15 December 2020

Michael Gasiorek is Professor of Economics at the University of Sussex and Director of the UK Trade Policy Observatory. Nicolo Tamberi is a Research Assistant in Economics for the UK Trade Policy Observatory. 

There has rightly been much talk recently about the disruption and economic damage that would result from a No Deal Brexit, and hence the economic importance of avoiding this outcome. This is on top of the economic havoc being wreaked by the Coronavirus pandemic. Despite this, we have seen the Prime Minister suggesting that No Deal would be a ‘good outcome’ for the UK and that the UK would prosper. How can this be squared?

If we focus on the economic outcomes, the short answer is that it cannot be squared. A No Deal outcome, in particular, one at this late stage will directly lead to higher costs, higher prices, lower competitiveness and job losses. There will almost certainly be immediate effects in terms of disruptions at the ports, queues of lorries, possible shortages of some goods, and short-term price hikes for others. Over the subsequent few months, some of these issues will no doubt get resolved as businesses, processes and procedures adjust.

However, longer-term, for an economy for which trade accounts for over 60% of GDP, increasing barriers on nearly half of that trade cannot but lead to negative economic consequences. Our latest economic simulations, based on the detailed modelling of 148 industries (10 agricultural, 122 manufacturing sectors, and 16 services sectors) suggest that the impact could reduce aggregate output in the UK economy of the order of 2.5% if we consider the direct costs of increased barriers, and 5.0% if we also consider the impact on intermediate input costs for firms which makes them less competitive both internationally and domestically.

This has all been said before by us (the UKTPO), and by numerous other studies.[1]  Nevertheless, it is worth restating and reinforcing. To those that argue that a deal is at least as, if not more important to the EU, it is worth noting that the aggregate impact on EU output from these changes in barriers is -0.8%.

These negative impacts on the UK come from the increased barriers on both exports and on imports. These barriers arise from the introduction of tariffs (due to leaving the Customs Union), and from the higher costs associated with regulatory compliance (due to leaving the Single Market) and also because of the increased bureaucracy and paperwork required to export to the EU and the associated border formalities. For UK exports this makes businesses less competitive in the EU, reduces sales and impacts on profits. The simulations suggest that exports may decline by more than 16%. For UK workers this translates into job losses.

For UK imports the increase in barriers between the UK and the EU raises domestic price – and this is bad news for consumers and for firms buying imported intermediates. Prices rise in all of the 148 sectors modelled, and the (unweighted) average change in prices is over 4.5%. The higher barriers to imports do ‘protect’ some UK sectors and businesses – because it is harder for EU firms to access the UK market, and this may offset the losses from the increased barriers on UK exports. Industries which might see output increase include, for example, some food processing sectors, and some wood and timber products.

However, with regard to imports from January 1^st 2021, the UK will also be applying its ‘global tariff’ on imports from all countries with whom it trades on WTO terms. In comparison to the existing tariff (which is currently the EU’s tariff), this means that the share of imports on which the UK charges no tariffs has increased from 52% to 70%, and others have also been slightly reduced. This reduction in tariffs will offset some of the increase in domestic prices arising from the increase in UK-EU barriers. The net effect on output in any given industry will depend on the balance between the increase in costs of importing from the EU, the decrease in tariffs on imports from the rest of the world and the impact on their exports. On balance we find that output declines in 124 of the 148 sectors – which highlights the impact on businesses of decreased access to the EU market.

How much difference would getting agreement on a deal make?

Here it is important to note that the deal that is possibly close to being negotiated is a relatively ‘hard Brexit’ – leaving the Customs Union, leaving the Single Market, with probably a minimal agreement on services, and not much generosity with regard to rules of origin. It would therefore be a mistake to think that a deal would constitute a significant economic success for the UK. Indeed, we find that output declines by 3.7%, exports go down by 12%, and the average increase in prices is still over 3%. In comparison to ‘No Deal’ this outcome is clearly better. But in comparison to where we are now – the UK economy will still be somewhat worse off.

There is not much to be positive and optimistic about here. Free trade deals with other countries such as the US, or Australia may mitigate some of these effects a little – but only a little. Not only that, the results described here only consider the impact of changes in the costs on final and intermediate goods trade. We have not taken into account any longer run changes on investment, on migration flows, nor on the composition of the workforce. In this regard, No Deal will certainly have a much bigger negative impact and will make it harder to deal with future challenges such as the UK’s productivity problem, or achieving net-zero emissions which will depend on international coordination and exchange.

So, in what sense could ‘No Deal’ be a good outcome for the UK? You won’t find the answer by looking at the economic consequences.

Footnotes

[1] See, for example: https://blogs.sussex.ac.uk/uktpo/publications/deal-or-no-deal-the-economic-consequences-of-the-uks-no-deal-tariffs/, or https://blogs.sussex.ac.uk/uktpo/publications/brexit-and-global-value-chains-no-deal-is-still-costly/

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