Brexit and economy: the blow was “substantially negative”

This is the first part of a new FT series, Brexit: The Next Phase.

Nearly two years after Britain left the EU, economists have reached a consensus: Brexit has significantly damaged the country’s economic performance.

They agree that the vote to leave the bloc has impoverished households, uncertainties in negotiations have weighed on business investment and new trade barriers have damaged economic ties between the UK and the EU.

Although economists and officials disagree on the precise magnitude of Brexit’s effect, they consider it significant. They also agree that new trade deals with countries such as Australia and the regulatory freedoms gained by leaving the bloc are nowhere near offsetting the damage.

Andrew Bailey, Governor of the Bank of England, told MPs this month that the central bank assumed Brexit would lead to “a long-term decline in the level of productivity of just over 3%” – of which the most had already happened. “We haven’t changed our view on this so far,” he said.

The Office for Budget Responsibility, the fiscal watchdog, expects the UK economy to end up being 4% smaller than it otherwise would have been – a £100billion hit a year to prosperity – leaving public finances less sustainable partly because of a ‘significant negative impact on UK trade’.

Some former officials went further. “In other words, in 2016 the UK economy was 90% the size of Germany,” said Mark Carney, former BoE governor. “Now it’s less than 70 percent.”

The former Canadian governor was widely criticized for his use of the statistic, with Jonathan Portes, professor of economics and public policy at King’s College London, saying the seemingly dramatic contraction stemmed from currency movements, not Brexit. But Portes also acknowledged that there is no doubt that the negative effects of Brexit can be seen both in UK economic data and in extensive academic work.

Before the 2016 referendum, Brexiters such as Lord Daniel Hannan, an adviser to the Board of Trade, feared that close trade ties with the EU would dampen Britain’s economy. Britain was ‘chained to a corpse’, he said.

But since the eve of the coronavirus pandemic, the UK’s economy has underperformed all other G7 counterparts and is the only one not to have regained its size by the end of 2019.

The OECD expects the UK’s performance over the next two years to be worse than any other advanced economy except Russia.

While these comparisons provide plenty of headlines, academic economists fear these sketchy statistics are polluted by specific UK-related Covid-19 weaknesses or energy shock effects.

To identify the specific economic impacts of Brexit, they use various methods to construct a so-called counterfactual – a simulated history of the UK if it had remained in the EU – and then compare it with the reality of the UK economy afterwards. the Brexit referendum.

In two areas, there is now a clear consensus for them to say with certainty that the impact of Brexit on British prosperity was, as Swati Dhingra, an external member of the BoE’s Monetary Policy Committee, recently pointed out, ” undeniable “.

First, the pound depreciated by more than 10% after the Brexit vote in 2016 and has remained at this level ever since. This drop raised import prices, business costs and inflation, but failed to boost wages, exports or the competitiveness of the UK economy. The Resolution Foundation estimated that the depreciation increased import prices and headline inflation. He calculated that as a result real wages fell by 2.9%, costing households £870 a year on average.

The second obvious effect has been on business investment, which has stagnated in real terms since after 2016 before falling during the pandemic.

Simon French, chief economist at Panmure Gordon, said Brexit had driven up the cost of capital for UK businesses as investors worried about dwindling prospects of doing business in Britain. While he said other countries have also seen weak business investment during the pandemic, the effect has been much worse in the UK and examining EU and US trends” suggests material understatement [of investment] around £60 billion a year.

Most of the latest academic efforts have attempted to quantify the trade impact of Boris Johnson’s Brexit deal, the Trade and Cooperation Agreement, which came into force in early 2021.

This work has been thwarted by changes in the way UK and EU statistical agencies collect import and export data and by disagreements over how best to identify a Brexit effect. But the results of studies now appearing suggest very large declines in trade between the UK and the EU, a decline in the variety of goods traded, a loss of commercial relationships between businesses and similar patterns in services.

“There is strong evidence that the TCA has reduced UK trade with the EU by around 15% so far,” said Thomas Sampson, associate professor at the London School of Economics. But he noted that the UK’s trade with the rest of the world had also fallen by a similar amount, leading him to be ‘not 100 per cent convinced that we have seen a [Brexit] effect on exports so far”.

Other scholars are less concerned about the separation between trade with the EU and the rest of the world, arguing that there has been a definite decline in UK-specific trade performance coinciding with Brexit.

Martina Lawless, a research professor at the Irish Institute for Economic and Social Research, said Brexit had been “substantially negative” for the UK, with her estimates showing a drop in EU imports and exports of ” almost 20%”.

Almost all countries except the UK experienced a trade boom in 2021, she noted. “If something hadn’t happened in January 2021, UK trade should have grown as well.”

The most sophisticated statistical modeling took place at Aston Business School, where economics professor Jun Du found that imports into the UK from the EU have largely recovered. However, she estimates that exports to the bloc are now 26% lower than they would have been without the new trade barriers.

The effect of this can be seen most clearly in trade in goods, such as food exports, where there are technical barriers and tighter border controls. There was also a sharp drop in the number of goods traded, with varieties falling from 70,000 to 42,000 before the new rules came into force.

According to Du, small businesses have been hardest hit because the barriers represent a greater cost relative to the value of trade, which bodes ill for the future. “[Small companies are] not just unproductive businesses, but also new businesses – that’s why we’re worried about future growth – when you lose that, your pipeline breaks,” she said.

“There is little dispute that the trade was damaged [by Brexit] big time,” she added.

Similar evidence is emerging in services trade, economists said. Dhingra told MPs this month she could be even more certain there was a ‘stagnation’ in exports because trade data for the sector had not been skewed by changes in collection methodology such as for the trade in goods.

So far, ministers have dismissed the economic evidence. Jeremy Hunt, the Chancellor, said last week he did not accept the OBR’s estimate that Brexit had caused a 4% hit to Britain’s economy.

“We have great opportunities to become much richer than we otherwise would have been,” he added, citing regulatory freedoms and trade deals that could be struck with other countries.

The government has not quantified these potential gains, and when it has – as with the Australia trade deal – they have been estimated to be minimal, boosting output by just 0.08%.

Economists say this is a meager compensation for the economic losses the country has suffered so far.

“We now know that Brexit has made life worse for British households by raising the cost of living and has made life more difficult for British businesses. [by increasing trade barriers]and it has impoverished the UK,” Sampson said.