2. The UK must maximise openness to the global economy to help tackle the productivity challenge

Chapter 2 - The UK must maximise openness to the global economy to help tackle the productivity challenge

The UK faces a productivity challenge that acts as a drag on its trade performance across the board. Despite some progress in closing the gap, prior to the global financial crisis the UK was less productive than most comparable large developed economies. For the UK to pay its way in the world, and capitalise on those growth opportunities occurring across the globe, it must maximise openness to boost productivity and become more competitive.

Globalisation and the rise of emerging markets present a great opportunity for Britain. Openness to global exports, imports, investment and migration combined with the right industrial strategy and policies to boost skills levels can drive a virtuous circle of increased productivity and competitiveness that will support growth and exports, creating jobs and boosting prosperity.

In the current wave of globalisation, the world economy is becoming more open and integrated, with tariff barriers lower than ever before and non-tariff barriers being lowered to help facilitate a boom in supply-chain trade. However, it is increasingly difficult to make progress through multilateral deals at the World Trade Organization, with the Doha Round struggling to deliver results since its inception in 2001. Instead, a variety of bilateral and regional trade deals are taking the lead in dismantling trade barriers – for example, for the last few decades the UK has used membership of the European Union as the vehicle for pursuing greater openness.

2.1 The key to increasing exports is meeting the productivity challenge through continued openness of the UK economy

Long-term sustainable GDP growth is driven by improvements in productivity, especially in developed economies where workforce growth, catch-up capital accumulation and natural resources are limited (see Exhibit 11). By enabling resources and labour to be used more intensively, productivity growth both increases the overall size of an economy and improves real income and the standard of living. And, by raising efficiency and lowering the cost of goods and services, improvements in productivity raise a country’s competitiveness, enabling it to increase exports and participate in attractive high-value-added parts of global supply chains. Success for the UK in the modern global economy will not rest on competing for the lowest labour costs or handing out subsidies; it will instead be driven by boosting productivity through skills, technology and innovation.

Exhibit 11: Improvements in productivity are the main drivers of growth in mature economies

Exhibit 12: Much UK success comes from operating at high-value-added parts of the global economy

The UK's motorsport sector is a jewel in the crown of UK engineering and a hidden powerhouse of the UK economy with global sales exceeding £6 billion, employing 40,000 people at 4,000 mostly SME companies. Motorsport Valley UK is home to 8 of 11 Formula 1 teams, more than at any time in history, all of which are located amongst an innovative community of leading producers supplying a wide variety of motorsport all over the world. Europe is the sector’s leading market, closely followed by the US

The UK faces a substantial productivity challenge. For several decades, UK productivity has lagged behind not only that of the high-productivity United States but also that of comparable western European countries including Germany and France (see Exhibit 13). From the 1980s up until the financial crisis, UK overall productivity grew more rapidly than in other major advanced economies, but in 2007 it was still 9% below that of Germany and 20% below that of the US (while it had just pulled equal with that of France).

-20 %

UK productivity is a fifth lower than in the US

Since the global financial crisis in 2007, British labour productivity has declined sharply, as employment has performed surprisingly strongly considering the depth of the recession. While it remains unclear just how much of this shortfall in labour productivity is permanent and how total factor productivity has been affected – there may be a rebound in the coming years as GDP recovers – these figures underline the productivity and competitiveness challenge that the UK faced even prior to the downturn.

Exhibit 13: Britain’s productivity has historically lagged that of other advanced economies[1]

UK=100 France West Germany/Germany US
GDP/hour worked
1973 95 132 160
1979 112 157 166
1991 123 161/143 156
1995 117 133 146
2007 109 119 147
Total Factory Productivity (TFP)
1973 87 112 127
1979 103 135 135
1991 110 133/123 128
1995 104 115 123
2007 101 110 125

Source: Nicholas Crafts. The economic legacy of Mrs Thatcher, 2013

Greater openness and trade can feed into greater productivity in a virtuous circle

The UK has always been an open economy. However, by further opening its economy to exports, imports, international skilled labour and capital, the UK can benefit from a virtuous cycle of increased competitiveness, productivity and growth. Openness is promoted by:

  • Securing market access to trade in both exports and imports at every stage of the value chain
  • Increasing access to labour and investment through migration and capital flows
  • Improving the business climate for foreign direct investment
  • Having a regulatory climate that is both competitive and enabling to trade.

Empirically, the link between international openness and productivity growth is backed by a study of 93 countries by the National Bureau of Economic Research (NBER), which found a clear link between openness and trend productivity growth, even after controlling for reverse causality (as well as openness driving productivity, increased productivity can drive greater openness).[2]

To manage this openness effectively, however, domestic policy needs to be adapted to ensure that the UK economy is best placed to face the opportunities and challenges that being open to globalisation brings. The creation of an appropriate industrial strategy to maximise investment in productive sectors is essential, as is the need for suitable measures to handle the transition costs of structural changes to employment, managed migration, and skills policies to make sure the UK stays ahead of its competitors.

Exhibit 14: Openness to trade, investment and migration can drive a virtuous circle and increase productivity and prosperity when combined with an industrial strategy and measures to handle transition costs

interactive icon View Interactive Exhibit 14

Exhibit 14 shows how openness to trade, investment and people can drive the economy to greater productivity and prosperity. Trade expands the market available to domestic firms, allowing them to expand and exploit economies of scale. Domestic industries that do not export themselves but who supply other exporters will also participate in the growing hub. Furthermore, imports of intermediates and participation in global supply chains, together with the utilisation of international skills, capital and knowledge, also enable increased specialisation and scale. Meanwhile competitive pressures from abroad will drive domestic innovation and adoption of new technologies.

This results in improved labour and capital productivity, product quality and international competitiveness. Together with domestic supply-side reforms, this openness allows domestic industries to participate in high-value stages of global value chains. Over the longer term, productivity gains drive structural changes to the patterns of production, with the creation of specialised clusters that pull in foreign direct investment. This, in turn, enables further success in trade, which sets off further rounds of productivity gains that boost the living standards of UK citizens.

Exhibit 15: Specialisation and scale allowing UK business to compete globally

 

Weir Group is one of the UK’s largest industrial companies specialising in the manufacture of high-tech pumps and valves for the energy and mining sectors. The development of European and Global standards has supported the growth of Weir Minerals Europe, the Group’s largest UK operation. The business exports more than 80% of its products to more than 50 countries.  Aided by the Single Market, sales growth in Europe has been particularly strong, with new operations in Germany, Benelux, Scandinavia, Ukraine, Hungary, Spain, Turkey and Poland.

Openness to movements of people directly helps the UK’s global role in a number of ways. It can lead to direct economic benefits as citizens move across borders to travel and learn in the UK, which is increasingly important to the tourism and education sectors as visitors from high-growth economies begin to travel and be educated more widely. Immigration can also help fill skills shortages for business, as well as facilitating cross-border management structures for global companies. Finally, the immigrant population is reckoned to be a net contributor to the public finances, largely because they are much more likely to be of working age than the UK-born population.[3] Over the long term, immigration could have a substantial positive impact on the UK’s fiscal position: the Office for Budget Responsibility has projected that the public sector net debt could be 52% of GDP in 2060 with net migration of 260,000 per annum but that this could rise to as high as 181% with zero net migration.[4]

But the case for increasing openness to labour and mobility of workers and consumers rests not only on the balance of the direct benefits. There are significant indirect benefits to openness too, especially in a world of increasingly open and interconnected economies: making travel between countries as easy as possible is critical in building the personal relationships that often underpin trade and investment partnerships.

Exhibit 16: Building outward links through openness to movement of people

AVF Group: For AVF Group, a mid-size company who sell mounts and stands for audio visual equipment to corporate and domestic customers around the world,  one major advantage of the free movement of labour has been the ability to recruit staff from the EU in the UK with language skills that enable the company to operate in new markets. For a company with 37 employees in the UK, being able to recruit staff who speak French, Spanish and German has opened up new opportunities. Additionally, the recent signing of a free trade agreement between the EU and Colombia has helped break down many of the trade barriers that is slowing growth for the company in the BRICs.

ship water export

Pure openness can be challenging

Pure openness can be challenging and have social impacts in the short to medium term, as shifts in the sectoral and employment composition of the economy cause dislocation effects such as changes in the nature of job opportunities and the skills required to fill them. Labour market impacts in particular necessitate active measures to promote re-skilling throughout the workforce and spread the aggregate benefits arising from migration.

For some parts of the British economy, greater competition – both from other member states and from outside the EU – has been damaging, with uncompetitive sectors migrating to other markets. Industries and sectors that have struggled to compete internationally have seen production moved outside the UK, both to EU states and further afield. For example, whereas the UK was once a major shipbuilder and coal miner, the creation of – and access to – global markets has dramatically reduced the UK’s industrial base in these sectors. UK shipbuilding has not migrated to other EU countries; instead, South Korea and China now build 74% of the world’s ships.[5]

For the UK to realise the benefits associated with openness, action at home is needed to ensure it is positioned to compete on the world stage for the long term. This means business and government working in partnership to put in place a coherent industrial strategy that gets behind key sectors where the UK has competitive strengths and sees strategic future opportunities, as well as developing a skills system that is demand-led . The CBI believes that a coherent 21st-century industrial strategy for the UK needs to be anchored around:

Improving the competitiveness of the business environment: Concerted action is needed to improve and strengthen the competitiveness of the UK business environment in the face of rising global competition. This means ensuring that the UK is competitive relative to other countries on indicators such as business taxes, infrastructure quality, access to finance, and education and skills. 

Championing key sectors: A more targeted approach to supporting champion sectors such as automotive, life sciences and the information economy is essential. Strategic and open dialogue between business and government can help to unblock barriers to growth in key sectors

Strengthening supply chains: By strengthening supply-chain competitiveness and capabilities – especially among small and medium-sized suppliers – the UK has the potential to capture more value from investments at home and ensure that more UK content is included in the products and services exported overseas.

As the CBI’s recent Raising the Bar report argues, good progress is now being made on the industrial strategy agenda but it needs to be consolidated for the long term through effective implementation by government and business in partnership.[6] To be successful, industrial strategy must also be election-proof, with commitment to continuity on key policy areas across the political divide. 

Similarly, while the direct and indirect benefits of openness to movements of people are significant for business, there may be a period of dislocation and adjustment for some UK-born workers in certain sectors. An OECD study has encountered evidence of the temporary impacts of immigration on UK labour markets: a 1 percentage point rise in the non-UK-born share was found to increase UK-born unemployment by 0.4 percentage points two and three years later, but have no impact thereafter.[7] The UK needs to provide appropriate support for job search and training to ensure that any temporary dislocation does not have permanent effects.

Managing openness through an industrial strategy, skills and appropriate migration policies can help mitigate the uncertainty of globalisation while harnessing the opportunities it brings, but it will not remove all of these concerns either from the public consciousness or from the priorities of policymakers.

2.2. The world economy is generally becoming more open

The UK needs to continue to drive forward openness to take advantage of the opportunities of globalisation because the rest of the world is doing so on an unprecedented scale. In recent decades, barriers between the world’s economies have consistently diminished and globalisation has transformed the way in which goods and services are produced and delivered. World tariff barriers have fallen consistently over the last 20 years, with the trend increasingly driven by developing countries (see Exhibit 17).

Exhibit 17: Tariff barriers have fallen through the world in recent decades

Furthermore, non-tariff barriers (NTBs), such as regulatory divergence, state aid and dumping, are also being dismantled, albeit from a much higher base and more inconsistently. While NTBs are very difficult to measure in the aggregate directly, their declining impact is evidenced in analysts’ estimates of ‘border effects’. Broadly, these estimates of the aggregate impact of differing national markets, state structures and national cultures on trade are obtained by estimating how much cross-border trade there ought to be based just on fundamentals like geography, population and wealth. A recent study that estimated global border effects from 1980 to 2006 found that they had declined consistently through the period and by around a quarter overall.[8] However, non-tariff barriers undoubtedly persist, and are limiting the ability of UK businesses to seize potential opportunities around the globe: for example, US automotive export tariff rates of between 0.5% and 1.5% rise to an effective tariff rate of over 20% when one considers the NTBs that continue to exist due to regulatory divergence, severely limiting the ability of firms to get into the US market.[9]

In addition, barriers to the mobility of people and capital are also in retreat. The proportion of international migrants in the world population edged up from 2.9% to 3.1% between 1990 and 2010 but it rose more markedly in Europe, from 6.9% to 9.5%. Global cross-border capital flows, meanwhile, grew remarkably rapidly from the mid-1990s to the financial crisis and, although they fell sharply in 2008–09, they have partially rebounded and were estimated to be at 2005 levels in 2012 (see Exhibit 18).[10]

Exhibit 18:: Capital and people are increasingly internationally mobile

Bilateral and regional trade deals are taking the lead in dismantling tariff and non-tariff barriers

Over the last decade, new commitments to maximise openness and access to the global economy have been best achieved largely outside the WTO-led model of multilateral integration. The lack of agreement to date in the Doha Round negotiations has contributed to a shift in emphasis away from the traditional multilateral trade talks designed to reduce global trade costs towards a mixture of bilateral and regional trade deals aimed at promoting deeper integration of national economies.

Although its dispute resolution mechanisms are still integral to the global trading landscape, the waning of the WTO model as a vehicle for securing new trade commitments has been driven in part by a shift in international trading patterns throughout the second half of the 20th century: at first trade between advanced economies was well served by the WTO model, but rapid increases in global supply-chain trade and trade between advanced and emerging economies, in combination with entrenched political blockages in WTO negotiations, have meant that a different approach has been required to break down modern trade barriers in recent years.

Among lower-middle economies, intra-industry trade began to take off from the 1980s onwards, creating new complementary regional hubs alongside the more established high-income country hub. In the 21st century, intra-industry trade is at the fore, and other links are developing between these hubs, taking the world into a new phase of globalisation (see Exhibit 19).

Exhibit 19: Trade links both within regions and between them are increasingly important in the complex 21st century global economy

The effective operation of supply-chain trade requires that openness be taken well beyond tariff and quota elimination to encompass other issues such as customs procedures and intellectual property rights protection, regulatory harmonisation and capital and labour mobility (see Exhibits 20 and 21). Such measures, some of which have been pushed at WTO level by the EU, have so far been difficult to advance successfully at the multilateral level and so have been pursued actively at the regional and bilateral level.

Exhibit 20: The new phase of globalisation

 

Airbus in the UK: Wings for the entire family of Airbus are assembled at Broughton in North Wales before being shipped to Hamburg and Toulouse where the final aircraft are assembled. With major manufacturing sites in France, Germany, Spain and the UK, Airbus is a pan-European operation which has benefitted from being able to operate across national borders without trade barriers of tariffs.

Exhibit 21: Trade barriers in the modern global economy[11]

     
  1. Tariff barriers. Although these have been eroded by successive multilateral trade rounds, high tariffs in some countries still pose problems for EU exporters.
  2. Burdensome customs procedures for import, export and transit as well as unfair or discriminatory tax rules and practices.
  3. Technical regulations, standards and conformity assessment procedures that are not in line with WTO rules on Technical Barriers to Trade (TBT Agreement).
  4. Misuse of sanitary and phytosanitary measures i.e. those that are not justified on health and safety grounds within existing WTO rules.
  5. Restrictions on access to raw materials, particularly restrictive export practices, including export taxes, which drive up prices for products such as hides and skins, and key mineral and metal goods, as well as dual pricing practices.
  6. Poor protection of intellectual property rights including geographical indications and the lack of proper implementation and enforcement.
  7. Barriers to trade in services and foreign direct investment such as unjustified foreign ownership caps, joint venture obligations and discriminatory treatment.
  8. Restrictive government procurement rules and practices that prevent EU companies from bidding effectively for public contracts in third countries.
  9. Abusive and/or WTO-incompatible use of trade defence instruments by third countries.
  10. Unfair use of state aids and other subsidies by third countries in a way that constitutes market access barriers

Emerging economies eager to accelerate their industrialisation (especially smaller countries that do not enjoy the vast potential domestic markets of China and India), together with developed economies looking for low-priced factor inputs, have facilitated the rise of supply-chain trade with a series of reforms and trade deals made independently of the WTO.[12]

Exhibit 22: Regional trade agreements have expanded rapidly in recent years

As Exhibit 22 shows, the pace of regional trade deal-making has been picking up since the mid-1990s and accelerated sharply once the Doha Round began to collapse. Almost all of the world’s major economies are now part of regional multilateral free trade areas that go beyond the WTO base, with China and Australia notable exceptions (see Exhibit 23).

Exhibit 23: Most countries are part of some form of regional multilateral trade area

2.3 Different countries have pursued varying degrees of integration, offering the UK potential alternative models

The pace of integration is nevertheless uneven, and different countries around the world have adopted a variety of regional models of trade relations, often evolving from political initiatives to promote peace and security, to enhance openness in a way that suits their economic priorities and adapts to political constraints.

Some have prioritised a series of bilateral agreements that can be negotiated individually to provide increased market access in different parts of the globe, as South Korea has done. Others have also pursued their own FTAs, but at the same time have taken clear steps to be part of a regional trading bloc with the objective of explicitly reducing trade barriers (tariff and non-tariff) among participating members, such as ASEAN and NAFTA. A number of countries have gone one step further to introduce a customs union with a common commercial policy and a single external tariff, as Mercosur has tried to do, although with limited success. 

40 yrs

The UK has used membership of the EU as a vehicle for 'openness' for four decades

Forms of economic union, such as the EU, have been even more ambitious, eliminating all tariffs internally and attempting to fully break down non-tariff barriers to trade in an effort to create a Single Market, for example through harmonised product regulation as well as pursuing external openness through FTAs. Finally, even deeper levels of integration towards monetary union, such as in the Eurozone, have attempted to facilitate trade by reducing the uncertainty that comes from exchange-rate fluctuations between trading partners.

Exhibit 24: Countries have adopted different models of interaction on regional and global trade

For the last 40 years, the UK has used membership of the European Union as the vehicle for pursuing greater ‘openness’

The European Union is the most internally open and integrated of any international market, with measures to promote openness encompassing the total removal of tariffs and other physical barriers to trade between its 28 members, including via competition rules to prevent non-tariff protectionist measures such as dumping and state subsidy. Common EU standards and regulations are aimed at making it more practical for businesses to operate throughout the EU, while measures to promote labour and capital mobility have allowed considerable cross-border investment flows and migration of skills. Within its borders, the EU has lower barriers to trade – and therefore greater trade and supply-chain integration – than any other trading bloc in the world.[13]

"

The EU is the most internally open and integrated of any international market.

The EU also promotes global openness with non-EU countries, primarily as a regional bloc in trade negotiations. EU membership is a crucial component of its members’, not least the UK’s, attractiveness as places to invest and do business for firms from across the globe.

In principle, the EU’s impact on Britain’s productivity, access to world markets and attractiveness as a place to do business can be leveraged to enhance the UK’s global role. However, membership of the EU does entail compromise, and limits the UK’s ability to pursue other forms of integration with the world economy.

2.4 The UK needs to maximise ‘openness’ to the global economy to boost productivity and increase exports

If the UK is to be successful in adapting its global trading role to the changing world, it must overcome the productivity challenge that acts as a drag on its trade performance across the board. To do this, the UK must pursue even greater levels of openness to the global economy. Openness to trade, investment and migration can be challenging, but done in the right way it can drive a virtuous circle of increased productivity and competitiveness that will support growth and exports.

"

The cornerstone of the UK’s present strategy for driving forward trade and openness is its membership of the European Union.

The rest of the world is also becoming more globalised, open and deeply integrated, with tariff barriers lower than ever before and non-tariff barriers being lowered to help facilitate a boom in supply-chain trade. Increasingly, the leading edge of that process is being driven by regional trade blocs and bilateral deals between them rather than multilateral negotiations on the WTO model. Britain needs to remain engaged in this process.

The cornerstone of the UK’s present strategy for driving forward trade and openness is its membership of the European Union. The EU, which still accounts for around half of the UK’s trade, is the world’s most ambitious trade bloc, where the dismantling of internal non-tariff barriers to trade has gone the furthest.

However, the EU’s Single Market is far from perfect and membership entails compromises that in some cases limit Britain’s choices and might in practice do harm to its openness and prosperity. An assessment is needed as to whether the EU has been, and still is, the best way for Britain to underpin its global future, driving openness and raising productivity. Chapter 3 begins this assessment with an examination of the evidence on where membership has been of benefit and where it has been costly.


References

[1] Crafts, The economic legacy of Mrs Thatcher, 2013

[2] Sebastian Edwards, ‘Openness, Productivity and Growth: What Do We Really Know?’, NBER Working Paper 5978, March 1997

[3] The employment rate of migrants was slightly lower than UK-born rate, at 67% against 72% in 2012, largely due to lower female labour force participation. The Migration Observatory, ‘The Fiscal Impact of Immigration in the UK’,2013

[4] Office for Budget Responsibility, ‘Fiscal Sustainability Report’, 2012

[5] Barry Rogliano Salles, 2013 Annual Review: At a Low Ebb, 2013

[6] CBI, ‘Raising the bar’, 2013

[7]Sébastien Jean & Miguel Jimenez, ‘The Unemployment Impact of Immigration in OECD Countries’, 2007

[8] J. De Sousa, T. Mayer & S. Zignago, ‘Market Access in Global and Regional Trade’, 2012

[9] CEPR, ‘Estimating the Economic Impact on the UK of a Transatlantic Trade and Investment Partnership (TTIP) Agreement between the European Union and the United States’, 2013

[10] McKinsey analysis, based on data from

[11] Based on principles laid out in: European Commission, ‘Global Europe: a stronger partnership to deliver market access for European Exporters’, 2007

[12] R. Baldwin, ‘WTO 2.0: Global governance of supply-chain trade’, 2012

[13] J. De Sousa, T. Mayer & S. Zignago, ‘Market Access in Global and Regional Trade’, 2012