Trade, Development, and Immigration

Estimating the fiscal benefits of a UK export boost


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Tax and Fiscal Policy
Last month the Secretary of State for International Trade, Liam Fox, launched an ambitious new Export Strategy, with the aim of raising UK exports as a percentage of GDP from 30% to 35%. Most economists would agree that increased openness to trade (both exports and imports) is a ‘good thing’; it allows countries to benefit from more specialisation and competition, from economies of scale, and the greater sharing of knowledge. Consumers, in particular, gain from lower prices, higher quality, and more choice.

Of course, an increase in exports is not simply an end in itself, but a means to pay for more goods and services, including imports, to be consumed in the UK. One channel by which this operates is the fiscal boost, or the ‘export dividend’, resulting from the impact of an increase in exports on tax revenues and government spending. This blog makes a first stab at estimating what this export dividend might be.

Let’s start by tracing through the impact of a hypothetical 10% increase in exports, and initially assume that this feeds through one-for-one to an increase in GDP. UK exports were worth a total of £620 billion in the last four quarters (£343 billion of goods and £277 billion of services). On this basis, a 10% increase in gross exports, other things equal, would boost national income by around £62bn.

This would be partially offset by import content of exports – that is, the increase in imported raw materials and other components necessary to produce the additional exports. OECD data suggest that the ‘foreign value-added share of gross exports’ in the UK is around a fifth, implying that a 10% increase in gross exports would lead to an 8% increase in net exports. This would reduce the boost to GDP to around £50 billion (four-fifths of £62 billion).

However, this is only the direct impact. We also need to think about any potential ‘multiplier’ effects, where an initial boost to demand (in this case, foreign spending on UK exports) is magnified as it ripples through the economy, but also any offsetting factors that dampen the impact. In other words, the ‘export multiplier’ may be greater than 1, or, in some circumstances, less than 1.

The multiplier will partly depend on the degree to which the additional demand leaks out of the circular flow of income and spending within the UK. Some will be lost to additional imports (on top of those used in the process of producing exports), or saved rather than spent, or mopped up in tax revenues that the government does not recycle.

What’s more, when the economy is already operating close to full capacity (as is surely the case now), some of the increase in production for export may simply be diverted from production for domestic consumption. And unless there are large amounts of spare resources, an increase in demand may also lead to higher inflation and interest rates, so that the initially positive impact is likely to fade over time.

The upshot is that we can’t say with any great confidence whether the export multiplier will be higher or lower than 1, though we can conclude from the general evidence on fiscal multipliers that the net effect on aggregate demand is likely to be smaller in booms than in recessions. In good times, when there is little slack in the economy, the export multiplier might only be 0.5, meaning that the £50 billion increase in net exports in our example would only translate to a £25 billion increase in overall GDP.

Let’s assume though, for simplicity, that the positive effects of the additional demand spreading from the export sector through the rest of the economy broadly offset the negative effects from the crowding out of other activity, meaning that the export multiplier is indeed 1. What then might our illustrative £50 billion boost to GDP mean for the public finances?

In general, higher incomes and economic activity translate into higher tax revenues and lower government spending, especially on payments such as unemployment benefits. A rough rule of thumb is that a 1% increase in GDP would improve the budget balance by around 0.5% of GDP. Or, looked at another way, a £10 billion increase in GDP will improve the budget balance by around £5 billion.

There are several ways to arrive at these figures, including relatively sophisticated econometric studies. But you can also get there by simply looking at the shares of tax revenues and welfare spending in GDP and rounding up to allow for fiscal drag (where rising incomes pull more tax payers into higher tax bands).

Again, there are reasons why export-led growth might have a more or less favourable impact than other sources. On the upside, the effective tax rates for exporting firms could be higher than for those selling to home markets, to the extent that they are more productive and pay higher wages. However, a large part of the tax liability may fall on domestic firms in supply chains.

On the downside, export-led growth may help the public finances a little less than growth led by domestic spending simply because taxes on the consumption of exports will be collected by overseas governments, rather than our own. (Indeed, even the revenue from customs duties on imports are currently treated as EU taxes, though this will of course change after Brexit.)

Erring on the conservative side, we shall assume that each £10 billion of export-led growth will improve the budget balance by £4 billion, rather than the £5 billion that might apply to domestic demand.

Pulling all this together, a 10% increase in gross exports, leading to an 8% increase in net exports, might boost GDP by £50 billion and improve the annual budget balance by as much as £20 billion. To put this in context, the OBR has forecast that the overall budget deficit (public sector net borrowing) will be around £37 billion in 2018/19, and still around £22bn in 2022/23.

Indeed, even a balanced increase in trade, where exports and imports rise by the same amount, may have a positive impact on the public finances. This follows from the fact that increased openness in trade is strongly associated with an increase in GDP.

For example, Frankel and Rose estimated in 2000 that a one percentage point increase in trade openness (defined as the sum of imports and exports, divided by GDP) was associated with an increase of 0.33% in per capita incomes. More recent studies, summarised by HM Treasury, have shown similar results.

Applying this to our illustrative example, a 10% increase in both exports and imports would raise the trade openness of the UK by around six percentage points (from 61% to 67%, based on the combined trade in goods and services as share of GDP over the last four quarters).

Even if we assume that a one percentage point increase in trade openness boosts per capita incomes by just 0.2% (on the basis that the UK economy is already much more open than it used to be), this implies a boost to GDP of 1.2% (6*0.2%), or around £25 billion. In turn, this could produce a dividend to the public finances of around half that, say £12 billion.

In summary, this note has provided some ballpark numbers for the fiscal benefits of an increase in exports, or even simply a balanced increase in both exports and imports. I would welcome any comments, particularly about the methodology and assumptions used, but at first sight there is indeed a lot to play for here.

Julian Jessop is an independent economist with over thirty years of experience gained in the public sector, City and consultancy, including senior positions at HM Treasury, HSBC, Standard Chartered Bank and Capital Economics. He was Chief Economist and Head of the Brexit Unit at the IEA until December 2018 and continues to support our work, especially schools outreach, on a pro bono basis.


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