The expansive rhetoric of Liam Fox, UK trade minister, and his colleagues respects no boundaries. Liberated by Brexit from the shackles of the EU, he has argued, Britain’s entrepreneurs can now scour the world in search of new export markets. A service-based economy such as the UK can send exports to far-flung countries in no time and at zero transport cost.
Not so fast. Not only have so-called gravity models of trade shown that the distance to a trading partner and the size of its economy matter for goods but, remarkably, they also reveal that the same seems to be true for services.
The negative effect of distance on trade has been evident for decades, even if economists struggled to explain its persistence. The ubiquity of the standard shipping container, the computerisation of transport logistics and the digitisation of production processes, enabling dispersed economies to be woven into a single supply chain, have not reduced the importance of proximity.
The standard analysis for goods is that each doubling of distance with a trading partner halves trade between them. A survey of Canadian services exports found that each 1 per cent increase in distance with a trading partner reduced trade by a third of 1 per cent. The International Monetary Fund, which generated some estimates for the UK, found that the effect of distances on services trade was even higher than for goods.
Why might this be? One reason is simply that some sales of products such as legal and financial services are essentially add-ons to goods trade. Estimates show that service sales suffer from reductions in goods exports, meaning physical distance has a knock-on effect even to services delivered remotely.
More fundamentally, the supposition that digitisation kills distance may misunderstand the nature of the service economy, particularly those high-value-added parts in which the UK specialises. The globalisation boom of the 1990s and 2000s brought forth many excitable predictions of the “death of distance” and the contention that the world was now flat. It transpires, in fact, even as services have replaced goods, that the world remains quite lumpy, and that distance remains alive and kicking.
Many business and technology services value face-to-face contact, both to make sales and to service contracts. Few management consultants, for example, undertake large jobs without frequent on-site visits with clients.
The cost of travel and possible associated barriers to commerce, such as a lack of shared culture, could thus affect services trade just as the cost of shipping and trade finance affects goods.
Many business services have been outsourced to countries such as India. But they are more likely to be lower-value functions such as call centres than high-priced bespoke services such as law or management consultancy. When India tried to push its IT and business services sectors up the value chain, it began to focus on trying to negotiate for more work visas in every trade deal that it attempted to sign, recognising the value of sending staff to meet clients in person. Even with basic call-centre services, several companies have moved jobs back to the UK after problems with quality control in Indian operations.
The implications are clear. If the UK gives up access to services markets in the EU, it will find it difficult to replace it with business further afield even if it somehow manages to negotiate comparable access in other countries. Services may be delivered at the stroke of a computer keypad but securing and maintaining the contract often seems to require human interaction.
If Mr Fox expects the death of distance and the move to services-based global trade to compensate for the loss of markets from Brexit, he will be disappointed. The world remains larger than he seems to think.
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