Brexit And The Impact Of New Trade Ties

Source: ONS Business Impact of Coronavirus survey
Data taken from survey wave 20

The ONS Business Impact survey from mid-December indicated that half of manufacturers were only somewhat prepared, or not at all. And across the economy, a high proportion of firms reported the changes weren’t relevant to their business - which in some cases may have been because they weren't fully aware of the forthcoming changes. The chart above showed this tended to be more common among smaller businesses.

That said, it’s a mistake to assume this is only hitting smaller firms. While in general larger firms are likely to have been better prepared, many rely on SMEs as part of their supply chain. That was demonstrated in December when some of the major carmakers had to pause production amid a lack of supplies coming across the Channel.

In short, the situation is fairly bleak, but working out the magnitude of the impact on the wider economy is less straight forward.

One thing that looks inevitable is a fall in manufacturing production in January - perhaps in the region of 3-4%. That’s partly because the situation is unlikely to resolve itself quickly - and in fact may become worse in the short-term as border traffic builds up once again. Net trade is also likely to weigh on GDP through this year, assuming imports recover as lockdowns are unwound but exports take much longer to recover.

Of course it goes without saying that the Covid-19 crisis will dominate the GDP figures for the next few months. But assuming the economy starts to get back on its feet through the middle of 2021, the more interesting question is how Brexit will affect the recovery - and here are three factors to bear in mind.

Firstly, the new costs of customs declarations and transportation are here to stay - and this, combined with the higher administrative burden for European buyers, will inevitably reduce the competitiveness of UK exports. Unsurprisingly that's also likely to mean some British, Europe-facing firms will ultimately no longer be profitable, and some will be forced to move more parts of their operation overseas.

While impossible to quantify, this will put additional pressure on unemployment - which is likely to rise close to 7% through 2020 assuming wage subsidies are gradually removed.

Secondly, given Covid-19 travel curbs, the impact on services is only likely to become fully visible after the pandemic.

This is where the UK’s competitive advantage lies, and it is also where arguably life outside the single market is more complex. For goods trade, shipments need to meet a series of hurdles to cross the border, but after that they are more-or-less free to be sold anywhere in the EU. For services, the barriers generally take the form of regulation, and this can vary significantly between member states.

Qualifications are not automatically recognised under the trade deal - and this is unlikely to change soon. Some member states also go further with nationality/residency rules for certain professions - for example accounting/legal. Once people start to travel again, visa rules will also add extra complication. While the demand for business travel may fall post-pandemic, some services can only be supplied in-person (think engineering, for example).

The coming months will also reveal whether the UK secures a data adequacy agreement to keep information flowing, as well as on financial services equivalence.

Finally, the big question is what happens to the UK-EU relationship in the long term. Will the UK seek closer economic ties with time - for instance, rejoining a customs union? For now this is difficult to see. The deal includes a review clause in 2024, and that almost certainly means the issue of EU trade will play a role in the election that year.

Instead, perhaps the real question we should be asking is whether the UK-EU deal will stand the test of time. In part, this depends on how the UK decides to shape policy surrounding ‘level playing field’, the issue that monopolised much of the negotiating time last year. Under the terms of the deal, the UK has committed not to lower worker or environment standards, and accepted state aid controls.

But with time that could change, and divergence could see market access partially rescinded, for example via tariffs. The deal also sets the scene for ongoing negotiations in various areas, which with time could throw up challenges that again ultimately may end in tit-for-tat retaliation (fishing is the obvious example once annual negotiations begin after an initial transition).

For the economy, this means a degree of uncertainty and potential instability will be a feature of the UK’s European trading relationship.
Even before Covid-19 struck, investment had underperformed G7 peers, and this is likely to continue in the post-Covid-19 recovery phase. Businesses will be wary about possible future changes to the relationship that may require further tweaks to their operating model.
While we expect consumers to lead a rebound in GDP through the remainder of 2021 (assuming the vaccine programme goes as hoped), investment is likely to lag behind - and correspondingly drag on hiring. This will likely prevent the UK economy returning to its pre-virus size until late 2022 at the earliest.