has resulted in a big shift in foreign ownership in the past 30 years.

Half the banks in the City of London are foreign-owned and according to Reuters they take advantage of profit shifting — "London-based Goldman Sachs Group UK Ltd reported a $194m profit in the Cayman Islands, which has no corporate income tax, despite employing no staff there.

Citigroup reported twice as much profit at Citigroup Europe Plc, its main subsidiary in Ireland, than at its chief UK subsidiary. That's despite the UK arm employing more people than Ireland, and more senior staff — average wages at London-based Citigroup Global Markets Ltd were $288,000 per head last year compared with $48,000 at Dublin — based Citigroup Europe Plc."

Too much of a good thing?

FDI (foreign direct investment) has been good for economies as diverse as small Ireland and big China but over-reliance is not good in the long-term.

In 2015 foreign-owned firms accounted for 35.5% of the turnover of registered business firms in the UK non-financial economy and only 1.1% of the total number.

More than half the foreign-owned firms in 2015 were European while at 12,700 firms, more than half the overall total were exporters.

For companies with an annual turnover of €250,000 or more, the total of foreign-owned firms of 759 compares with the domestic-owned total of 627 — this is important in respect of large firms being responsible for the lion's share of export value.

The data show that foreign-owned businesses continue to be more likely to trade internationally than UK-owned businesses, with international trade participation rates being 67.4% for foreign-owned and 14.6% UK-owned businesses.

Research by EY, the professional services firm shows that "the UK has offshored a greater share of its manufacturing capability than the USA, Germany, and France since 1995 and there appears to be a correlation between the increased use of offshoring and the decline in the UK’s balance of trade in goods exports over the last two decades. UK manufacturers today import around 60% of the final value of their products, compared to US manufacturers who import around half this proportion. We found that UK manufacturers have tended to contract out their manufacturing rather than either build or buy facilities in other countries. Between 2010 and 2014 for example, German companies invested in 409 projects a year on average in Europe, compared to 256 from the UK. Even more striking is the difference in project types. German companies undertook on average 165 manufacturing and 54 logistics projects a year compared to 29 and 10 respectively from the UK."

The good news according to the Economist is that "foreign ownership and investment attracted by a gateway into the EU single market" has strongly revived the car industry. "It accounts for 800,000 jobs (direct and indirect) and 12% of British exports (80% of its output goes abroad). Britain now produces more cars than France.

In 2007, the manufacturing of motor vehicles accounted for 5.4% of UK manufacturing. In 2016 it accounted for 9.4%.

According to a 2012 survey in the Grocer trade magazine based on Nielsen research, of the 150 biggest grocery brands in the UK, only 44 are home-owned. Since then the Financial Times says the trend has accelerated.

The House of Lords was told in 2016:

"Our transport network provides a good example of a UK industry dominated by foreign-owned franchises. Three-quarters of rail franchises in the UK are now owned by foreign state-owned or state-backed rail companies. Prominent among these are the German state-owned company, Deutsche Bahn, and the rail company Abellio, which is the international arm of Nederlandse Spoorwegen, the Dutch national rail company. Foreign, state-owned rail companies are using profits earned by operating franchises in the UK to keep fares down and to support investments in the rail services of their respective countries. Our passengers and our taxpayers are subsidising a system that hands increasing profits to foreign, state-owned train operators, instead of investing them in our railways, as would be the case if they were under UK public ownership. This phenomenon is also evident throughout our national utilities. The energy companies provide a well-known example. The majority of UK customers, whether domestic consumers or businesses, are supplied by one of four foreign-owned companies: EDF, which is Electricité de France; E.ON and RWE, which are in German ownership; and Iberdrola, a Spanish company. There are substantial repatriations of profits and dividends from the UK companies to their owners abroad."

When the going gets tough...

Since 1997, over 50 firms that would today qualify for the FTSE-100 index of the top 100 big firms have been snapped up by foreign rivals, according to the Economist.

"By Schumpeter’s estimate, a quarter of Britain’s biggest firms are viewed as potential takeover candidates, including AstraZeneca and BP, an oil major. The earnings of British firms abroad have dropped by two-fifths, according to the Office for National Statistics. In the past 12 months, for the first time on record, they were less than the profits made by foreign-owned firms in Britain. In 1997, Britain had 11 firms big enough to be among the largest 100 companies by market value in the world, and that was still the case in 2007. Today it has only five in this select group."

According to Prof Chris Higson of the London Business School 88% of the CEOs of the global top 500 companies and 85% of their management teams are nationals of the country where the company has its headquarters (this, of course, excludes firms that shift their headquarters for tax purposes but operations remain at the home base). "In the modern world where nations are competing against each other for the capital of mobile, rent-seeking transnational businesses there is no reason at all to expect maximising shareholder value by corporations to coincide with the self-interest of the UK or of any other individual nation," he said in 2015.

American multinationals invest three-quarters of their capital investment in the US and 84% of research and development spending.

The Financial Times reported last February that not only is the UK breaking up from its biggest trading partner, but it is doing so when its next largest, the US, is moving towards protectionism. The UK is part of a global — but most of all European — value chain and has a relatively weak trade position in other markets, including the Commonwealth countries and the US.

The EU is the biggest market for almost every product group exported by the UK and the value of car exports to the EU are almost three times that of cars exported to the US.

The FT says about 60% of UK exports are intermediate and capital goods or raw materials to mainly European global supply chains, not final consumer goods.

The risk is that big multinationals can switch supplies over time to other locations.

The EU is also the UK’s largest destination for services exports and the main source of services imports. Services and goods should not be considered separate categories, but as interconnecting parts of the same supply chain.

In Germany, manufacturing firms account for 25% of service exports while services can also be used as intermediate inputs in production.

About 25% of the UK’s exports in services are associated with ‘financial services’; ‘other business services’ account for 30% of service exports.

The Centre for European Reform in a study concluded that Britain's goods and services trade gains significantly from membership of the European Union: "The idea that the UK would be freer outside the EU is based on a series of misconceptions: that a medium sized, open economy could hold sway in an increasingly fractured trading system, dominated by the US, the EU, and China; that the EU makes it harder for Britain to penetrate emerging markets; and that foreign capital would be more attracted to Britain’s economy if it were no longer a part of the single market. The UK should base policy on evidence, which largely points to one conclusion: that it should stay in the EU."

BBC Panorama - Election 2017: What Just Happened? (BBC Documentary 12.06.2017)

British are poor exporters

In 2015 UK goods and services exports value as a ratio of gross domestic product (GDP) was at 27.6% compared with 30% for France; 30.1% for Italy and 46.8% for Germany.

In 2012 George Osborne, the then chancellor, challenged companies to double exports to £1tn by the end of the decade and in 2016 a Bank of England paper noted that "over the past 25 years as a whole UK export volumes have risen less rapidly than world exports, such that ratio of UK export volumes to world import volumes has fallen by 23% since 1980 and by 15% since 1990. This has been much more pronounced than the decline in the ratio of UK GDP to world GDP, which has fallen by 8.0% since 1980 and 6.5% since 1990."

Germany has been able to expand trade beyond the borders of the EU but despite the rising demand in emerging economies, the biggest opportunities for the UK remain from trade between rich economies where consumers want choice.

Government statistics cited by the University of Nottingham show that "just a little over 1 in 10 of firms in the UK are exporters (about 228,700 firms). For exports of goods, just 1% of these export firms account for 70% of goods exports; with the top 5% accounting for 90%. For services, the top 1% of exporters account for 74% of export value; the top 5% for 87%.  Similarly, just 10 products (out of the 4,800 manufacturing products the UK sells) account for 25% of total manufacturing exports (there are very few service categories so it doesn’t make sense to perform this calculation for services)."

Several of the companies in the FTSE-100 index companies engage in little activity in Britain and it's likely that foreign-controlled firms account for at least 60% of the value of UK exports. We estimate that with adjustments for tax avoidance foreign firms account for 82% of the value of Irish exports.

These rates compare with 30% in France in 2016 according to official data; 21% in the US according to Bureau of Economic Analysis data for 2011; 55% of Canadian goods exports in 2014 according to Statistics Canada.

In Europe, Eurostat data show that in 2012 31% of German merchandise exports value was related to foreign-controlled firms; 35% in Denmark; 44% in Austria; and 54% in Sweden.

Both Germany and Denmark — the biggest economy and one of the smallest — are the export superstars of Europe.

In the UK more than 50% of business Research & Development expenditure (BERD) is made by foreign firms and it's at two-thirds in Ireland.

Both the UK and Ireland also have low levels of innovation.

Civitis, the UK think-tank, in a 2015 study Losing Control: A study of mergers and acquisitions in the British aerospace supply chain, said:

"Thirty years ago we spent a greater proportion of our GDP on research than most of our competitors, now we spend below the EU average and rate 159th out of 174 countries in the international league table, following a downward trend in business investment for the last 15 years. While Germany, Japan, France and the US all outspend Britain on R&D, they also seem far less willing to see the results sold to foreign companies. Foreign corporations have come to control 39% of UK patents, compared to an EU member state average of 13.7%, 11.8% of US patents and 3.7% of Japanese patents. At the moment this is more likely to reflect the level of foreign corporate ownership than the effects of the patent box."

Foreign companies account for about 20% of Danish BERD and in Germany, the rate is at about 25%.