Archive for the ‘Economics of Brexit’ Category

EU trade is just as important to the UK as it was in 2016. Why?

Has EU trade become less important to the UK since the referendum? Thomas Sampson (LSE) finds it has not. He discusses why this might be the case and whether COVID-19 could be the trigger for more UK firms to permanently shift away from trading with the EU, concluding that the Brexit trade shock is yet to come.

Economists predict that Brexit will lead to the UK being poorer in the long run than if it had remained in the EU. Although the models used to reach this conclusion are complex, most forecasts depend upon the same economic logic. New trade barriers between the UK and the EU will lead to lower trade, resulting in income losses through higher prices and less efficient production.

rotterdam
Rondvaart port, Rotterdam. Photo: Boris Doesborg via a CC-BY-NC-SA 2.0 licence

This reasoning delivers a simple testable prediction: Brexit will cause the UK’s trade with the EU to fall relative to its trade with the rest of the world. For example, analysis of Boris Johnson’s Brexit proposals by UK in a Changing Europe forecasts that UK-EU trade will fall by approximately one-third, whereas total UK trade will only drop by around 13 percent.

Although Brexit has already occurred, trade barriers between the UK and EU will not change until the end of the transition period. Consequently, it is too soon to evaluate the forecasts. Indeed, most economists expect it will take 10-15 years for the full economic consequences of Brexit to be realised. But economic decisions are forward looking, and there is evidence that the Brexit vote has already hurt the UK economy through slower GDP growth, higher inflation and reduced investment.

This makes now a good time to examine whether Brexit has already affected the geography of UK trade. After crunching the data up until the end of 2019, my conclusion is that it has not. I have found no evidence that Brexit has reduced the EU’s importance in UK trade since the referendum.

Some initial support for this conclusion can be seen in the first figure below, which shows the share of UK goods trade with the EU. After excluding precious metals from the data, the EU accounts for just under half of UK exports and around 55 percent of imports. (Because the UK is a hub in the international gold market, trade in non-monetary gold sometimes distorts UK trade statistics. Stripping precious metals from the data sidesteps this problem.) But the main message of this figure is that the EU’s share of both exports and imports has remained stable since the 2016 referendum.

The same is true for services trade, as shown in the next figure. Both before and after the referendum the EU accounts for approximately 40 percent of UK services exports and around 48 percent of services imports. There is certainly no evidence in either the goods or services data of a dramatic shift away from trade with the EU.

These figures are striking, but could be misleading. Other factors that affect UK trade patterns, such as differences in GDP growth across countries, might be hiding the effects of Brexit. Interpreted correctly, the prediction of trade models is not that Brexit will reduce the EU’s share of UK trade compared to its pre-referendum value, but compared to a hypothetical world where the UK voted to remain.

We cannot know for certain what would have happened to UK trade following a Remain vote, but allowing for changes in UK trade due to factors other than Brexit points to the same conclusion as the naïve analysis above. For example, the next figure shows changes in UK goods trade with the EU versus the rest of the world controlling for factors that affect overall trade levels by country. For each year from 2012-19, the blue diamonds are estimates of the level of UK-EU trade compared to UK-rest of world trade (with 2015 as the baseline year) after accounting for growth in each country’s import demand and export supply. The vertical lines indicate the 95 percent confidence interval for each estimate.
The figure shows that UK-EU trade grew more quickly than the UK’s trade with the rest of the world between 2014 and 2015. However, since the referendum there is no sign of either a negative or a positive Brexit effect on UK-EU trade.

Another way to look for a Brexit effect is to ask whether UK trade with the EU has grown more slowly since 2016 in industries that may face higher trade barriers following Brexit. Again, the answer is no. Using either the EU’s most-favoured nation tariffs or counts of EU non-tariff measures as proxies for potential post-Brexit trade barriers, I find no evidence that UK-EU goods trade has grown more slowly since the referendum in high barrier products.

In summary, both simple data on the EU’s share of UK trade and more sophisticated empirical analysis imply that Brexit has not shifted UK trade away from the EU so far. What does this teach us? One possibility is that the models are wrong and Brexit will not reduce UK-EU trade flows. As an author of the Centre for Economic Performance’s Brexit analysis I am not a disinterested observer, but I think this possibility is unlikely. The trade models used to study Brexit are based on extensive research showing that tariffs and non-tariff barriers reduce trade and that the single market has increased trade among EU member states. There is no reason to expect that Brexit will buck this trend.

An alternative explanation is that, faced with uncertainty over when Brexit would occur and what form it would take, most firms have chosen to maintain their existing trade patterns while waiting to learn what Brexit means. Though plausible, this reasoning does not explain all firms’ behaviour. 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.

More work is needed to reconcile these firm-level findings with the aggregate evidence presented above. It is possible that, so far, Brexit has only destroyed low value trading relationships, while leaving the large firms that dominate aggregate trade unaffected. If true, this hypothesis raises the question of when larger firms’ trade will be affected by Brexit. And the question of whether trade disruptions caused by COVID-19 could be the trigger for more UK firms to permanently shift away from trading with the EU. In which case, the COVID-19 crisis could accelerate changes in UK trade patterns due to Brexit.

For policy makers, the results discussed in this blog can be viewed as showing the glass is either half full or half empty. For the optimists, there is evidence that UK-EU trade has proven resilient so far. For the pessimists, it shows that the full economic costs of Brexit are yet to materialise. Moreover, trade adjustment often generates costs that are more concentrated, more disruptive and therefore more liable to provoke political opposition than the gradual slowdown in growth and increase in the cost of living that followed the referendum. There is more pain to come.

Notes

Formally, Figure 3 plots coefficient estimates from a regression of log bilateral trade on the interaction of year dummy variables with a dummy for UK-EU trade controlling for exporter-importer, exporter-year and importer-year fixed effects. Data for 2012-19 is from IMF Direction of Trade Statistics as reported by the importer and the sample is restricted to countries with a population greater than 1 million. Standard errors are clustered by exporter-importer. Estimating separate effects for UK imports and UK exports gives similar results.

The analysis of whether UK trade with the EU has grown more slowly since 2016 in industries that may face higher trading barriers post-Brexit uses WITS data at the HS 6 digit level on UK exports and imports, average EU most-favoured nation (MFN) tariffs and counts of non-tariff measures applied by the EU. I find that for products with higher MFN tariffs or subject to more non-tariff measures in 2015, UK trade growth with the EU compared to non-EU countries is not slower following the referendum than before the referendum. Details available upon request.

This post represents the views of the author and not those of the Brexit blog, nor LSE.

Chilly, with a touch of Frost: 22 May Brexit update

The relationship between Michel Barnier and David Frost is growing terser than ever, write Ros Taylor and Roch Dunin-Wąsowicz (LSE). Meanwhile, with unemployment rising rapidly, Britons are being encouraged to pick fruit and veg in exchange for the minimum wage and schooling for their children.

How are the talks going? Badly. Briefly: no deal looks likelier than ever.

frost
Photo: Conal Gallagher via a CC BY-2.0 licence

James Forsyth offers this insight:

After Michel Barnier’s despairing announcement last Friday setting out how little progress had been made, both sides have dug in. Chief UK negotiator David Frost said the EU’s approach was ‘perplexing’ and wanted to know why it was “insisting on additional, unbalanced, and unprecedented provisions in a range of areas, as a precondition for agreement between us”. The documents setting out the UK’s aspirations reiterate that

Whatever happens, the Government will not negotiate any arrangement in which the UK does not have control of its own laws and political life. That means that we will not agree to any obligations for our laws to be aligned with the EU’s, or for the EU’s institutions, including the Court of Justice, to have any jurisdiction in the UK.

Barnier’s reply to Frost:

I share your commitment to helping the process move forward together. I do not think,
however, that an exchange of letters regarding the substance of the negotiations is
necessarily the best way to discuss on substantial points. It cannot be a substitute for
serious engagement and detailed negotiations and, in particular, I would not like the tone
that you have taken to impact the mutual trust and constructive attitude that is essential
between us.

‘The sense of urgency around these negotiations is increasing,’ says the BBC’s Chris Morris. However, Sam Lowe thought some progress had been made when the UK admitted that there would be new admin requirements for GB-NI trade. Meanwhile, the UK has launched its ‘Global Tariff‘ to replace the EU’s External Tariff, which scraps what it calls ‘nuisance tariffs’ of less than 2% and simplifies others. Tariffs on meat and cars remain, to protect British industry. Others, such as tampons, dishwashers, screwdrivers, ground thyme, mirrors and Christmas trees have been scrapped altogether.

The Bruges Group is pleased:

COVID-19 is a reminder of how deeply the UK’s food security is dependent on the EU

Prior to and since the June 2016 referendum, the politics of Brexit has been accompanied by two recurrent (and seemingly contradictory) narratives: first, the narrative of Brexit as ‘taking back control’ for those voters ‘left behind’ by the twin forces of globalisation and multiculturalism; and second, the narrative of ‘Global Britain’ – that is, Brexit as an opportunity for the UK to reclaim its historical role as a champion of global free trade, unencumbered by the EU’s supposedly inward-looking, protectionist leanings. In this blog, Tony Heron (University of York) explores some of the tensions and contradictions between these two themes through the prism of food and agriculture – arguably the sector most defined by EU membership – in the midst of the Covid-19 pandemic. Simply put, what impact, if any, will the current crisis have on the political choices the government will be forced to confront in its trade negotiations with the EU and US.  

Covid-19 and the resilience of the UK food system

In 2008, the sight of Northern Rock customers queuing to withdraw their savings from the stricken highstreet bank became one of the first and – most enduring – images of the global financial crisis. Today, in the midst of the COVID-19 pandemic, the analogous imagery is provided not by banks but supermarkets with incidents of panic buying and hoarding by consumers worried about impending food shortages. Yet, unlike in 2008 with the banks, the food retail sector has shown itself to be surprisingly resilient in the face of the COVID-19 shock with supermarkets shelves, for the most part, remaining well-stocked.

The resilience shown by the UK food system in face of COVID-19 is both testament to the efficiency of global supply chains and a timely reminder of our dependence on the EU. Approximately 29% of the food consumed in the UK comes from the EU27 compared to just 4% each from the regions of Asia, Africa and the Americas. The UK’s reliance on the EU is especially acute in the horticulture sector, with approximately 40% of vegetables and 37% of fruit sold in the UK imported from the EU countries.

Brexit and the politics of food

Parallels are often made between Brexit and two other seismic episodes in British political history: the repeal of the Corn Laws (1846) and the Tariff Reform debate (1903-6). Like Brexit, these prior episodes are noted for the ways in which they divided the ruling Conservative Party between its nationalist-protectionist and metropolitan-liberal wings, ultimately leading to a formal rupture of the party in the first case and landslide electoral defeat in the second. These historical comparisons are also relevant for the ways in which each episode involved the politicisation of food. In an election poster from 1905, for instance, the strapline read: ‘we plead for the women and children, which will you have? Free trade or protection?’ The two choices were represented in the poster as two loaves of bread, a large ‘free trade’ loaf and a considerably smaller ‘protection’ loaf. In other words, the humble loaf was designed to cut through the technical details of trade and comparative advantage to appeal directly to working-class voters as ‘citizen-consumers’.

In the present setting, the idea of a ‘Brexit dividend’ in the form of cheap food has been a constant theme of the pro-leave prospectus. It is notable, however, that relatively few in government have been willing to make the case for ‘cheap food’ explicitly. The possible exception to this is Liam Fox during his time at the Department for International Trade (DIT), though his pronouncements were usually oblique and highly coded. For instance, when in government, Fox was fond of saying that ‘there will be no lowering of UK food standards’.

Outside of government, the case for cheap food has largely fallen to right-wing think tanks like the Legatum Institute. Other voices, such as Tim Wetherspoon, the maverick chairman of the Wetherspoons pub chain, MP Jacob Rees Mogg and John Longworth, the former head of the British Chambers of Commerce and director of the Leave Means Leave lobby group, have reiterated the same message: that ‘Brexit means cheaper food’.

Although few of these voices have made the point explicit (though see Bottle et al. 2018), the implication of the ‘cheap food’ policy, if implemented, is that it would have hugely disruptive effects on British farming, which currently meet around half of the country’s food needs. As noted by Michael Gove while he was Environment Secretary, British farming is noted, not primarily for its international competitiveness but for its high standards and commitments to animal welfare. Pointedly, the speeches and pronouncements which Gove made during his tenure at DEFRA rarely, if ever, mentioned ‘cheap food’.

In a speech to the National Farmers Union (NFU) in November 2018, Gove spoke positively of increasing public scrutiny of the circumstances in which food is produced and the need to make healthy food choices. ‘This scrutiny’, Gove said, ‘only strengthens the hand of British farmers. A demand for higher standards, for more sustainable production, for high standards in animal welfare and more nutritious choices can only mean a demand for more high-quality British produce rather than the alternative’. Although Gove did not go on to elaborate on what the ‘alternative’ referred to precisely, we can infer he meant cheaper imported food, presumably produced to lower standards and with less concern for animal welfare or the environment.

What’s on the menu?

The government’s steadfast refusal to countenance an extension to the Brexit transition period, coupled with the relaunch of free trade talks with the US, is fueling speculation that Boris Johnson’s government is intent on radically transforming the UK’s model of political economy. Applying this logic to food and agriculture, Brexit provides an opportunity to leave the EU’s regulatory orbit, including the Common Agricultural Policy, so as to reclaim and re-design a UK food policy from scratch. Yet, COVID-19 is a stark reminder of just how deeply the nation’s food security is dependent on the EU.

More significantly than this, Boris Johnson’s government seems reluctant to actually make the argument for the radical shake-up of the agricultural sector. Indeed, if anything, protecting the UK’s farmers seems to be hardening into something close to a negotiating ‘red line’to the obvious disappointment of some Brexiteers. Of course, a more tumultuous outcome cannot be ruled out, especially given the (quite high) prospects of a disorderly Brexit in which the UK’s relatively weak bargaining position vis-a-vis the US and other potential trade partners would be further exposed. But, for now, it is perhaps best to follow the old adage: never order the cheapest dish on the menu.

This post represents the views of the author and not those of the Brexit blog, nor the LSE. Image by PhilafrenzyCreative Commons Attribution-ShareAlike 4.0 International.

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