Making social science accessible

14 Jun 2023

UK-EU Relations

Utilising the latest econometric tools, Jun Du and Oleksandr Shepotylo attribute the UK’s recent poor relative economic performance to the EU-UK Trade and Cooperation Agreement (TCA). 

Global trade has been impacted by an unprecedented pandemic, increased geopolitical tensions, the energy crisis caused by Russia’s war on Ukraine and market volatility. These factors have had an impact across all top trading countries – but the UK has been additionally affected by new barriers to trade with its largest trading partner: the EU.

The missed global trade boom

The pandemic highlighted vulnerabilities in global supply chains, but firms have adjusted to better manage risk and build more resilience. After the sharp decline in the early months of the pandemic, global trade volumes have recovered – with global goods trade growing 30% between 2019 and 2020.

Yet, this growth in trade seems to have largely bypassed the UK. Only focusing on trade in goods, for the same three-year period, UK export growth was negligible (see figure below). Services did better, with 11% growth in export value in 2021 compared to 2019.

Interestingly, Germany and France – two major EU economies and top trading partners with the UK – also performed below the world average. Meanwhile, other EU countries which trade less with the UK, such as Belgium and Poland, demonstrate above-average growth rates.

Asia and Pacific regions, including China, Vietnam, Australia, Malaysia, and India, have also shown above-average growth rates, with Russia being able to capitalize on soaring energy prices.

Overall, the global economy has shown strong recovery in demand in early 2022. The US, Turkey, and Switzerland were among the world leaders in imports growth, with Europe trailing behind and the UK at the bottom of the pile.

The Trade and Cooperation Agreement

In our new research we attribute the UK’s poor relative economic performance to the impact of the EU-UK Trade and Cooperation Agreement (TCA) implemented in January 2021. The TCA kept trade between the EU and UK tariff and quota free but was less effective at preventing non-tariff measures (NTMs) from increasing.

Unlike tariffs, which are a straightforward tax on imported goods, NTMs can be more complex and take many forms, including regulations, standards, technical requirements, licensing requirements, and quotas. They can affect trade in various ways. For example, sanitary and health standards may boost consumer demand, while at the same time increasing the cost of production. This may lead to either an increase or reduction in trade, depending on which effect is stronger.

So, what role did the TCA play in the slowdown of the UK trade? In recent years, the UK economy has experienced turbulence on multiple fronts, including from COVID-19, geopolitical instability and the knock-on effects of trade disputes between China, the EU and US. Given this, it is hard to disentangle the impact of the TCA from other factors.

However, recent advancements in the field of econometrics give us the tools to establish how implementation of the TCA affected UK trade. Using what is known as the ‘synthetic difference-in-differences method’, we compare UK trade performance to a weighted average of other economies, constructed so that the ‘synthetic’ UK broadly tracks UK trade performance pre-Brexit. The difference between the UK’s trade performance and that of the synthetic UK since January 2021 represents our estimate of the impact of Brexit. The estimates measure the Brexit effect on UK trade, isolating other factors, such as COVID-19, global value chain disruptions, and inflation.

It becomes clear that the post-Brexit export challenges have persisted beyond the initial teething period. Our research finds the UK exporting to the EU by 22.1% less and importing form the EU by 9.5% less than it would have been if the UK did not leave the EU (see figure below).

When we further investigate the impact of Brexit on the variety of traded products, we find an estimated loss of 20-42% of product varieties in UK’s export basket over the 15 months since the start of 2021 (see below below).

The decline is likely to be disproportionally large among small, resource-constrained firms who exported single products or a limited range of products, and that exported less intensively relative to the overall sales. At the same time, we find signs of increased concentration of export values to fewer products and fewer exporters. This will worsen the ‘happy few’ phenomenon in the UK, where a small number of top exporters account for a large share of total exports.

This is concerning for the UK’s future trade and productivity. Many small businesses find it no longer viable to trade with the EU given the prohibitively high costs of doing so. Many of them locate in less prosperous regions where advanced manufacturing and engineering sectors cluster.

Ways forward

The reality faced by the UK is that it is harder to trade with the EU. This is a world of ‘global value chains’ (GVCs), where the production and distribution of goods and services involves a complex series of activities that cross-national borders.

A GVC typically involves multiple firms, located in different countries, that are involved in different stages of production, from research and development to design, manufacturing, assembly, marketing, and distribution. Production is fragmented and requires sending goods along supply chains that cross multiple borders, each time facing tariffs and NTMs. For the UK, this means more costly trade with the rest of the world when the EU is part of the chain in question.

Some barriers will become less obstructive in time (such as border disruptions), while other barriers are likely to stay (customs duties and levies, for example). This is assuming though that there isn’t further regulatory divergence with the EU.

Recognising that this is the case is an important first step. It is critical to support businesses – especially small ones – to be international rather than turning inwards.

The UK government has sought to counter these trade impacts by removing uncertainty and reducing trade barriers. The new ‘Windsor Framework’ is expected to mitigate to some extent the negative impact of the Northern Ireland Protocol.

Most recently, the UK government has signed the UK and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which will make it easier to trade with eleven countries located around the Pacific Ocean, including Australia, Canada, and Japan. This follows earlier deals with Australia and New Zealand.

A trade deal with India later this year could be a key step to boosting trade with commonwealth countries.

Yet, this may not be sufficient to fully compensate for leaving the EU, at least for the foreseeable future. The major challenge remains reducing new barriers to EU-UK trade and keeping value chains between the EU and UK live and competitive.

By Jun Du, Professor of Economics, and Oleksandr Shepotylo, Senior Lecturer, Aston Business School

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