A major shift in policy.
The UK’s decision to leave the European Union (EU) represents the largest shift in the UK’s economic policy in a generation. As noted in the Government’s white paper, the UK’s exit from the EU will mean exiting the single market, and most likely from the Customs Union. This will leave the UK free to negotiate trade agreements with other nations and to manage policy in areas such as migration and business regulation.
The UK economy will change as a result with implications for businesses across the UK and beyond. Understanding these changes will be a major challenge for businesses in the coming years. I previously wrote about how investors appear to perceive the initial impact of Brexit on the UK and this blog takes a more speculative long-term view of how changes to trade might impact the UK economy. I will continue to return to these themes as more data emerges on the actual performance of the UK economy.
…with significant implications for business…
The exit negotiations and any new Free Trade Agreements (FTA) will lead to changes in the costs of trade, which will reshape its flows to and from the UK. Changes to the costs of trade will affect businesses directly through their costs and relative competitiveness, and indirectly through the complex interactions in domestic and global supply chains. Although Article 50 negotiations may take two years to conclude, businesses need to start now to understand and plan for a range of risks and outcomes. For example, many businesses have an operational need to enter supply chain contracts that go beyond the two year negotiation period for the UK’s exit. Therefore there is an urgent need to understand and quantify the impacts – which sectors will be affected and by how much – under different scenarios, e.g. under WTO trade rules or new FTA.
For businesses forward planning for the UK’s future outside the EU, there are operational and strategic needs to understand the impacts of this seismic shift in the UK’s trading relationships:
- Operational – to identify risks and uncertainties, give confidence to enter into new forward-looking contracts where there is more certainty of outcome, and to form strategies to deal with the impacts.
- Strategic – sound and credible analysis can be used to engage with governments over the shape of trade deals.
…creating winners and losers…
Alternative future trading scenarios will impact the sectoral composition of the UK economy. It is likely that some sectors will gain, while others will lose out and this will impact the behaviour of customers, partners and suppliers in the market.
At EY, through our International Trade, Economics and Policy unit (ITEP), we have started to model the impact of changes to the UK’s trading relationships to help inform corporate thinking. This first assessment considers how potential trade deals with both the EU and the United States (US) might impact UK businesses. The analysis is based on the application of changes in tariff and non-tariff barriers (NTBs) to import and export flows, to provide an indication of how different sectors of the economy may be impacted by these structural changes in the barriers to trade.
We focus solely on changes in the costs of trade – i.e. tariffs and NTBs – without considering changes in other areas such as labour mobility, taxes and the regulatory environment. This is to allow us to isolate the impact of alternative future trade arrangements. We aim to extend our analysis over time to incorporate these additional effects.
…across different scenarios…
We have considered two trade scenarios which we compare to the baseline:
- Baseline: Tariff and non-tariff barriers (NTBs) to trade remain at their 2016 levels;
- Hard Brexit: The EU imposes common external tariff rates on imports from the UK and the UK responds in kind, applying equivalent rates to imports to the UK from the EU; and
- Brexit with US trade deal: As for Hard Brexit, but the UK negotiates a free trade agreement with the US, which reduces tariffs to zero and NTBs to the fullest extent possible.
Scenarios for changes in UK trade relationships
…with clear and differentiated impacts…
- The overall changes to the costs of trade could be the largest in food and drink manufacturing, textiles & wood products, chemicals & pharmaceuticals, and machinery & transport equipment. The pattern of changes to the costs of trade is broadly the same under the two scenarios considered – Hard Brexit, and Brexit + US trade deal.
- These projected changes in export and import prices are much larger in the food and drink manufacturing sector than in other sectors, with a particularly steep increase expected in the price of food and drink imports (which are predominantly sourced from the EU) at least until the economy is able to adjust.
Impact of disruption on GVA by sector (£Billion)
Overall, our modelling suggests that the machinery and transport and chemicals and pharmaceuticals sectors will suffer the largest reductions in output compared to the baseline. Most sectors are smaller, although there are a few gainers (sectors that use similar inputs to the highly disrupted sectors, so are now able to expand production). The sectoral pattern of winners and losers is very similar under both the Hard Brexit and US trade deal scenarios, but the latter does significantly moderate the overall impact on total trade and GDP.
The differential impacts on different sectors of the economy depend upon:
- how industries interact in their supply chains – i.e. the proportion of intermediate goods used in other production, and the share of output that is used for investment in the economy;
- the exposure of each sector to trade – i.e. the share of exports and imports in total production;
- the sensitivity of demand to changes in incomes and prices – in particular total food and drink demand is relatively insensitive to changes in incomes and prices, which means that domestic production is more likely to replace lost imports.
These drivers highlight the inevitable uncertainties in analysis of this type, such as the structure of the economy (how resources are used to produce goods and services) and the responsiveness of demand to price changes. Nevertheless we can begin to highlight broad trends and as more data and information emerges as the UK moves towards Brexit, we can refine the analysis.
…that merit corporate attention.
The impact of Brexit and future UK trade deals is complex to predict. Our analysis suggests that the impact will vary by sector as a result of inherent characteristics and differences in capabilities across countries. It is important that businesses understand their relative position and the likely impact of alternative scenarios. This will enable them to make the most appropriate strategic moves and also to ensure they are able to seek to influence policy in the right direction. Nothing is fixed with Brexit and the winners are likely to be those businesses that identify and execute the right moves to optimise their future positions.