International Trade & the 2018 Budget: Economic Outlook

Politicians, journalists and the public have spent the last few days dissecting the domestic implications of the 2018 Budget. On the back of upgraded forecasts for tax receipts and inflation from the independent Office for Budget Responsibility (OBR), the Chancellor has made a raft of new spending pledges and tax cuts focused on various domestic policy priorities. However, speculation about its durability in the event of failed Brexit negotiations aside, little consideration has been given to the international implications of the Budget. We spoke to James Dinsdale at Trade Finance Global, who recently launched their finance and Letter of Credit Guide for TFG.

As such, this article focuses on the implications of the Budget for the UK’s international trade outlook. This piece uses key considerations made by both the Treasury and the OBR to answer the big questions about the current and future economic outlook for the UK and the world.

How is trade affecting the UK Economy?

In short – positively (in 2017 at least).

A little-publicised Budget statistic was that net trade contributed positively to the UK’s GDP growth in 2017. In theory, the relative decline of the pound since June 2016 has granted non-GBP denominated traders increased purchasing power, making UK goods “better value” in the international market. Economists have consequently predicted a lift in the volume and relative value of UK exports. Broadly, this has held true. Import volumes grew by 3.2%, but this was outstripped by impressive export growth of 5.7% over the same period. This had tangible, positive implications for the economy, with the OBR has estimated net trade added 0.7 percentage points to GDP across 2017. For comparison, the ONS estimates that 0.3% growth across the whole UK service sector in Q1 of 2018 contributed 0.21 percentage points to GDP.

Moreover, the UK’s current account balance narrowed to a deficit of 3.7% of GDP in 2017, from 5.2% in 2016. The current account balance consists of the trade balance (explained above) plus the UK’s primary income balance (net factor income, such as loans and investments) and secondary income balance (which are international transfers between countries without reciprocal economic counterparts). The Treasury claims the main reason for this shift was the largest annual improvement “since records began in 1946” in the primary income balance. This might suggest a continuation of the trend in the UK economy of increased reliance on its abundant factor of production (namely, capital) to grow its balance of payments.

How will Brexit affect trade?

In short – we don’t know, and neither does the Treasury or the OBR.

Since the beginning of Brexit negotiations, the OBR has not attempted to predict the precise nature of the UK’s final deal with the EU. Instead, it has always assumed that the UK and the EU will agree a deal, and that that deal will broadly maintain a fiscally neutral flow of goods and services. This is because despite the changing political environment, this has been government policy since its 2016 White Paper was published.

That said, the OBR has altered its forecasts to include a hypothetical “transition period” in line with the government’s 2018 technical note on temporary customs arrangement – now commonly known as “the backstop”. The transition postpones the point at which the OBR forecasts EU exit to affect imports and exports to 2021.

This is significant because the OBR is forecasting that net trade will make a broadly neutral contribution to UK GDP in the medium term. Declining import and export values for 2018 have forced the OBR to downgrade its forecast on the contribution of net trade to GDP growth for this year, although it still expects trade to contribute a 0.2 percentage point increase to GDP across 2018 as a whole. However, the OBR’s future predictions are that net trade will subtract 0.1 percentage points from GDP growth in 2019 and 2020, with no contribution to GDP growth in 2021 and 2022, and a 0.1 percentage point subtraction from GDP growth in 2023. However, if the Brexit negotiations produce a policy environment which causes significantly more disruption to UK businesses engaged in importing and exporting than the OBR’s assumption – such as a no-deal Brexit imposing WTO rules, or even a Canada Plus Plus deal which does not cover UK services as extensively as existing EU single market agreements – then their forecasts for net trade (and consequently, GDP growth) could be quite significantly downgraded.

In response, the Budget asserts that the government “is confident of getting a good deal” that justifys the OBR’s assumptions but is planning for all scenarios “including the unlikely event no mutually satisfactory agreement can be reached with the EU”. However, as the OBR is not, this could create a fiscal headache for the Chancellor in future post-Brexit Budgets.

What about the Global Economy?

In short – global growth is forecast to be positive until 2019.

The OBR characterises the global economy as “solid” in the first half of 2018, and highlights “momentum” in the US economy as a key driver on continued global growth. However, it also points out that growth in the euro area has moderated and describes development in emerging economies as “mixed”. There is no explicit mention of the world’s second largest economy (China) or its deteriorating relationship with the world’s largest (the USA); however, the OBR does allude to increasing global trade tensions and tightening financial conditions in emerging economies as two key factors influencing its decision to downgrade global growth 0.2 percentage points to 3.7% for 2018 and 2019. This is higher than its forecast for the UK economy, suggesting that opportunities will continue to grow for UK firms who are looking to begin or expand their exporting operations.

Verdict: Cautiously Optimistic

The Budget contains a number of fiscal assumptions from the OBR which may well turn out to be wide of the mark as macroeconomic trends and international policy shifts shape international trade flows. Despite these destabilising influences, the Budget is positive about both the global economy’s future growth prospects, and the effect of Britain’s engagement with world economies through trade for UK GDP growth.

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