Factors Affecting UK Trade Patterns

There are various factors that influence trade between countries, with some factors encouraging trade and others deterring trade.  UK has the advantage of being a member of WTO since 1995, GATT since 1948 and various RTA’s. Firstly, two factors which are interrelated with one other are political and legal factors that impact trade between UK and its partners. Despite the globalization of businesses, firms must accept and act based on local rules and regulations of the countries in which they operate or export to. Thus, global businesses need to observe and assess the political and legal climate in countries that they trade in, being goods or services.

Based on the UK trade partners, all countries except for China are pluralistic regimes that practice democracy. China is more of an authoritarian government with its strong government and limited individual rights. However, over the past two decades, China is pursuing a new balance between how much the state plans and manages the national economy. Today, China has been successful in merging state intervention with private investment to bring forth a robust, market driven economy, while still using the communist form of government (Carpenter and Dunung, 2012).     

Other factors that affect international trade between trade partners of the UK include relevant policy variables: tariff, inflation, exchange and capital control, gross domestic product (GDP), import duty, and foreign direct investment. According to Raballand (2003) foreign direct investment increases the host country’s exports, although the impact on imports is considered relatively weak. When tariff barriers are present, restrictions on FDI begin to increasingly distort trade. A tariff barrier in the importing country has a negative effect which is insignificant on the effect of exports to the country. Furthermore, per capita, G.D.P and population are factors that play a significant positive impact on exports. However, distance between countries has a negative impact on trade, as trade costs that include transportation and communication increase in regards to distance (Raballand, 2003).

Standard gravity variables of distance as an indicator of transport costs play an influential role with UK and its trading partners. Countries that are UK’s trade partners are those that are a shorter distance, comprising mostly EU countries, while non-EU countries US and Canada are also a short sea and air distance from the UK, with average distance being 6,800km, and air distance equalling 4,200km. Commonly, neighbour countries have more integrated logistics network which reduces trans-shipments. Furthermore, neighbouring countries are also more likely to have transit and custom agreements that decrease the transit time and lower shipping & insurance costs. Thus, distance affects trade volumes through transportation costs.  Furthermore, there are low tariff rates between organization of economic cooperation and development (OECD) countries.     

Trade Theories 

International trade can be defined as the exchange of capital, goods, and services across international borders or territories. Based on the time in history, trade methods and theories have been expanding and adjusting itself. The 15^th and 16^th century trade was defined by mercantilism which stressed the countries should simultaneously encourage exports and discourage imports; a common concept that still resonates in modern trade policies. It was Adam Smith who can be traced back to today’s standard theory of international trade with is Wealth of Nations, followed by David Ricardo’s Principles of Economics, published in 1951. Adam Smith’s absolute advantage argued that wealth of nation depends on goods and service available to its citizens rather on gold reserves of sovereigns. Maximizing the availability depends on putting all resources to use and then on the ability to obtain goods/service; to pay for them by production of goods/service produced more cheaply in the country; and costs measured in terms of direct and embedded labour inputs.

This principle fit the development of capitalist economies based on production through wage labour. Schumacher (2012) asserts that Smith’s theory was established as a predecessor to the theory of comparative advantage. Ricardo’s comparative advantage asserts the possibility of system wide gains from trade occur even if the country has no absolute advantage in the production of no product. Helpman (2010) placed an emphasis on interactions of policies and regulatory framework with specific needs of specific sectors of the economy having a comparative advantage than others. Furthermore, Ricardian comparative advantage was implemented in importance of financial institutions for development by Beck (2003) and Manova (2008) revealing that countries with better financial development export more in sectors that have a greater tendency to depend more on external financing, based on a study of OECD countries. Levchenko (2007) has also agreed with Ricardian comparative advantage with the study asserting that countries with better rule of law have shown to export comparatively more in sectors that have lower levels of input concentration.

Although not a particular theory, the Heckscher-Ohlin model is used to evaluate international trade, specifically trade equilibriums between countries that have different features. The general principle of the model is; by trading goods, countries are indirectly trading factors that are contained in the production of those specific goods. The model was tested for the USA by Baldwin (1971) based on the country’s commodity structure. The results of the factor content of US exports and imports in 1962 by Baldwin (1971) are summarised in the table below showing that K/L higher in imports, however, the US was much more capital abundant in 1962 than compared to the rest of the world.

Table 1; Import / Export primary factors (source: Baldwin, 1971)

Lastly, the New Trade Theory (NTT) is a collective economic model in international trade that places an emphasis on the role of increasing returns to scale and network effects. The assumption of constant returns to scale are relaxed. An important source and destination for FDI has become high income industrialised countries such as the UK. Just in 1997 the total outward FDI stock of US, Japan, and the EU was equal to 1560 billion GBP with 63% of this amount concerned FDI stock just within EU, Japan, and US (UN Intl Trade Stats, 1997; WIR, 1999).

Since, there has been an increase in both intra- and inter industry trade between more developed and industrialised countries,  the NTT has been increasing its effort to support the increased importance of trade between industrialised countries and the frequency intra-industry specialisation between them. Using the NTT as a premise, Markusen and Venables (1998) develop a framework to analyse the increasing importance of FDI in regards to trade in the world economy. Using a two country model, Markusen and Venables (1998) assert that the convergence of countries in size and relative endowments moves the trend from national to multinational firms; known as convergence hypothesis, in which multinational production displaces national firms and trade as the two countries converge either by relative size, relative factor endowments, or relative production costs. This is evident with the US-UK trade relationship with UK’s comprising of 25% share in the American economy (The Economist, 2013). The leading importers of UK’s Oxford made BMW’s Mini are USA, Germany, China, and France (The Economist, 2015). The same relationship can be seen with UK-EU countries.  According to the chart below, by 2012 Britain’s exports and imports largely depended on goods and services from EU countries.

Figure 4; Trade trends of UK in 2012 (Source: ONS, 2012)

It is an accepted idea that free trade benefits all countries in the world; although, hardly any country has practiced free trade policies thoroughly. However, UK believes in free trade as the economy is dependent on foreign trade making the government support free and unrestricted trade. Due to its dependency on trade, the UK has few restrictions on foreign trade and investment. Furthermore, the strength of the Great Britain Pound and its state economy has made the country an attractive investment place for foreign investors. The UK government has adopted numerous programs to promote and attract foreign businesses and investments. One of the key programs has been allowing local and regional governments to establish enterprise zones in which companies receive exemptions from property taxes and reimbursements for costs that are involved in the construction of new factories or business locations. The country also hosts free trade zones in the UK allowing goods to be stored for shipment without tariffs or import duties.