Brexit is expected to make the UK poorer in the long run compared to remaining an EU member. Although the analysis used to reach this conclusion is complex, most forecasts depend upon the same economic logic. Brexit will create new trade barriers between the UK and the EU, leading to lower trade and causing income losses through higher prices and less efficient production.
This reasoning implies that Brexit will cause the UK’s trade with the EU to fall relative to its trade with the rest of the world. To date, there is little evidence this has occurred. Prior to the referendum, in 2015, UK exports of goods and services totalled £530 billion, of which 42% went to the EU.
In the same year, UK imported £557 billion of goods and services, with 53% coming from the EU. Fast forward to 2019 and not much had changed. The EU accounted for 43% of UK exports and 51% of UK imports.
Where are we now?
But perhaps this stasis should not come as a surprise. Trade barriers between the UK and EU did not change until the start of 2021. Faced with uncertainty over when Brexit would occur and what form it would take, firms may have chosen to maintain their existing trade patterns while waiting to learn what Brexit means. Consequently, it is too soon to evaluate the forecasts.
However, now that a trade deal has been reached, new trade arrangements are being implemented. The deal ensures that there will be no tariffs or quotas on UK-EU trade, but does not prevent the introduction of new non-tariff barriers.
Goods trade costs will increase due to customs red tape, border delays, rules of origin requirements and the need for products to satisfy different regulations and standards in the UK than the EU.
For services, which accounted for around one third of UK-EU trade in 2019, the increase in trade costs is likely to be even larger. Compared to membership of the EU’s single market, the trade deal does little to ensure market access in services.
Financial firms no longer have passporting rights to serve EU clients, there is no guarantee of mutual recognition of professional qualifications, labour mobility is severely restricted and firms will have to navigate a maze of country and sector specific regulations on service providers.
Where are we heading?
The full economic effects of Brexit will take a decade or more to materialise. But how UK and EU firms adapt to the trade deal should start to become apparent in the next few years, helping us to answer these five important questions.
First, how will Brexit affect the level of trade between the UK and the EU? There is already evidence that Brexit has caused some firms to stop trading with the EU in anticipation of future changes in trade policy.
Research by Crowley, Exton and Han using UK data and by Martin, Martinez and Mejean using French data finds that the Brexit vote has led to fewer trading relationships between UK and EU firms.
So far, it is likely that Brexit has only destroyed low value trading relationships, while leaving the large firms that dominate aggregate trade unaffected. But there is no guarantee this will continue to be the case.
Second, which sectors, regions and types of workers will be most affected by changing trade patterns? Trade adjustment often generates costs that fall disproportionately on small groups who lose market access or face increased competition.
We will soon learn which groups are worst hit by the new UK- EU trade relationship and, just as importantly, whether the plight of the losers provokes political opposition that erodes support for Brexit.
Third, which type of trade barriers matter most for UK-EU trade? The trade deal creates many new non-tariff barriers between the UK and EU. Quantifying the magnitude of these non-tariff barriers is challenging and there is substantial uncertainty over their relative importance. Studying how changes in trade depend upon which barriers are most prevalent in different sectors will provide new evidence on the origins of trade costs.
Fourth, how will Brexit affect UK productivity? UK productivity growth since the financial crisis has been anaemic, giving rise to what is called the UK productivity puzzle. Slow productivity growth reduces output leading to lower wages and living standards.
There is some evidence that raising trade barriers is bad for productivity, but the existence and size of this effect is controversial. Analysing productivity growth in firms that trade with the EU will shed light on whether, as many economists fear, Brexit will worsen the UK’s productivity crisis.
Fifth, how will Brexit affect the recovery from Covid-19? Lockdowns and reduced demand have reduced output and left many firms in financial trouble. Firms that are financially constrained or have staff on furlough will have less capacity to deal with changes in trade barriers.
Could Covid-19 accelerate Brexit-induced changes in UK trade patterns by causing some UK firms to permanently shift away from trading with the EU? Alternatively, will the short-run impact of Brexit be swamped by Covid-19? Careful, data-intensive research will be needed to disentangle the economic effects of Brexit from those of Covid-19.
After four and a half years of waiting, debating and speculating, the UK has finally left the EU’s single market and customs union. Because economic disintegration on this scale has no historical precedent, there is a great deal of uncertainty over what comes next for UK trade. For businesses this is a challenge, but for researchers it’s a learning opportunity.
By Dr Thomas Sampson, Associate Professor of Economics at the London School of Economics. This piece was taken from the Brexit and Beyond: Economy report, which is part of the Brexit and Beyond report.