An Analysis Of UK’s Trade Pattern And Comparative Advantage

Background and Framework of UK’s Trade

David Ricardo proposed the theory of comparative advantage to address the problem arose from the most fundamental trade theory of absolute cost advantage. The theory suggests that one country enjoys a comparative advantage over other when it faces a comparatively lower opportunity cost. It is then mutually beneficial for both countries to specialize in goods following the principle of comparative advantage (Levchenko and Zhang 2016). The report focuses on trade pattern of United Kingdom. It tries to investigate whether the trade pattern in UK follows the theory of comparative advantage. In today’s world, countries engage in both visible and invisible trade. The gain from trade depends on relative cost advantage and degree of specialization. The paper is organized as follows- background or motivation, research hypothesis, method and data, analysis and conclusion.

Long since United Kingdom has been involved in international trade. Trade accounts nearly half of the UK’s GDP. The external sector has accounted rapid growth in the last few years. The main exported goods of UK include machinery, automobiles, transport equipment, chemicals, electronic equipment and oil. One major area where UK enjoys a comparative advantage is in different services (Meyer 2017). Of the services that UK exports financial services constitute a lion share making positive contribution to the UK’s balance of trade. In fact, the service sector has enjoyed a surplus in the BOP account as against deficit in goods trade. The imported items of UK mainly include transport equipment, machines and food stuffs.

After discussing the UK’s trade background and basic trade framework the following hypotheses are framed.

Hypothesis 1

H₀₁: There is no statistically significant relation exists between real GDP and export

H_A1: A statistically significant relation exists between real GDP and export

Hypothesis 2

H₀₁: The mean trade balance from good is not significantly different from mean trade balance from services.

H_A1: The mean trade balance from service is greater than the mean trade balance from services.

In addition to the two main hypothesis, the others areas of interest of the research paper are whether any other trade pattern apart from comparative advantage exists in UK, major import and export partners and the associated trade policies.

The first hypothesis is about testing whether a statistically significant relation exists between net export and real GDP. In order to test this inference a regression analysis needs to be conducted using data analysis tool in excel. The second hypothesis is about where the trade balance from service sector is greater than that from goods sector. For this, independent two sample t test is conducted using excel software (Chatterjee and Hadi 2015). To address other areas of research graphs and charts are made in excel and the obtained results are evaluated in context of UK economy.

Hypotheses Testing

Data

For the designed research quantitative data are collected from different official website for the last sixteen years (2001- 2016). Data are collected on different indicators like real GDP, export and import, trade balance and others. The entire research is based on quantitative data analysis.

Table 1: UK’s trade summary in 2016

The table above represents a brief summary of export and import volume of UK in 2016. Export in UK worth nearly 4,11,463 million USD. The total number of exported items are 4501. The worth of import during the same year was 6,36,368. The number of imported items exceed that of imported items. This lead to a deficit in overall balance of trade.

UK participated in trade of both goods and services. The trade of goods refers to as visible trade while trade of service is commonly known as invisible trade.

The figure above shows that overtime UK has success increased proportion of export volume as compared to import volume.

As shown from the figure, the major categories of export are motor cars and auto parts, gold, medicament, turbo jet, petroleum oil and other related product. Machine and transport equipment constitute largest share of UK export with the share being 39.2%. The next two important categories of export are manufactured items and chemicals with respective share being 14.0% and 16.6%.

The major export markets of UK are in United States, Germany, France, Netherland and Ireland. Among these countries, United State captures the highest share.

The import pattern of UK reveals a surprising pattern. The imported items mainly have the items that are exported. In the imported group, the higher weightage is on motorcars and auto parts, Gold, Petroleum items, medicament, electrical and others. This kind of trade pattern is known is intra-industry trade where country exchanges goods belong to similar industry (Michaely and Wajnryt 2017). UK though have a comparative advantage in manufactured items but still it imports manufactured and transport equipment of some other kind not produced within the nation.

For imported items, UK mainly relies on Germany, China, United States, Netherland and France. Germany has the highest share among all other partners.

Coming to the service sector, UK has a comparative advantage in financial service. A strong financial service sector need high qualification of the labor force, strong capital base, sufficient knowledge of English and efficient training and skill program (Corley 2017). UK has all these characteristics and hence, enjoys a comparative advantage in financial services.

Import and Export Partners and Other Trade Patterns

In the service sector export, financial service constitutes the highest share. The other exported service of UK includes business service, travel and transport, insurance, license fees and others.

There are two specific reasons behind UK’s comparative advantage over most of developed nations. The first crucial fact is that UK focuses on a relatively small number of subsectors as compared to highly industrialized nations focusing on different sub sectors. The comparative advantage of Germany reveals that the nation enjoys a higher comparative advantage in a comparatively large number of subsectors (Valero 2017). Similar is the case for other contemporary economies such as France, Japan, Italy, Canada and USA. The greater concentration on just few sectors brings greater efficiency.

In computation of GDP, exports earnings play an important role. The higher export earning meaning a higher GDP and vice-versa. This economic intuition is examined by using regression statistics. The regression result is given below

Table 2: Summary of Regression Result

The regression result shows an estimated value of multiple R square as 0.80. This mean export can explain 80 percent variation in GDP. The co-efficient of export is 2.90. A positive value of co-efficient implies a direct relation between GDP and export value. For 1 percent change in the value of export, GDP changes by 2.9 percent. However, in order to validate this result, the co-efficient should pass the test of statistical significance. The p value for the estimated co-efficient is 0.0001. The probability value less than the significant value of 0.05 indicates the rejection of null hypothesis of no relation between GDP and export. Therefore, export in UK is a statistically significant determinants of UK GDP. This validates the theory of comparative advantage that countries are better off by involving in trade.

As observed from basic trade framework of UK, the nation has a relatively higher comparative advantage in service production. Therefore, as per Ricardo’s theory of comparative advantage trade of service should give UK a greater benefit than trade of goods. This leads to the second hypothesis of the research paper. A t test is performed to test equality of means between goods and service trade balance. The t test result is summarized below

Table 3: Result of t test

The p value of one tail t test is less than significance value of 0.05. This implies a rejection of null hypothesis of equal mean between the two groups. The acceptance of alternative hypothesis indicates the mean trade balance for service sector is significantly higher than that from trade of goods.

The theory of comparative advantage suggests countries always gain from engaging in trade. Therefore, countries should support free trade policies. In UK, trade accounts for a significant share in GDP. The findings give result consistent with the trade theory. Overtime, UK has reduced the tariff rate as much possible and settle the tariff rate around 2 percent  (Eichengreen 2018).

Conclusion

The paper discusses the comparative advantage theory with particular focus on UK economy.UK ranks second in terms of participation in international trade. UK though engages in trade of both goods and service, service trade appears to be more profitable. UK enjoyed a surplus in service trade balance as against a deficit from trade of goods. United States, Germany, China, France and Ireland are some of the major trading partners of UK. UK mainly export manufactured goods, auto parts, transport equipment, gold and medicament. More or less similar category of goods are imported as well. The service export of UK in include financial and business service, transportation, insurance, loyalty and fees and other service. UK has always given priority to free trade and reduces the trade barriers as low as possible.

Reference list 

Chatterjee, S. and Hadi, A.S., 2015. Regression analysis by example. John Wiley & Sons.

Corley, T.A.B., 2017. The British pharmaceutical industry since 1851. In The Pharmaceutical Industry (pp. 14-32). Routledge.

Eichengreen, B., 2018. Trade Policy and the Macroeconomy. IMF Economic Review, pp.1-20.

Levchenko, A.A. and Zhang, J., 2016. The evolution of comparative advantage: Measurement and welfare implications. Journal of Monetary Economics, 78, pp.96-111.

Meyer, F.V., 2017. International trade policy (Vol. 14). Routledge.

Michaely, M. and Wajnryt, D., 2017. Intra-Industry, Intra-Product, and Inter-Product Trade. Global Economy Journal, 17(3).

Valero, A., 2017. The UK’s New Industrial Strategy (No. 038). Centre for Economic Performance, LSE.

Atlas.media.mit.edu. (2018). OEC – United Kingdom (GBR) Exports, Imports, and Trade Partners. [online] Available at: https://atlas.media.mit.edu/en/profile/country/gbr/ [Accessed 31 Mar. 2018].

Data.worldbank.org. (2018). Tariff rate, applied, simple mean, all products (%) | Data. [online] Available at: https://data.worldbank.org/indicator/TM.TAX.MRCH.SM.AR.ZS?locations=GB [Accessed 31 Mar. 2018].

Michaelides, L. and Blake, C. (2018). Exports and imports statistics by country for UK trade in services – Office for National Statistics. [online] Ons.gov.uk. Available at: https://www.ons.gov.uk/businessindustryandtrade/internationaltrade/bulletins/exportsandimportsstatisticsbycountryforuktradeinservices/quarter2aprtojun2017 [Accessed 31 Mar. 2018].

Stat.wto.org. (2018). Trade Profiles. [online] Available at: https://stat.wto.org/CountryProfile/WSDBCountryPFView.aspx?Country=GB&Language=S [Accessed 31 Mar. 2018].

Wits.worldbank.org. (2018). United Kingdom Trade Statistics | WITS. [online] Available at: https://wits.worldbank.org/CountryProfile/en/GBR [Accessed 31 Mar. 2018]

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