What trading on WTO terms alone really means for Britain

Even without the chaos of ‘no deal’, trading only on WTO terms post Brexit would mean substantial disruption to supply chains, with new tariffs, regulatory barriers and customs checks applying on day one of Brexit, explains Richard Barfield. Three sectors with the most jobs at risk are administration and support services, wholesale trade, and legal and accounting services.

Brexit has put trade at the centre of the national debate in the UK for the first time since the early 1970s. It is not surprising that many politicians and commentators are finding it difficult to deal with the trade issues. As an unexpected by-product, Brexit has reminded citizens in the EU27 of the benefits of EU membership.

Forty years of integration with the European economy

My recent report “UK trade and the World Trade Organisation” explains the UK’s trade position after Brexit and the trade implications of the departure from the European Union. Trade is the heartbeat of any economy. Healthy trade signifies a healthy economy which creates jobs and funds public services. Seven to eight million UK jobs depend on international trade. If trade falls, the economy and jobs suffer.

UK trade benefits from over 40 years of investing in integrating the UK into the world’s largest, virtually friction-free market. According to the Institute for Fiscal Studies, the value of EU membership to the UK runs at about 4% of Gross Domestic Product (GDP) – that is £80 billion a year (or nine times the UK’s annual net contribution to the EU). In 2017, imports and exports were worth £1.26 trillion. Half of that trade was with the EU27.

To succeed, international trade must overcome many barriers such as different cultures, languages, and legal systems. The most obvious physical barrier is distance, which introduces transportation costs and delays. As a result, most countries conduct most of their trade with their neighbours – in both goods and services. At least 68% (over £850 billion) of UK trade is EU-related:

• 49% (£615 billion) of UK trade was with the EU27
• 7% (£86 billion) with the European Free Trade Association member states, UK Crown Dependencies and Gibraltar.
• 12% (£156 billion) of UK trade was with “third countries” with EU trade agreements (including Turkey and Russia as well as more distant countries like Singapore, Canada and Japan)

The EU is also in the process of negotiating agreements with other UK trading partners that account for a further 10% of UK trade.

The UK trade ecosystem is complex:  imports and exports are inter-twined. Exports of manufactured products in sectors like automotive, food and pharmaceuticals depend on imports of intermediate components and raw materials. UK services and goods depend on each other, for example, restaurants, hotels, and supermarkets depend on food manufacturing. Service sectors are often linked, for example financial services and professional services depend on each other.

Brexit increases trade barriers, which will impede the UK’s EU-related trade. New tariffs, customs and regulatory barriers mean UK exports to the EU will suffer, and imports from the EU will become more expensive. This twin-pronged attack will reduce UK competitiveness putting jobs and livelihoods at risk and will discourage investment in UK-EU trade. Non-tariff barriers are potentially much more expensive than tariffs, ranging by sector under a WTO scenario from 5% to over 20% compared to a post-Brexit WTO weighted-average tariff of around 5% on UK-EU goods trade.

Small and medium-sized UK-based companies that trade with the EU will be particularly vulnerable as they lack the capacity to absorb new Brexit-related costs. The paper includes some real-life SME case studies.

Benefits outweighed by costs

Against these risks, Brexit could bring some benefits to trade. These include new trade deals with other countries such as Australia and the potential to reduce regulation in the UK. However, the regulatory and trade opportunities are unspecified and uncertain, and the UK government believes that the benefits to trade of Brexit are likely to be much smaller than the costs. International trade deals, which are complex and wide-ranging, take several years to negotiate, and the UK is not always at the front of the queue.  For example, Australia and India have prioritised negotiating their agreements with the EU before the UK.

By international standards for developed countries, the UK is relatively lightly regulated which means that the opportunities to benefit from reducing regulation are limited.  As the EU is the UK’s major trading partner by far, the UK economy benefits from following EU rules and standards (with or without Brexit). This limits trade-related regulatory change and makes a trade deal with the US unlikely, because US regulatory standards diverge from those of the EU. The government will also find it challenging politically to reduce regulations such as food standards, workers’ rights or environmental standards.

Long-run estimates of economic impacts are useful to rank Brexit options and compare the consequences. As a rule of thumb a long-run 1% drop in overall UK exports is equivalent to a 0.2% to 0.3% drop in UK GDP, which translates into a similar effect on long-run employment.

The impacts on UK jobs are bounded by two extremes: an orderly ‘Basic World Trade Organisation’ option which introduces the highest barriers to trade and the European Economic Area (EEA) option (like Norway) the lowest.  A UK-EU FTA (such as Canada +) and the Chequers proposal fall between these two boundaries.

Even without the chaos of ‘no deal’, the Basic WTO option would mean substantial disruption to supply chains, with new tariffs, regulatory barriers and customs checks applying on day one of Brexit.  An FTA would be a small step up from Basic WTO, while Chequers would create near frictionless trade in goods but do little for services. Canada+ would do more for services but less for goods than Chequers (because it has no customs union dimension) but would fall a long way short of Single Market membership and require a hard border on the island of Ireland.

The Basic WTO option would reduce employment by the equivalent of 0.8 million to 1.3

million jobs (assuming wages and productivity remain unchanged).  Even the EEA option is expected to have a material impact on exports, with an employment effect equivalent to the loss of over 0.3 million jobs. This flows principally from the UK’s proposed exit from the EU Customs Union. This affects trade in goods, particularly in relation to UK-EU integrated supply chains. There is then a knock-on effect to services trade associated with goods.

Note that these are job losses relating to trade effects. Other Brexit factors cause higher losses in full-blown economic impact studies.

The paper drills the trade effects down to UK sectors and regions, drawing on other studies:

• Sectors that will bear most of the costs of Brexit due to trade effects are financial services; automotive; agriculture, food and drink; consumer goods; and, chemicals and plastics. The three sectors with the most jobs at risk are administration and support services, wholesale trade, and legal and accounting services.
• The regions expected to be most at risk from trade effects are Cumbria, Hampshire, Herefordshire, Gloucestershire, Lancashire, Leicestershire, East Riding/North Lincolnshire, Warwickshire and Wiltshire.
• Regions with a high proportion of EU exports in the most vulnerable goods sectors include Northern Ireland and Cornwall (food, live animals and manufactures), Northumberland, Tees Valley and Durham (chemicals, machinery and transport equipment) and East Wales (manufactures, machinery and transport equipment).

Job losses from Brexit will not be limited to the UK. In the EU27, Ireland is particularly at risk as well as regions in Germany, the Netherlands and Belgium.

The Brexit option that would limit Brexit trade barriers to a minimum would be an EEA arrangement combined with a customs arrangement.

The high-level estimates in the report show the very serious consequences of Brexit for trade and jobs. As the Withdrawal Agreement is finalised, the future UK-EU trading relationship needs to be defined clearly before the UK leaves the EU in order to assess the implications of Brexit for the UK — sector by sector and region by region – and for the EU27.

The populist Brexit movement won the 2016 referendum by appealing to emotions, but may now run the risk of being destroyed by anger over the prospect of lost jobs.

 

Richard Barfield is founder of Richard Barfield Advisory Services. He is author of the report UK trade and the World Trade Organisation – A Brexit briefing for non-specialists.