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Resilience and Renewal

Navigating a changing world of trade

Author: ICAEW

Published: 07 Nov 2023

silver car auto factory assembly line man employee engineer ICAEW economy business

International trade and strong supply chains are a cornerstone of economic growth and opportunity. But unlike its international peers, the UK’s trade performance has failed to bounce back after the pandemic. Here, we examine the key challenges UK businesses face when trading internationally, while the next article considers possible solutions.

International trade is a critical component of a thriving economy. The World Bank calls it an “engine of growth,” as it helps countries to increase economic opportunity and productivity, create jobs and raise living standards for the population.

Defining international trade

To many, the idea of global trade conjures up container ships and lorries moving consumer goods across borders that may then be subject to duties and tariffs depending on complex trade agreements. The movement of goods is, of course, one aspect of trade, but as Sally Jones, UK Trade Strategy and Brexit Leader at EY, explains, the scope of global trade is much broader. “When we talk about trade, we generally mean anything that’s covered by the World Trade Organization (WTO). That includes imports and exports of goods and services, foreign direct investment (FDI), trade negotiations, trade disputes, intellectual property and so on. It’s a really wide gamut of things. What it’s not, as many assume, is just customs duties and tariffs; it’s much broader than that.”

In fact, the OECD estimates that 70% of international trade today relates to complex global ‘value chains’, as services, raw materials, and other key inputs to production cross borders several times before being amalgamated into a final product – a car, say – and transported internationally. These global value chains have largely been created over the past 70 years, during which, as the WTO shows, the volume and value of trade flows has risen massively. These value chains are an intrinsic part of economic growth and market competitiveness, providing businesses with greater choice in the inputs they use and more potential markets in which to sell. Indeed, few countries, with the exception of perhaps China and the US, can service entire value chains domestically and are reliant on inputs – of goods and services – from elsewhere in the world to facilitate production.

Making the case for international trade

Underpinning the case for international trade is what economists call comparative advantage, that is an economy’s ability to produce a particular good or service at a lower cost or more easily than its trading partners. As countries specialise more in those things that they are better at producing, this in theory increases the overall value of GDP and income. But of course, the reality is more complex, because while economies as a whole may benefit and some sectors will grow strongly, other areas of the economy will lose out, costing businesses and jobs.

That said, in aggregate terms, strong export nations tend to be more productive because firms that trade overseas have exposure to competitive pressures from international markets, pushing them to be more productive and absorb new innovations from international competitors. Analysis by the Office for National Statistics (ONS) has shown that traders were more productive than non-traders, with businesses recording exports or imports 21% and 20% more productive than those that did not.

Ed Saltmarsh, Technical Manager for VAT and Customs at ICAEW, says: “Exporting allows you to sell more, providing you with more economies of scale. It also reduces your risk because you’re diversifying your markets. Then there’s brand awareness; the more countries you sell in, the bigger your brand.” Professor L. Alan Winters at the University of Sussex and Principal Director and Co-Director of the Centre for Inclusive Trade Policy adds: “There is some theory to argue that by exporting, businesses learn about and understand different demand patterns. It can also help in the product development and possibly in the production process. The ability to import is also very important to production to ensure competitiveness with the rest of the world.”

Certainly, international trade appears to help companies develop greater strength and resilience. The ICAEW’s Business Confidence Monitor (BCM), one of the largest and most comprehensive quarterly surveys of UK business activity, shows that the business confidence of exporters consistently tracks above that of non-exporters. For example, in the two years post-pandemic (Q3, 2021 to Q3, 2023), exporter confidence averaged 8.1 on the BCM index, compared with 2.9 for non-exporters. This greater confidence even held true after the Brexit vote, when uncertainty for exporters was a particular concern, but still exceeded that for non-exporters. Of course, international trade will not be the sole driver for this greater business confidence among exporters. Firms that trade internationally also tend to be larger enterprises with more resources at their disposal, which will also be a contributing factor in the BCM’s findings. Nonetheless, most experts agree that international trade has numerous upsides for firms.

Business confidence
Source: ICAEW Business Confidence Monitor

The UK’s trade struggles

While the benefits of international trade may be clear, the UK is not doing enough of it. Government statistics show that, at the end of 2021, 11.4% of non-financial businesses in Great Britain exported overseas. Of course, exporting is not appropriate for all businesses, particularly small businesses serving local communities. As Winters notes, “in any economy, only around 15% of firms export,” but there is significant room for improvement.

The UK’s growth in international trade has been sluggish since the Global Financial Crisis (GFC) of 2008. Analysis from the Social Market Foundation, for instance, shows that since the GFC, the UK has struggled to grow exports of goods at a similar rate to before 2008 and that by the end of 2019, there was a 26% shortfall between where goods exports would have been had previous trends continued and the actual position.

This long-term sluggishness has been compounded by more recent shocks, notably the COVID-19 pandemic, which created a global slowdown in trade, wrought havoc on supply chains, and is still being unwound today. Indeed, in the two years post-pandemic, 33% of exporters surveyed by the BCM have found transport issues to be a growing business challenge compared with 12% in the two years prior. And then there is, of course, Brexit, which has changed the UK’s trading relationships with both the EU and the rest of the world.

Transport issues
Source: ICAEW Business Confidence Monitor

Unpicking the relative impact of these challenges is no simple task, given the complexity of global trade and the overlapping nature of the shocks. What is clear, however, is that the UK is struggling relative to its economic peers. OECD data on trade openness (the size of trade flows relative to GDP) shows that the UK’s trade performance declined more sharply than other G7 economies in the wake of the pandemic, and it has failed to recover as quickly.

As the government’s Made in the UK, Sold to the World strategy for boosting exports shows, reinvigorating international trade is an economic imperative for the UK. Yet it also raises the question of what is stopping businesses from trading internationally in the first instance, and if they do trade, what barriers are they facing? In answering these questions, three clear themes emerge: a lack of trade know-how; increasing protectionism in nearly all parts of the world; and the new challenges of trading with the EU post-Brexit.

A lack of trade know-how

Lack of understanding is one of the largest barriers to businesses getting involved in international trade, particularly exports. Saltmarsh states: “I think the biggest barrier to exporting is just a lack of knowledge about exporting. Businesses, particularly small businesses, don’t necessarily want to take that plunge into exporting, get it wrong, and come up against all sorts of issues they don’t have to deal with when selling domestically.

“Historically, businesses used to see the EU as a test for exporting because it was so much easier to sell to the EU when we were a member. In many ways, it wasn’t that different from selling domestically. So, businesses could have a go at that without dealing with the customs and regulatory checks and focus on trading logistics in the EU. If that went well, they would be more likely to export further afield.”

The issue is that the complex nature of trade means that many businesses struggle to or don’t have the bandwidth to understand all that is required of them.

“Trade is not easy,” states David Henig, Director of the UK Trade Policy Project at the European Centre for International Political Economy (ECIPE). “The EU single market is very much the exception. Generally, trade always involves lots of paperwork, barriers and small problems you don’t necessarily think about, like insurance, travel time, finding markets, arranging payments and so on. These are really difficult things, especially for small companies, which means they have a higher cost of trade than larger companies. Companies have to be more efficient to trade successfully because they’ve got to make sure they’re competitive and can handle those costs.”

Alongside this is the question of skills. “If firms are going to get into exporting, that takes expertise,” notes Winters. “Exporting firms typically have a higher-than-average level of skills, and it’s quite a wide range of skills.” And as the BCM data shows , sourcing these skills is a growing challenge, with exporters affected more than non-exporters by skills shortages. Between Q3, 2021 and Q2, 2023, 37% of exporters, for instance, cited the availability of non-management skills as an increasing challenge, compared with 34% of non-exporters.

Skills shortages
Source: ICAEW Business Confidence Monitor

A new age of global protectionism

Adding to the complexities of trade is an increase in trade protectionism. Jones states: “For 70 years, from 1946 onwards, governments around the world were acting collectively to reduce trade barriers. And so, every year, in every way, international trade became a little easier. That trend of reducing trade barriers slowed and reversed around 2007-08. And so, we’ve now had 15 years of increased protectionist measures and increased trade barriers. When we surveyed international businesses in 2021, we found that everybody in every geography was struggling with trade issues.” 

This shift towards protectionist measures is captured in the WTO’s World Trade Report 2023, which highlights an increase in the number of newly imposed countervailing measures and the number of trade concerns raised by members.

Some of these measures, such as the Inflation Reduction Act (IRA) in the US, have been very high profile, others less so, but together, they present challenges for countries and businesses active in international trade.

They also render international trade less attractive to businesses wanting to take the first step into exporting. For instance, the Social Market Foundation’s research shows that the top three export barriers for SMEs considering exporting are customs, logistics and tariffs.

Trade in a post-Brexit world

Finally, there are the new realities of trading with the UK’s biggest trade partner, the EU, which accounted for 42% of the UK’s exports in 2022. Almost three years have passed since the EU-UK Trade and Cooperation Agreement (TCA) came into force in January 2021. Still, after 45 years of no trade barriers and trade policy expertise lying in the hands of the EU, its implementation has been a steep learning curve for policymakers and business alike.

House of Commons data shows that in the immediate aftermath of the TCA, EU-UK trade fell in both directions. However, trade levels have started to recover, and UK exports and imports with the EU now exceed their 2019 levels. Where the question mark lies is whether the UK can sustain strong growth rates of trade as it recovers its trading relationships and settles into a new status quo. 

The challenge is that trade with the EU is now more difficult, which acts as a dampener on trade activity. Winters states: “From a trade point of view, Brexit has turned out, more or less, as the vast majority of economists predicted. It’s making trade more difficult with the EU. We all understand that with trade, as you gradually reduce the costs of doing trade, trade increases, and more firms can start to trade and be stronger drivers for the economy. That includes imports as well as exports.”

From a practical perspective, the new trading arrangements have introduced a number of changes, for both goods and services companies. The process for UK businesses exporting goods to the EU, for example, is now much more complex. Alison Horner, VAT and Indirect Tax partner at MHA, details: “Businesses are now crossing a customs border, which introduces issues relating to not only tariffs, but also the origin of some goods, and whether businesses have got the right registrations in place. If, for example, there is a UK business exporting fruit to the EU, it will incur a customs duty charge, which is going to affect its profit margin. It will also have extra administration and compliance issues to address. It may also incur costs in getting a representative because many countries require you to have a fiscal rep, and it may have to register for VAT and deal with the associated compliance and updates to invoicing to deal with this.”

The changes have been more challenging for some sectors than others, with some, such as agricultural and pharmaceutical sectors, needing additional licences. Then there are many other aspects to consider such as the Carbon Border Adjustment Mechanism, a tariff on carbon-intensive products. Undoubtedly, the complexity of the rules makes exporting a less enticing prospect for many businesses. It also means many established exporters are getting caught out by the new regulations or not operating as efficiently as possible. Horner explains: “We’ve had a lot of businesses caught up with not dealing with Incoterms correctly or by not having the correct processes set up for VAT registrations and everything else. One of the things that we have had to look at for clients is how businesses were selling into Europe, especially for B2B companies, to make sure that they’re not impacted from a tax perspective and also to make their supply chains work so that they’re not held up in the ports or crossing too many countries.”

Beyond the initial trading issues, there are also several strategic considerations that businesses have to take into account. Horner says: “The next biggest challenge for business is determining whether they need to set up a legal entity in Europe for their European operations. This raises questions like where is the best place to establish myself as a UK company? What are the tax implications of the different markets? What licensing requirements do I need to fulfil?”

These are, of course, the challenges from the UK perspective. Equally, Brexit has meant changes for businesses importing into the UK, but the full impact of these is still to be felt. Border controls for imports have been phased, for instance, with the final part recently postponed until 2024. Susanna Di Feliciantonio, Head of European Policy at ICAEW, says: “The EU imposed custom checks pretty much immediately, but the UK staged them. When the full checks come in, and they have been postponed and postponed and postponed, that may have a further impact on incoming trade. A lot of smaller companies will be going through these checks to import into the UK, which could act as a further dampener on activity.”

The world of international trade has changed substantially over the past five years. Global trade still offers many benefits to businesses and there are opportunities to be had, especially for businesses that take a more global outlook, but it is materially more difficult. Adapting to this new situation and encouraging more businesses to step into the world of trade will take a coordinated and long-term plan from policymakers. Chartered accountants, together with other professions, must play a fundamental role in helping businesses make this shift and ensuring UK PLC stays open to trade to the benefit of all of us.

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