The transition period put in place following the UK’s departure from the EU came to an end at 11:00 pm UK time on 31 December 2020. Under the new trading arrangements, finalised on Christmas Eve only a week before they were due to come into force, trade in goods remains tariff free. At the same time, many impediments to cross-border flows of goods and services have been introduced where previously there were none. These changes are likely to have both short-term and long-term consequences for economic activity, both in the UK and in the EU-27.
Although no tariffs are levied on the movement of goods, both sides now have the right to implement customs checks on imports. While the UK has opted to phase these in over time, the EU has had controls in place since 1 January. With a meaningful number of UK exporters less than fully prepared for the new controls, disruption has occurred at UK ports with lorries halted from boarding as they lacked the correct paperwork. Fewer cargoes able to make the trip means less demand for ships as the experimental ONS statistics on shipping show. Specifically, in the first five weeks of 2021, visits of cargo ships and tankers to UK ports were down by almost 20% on the corresponding period of 2020. It is also visible in the PMI survey of UK manufacturers, which shows a dramatic lengthening of delivery times, second only to that seen last April in the opening stages of the pandemic.
Based on a range of surveys, the Bank of England concluded in its November Monetary Policy Report that traders representing around 30% of UK exports to the EU were not ready for the changes implemented at the end of the year, and that this by itself would temporarily reduce the level of UK GDP in 2021 Q1 by 1%. With COVID-related lockdowns across the four nations affecting economic activity at the same time, it may be hard to identify precisely the impact of short-term, Brexit-related disruptions. Our own forecast, for what it is worth, is that the UK economy will contract by around 4% in the first three months of this year.
The long-term consequences of Brexit for the UK economy will depend on its impact on the quantity of trade that takes place between the UK and the EU, and between the UK and other countries. Writing more than 200 years ago, David Ricardo argued that, by focusing on producing goods and services in which it had a comparative advantage, and exchanging those goods and services with other nations, a country could raise its overall productivity, and become better off. Countless empirical studies demonstrate this result. The UK joined the EEC – the forerunner of what is now the EU – in January 1973. In the following two years, UK trade as a share of GDP rose by more than a third. We estimate that, if one half of this increase were to unwind, the resulting reduction in productivity would leave UK GDP some 2%-3% lower than it would have been otherwise after five years.
Looking ahead, it will be important to monitor the relative performance of the UK and the EU-27 economies to judge the potential impact on UK productivity of the reduction in trade that is likely to follow its decision to leave the EU. Since the 2016 referendum, the EU-27 economies have tended to grow slightly quicker than the UK. Additionally, the UK has suffered a more severe GDP slump during the 2020 pandemic.
And, to better discern the potential socio-economic implications of a potential Brexit-related trade shock, Fathom’s latest quarterly forecast highlighted those industry sectors that export a particularly large share of their output to the EU. As our chart shows, it is the manufacturing sectors, including food and clothing, and financial services, that appear most vulnerable. By region, these activities are concentrated in the Midlands and the North West of England, and in the City of London and Canary Wharf. For an example of how much frictionless trade matters to the UK, one need only read Thursday’s headlines of EU-based banks being unable to trade via London to buy EU shares, resulting in a substantial loss of fees for the City of London.
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