Adverse Effects Of Brexit

The economic consequences of Brexit are overwhelmingly negative, estimate Swati Dhingra and Thomas Sampson (LSE). The more the UK distances itself from the EU’s economic institutions and policies, the greater will be the increase in trade barriers and the higher will be the costs of Brexit, they claim. This is the first of two blogs based on the CEP Election Analysis briefing on Brexit. It summarizes CEP research on the long-run economic effects of different forms of Brexit. The second blog will analyse how the referendum outcome has affected the UK economy so far.

Since the UK voted to leave the European Union in June 2016, Brexit has dominated UK politics and economic policy. Three and a half years after the referendum, the UK is yet to leave the EU, there is no certainty over if or when Brexit will take place, and the shape of future UK-EU relations is yet to be determined. Building on methods from earlier work on international trade, the CEP has developed a state-of-the-art model of international trade to analyse how Brexit will affect UK trade and living standards. This model has been used to study how different options for UK-EU trade relations after Brexit would affect the UK economy by analysing how changes in trade barriers affect UK trade, output and income levels in the long run.

Leaving the EU will introduce new costs of trade between the UK and the EU that make it harder for UK firms to do business with the rest of Europe. However, the extent to which trade barriers increase will depend upon the nature of the post-Brexit relationship the UK agrees with the EU.

Table 1 summarizes the model’s forecasts for four scenarios: (i) soft Brexit – UK remains in the EU’s single market, but not its customs union; (ii) Theresa May’s deal – UK leaves the single market, but maintains a customs union with the EU; (iii) Boris Johnson’s deal – UK leaves the single market and the customs union and agrees a free trade agreement with the EU similar to the EU-Canada agreement; (iv) hard Brexit – future UK-EU relations are based on World Trade Organization (WTO) terms.

For each case we estimate the predicted effect of Brexit on UK income per capita ten years after the deal is implemented relative to an alternative scenario where the UK remains in the EU. We report both estimates from our static trade model and estimates that adjust for the effect of trade integration on productivity. Trade integration can raise productivity through increased competition, or stimulating innovation, but these effects are not included in the static model. The estimates that adjust for productivity changes are around two and a half times as large as the static estimates.

Table 1: Effect of Brexit on UK income per capita

Source: CEP calculations. See Dhingra et al. (2016), Levell et al. (2018) and Bevington et al. (2019) for details. Pound values calculated at 2018 prices using data from the ONS and rounded to the nearest hundred pounds.

Economic consequences of Brexit are negative

Table 1 shows that in all cases Brexit leaves the UK worse off economically than remaining in the EU. The worst-case scenario is a Brexit on WTO terms, which is estimated to reduce income per capita by up to 8.1 per cent. This is roughly double the cost of either a soft Brexit that keeps the UK in the single market, or a deal that maintains a customs union with the EU. The more the UK distances itself from the EU’s economic institutions and policies, the greater will be the increase in trade barriers and the higher will be the costs of Brexit.

The estimates in Table 1 do not account for the effects of Brexit on fiscal transfers between the UK and the EU, or for possible gains to the UK from striking new free trade agreements with countries outside the EU. However, even under optimistic assumptions, these effects would be much smaller than the costs shown in Table 1. The UK is a net contributor to the EU budget, but fiscal savings from Brexit are likely to be at most 0.3 per cent of UK income (Dhingra et al. 2017) and the government estimates new trade deals would increase UK output by at most 0.2 per cent (HM Government 2018).

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