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Lower exports, lower productivity

The UK's drop in exports threatens to reduce productivity and long-term growth
April 1, 2022

To paraphrase Michael Gove, Britain has had enough of exports. Figures from the Dutch research group CPB show that in the last three months the volume of UK goods exports was lower than it was in the first quarter of 2020, even though world trade has risen 10.5 per cent since then. And UK data show that goods exports are down by 5.3 per cent in the last three years and imports are down 7.4 per cent, even though GDP is up by 0.8 per cent in this time.

If they continue, these developments will make us poorer. As the Office for Budget Responsibility says, “this fall in the trade intensity of UK output is likely to reduce the level of potential productivity”.

History tells us that growth in international trade is associated with growth in labour productivity: the more we trade, the more efficient we are at producing things. Rapid expansions in world trade in the late 19th century and after WWII were accompanied by faster growth in UK productivity, while slowdowns in world trade (such as during the Napoleonic wars and between the two world wars) saw slower productivity growth. And the slowdown in world trade since the financial crisis has seen a slowdown in global productivity growth.

Of course, in itself, correlation is not causality. But there are are good reasons why less trade makes us less efficient and poorer.

One was pointed out by Adam Smith in 1776. Productivity improvements, he said, “seem to have been the effects of the division of labour”. Less trade means a lesser division of labour and hence less productivity. If you were to emulate Tom Good and try to become self-sufficient, you’d be poorer. What’s true of individuals is true of countries: just look at North Korea for an extreme example.

Also, more international trade means stronger competition. That forces companies to become more efficient and more innovative to fend off foreign rivals. Also, a bigger and freer export market means the rewards for being efficient enough to export are greater, which provides a further incentive to innovate. If, on the other hand, exporting means more red tape, then why bother becoming efficient enough to compete against foreign firms?

What’s more, where competition is stronger, capital and labour are released from inefficient companies and move towards towards those that are good enough to fend off imports or expand exports. That raises aggregate productivity.

And then there’s a learning effect. Managers who import and export visit customers and suppliers overseas and so can see how they operate – which means they can more easily learn tricks of the trade from best practice overseas.

These mechanisms should not be controversial. They are a big part of the case for free markets generally, for why trade barriers between, say, Leicester and Nottingham would be stupid. What is controversial is the magnitude of them. Yes, they might be small from year to year. But small effects compound over time. Which is why most economists think Brexit will eventually make us poorer than we would otherwise have been.

This, though, is not a failure of intellect. The mechanisms through which trade affects productivity have been well known for ages, and as Rishi Sunak says, it “was always inevitable” that Brexit would reduce trade. Instead, in voting for Brexit, the public voted to become poorer – the only question being why they did so.