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Geopolitics & Security

Three Years On, Brexit Casts a Long Shadow Over the UK Economy

Commentary3rd February 2023

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When Britain left the European Union on 31 January 2020, Boris Johnson, then prime minister, proclaimed that Britain would “rediscover the muscles that we have not used for decades”. Three years after a rupture in its economic ties with Europe, the country appears anything but muscular. Britain has the lowest growth rate among G7 countries and the IMF forecasts that it will be the only leading economy to shrink this year. While Brexit is not the only reason behind the economic underperformance, it is an important factor.

Here are six charts that tell us what Brexit has meant for the British economy to date.

1. The Brexit hit to trade has been significant and may have occurred more quickly than previously assumed

Britain’s trade has been hit significantly by its departure from the single market. Trade in goods with the EU fell sharply after the Brexit transition period ended, with UK imports from the EU dropping by approximately 25 per cent more than UK imports from the rest of the world, a trend which persisted throughout 2021. A recent revision to the official trade data (marked as “EU adjusted” in the chart below) has shown a slight uplift in imports compared to previous data, but the EU imports are still shown to have underperformed the non-EU ones.

This analysis is consistent with other studies showing that the short-term shortfall in imports after leaving the EU has ranged between 14 to 25 per cent, with that of exports around 6 per cent. This would imply that the short-term trade hit has been greater than forecast before and after the referendum.

The asymmetry in the impacts on imports and exports likely demonstrates the complexity of supply chains, with trade in intermediate goods being affected more rapidly due to the expectation of future trade barriers. Indeed, the full scale of trade barriers is yet to be seen because the UK government has delayed the introduction of most border checks on EU products. In the meantime, this has also put UK businesses at a competitive disadvantage compared with EU ones.

Even more concerning is a recent Bank of England analysis showing that trade with the EU may be even weaker than implied by the official data. The Bank’s Monetary Policy Committee – which sets the official interest rate – has concluded that these sharp impacts would imply that the productivity hit from Brexit may have taken effect more quickly than previously assumed.

Figure 1

Source: TBI analysis of ONS data

2. Britain’s trade openness has fallen more than has been seen in other comparable economies since Brexit

The UK economy is now less open to trade than before Brexit. Trade openness – measured as the ratio of trade relative to gross domestic product – has fallen by 8 percentage points between 2019 and 2021, driven by a sharp fall in trade with the EU. Undoubtedly, the pandemic adversely affected trade for the UK as it did for other economies, but the UK’s drop is at least 3 percentage points greater than comparable countries, suggesting that Brexit is one of the main drivers of this underperformance.

Figure 2

Source: TBI analysis of OECD data (Note. Percentage point changes in trade-to-GDP ratio. Data for the US only available until 2020)

3. The red tape faced by British businesses is at a record high

Higher costs of trade can be seen not only in the aggregate data, but also in the paperwork faced by British businesses following Brexit.

Customs-export declarations that businesses must fill in when moving goods from the UK more than tripled after the UK left the single market and customs union, while import declarations have increased by 50 per cent during this time. This is an unprecedented increase in the red tape facing businesses. Not only does this raise the cost of trade – disadvantaging smaller firms that cannot absorb extra costs – but it ultimately contributes to higher consumer prices.

Figure 3

Source: HMRC Customs declaration volumes for international trade in goods in 2021, published July 2022

4. The post-Brexit investment levels are over 30 per cent lower than the pre-referendum trend

Trade is not the only casualty of Brexit. The decision to leave the EU has fuelled significant uncertainty since the 2016 referendum, undermining business investment in the UK economy. Although business investment in Britain had been growing steadily since the 2009 financial crisis, this trend was abruptly interrupted precisely at the time of the 2016 referendum. Business investment in the UK is 31 per cent below the pre-referendum trend. In the EU, by contrast, business investment is currently 2 per cent above its pre-2016 trend.

Not all this difference can be attributed to Brexit, not least because Covid has affected countries differently. Studies trying to identify the effects of Brexit on investment have found that the mean estimated shortfall is 19 per cent – almost double the average forecast.

Figure 4

Source: TBI calculations using ONS and Eurostat data

5. Britain’s overall economic performance today is worse than forecast before and after the 2016 referendum

When comparing latest estimates with the forecasts before and after the 2016 referendum, our analysis shows that the economic hit from Brexit has been greater than forecast on all but one indicator – the exports of goods. The actual GDP hit is more than double the mean forecast, vindicating those who were accused of fearmongering by Brexiteers.

The UK economy is estimated to be 5.5 per cent poorer now than it would have been had it stayed in the EU, according to a study by the Centre for European Reform that compares the UK’s current performance with a counterfactual UK that did not leave the EU. Imports and exports of goods have been hit significantly and so was investment. It is estimated that, had the UK stayed in the EU, tax revenues would have been about £40 billion higher than today.

Figure 5

Source: TBI analysis of published evidence and forecasts

6. The freedom to make trade deals has made no difference so far

Before and after the referendum, Brexiteers argued that the costs of leaving the EU would be offset by newfound freedom to make trade deals with other countries. Since leaving the EU, the UK has replicated most trade agreements signed as a member of the EU, but it has negotiated and agreed only two new trade deals – with Australia and New Zealand – and a new digital trade deal with Singapore.

At the start of 2023, the share of UK trade covered by free trade agreements (FTAs) is 61 per cent, expected to rise to 62 per cent after the agreements with Australia and New Zealand come into effect. The overall share has fallen from 64 per cent in 2019 when the UK was inside the EU. Not only does this mean that the share of trade covered by FTAs has regressed in recent years, but also that the UK government has missed its target of 80 per cent of all UK trade being covered by free trade agreements by the end of 2022.

Even if the UK were to successfully complete the ongoing negotiations to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and a deal with India, that would only contribute 0.4 per cent and 1.5 per cent, respectively, to the target. Negotiating a deal with the US – representing 16.8 per cent of UK trade – is on hold because the Biden administration decided to pause negotiations. In other words, there is no plausible scenario under which Britain can achieve its 80 per cent target in the foreseeable future.

Figure 6

Source: TBI analysis of ONS and Department of International Trade data

7. The dividends from regulatory autonomy remain elusive

Regulatory autonomy has been seen as a prize from pursuing a threadbare trade agreement with the EU. Some reforms have been completed by the government and others are in the pipeline. The UK has set up a new domestic subsidy-control regime, replacing EU state-aid rules with looser requirements. In financial services, the UK chancellor has recently announced a package of reforms seeking to rewrite regulations for parts of the sector such as the Solvency II insurance rules. At the same time, in a sign that regulatory competition in financial services is the new normal, European regulators have been trying to lure traders who had previously serviced EU markets from the UK to relocate fully to the continent.

Despite these reforms, what is becoming evident is a trade-off between regulatory change and costs to business. The greater the regulatory divergence with the EU, the higher the costs that businesses face – especially in the sectors closely integrated into the European markets. Perhaps unsurprisingly, the government has delayed the introduction of various new legislative changes, such as the implementation of a new UK product standard (the UKCA) that replaces the EU-wide CE marking, new veterinary-certification requirements and also various post-Brexit authorisation deadlines for sectors such as chemicals.

What next for post-Brexit Britain?

It is true that the British economy was hit by the forces of the pandemic and global inflationary pressures. Disentangling those impacts from Brexit is not straightforward. But the decision to leave the EU single market has irrefutably led to new trade barriers, contributed to higher consumer prices and made the economy less open globally.

In all this, Brexit has exposed and exacerbated the underlying weaknesses in the British economy – low productivity, low business investment, falling global competitiveness and, perhaps most strikingly, an absence of strategy from the government to tackle these problems.

The promise of post-Brexit dividends has not materialised. As our recent polling demonstrated, voters acknowledge the impacts of Brexit and overwhelmingly support a closer economic relationship with the EU. What they do not want, for most part, is to revive old battles that have created a collective trauma for the public as well as the British state.

It is time for Britain’s political leaders to acknowledge the pain that Brexit is causing more openly and seek to improve the trade arrangement with the EU. If they cannot do so, Britain’s economic malaise will over time become even more chronic than today.

Lead Image: Getty Images


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