UK Services Exports: Storms over Channel; Brighter in the East

May 13, 2016

Your financial services are anti-Brexit but their EU exports don’t pay for your EU trade deficit. UK services are more successful exporting outside EU, with creative and IT services growing fastest. Their safest course lies outside the emerging Single Market in services.

 

  • Service industries export 55% more to countries outside EU than inside

  • Finance brings an EU surplus of £10 bilion per year: just 12% of your deficit in goods

  • Creative services are growing faster than finance

  • The priority for UK services industries is ready access to global talent

     

UK financial services – which account for just under half your trade in services – have most to gain from voting to stay in EU. Barrier-free exports to the EU are growing by 6%, and the industry generates a surplus for UK–EU trade of over £10 billion per year.

 

But the interests of the UK services sector as a whole – creative industries, IT, accountants and consultants – are different. For them, the regulatory risks of staying in the EU may outweigh the marginal benefits of a Single Market in services — if that’s ever completed. In any case, your £20 billion services surplus doesn’t pay for a quarter of the £85 billion deficit the Single Market delivers to your trade in goods.  

UK Services: Exporting more outside EU than in

Calculating the export revenue that UK services generate is complex. The data are inconsistent, so EU figures differ substantially from official UK sources, or industry bodies[1]. Your Office for National Statistic (ONS)[2] estimates that UK’s surplus in services is £21–£22 billion per quarter, with financial services accounting for half, or £10.3 billion. This estimate is slightly more generous than data from industry body, CityUK.

 

Taking the ONS numbers as the most consistent, UK services export far more to countries outside the EU (£34 billion per quarter) than inside EU (£22 billion). You earn a higher surplus on non-EU trade too. For the last quarter of 2015, your surplus on trade in services beyond EU was £16 billion[3], as opposed to £5.1 billion inside EU. In fact, you earn a higher surplus on trade in services with the United States, than for the whole of the EU.

 

So the starting point for understanding the service industries interests in the Brexit debate is that UK services exports are already highly global — more so than your goods exporters. And just as important, three-quarters of the overall trade surplus that UK services generate is from trade outside the EU[4].

 

But the interests of services industries should be set in proportion: overall, your trade in services to EU is still far smaller than your trade in goods. Total annual services exports to EU are approximately £85–£90 billion, while your exports of goods is £134 billion[5]and imports, £220 billion. However, the £20 billion surplus you earn on services trade with EU is dwarfed by the £85 billion deficit[6] you incur in goods. The result is an overall trade deficit of £65 billion per year with the EU.

 

While the success of your services exports outside the EU puts your overall non-EU trade in surplus, your overall deficit with EU is growing rapidly every year. The surplus your services earn in trade with EU would have to grow by £10 billion per year to reverse this trend.  

Warning to all services: EU approaching

The EU has so far had a limited impact on UK service industries. The proposed Single Market in services is a work in progress: there remain multiple barriers to cross-border service provision, such as activities that require licensing or registration. The Single Market is most advanced in financial services, where ‘passporting’ gives UK-registered banks the ability to extend banking services with relative freedom. The UK insurance industry has more limited rights of access on the continent.

 

How far advanced is the Single Market in Services? The pro-EU policy group, Centre for European Reform estimate that the 2006 Services Directive has reduced barriers in services by approximately one-third. The UK government wants to complete the Single Market; it formed part of David Cameron’s February re-negotiation.

 

People working in services industries should consider what a Single Market will likely entail. Fresh regulation will be required to standardise licensing, registration and qualifications. The EU may try to create pan-European rules for services standards, digital products or ecommerce. In finance, where EU has made the greatest inroads, the cost of regulatory compliance is already large: €33.3 billion in 2012-2015 according to Business for Britain[7].

 

Consider the big picture. If you look at UK trade in total, the sector that currently performs best is the one least impacted by EU: services trade outside the EU generates a surplus of £65 billion per year. The sector most impacted by the EU and the single market – UK’s trade in goods within the EU – performs the worst, with an £85 billion deficit. Exports of services to countries outside the EU are growing 6–8% per year[8]. Exports of goods to Europe stalled in 2008 and haven’t grown since.

 

This is why your manufacturers, especially small companies, are inherently more hostile to EU than services companies. Manufacturers know what the Single Market means. Its impact is unarguable. Services companies don’t know what a Single Market will look like or cost. But they should realise that once the rules are in place, the UK government will not be able to reverse any trend that sets in.

UK & foreign Banks: Relying on British political support in EU

Since the EU has an uneven impact on services, figuring out whether UK services get a good deal is a sector-by-sector analysis. Financial services clearly have the most to lose from Brexit, and a withdrawal from the partial Single Market. An end to ‘passporting’ will mean UK banks will need to gain separate licences to operate in the EU. If the EU decides not to tolerate circumvention techniques, like off-shore style brass-plating, the EU will ban them.

 

More importantly, outside the EU, UK banks – and foreign banks with European head offices in UK – would also lose regulatory protection. It’s far from clear how effective this protection is now. The EU Commission (which has the sole right of proposing finance regulation) has already singled out the UK finance industry for special attention, by – uniquely – asserting the power to limit pay and bonuses.

 

But banks know they are unpopular, in a way that, say, car makers aren’t. Outside the EU, there is little to stop the Commission from steadily re-fashioning EU markets in retail and wholesale finance in a more socially conscious fashion. And if EU has established the power to set bankers’ pay, are there any aspects to UK finance it can’t impinge upon?

 

For the moment, UK and foreign banks have concluded that the lesser risk is to stay within the EU, and rely on UK governments to fight their regulatory corner. Hence Goldman Sachs’ funding for the Remain campaign. However, the finance industry is also, in effect, betting that future UK governments have both the skill and political capital to consistently protect their interests.

 

Is this reasonable? It depends on priorities. A more hard-headed trading analysis might suggest that UK governments make the interests of services exporters paramount only when their surpluses cover the deficits of industries that do less well out of the Single Market. Of this there is no prospect. The fact that the City is dominated by foreign-owned banks also raises the question of how high a price UK should pay for making it easy for non-British companies to operate across EU.

US services exporters: A roaring trade with EU

Looked at from outside, that price shouldn’t be set very high at all. The US services industry – including financial services – generate huge exports to EU, despite being outside the Single Market. According to official data, total US services exports to EU were US$209 billion in 2013, having grown a very healthy 107% since 2003. The US earns a healthy surplus on that trade – about US$60 billion – which is almost twice UK’s EU surplus.

 

True, the composition of US services exports is different. Royalties and intellectual property generate the most exports, which include films, TV and software. But to what extent do US banks export direct from US to EU, and, overall, is it a profitable trade for US?

 

According to US Department of Commerce’s Bureau of Economic Analysis 2014 estimates, US financial firms earned a global surplus on exports of US$67.8 billion[9], which is 29% of its global services surplus. Assuming the surpluses to be evenly distributed across markets, this implies a US$17 billion[10] surplus in trade in finance with EU (which is slightly ahead of the £10 billion surplus that UK-based financiers earn).

 

This US finance figure is speculative, not least because big US investment banks can chose to book income either within EU or outside it, but the comparison is pertinent. Without any of the protection or benefits enjoyed by UK companies, US finance firms are successful exporters to EU and the industry as a whole generates a surplus that is roughly the same, or slightly higher, than yours. If Wall Street can do it, why can’t the City?

Creative Industries: Untouched by EU — for now

Services exporters outside the finance sector are less affected by the EU than any other sector of the UK exporters — at least for the moment. One sector the Brexit debate should focus on is the UK’s creative services industry, for the simple reason that it’s the fastest growing in your services economy. Official data estimate that as a group, creative services have grown by 15.6% since 2008.

 

The reason creative industries matter to Brexit is that with digital media and online collaboration tools, their output is now highly exportable. Back in 2011, creative services generated exports of £15.5 billion, but they are growing almost 50% faster than the services sector exports as a whole. The CBI forecasts that creative services (including IT) will be the principle driver of growth in London’s economy up to 2019, outpacing finance.

 

So what does Brexit mean for your most obviously emerging industry? As things stand, not very much. So far, the EU barely attempts to regulate the output of creative services or IT. If they did, the reaction would be audible. Software programmers, for example, would baulk at moves to create pan-European standards – not least because big software companies would dominate the process. Extending state subsidy rules to UK media wouldn’t please the BBC either.

 

The interests of UK creative industries are impacted by EU in one vital respect, however. Surveys consistently report that creatives’ principal business challenge is hiring and retaining the skills they need. But as the UK tries to stem immigration, it is tightening the rules on skilled migration from outside the EU. Unable to stop immigration from EU, it is choking immigration of skilled English speakers from the rest of the world.

 

This is a live political issue in Australia, with a long-standing tradition of exchange of skilled workers with UK. And it doesn’t just impact services industries. Stemming the flow of nurses, doctors and teachers between UK and Australia robs both countries of professional experts who could bring fresh ideas and energy. Both countries lose out, and so do UK citizens: as taxpayers and consumers of social services.

 

But an immigration policy that stops skilled young people from around the world from coming to UK will have a negative, long-term impact on your creative industries, and services industry more widely. UK companies of all sizes will miss out on the chance to bring in fresh talent. That talent will go elsewhere. Your services industries, let alone your exports won’t expand to their full potential. This is not just a long-term economic loss to UK, it is also a loss to the interconnected careers of the 2.55 million people who now work in creative industries.

The balance of interest

So how do the interests of your services stack up? Given that services trade outside the EU is significantly larger than trade within it, you should probably take careful note of those who fear the impact of EU regulation. Just as with goods manufacturers, EU regulations will impact everyone whether or not they export to EU.

 

Or to put it another way, there is a clear risk that a Single Market in services will start to do to your services exporters what it’s already done to your goods producers. That would be a disaster for UK trade. As a result, you should be extremely wary of placing the narrow and particular interests of financial services ahead of the interests of services as a whole.

 

  • If the US is any guide, UK financial services can still grow and earn a healthy surplus on EU trade outside the Single Market, even if banks take a one-off hit.

  • UK banks may secure a better deal outside EU, if UK decides to leverage its £85 billion trade deficit to secure access and regulatory protection.

  • Most UK services companies have no interest in the Single Market, except the hope it is not extended to them. Many of them are your fastest-growing exporters.

  • The fastest growing sector in your economy will not get free access to world-class skills so long as UK is unable to stem migration from Europe.

 

In economic terms, the Brexit debate is turning into multiple fights between commercial interests: big companies versus small ones, and exporters versus domestic industries. But the most vocal fight is between finance interests in London and companies that make physical goods. The City has a long history of getting its way in UK politics. And since your Chancellor is currently borrowing £72 billion[11] per year from City institutions, the City’s view on Brexit will be heard with deference, and possibly in silence at No. 11 Downing Street.    

 

But history offers a cautionary tale. Back in 1925, your then Chancellor, Winston Churchill had to weigh the pros and cons of returning the Pound Sterling to the Gold Standard. The City bombarded Churchill with the advice that a return to the Gold Standard would restore London to its global pre-eminence, recently lost to New York.

 

With a keen understanding of how a high exchange rate would damage UK exports, Churchill protested: ”I would rather see finance less proud, and industry more content.”

 

In the end, the interests of London financiers prevailed, Churchill, relented, and Sterling returned to Gold. And the consequences? Overpriced UK exports slogged it out in world markets until the 1930s Great Depression, which deranged the whole economy all over again. UK trade never recovered before WW2, which promptly vapourised Britain’s industrial exporting economy, as it turned out for ever. And the City? Those proud and vocal financiers spent the next 60 years in the second division anyway.

 

 

© Phil Radford

 

 

References

 

[1] One reason for this is that multi-national companies with offices in multiple jurisdictions often have a choice as to where to book income from cross-border services.

 

[2] Chapter 12. Quarterly trade data from ONS are used in this analysis, since they are the most detailed and consistent (from quarter to quarter) for trade in UK services. See, eg. Quarterly trade data for November 2015

 

[3] This surplus is fairly constant, fluctuating between £16–£18 billion per quarter.

 

[4] According to quarterly ONS reports. This analysis assumes that the overall ratio of services surpluses as between Non-EU and EU countries applies to Financial Services; the sector’s biggest constituent. Hence, of the total annual services surplus with EU trade (£21 billion), half is attributed here to financial services.

 

[5] HMRC. 2015 data, February 9th 2016 release.

 

[6] HMRC data. February 9th Release for 2015.

 

[7] Page 40.

 

[8] There are multiple estimates for this number. See, e.g., the Pro-EU CER. Page 5.

 

[9] Chart 5

 

[10] UK sources suggest EU attracts 36% of US financial services exports, which might suggest a slightly higher surplus.

 

[11] PSBR was £72.5 billion in the year ending March 2016.

 

 

 

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