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?
Donald Trump has threatened to pull out of the World Trade Organization. ‘If they don’t shape up, I would withdraw from the WTO,’ he said. He argues that the USA is being treated very badly by the WTO and that the organisation needs to ‘change its ways’.
Historically, the USA has done relatively well compared with other countries in trade disputes brought to the WTO. However, President Trump does not like being bound by an international organisation which prohibits the unilateral imposition of tariffs that are not in direct retaliation against a trade violation by other countries. Such tariffs have been imposed by the Trump administration on steel and aluminium imports. This has led to retaliatory tariffs on US imports by the EU, China and Canada – something that is permitted under WTO rules.
Whether or not the USA does withdraw from the WTO, Trump’s threats bring into question the power of the WTO and other countries’ compliance with WTO rules. With the rise in protectionist sentiments around the world, the power of the WTO would seem to be on the wane.
Even if the USA does not withdraw from the WTO, it is succeeding in weakening the organisation. Appeals cases have to be heard by an ‘appellate body’, consisting of at least three judges drawn from a list of seven, each elected for four years. But the USA has the power to block new appointees – and has done so. As Larry Elliott states in the first article below:
The list of judges is already down to four and will be down to the minimum of three when the Mauritian member, Shree Baboo Chekitan Servansing, retires at the end of September. Two more members will go by the end of next year, at which point the appeals process will come to a halt.
This raises the question of the implication of a ‘no-deal’ Brexit – something that seems more likely as the UK struggles to reach a trade agreement with the EU. Leaving without a deal would mean ‘reverting to WTO rules’. But if these rules are being ignored by powerful countries such as the USA and possibly China, and if the appeals procedure has ground to a halt, this could leave the UK without the safety net of international trade rules. Outside the EU – the world’s most powerful trade bloc – the UK could find itself having to accept poor trade terms with the USA and other large countries.
- Explain the WTO’s ‘Most-favoured-nation (MFN)’ clause. How would this affect trade deals between the UK and the EU?
- Would the trade deals that the EU has negotiated with other countries, such as Japan, be available to the UK after leaving the EU?
- Demonstrate how, according to the law of comparative advantage, all countries can gain from trade.
- In what ways is the USA likely to gain and lose from the imposition of tariffs on steel and aluminium?
- How could a country that supports free trade ever support the imposition of tariffs?
- Why are tariffs not the most serious restriction on trade?
A paper by three University of Sussex academics has just been published by the university’s UK Trade Policy Observatory (UKTPO). It looks at possible trade relations between the UK and the EU post Brexit. It identifies four key government objectives or constraints – what the authors call ‘red lines’ – and five possible types of trade arrangement with the EU.
The four red lines the authors identify are:
||Limitations on the movement of people/labour;
||An independent trade policy;
||No compulsory budgetary contribution to the EU;
||Legal oversight by UK courts only and not by the European Court of Justice.
Just how tight each of these four constraints should be is a matter for debate and political decision. For example, how extensive the limitations on the movement of labour should be and whether or not there should be any ‘voluntary’ budgetary contributions to the EU are issues where there is scope for negotiation.
Alongside these constraints is the objective of continuing to have as much access to and influence over the Single Market as possible.
The five possible types of trade arrangement with the EU identified in the paper are as follows:
||Full Customs Union (CU) with the EU-27
||Partial Customs Union with EU (based on EU-Turkey CU)
||Free Trade Area (FTA) with access to the Single Market (European Economic Area)
||Free Trade Area without automatic access to Single Market
||Reversion to World Trade Organisation (WTO) Most Favoured Nation (MFN) terms
To clarify the terminology: a free trade area (FTA) is simply an agreement whereby member countries have no tariff barriers between themselves but individually can choose the tariffs they impose on imports from non-member countries; a customs union is a free trade area where all members impose common tariffs on imports from non-member countries and individual members are thus prevented from negotiating separate trade deals with non-member countries; membership of the European Economic Area requires accepting freedom of movement of labour and compulsory contributions to the EU budget; WTO Most Favoured Nation rules would involve the UK trading with the EU but with tariffs equal to the most favourable ones granted to other countries outside the EU and EEA.
The red lines would rule out the UK being part of the customs union or the EEA. Although WTO membership would not breach any of the red lines, the imposition of tariffs against UK exports would be damaging. So the option that seems most appealing to many ‘Brexiteers’ is to have a free trade area agreement with the EU and negotiate separate trade deals with other countries.
But even if a tariff-free arrangement were negotiated with the EU, there would still be constraints imposed on UK companies exporting to the EU: goods exported to the EU would have to meet various standards. But this would constrain the UK’s ability to negotiate trade deals with other countries, which might demand separate standards.
The paper and The Economist article explore these constraints and policy alternatives and come to the conclusion that there is no easy solution. The option that looks the best “from the UK government’s point of view and given its red lines, would be an FTA with a variety of special sectoral arrangements”.
Brexit means…a lot of complex trade decisions The Economist, Buttonwood’s notebook (15/11/16)
UK–EU Trade Relations post Brexit: Too Many Red Lines? UK Trade Policy observatory (UKTPO), Briefing Paper No. 5, Michael Gasiorek, Peter Holmes and Jim Rollo (November 2016)
- Explain the difference between a free trade area, a customs union and a single market.
- Go through each of the four red lines identified in the paper and consider what flexibility there might be in meeting them.
- What problems would there be in operating a free trade agreement with the EU while separately pursuing trade deals with other countries?
- What is meant by ‘mutual recognition’ and what is its significance in setting common standards in the Single Market?
- What problems are likely to arise in protecting the interests of the UK’s service-sector exports in a post-Brexit environment?
- What does the EU mean by ‘cherry picking’ in terms of trade arrangements? How might the EU’s attitudes in this regard constrain UK policy?
- Does the paper’s analysis suggest that a ‘hard Brexit’ is inevitable?