There have been many analyses of the economic effects of Brexit, both before the referendum and at various times since, including analyses of the effects of the deal negotiated by Theresa May’s government and the EU. But with the prospect of a no-deal Brexit on 31 October under the new Boris Johnson government, attention has turned to the effects of leaving the EU without a deal.
There have been two major analyses recently of the likely effects of a no-deal Brexit – one by the International Monetary Fund (IMF) and one by the Office for Budget Responsibility (OBR).
The first was in April by the IMF as part of its 6-monthly World Economic Outlook. In Scenario Box 1.1. ‘A No-Deal Brexit’ on page 28 of Chapter 1, the IMF looked at two possible scenarios.
Scenario A assumes no border disruptions and a relatively small increase in UK sovereign and corporate spreads. Scenario B incorporates significant border disruptions that increase import costs for UK firms and households (and to a lesser extent for the European Union) and a more severe tightening in financial conditions.
Under both scenarios, UK exports to the EU and UK imports from the EU revert to WTO rules. As a result, tariffs are imposed by mid-2020 or earlier. Non-tariff barriers rise at first but are gradually reduced over time. Most free-trade arrangements between the EU and other countries are initially unavailable to the UK (see the blog EU strikes major trade deals) but both scenarios assume that ‘new trade agreements are secured after two years, and on terms similar to those currently in place.’
Both scenarios also assume a reduction in net immigration from the EU of 25 000 per year until 2030. Both assume a rise in corporate and government bond rates, reflecting greater uncertainty, with the effect being greater in Scenario B. Both assume a relaxing of monetary and fiscal policy in response to downward pressures on the economy.
The IMF analysis shows a negative impact on UK GDP, with the economy falling into recession in late 2019 and in 2020. This is the result of higher trade costs and reduced business investment caused by a poorer economic outlook and increased uncertainty. By 2021, even under Scenario A, GDP is approximately 3.5% lower than it would have been if the UK had left the EU with the negotiated deal. For the rest of the EU, GDP is around 0.5% lower, although the effect varies considerably from country to country.
The IMF analysis makes optimistic assumptions, such as the UK being able to negotiate new trade deals with non-EU countries to replace those lost by leaving. More pessimistic assumptions would lead to greater costs.
Building on the analysis of the IMF, the Office for Budget Responsibility considered the effect of a no-deal Brexit on the public finances in its biennial Fiscal risks report, published on 17 July 2019. This argues that, under the relatively benign Scenario A assumptions of the IMF, the lower GDP would result in annual public-sector net borrowing (PSNB) rising. By 2021/22, if the UK had left with the deal negotiated with the EU, PSNB would have been around £18bn. A no-deal Brexit would push this up to around £51bn.
According to the OBR, the contributors to this rise in public-sector net borrowing of around £33bn are:
- A fall in income tax and national insurance receipts of around £16.5bn per year because of lower incomes.
- A fall in corporation tax and expenditure taxes, such as VAT, excise duties and stamp duty of around £22.5bn per year because of lower expenditure.
- A fall in capital taxes, such as inheritance tax and capital gains tax of around £10bn per year because of a fall in asset prices.
- These are offset to a small degree by a rise in customs duties (around £10bn) because of the imposition of tariffs and by lower debt repayments (of around £6bn) because of the Bank of England having to reduce interest rates.
The rise in PSNB would constrain the government’s ability to use fiscal policy to boost the economy and to engage in the large-scale capital projects advocated by Boris Johnson while making the substantial tax cuts he is proposing. A less optimistic set of assumptions would, of course, lead to a bigger rise in PSNB, which would further constrain fiscal policy.
- What are the assumptions of the IMF World Economic Outlook forecasts for the effects of a no-deal Brexit? Do you agree with these assumptions? Explain.
- What are the assumptions of the analysis of a no-deal Brexit on the public finances in the OBR’s Fiscal risks report? Do you agree with these assumptions? Explain.
- What is the difference between forecasts and analyses of outcomes?
- For what reasons might growth over the next few years be higher than in the IMF forecasts under either scenario?
- For what reasons might growth over the next few years be lower than in the IMF forecasts under either scenario?
- For what reasons might public-sector net borrowing (PSNB) over the next few years be lower than in the OBR forecast?
- For what reasons might PSNB over the next few years be higher than in the OBR forecast?
The EU has recently signed two trade deals after many years of negotiations. The first is with Mercosur, the South American trading and economic co-operation organisation, currently consisting of Brazil, Argentina, Uruguay and Paraguay – a region of over 260m people. The second is with Vietnam, which should result in tariff reductions of 99% of traded goods. This is the first deal of its kind with a developing country in Asia. These deals follow a recent landmark deal with Japan.
At a time when protectionism is on the rise, with the USA involved in trade disputes with a number of countries, such as China and the EU, deals to cut tariffs and other trade restrictions are seen as a positive development by those arguing that freer trade results in a net gain to the participants. The law of comparative advantage suggests that trade allows countries to consume beyond their production possibility curves. What is more, the competition experienced through increased trade can lead to greater efficiency and product development.
It is estimated that the deal with Mercosur could result in a saving of some €4bn per annum in tariffs on EU exports.
But although there is a net economic gain from greater trade, some sectors will lose as consumers switch to cheaper imports. Thus the agricultural sector in many parts of the EU is worried about cheaper food imports from South America. What is more, increased trade could have detrimental environmental impacts. For example, greater imports of beef from Brazil into the EU could result in more Amazonian forest being cut down to graze cattle.
But provided environmental externalities are internalised within trade deals and provided economies are given time to adjust to changing demand patterns, such large-scale trade deals can be of significant benefit to the participants. In the case of the EU–Mercosur agreement, according to the EU Reporter article, it:
…upholds the highest standards of food safety and consumer protection, as well as the precautionary principle for food safety and environmental rules and contains specific commitments on labour rights and environmental protection, including the implementation of the Paris climate agreement and related enforcement rules.
The size of the EU market and its economic power puts it in a strong position to get the best trade deals for its member states. As EU Trade Commissioner, Cecilia Malmström stated:
Over the past few years the EU has consolidated its position as the global leader in open and sustainable trade. Agreements with 15 countries have entered into force since 2014, notably with Canada and Japan. This agreement adds four more countries to our impressive roster of trade allies.
Outside the EU, the UK will have less power to negotiate similar deals.
- Draw a diagram to illustrate the gains for a previously closed economy from engaging in trade by specialising in products in which it has a comparative advantage.
- Distinguish between trade creation and trade diversion from a trade deal with another country or group of countries.
- Which sectors in the EU and which sectors in the Mercosur countries and Vietnam are likely to benefit the most from the respective trade deals?
- Which sectors in the EU and which sectors in the Mercosur countries and Vietnam are likely to lose from the respective trade deals?
- Are the EU–Mercosur and the EU–Vietnam trade deals likely to lead to net trade creation or net trade diversion?
- What are the potential environmental dangers from a trade deal between the EU and Mercosur? To what extent have these dangers been addressed in the recent draft agreement?
- Will the UK benefit from the EU’s trade deals with Mercosur and Vietnam?
On 21st February 2019, the Department for International Trade (DIT) published a document outlining the UK’s progress in negotiating new free trade agreements (FTAs) with a number of non-EU countries. It advises UK firms that FTAs with Turkey and Japan will not be finalised before the official exit day from the European Union – 29th March 2019. Many business groups expressed concern at this news.
The EU has successfully negotiated a number of FTAs. These deals enable all 28 states in the European Union Custom Union (EU-CU), including the UK, to trade at preferential (i.e. lower) tariffs with over 70 non-EU countries. These include Canada, South Korea, Mexico, Israel, Norway, South Africa and Turkey. Research by the CBI estimates that UK exports to these countries were approximately £41bn in 2017 – approximately 13 per cent of all UK exports. In July 2018, the EU signed its largest ever FTA – with Japan. This deal covers 635 million people.
If the UK leaves the European Union without a deal on the 29th March, then it immediately loses membership of the EU-CU. Preferential tariffs will no longer apply to trade between the UK and the non-EU countries which signed the FTAs. Without any new arrangements in place, tariffs and quotas will revert to the non-preferential (i.e. higher) rates outlined in registered schedules with the World Trade Organization.
Given the economic significance of this trade, the UK government has spent the past two years trying to negotiate new FTAs to replace those previously agreed by the EU. For example, on February 11th, the government announced that it had signed a ‘continuity agreement’ with Switzerland covering trade worth £32bn per year. Deals have also been finalised with Chile, Israel, and the Faroe Islands that replicate the terms of the EU agreements. However, government officials informed 30 business groups in early February that it was highly unlikely that most of the new replacement FTAs would be concluded in time for March 29th.
The document published by the DIT on the 21st February confirms this position and describes the current status of most of the new FTAs as:
For both Japan and Turkey, the outlook is more negative. The guidance states:
We will not transition this agreement for exit day.
The head of EU negotiations at the CBI commented that:
We are really concerned that firms could be blindsided by this.
The government stated that it would significantly increase the resources devoted to the trade negotiations and expected to sign more deals over the next couple of weeks.
If the UK leaves the EU on the 29th March with a deal, then it remains in the EU-CU during the 21-month transition period. Trade will still be covered by the 40 existing EU deals. This gives UK officials until the end of December 2020 to conclude a new set of FTAs.
- Using a demand and supply diagram, illustrate the impact of tariffs on imported goods.
- The EU is perhaps the most famous example of a customs union. Find out some other examples.
- Discuss some of the potential disadvantages of free trade.
- Discuss some of the advantages and disadvantages of the UK remaining in the European Union Custom Union.
- What is a ‘registered schedule’ at the World Trade Organization?
One of the key questions about Brexit is its effect on UK trade and cross-border investment. Once outside the customs union, will the freedom to negotiate trade deals lead to an increase in UK exports and GDP, as many who support Brexit claim; or will the increased frictions in trade with the EU, and the need to negotiate new trade deals with those non-EU countries which already have trade deals with the EU, lead to a fall in exports and in GDP?
Also, how will trade restrictions or new trade deals affect capital flows? Will there be an increase in inward investment or a flight of investment to the EU or elsewhere? Will many companies relocate away from the UK – or to it?
Although there has been a cost up to now from the Brexit vote, in terms of a depreciation in sterling and a fall in inward investment (see the first article below), the future effects have been hard to predict as the terms on which the UK will leave the EU have been unclear. However, with a draft withdrawal agreement between the EU and the UK government having been reached, the costs and benefits are becoming clearer. But there is still uncertainty about just what the effects on trade and investment will be.
- First, the 585-page draft withdrawal agreement is not a trade deal. It contains details of UK payments to the EU, commitments on the rights of EU and UK citizens and confirmation of the transition period – initially until 31 December 2020, but possibly extended with mutual agreement. During the transition agreement, the UK would remain a member of the customs union and single market and remain subject to rulings of the European Court of Justice. The withdrawal agreement also provides for a continuation of the customs union beyond the transition period, if no long-term trade agreement is in place. This is to prevent he need for a hard border between Ireland and Northern Ireland.
- Second, there is merely a 26-page ‘political declaration‘ about future trade relations. Negotiations on the details of these can only begin once the UK has left the EU, scheduled for 29 March 2019. So it’s still unclear about just how free trade in both goods and services will be between the UK and the EU and how freely capital and labour will move between them. But with the UK outside the single market, there will be some limitations on trade and factor movements – some frictions.
- Third, it is not clear whether the UK Parliament will agree to the withdrawal agreement. Currently, it seems as if a majority of MPs is in favour of rejecting it. If this happens, will the UK leave without an agreement, with trade based on WTO terms? Or will the EU be prepared to renegotiate it – something it currently says it will not do? Or will the issue be put back to the electorate in the form of a People’s vote (see also), which might contain the option of seeking to remain in the EU?
So, without knowing just what the UK’s future trade relations will be with (a) the EU, (b) non-EU countries which have negotiated trade deals with the EU, (c) other countries without trade deals with the EU, it is impossible to quantify the costs and benefits from the effects on trade and investment. However, the consensus among economists is still that there will be a net cost in terms of lost trade and inward investment.
Such as view is backed by a government analysis of various Brexit scenarios, released in time for the House of Commons vote on 11 December. This concludes that the UK will be worse off under all Brexit alternatives compared with staying in the EU. The main brake on growth will be frictions in trade from tariff and non-tariff barriers.
This analysis was supported by a Bank of England paper which modelled various scenarios based on assumptions about different types of Brexit deal. While recognising the inherent uncertainty in some of the empirical relationships, it still concluded that Brexit would be likely to have a net negative effect. The size of this negative effect would depend on the closeness of the new relationship between the UK and EU, the degree of preparedness across firms and critical infrastructure, and how other policies respond.
- Identify the main economic advantages and disadvantages for the UK from leaving the EU?
- How does the law of comparative advantage relate to the question of the relative trade gains from leaving and remaining in the EU?
- What is the difference between the following models of relationship with the EU: the Switzerland model; the Norway model; the Turkey model; the Canada (plus or plus, plus) model; trading on WTO terms?
- Why is the consensus among economists that there will be a net economic cost from leaving the EU, no matter on what terms?
- Is the UK likely to achieve more favourable trade deals with non-EU countries as an independent country or as a member of the EU benefiting from EU-negotiated trade deals with such countries?
An agreement in principle was reached on September 30 between the USA, Canada and Mexico over a new trade deal to replace the North American Free Trade Agreement (NAFTA). President Trump had described NAFTA as ‘the worst trade deal maybe ever signed anywhere, but certainly ever signed in this country.’ The new deal, named the United States-Mexico-Canada Agreement, or USMCA, is the result of 14 months of negotiations, which have often been fractious. A provisional bilateral agreement was made between the USA and Mexico in August. At the same time, President Trump threatened a trade war with Canada if it did not reach a trade agreement with the USA (and Mexico). The new USMCA must be ratified by lawmakers in all three countries before it can come into force. This could take a few months.
So is USMCA a radical departure from NAFTA? Does the USA stand to gain substantially, as President Trump claims? In fact, USMCA is little different from NAFTA. It could best be described as a relatively modest reworking of NAFTA. So what are the changes?
The first change affects the car industry. From 2020, 75% of the components of any vehicle crossing between the USA and Canada or Mexico must be made within one or more of the three countries to qualify for tariff-free treatment. The aim is to boost production within the region. But the main change here is merely an increase in the proportion from the current 62.5%.
A more significant change affecting the car industry concerns wages. Between 40% and 45% of a vehicle’s components must be made by workers earning at least US$16 per hour. This is some three times more than the average wage currently earned by Mexican car workers. Although it will benefit such workers, it will reduce Mexico’s competitive advantage and could hence lead to some diversion of production away from Mexico. Also, it could push up the price of cars.
The agreement has also strengthened various standards inadequately covered in NAFTA. According to The Conversation article:
The new agreement includes stronger protections for patents and trademarks in areas such as biotech, financial services and domain names – all of which have advanced considerably over the past quarter century. It also contains new provisions governing the expansion of digital trade and investment in innovative products and services.
Separately, negotiators agreed to update labor and environmental standards, which were not central to the 1994 accord and are now typical in modern trade agreements. Examples include enforcing a minimum wage for autoworkers, stricter environmental standards for Mexican trucks and lots of new rules on fishing to protect marine life.
Another area where the USMCA agreement has made changes concerns trade in dairy products. This particularly affects Canada, which has agreed to allow more US dairy products tariff-free into Canada (see the CNN article at the end of the list of articles below). New higher quotas will give US dairy farmers access to 3.6% of Canada’s dairy market. They will still pay tariffs on dairy exports to Canada that exceed the quotas, ranging from 200% to 300%.
The other significant change for consumers in Mexico and Canada is a rise in the value of duty-free imports they can bring in from the USA, including online transactions. As the first BBC article listed below states:
The new agreement raises duty-free shopping limits to $100 to enter Mexico and C$150 ($115) to enter Canada without facing import duties – well above the $50 previously allowed in Mexico and C$20 permitted by Canada. That’s good news for online shoppers in Mexico and Canada – as well as shipping firms and e-commerce companies, especially giants like Amazon.
Despite these changes, USMCA is very similar to NAFTA. It is still a preferential trade deal between the three countries, but certainly not a completely free trade deal – but nor was NAFTA.
And for the time being, US tariffs on Mexican and Canadian steel and aluminium imports remain in place. Perhaps, with the conclusion of the USMCA agreement, the Trump administration will now, as promised, consider lifting these tariffs.
- USMCA, the new trade deal between the US, Canada, and Mexico, explained
Vox, Jen Kirby (2/10/18)
- USMCA: What Donald Trump’s Nafta replacement trade deal means and how it will work
Independent, Mythili Sampathkumar (2/10/18)
- USMCA trade deal: Who gets what from ‘new Nafta’?
BBC News, Jessica Murphy & Natalie Sherman (1/10/18)
- Can Trump really cut the US trade deficit?
BBC News, Andrew Walker (2/10/18)
- How is ‘new NAFTA’ different? A trade expert explains
The Conversation, Amanda M. Countryman (2/10/18)
- Was NAFTA ‘worst trade deal ever’? Few agree
PolitiFact, Jon Greenberg (29/9/18)
- NAFTA out, USMCA in: What’s in the Canada, Mexico, US trade deal?
Aljazeera, Heather Gies (2/10/18)
- Mexico boosted by US-Canada agreement on revamped Nafta deal
Financial Times, Jude Webber (3/10/18)
- Nafta Is Dead. Long Live Nafta.
- Trump Clears Deck for China Trade War With New Nafta Deal
Bloomberg, Rich Miller, Andrew Mayeda and Jenny Leonard (2/10/18)
- Fact check: Is Trump right that the new trade deal is “biggest” ever?
CBS News (2/10/18)
- Commentary: What Trump’s new trade pact signals about China
Reuters, Andres Martinez (4/10/18)
- Canada opened its dairy market. But by how much?
CNN, Katie Lobosco (2/10/18)
- What have been the chief gains and losses for the USA from USMCA?
- What have been the chief gains and losses for Mexico from USMCA?
- What have been the chief gains and losses for Canada from USMCA?
- What are the economic gains from free trade?
- Why might a group of countries prefer a preferential trade deal with various restrictions on trade rather than a completely free trade deal between them?
- Distinguish between trade creation and trade diversion.
- In what areas, if any, might USMCA result in trade diversion?
- If the imposition of tariffs results in a net loss from a decline in trade, why might it be in the interests of a country such as the USA to impose tariffs?