Trading blows

These are anxious times in global trade, and the UK has particular reason to worry. Before the dust has settled on one great disruption – Brexit – Donald Trump, with talk of sweeping tariffs, threatens another. This report asks what our economic experience of the first might teach us about how to handle the second. Brexit so far has turned out to be a tale of two sectors: while traded services have held up surprisingly well, Britain’s goods trade has proved vulnerable. The incoming American administration’s protectionism aims squarely at goods, threatening a second hammer blow there. The 10-20 per cent generalised tariffs that Trump has floated are of equivalent scale for goods exports to the US to the non-tariff barriers that Brexit imposed on goods sales to the EU. The knock-on effects could be darker still if Trump’s mooted super-tariffs on rivals such as China combine with retaliation to lurch towards global trade tension or even, in the extreme case, a truly global trade war. No longer part of a large trading bloc, the UK would then face sharp dilemmas in a scramble to retain access to overseas markets and its flow of imports.

It’s a very long time since Britain was ‘workshop to the world’, but the recent relative slide in its goods trade has been intense, with the value of UK goods exports rising by just 0.3 per cent each year since 2019, far below goods export growth across the OECD of 4.2 per cent annually over the same period. Indeed, the only sector larger in 2023 than 2007 in export volume terms is machinery and transport. Brexit effects are evident in various ways, including falling EU sales from smaller traders, on whom the fixed costs of new paperwork weigh heavily.

And there’s no room for complacency about the further disruption, which the Trump tariffs (and reaction to them) threaten. Even in its relatively shrunken form, manufacturing remains a crucial source of ‘good jobs’, with pay at middling or better rates. Exports account for around a quarter of final demand, far more than for services. The Government’s Industrial Strategy recognises the particular role of ‘advanced’ manufacturing, and yet the UK’s exports are increasing slowly in what should be growth fields, such as motor vehicles, as well as in areas of UK comparative advantage, such as pharmaceuticals. Disrupted imports are just as much of a threat for UK industry – which is embedded in international supply chains – and to all of us as consumers. All told, 60 per cent of all the goods we use – whether as inputs into domestic industry or consumed by government or households – are foreign-made. That means any UK recourse to tariffs within a trade war would be costly.

In the distant past, trade in services was something of an afterthought – they were described as ‘invisibles’ on the balance of payments. Today, overseas service sales are central to Britain’s prospects. Services as a whole account for more than 80 per cent of UK output, giving them a dominant bearing on family finances. And although services as a whole remain less exposed to trade than goods, Britain’s mighty finance sector is actually today more export-intensive than manufacturing. Services overall provides the majority – some 54 per cent – of UK exports. All this makes the UK a ‘service superpower’, selling more internationally than any other country except the US.

Brexit looked like it could be a big problem. The services trade barriers implemented post-Brexit are high in some areas, because the Free Trade Agreement between Britain and the EU is, like most such agreements, overwhelmingly focused on goods. But, despite this, by increasing sales beyond Europe and nurturing sectoral strengths, the UK has maintained a buoyant overall export performance: its total share of OECD service exports has risen by 0.9 percentage points since 2019.

The UK needs to keep this up. For a medium-sized economy, sales into a growing global service trade have huge potential to grow. While a large chunk of direct rewards accrue at the top of the income scale, some major exporting areas, such as education, employ substantial numbers of poorer and middling families. Much more generally, service exports buoying incomes across a local economy translates into local demand and thus more and better earning opportunities in non-tradable services (think of local restaurants or beauticians).

The UK’s service exports now break pretty evenly between the EU (£170 billion), the US (£126 billion) and the wider world (£172 billion). The recent growth has been powered along by strong American sales, and rocketing service exports to India, which are up three-fold since 2016 (+215 per cent).

Long-established UK strengths (such as insurance and ‘other business services’) have been important in recent growth. Also important are two specific ‘workarounds’ to traditional barriers to trading services. One is remote trading, without people moving. Very often this involves digital channels, which were given a tremendous boost of necessity during the pandemic. Right across Britain’s big service industries, more overseas trading is now done this way than by workers heading abroad or customers (such as tourists) heading to the UK. The ‘remote’ proportion of direct services exports (i.e. non-subsidiary sales) rose from two-thirds (65 per cent) to about three-quarters (72 per cent) since 2019. For the giant ‘other business services’ category, the share has risen from 70 per cent to 81 per cent, extending an established trend of digital trade sharply reducing services trade costs.

An even more significant workaround involves companies setting up subsidiaries to trade in foreign markets: two thirds (66 per cent) of all UK services sold abroad were supplied this way in 2019. Some sectors hugely ramped up this approach after Brexit: in Information and Communication, for example, the share of total trading (exporting and importing combined) done through affiliates increased by 4.1 percentage points post-referendum compared with pre-referendum, even controlling for trends over time and sector. Others – such as Professional, Scientific and Technical fields – either couldn’t or didn’t adapt in the same way.

Both types of workarounds have facilitated export growth. Those fields, like ‘other business services,’ that have strongly pivoted to digital have thrived (with the volume of total exports up from £65 billion in 2007 to £153 billion in 2023) while others which were less able to do so have stagnated. Consider Transport, which is linked to the physical presence of people and equipment, and also strongly intertwined the goods trade: its exports fell from £25 billion to £21 billion over the same years.

Britain’s service trade has come through Brexit surprisingly unscathed overall, and it is not directly targeted by Trump’s potential tariffs. And yet it cannot be assumed that recent growth will continue. For one thing, there are tentative signs – in some sectors at least – of customers getting ‘Zoomed out’ by all the digital trade. Both service exports as a whole, and those booming ‘other business services’ in particular, saw the share of digital sales slip back somewhat between its pandemic peak and 2022, with declines of 10 and 8 percentage points respectively. Another concern are regulatory barriers, which are already impeding export potential in some areas: the overall growth in service exports has come disproportionately from unregulated fields. Advertising and market research is one example: its exports more than doubled (up by 128 per cent) between 2015 and 2022. In total contrast, some big sectors which require workers to have professional qualifications in every jurisdiction they operate in have seen exports grow slower than the average services sector: consider accounting, for example, whose foreign sales grew at a comparably modest 39 per cent over the same years, or legal services which has seen growth of 35 per cent.

All this is before we consider the potential consequences of a world mired in new conflicts over commerce. Geopolitical tensions or disputes over the tax treatment of subsidiaries or digital sales could spur states to put restrictions on both our ‘workarounds’ against trade barriers. Moreover, some services, such as software and after-sales support for advanced manufacturing are often intertwined with goods trade. They wouldn’t escape a global goods trade war without serious damage.

As ministerial minds turn towards a new trade strategy, due next year, they confront multiple and formidably difficult balancing acts. For a start, they will need to carefully apportion diplomatic effort between goods (where vulnerabilities warrant a broadly ‘defensive’ approach) and services (where a more ‘expansive’ strategy is warranted). Getting the right ratio of effort here is a delicate calculation even before we consider its potential to get caught on the horns of the looming geopolitical dilemma that Britain is desperate to avoid – the unwanted choice between trading with the US or with the EU.

If goods were the only issue, the over-riding strategy would be relatively clear: stay as open as possible as is consistent with holding your biggest trading partner close. That partner is still, overwhelmingly, the EU, from which we buy over half all our goods imports (£318 billion) and sell only a little less than half of our goods exports (£186 billion). The UK would obviously need to be pragmatic and grab any sector-specific deals the US and others may offer, so long as they could be had without jeopardising that crucial cross-Channel relationship. But from a goods perspective, it makes sense to hold fast to EU standards, even if this could complicate or even reduce the (already low) chances of an attractive general US-UK Free Trade Agreement.

The same logic could condition Britain’s response to the Trump tariffs in goods trade. For the UK in isolation, the least-bad option might be living with tariffs, while being measured and selective about any retaliation, so that Britain’s businesses and consumers continue to benefit from £58 billion of annual imports from the US. In a world of rising trade tension, however, such unilateral openness could be hard to sustain if the EU became anxious about the UK being a backdoor for goods from the US and beyond. The UK has already taken a very different stance towards China’s electric vehicles than either the US or the EU, by continuing to allow them in with its (relatively modest) existing 10 per cent tariff. For a medium-sized country dependent on a nearby giant market for trading goods, there may be limits to the scope for such independence.

So there are potential conundrums even before we get to services, where UK interests are much more expansive and varied. Our analysis points to a host of important objectives. One is keeping those crucial ‘workarounds,’ subsidiaries and digital sales, running smoothly by proactively seeking new agreements to remove (and avoid creating) barriers to trade through these channels. A serious effort also needs to be made to allow regulated services finally to share in Britain’s service export boom. Brokering mutual recognition agreements on professional qualifications is urgent, and something that the private sector cannot sort out alone. Hammering such deals out with giant European and American markets are both obvious priorities, but so too must be large growing markets, notably India and Singapore.

Fortunately, some of the testing features of goods trade – hard borders, physical checks, fears about ‘backdoor’ access – don’t arise in quite the same way for services. Nor is the service trade caught in the same political glare that Trump is shining on the merchandise trade. And thus in services there is less reason to fear Britain being forced to ‘choose’ between America and Europe. It can – and must – look freely around the world with an opportunistic eye for any takers for negotiating service deals, and be pragmatic too about the many different ways in which progress can be forged. The detail will be varied, often technical and rarely glamorous. It may not make headlines, but it will sustain the trade in services, which is, in the end, Britain’s brightest hope for the future.