The great Brexit trade-off

Two years ago Boris Johnson’s government had just won a thumping election victory promising to “get Brexit done” and on 31 January 2020 the UK’s formal departure from the EU came into force. A lot of water has since flowed under the bridge and little could they have known that two years later Johnson would be embroiled in a fight for his political survival following the publication of the long-awaited Sue Gray report into “Partygate.” Despite having delivered on his signature policy, Johnson’s premiership has today come into question as never before, with even MPs on his own side prepared to stick the boot in (this intervention from Theresa May was priceless).

It is no surprise, therefore, that a very different government report released today has received virtually no coverage. Benefits of Brexit “sets out some of our achievements so far” and outlines how the government plans to “seize the incredible opportunities that our freedom presents.” It is hard to know where to start. So far, according to the report, Brexit has “ended free movement and [enabled] control of our borders”; “restored democratic control over our lawmaking”; “taken back control of our waters; “reintroduced our iconic blue passports” and “enabl[ed] businesses to use a crown stamp symbol on pint glasses”. To use one of Johnson’s favourite phrases, it really is a pyramid of piffle.

The ending of free movement has been such a great success that last autumn it made a significant contribution to the lorry driver shortage that seemed to impact most heavily on the UK. As for control of the borders, all it has done is make life harder for everyone. Queues have been building up at ports on both sides of the Channel as border controls are reintroduced. Restoring “democratic control over our lawmaking” rings somewhat hollow following the shenanigans in parliament in recent months, with MPs prepared to rig the rules to protect their own and apparently failing to follow the guidelines that all other citizens have to follow. Taking control of waters counts for nothing if fishermen cannot sell their catch and there is mounting anger in fishing communities that Brexit has not delivered the promised benefits. If the restoration of blue passports and the crown stamp symbol on pint glasses really are of such importance to the government, far be it for me to suggest that there was nothing stopping either of these things from being introduced whilst the UK was a member of the EU.

The losses from trade

The most obvious problems are manifest in trade flows due to the form of Brexit implemented by the UK. Merchandise exports in November 2021 were 7% below the average level in Q4 2019 with services exports down 9.4%. Despite a rally from the depths of 2020 exports are struggling to get back to pre-pandemic levels. By contrast German exports in November were 6.9% above Q4 2019 levels. However the statistical office reported that German exports to the UK in November 2021 were down 7.9% compared to the same period a year earlier, suggesting that exporters are finding it more difficult to conduct business with the UK. 

This accords with the results from a paper by Fernandes and Winter (2021) looking at transaction-level export data for Portugal which suggested that exporters reduced export volumes and export prices in the UK market after the referendum shock in a bid to remain competitive. As the trading relationship between the UK and EU continues to evolve, the authors note that such behaviour is likely to make the UK a less attractive market for EU exporters with the decline in prices placing an increased squeeze on margins. Their estimates also point to “a high degree of exchange rate pass-through into consumer prices in the UK after the shock, implying rising inflation and living costs."

Aggregate data suggest that in real terms, UK merchandise trade volumes are currently 12% below Q4 2019 levels. According to the CPB World Trade Monitor global trade volumes have surged, with exports up 17% on late-2019 levels. As a consequence the UK’s share of world trade has fallen well below 2019 levels even if there has been a sharp rebound in the most recent figures (chart above). We only have a year’s worth of data and the Covid shock has obviously exacerbated the problem but it is clear that Brexit has got off to a bad start in terms of its trade impact. There is nothing on the horizon to suggest that the trade agreements currently in the pipeline will generate a big enough boost to offset the damage done to trade relationships with the EU.

Business investment has also clearly stalled (chart below) as the uncertainty effect kicked in. Between 2016 and 2019 there was very little growth in investment volumes and although it has come off its 2020 lows, it is still almost 10% below the 2016-2019 average. As a result, growth in the net capital stock slowed in the wake of the Brexit referendum, from around 2¼% per year prior to 2016 to a rate around 1¾% over the period 2017-19.  To the extent that this is a fundamental driver of the economy’s potential growth rate, the evidence does point to an uncertainty shock adversely affecting the UK’s growth rate and is consistent with the OBR’s prediction that Brexit will cost 4% of GDP in the medium-term.

Obviously it is still very early in the post-Brexit period and until the pandemic effect has fully unwound we will not be in a position to make any definitive assessment. But on the evidence so far many of the downsides which we warned about appear to be making their presence felt. In Johnson’s foreword to the Brexit report he noted that it will allow the UK to “seize the incredible opportunities that our freedom presents and use them to build back better than ever before—making our businesses more competitive and our people more prosperous.” The problem with much of the Brexit bluster is that it assumes the UK will have sufficient control over its future to realise these possibilities on its own. It makes no allowance for the fact that other governments may not want to play ball. Those who run businesses take a much more realistic view about what Brexit means for them and government boosterism cuts no ice. And even in the unlikely event there are considerable upsides, it is highly probable that on the basis of recent events Johnson will not be in office long enough to enjoy them.