Tinteán

Economic Impact of Brexit on the UK and Ireland

by Brian M. Deane

It’s a grave matter. photo Brian Deane

Introduction

The result of the referendum in 2016 indicated that the British people decided, 52 to 48 percent, to leave the European Union (EU). However, the economic consequences of leaving were, not at that time or since, made clear. Indeed, one might have thought that both politicians and the media were at times attempting to obfuscate the issues rather than clarify them. In this brief paper the channels through which Brexit will give rise to economic impacts are identified for both the UK and Ireland.

The European Union

A brief outline of the role and development of the EU will be helpful in establishing what it is that the United Kingdom (UK) intends to withdraw from.

The genesis of the EU goes back to the immediate post war period and a desire to find a way to put an end to the disastrous wars between neighbours. The first step was an agreement (Treaty of Paris) by six countries: Belgium, France, Italy, Luxembourg, the Netherlands and West Germany to establish a mechanism that would manage their industrial production. This resulted in the setting up in 1950 of the European Coal and Steel Community.

In 1957, The European Economic Community was set up with the task of developing a common market covering a wide range of goods and services. In 1968 duties between the six countries were removed and common policies in trade and agriculture put in place. In 1973 Ireland, the United Kingdom and Denmark joined, enlarging the Common Market to nine countries. The process of other countries joining the Market continued through to 2013, when Croatia became the twenty-eighth member. In 2002 the EU launched its most ambitious project, the euro, the establishment of a single currency area. Twelve countries joined initially with their national currencies being replaced by the euro. In Ireland the punt was replaced by the euro. There are now nineteen countries in the euro area and the euro is now a major force in world currency markets.

The process of creating a single common market has been a painstaking and difficult task. Negotiations between member states required agreement on many hundreds of issues. To mention just a few: the removal of all border controls, common asylum and visa policies, rules on the sale of goods so that a product manufactured and sold in one member state can be sold in all the other countries, rules allowing people to practice professions in other member countries, qualifications obtained in one country must be acceptable in others, differential tax rates have been partially aligned, public contracts must be open to bidders from other countries.

Policies had to be developed, agreed and put in place. Among the more important were those relating to transport, competition, protecting consumers and public health. Obtaining agreement on these issues was a major achievement that required long hours of effort on the part of officials in all countries.

The scale of what has been achieved can to some extent be seen from the size of the Common Market today. As of January 2019, the population of the twenty-eight countries that make up the Common Market was 513.5 million. Data for 2018, indicates that GDP for the Market (the total monetary value of all the finished goods and services produced within the area) was US$18.8 trillion, accounting for twenty-two percent of the global economy.

Economic Impact on The UK

I spent the July and August just past in the UK and Ireland, and had the benefit of listening to many people talking about Brexit. From these conversations it was clear, not surprisingly in view of the lack of clear information from politicians and the media, that there was a poor understanding of the issues involved. This brief paper will attempt to clarify the economic impact of Brexit and briefly describe its relevance.

With respect to the UK, economists have identified the following areas as those where Brexit will have important economic impacts.

Trade Channel

Historic evidence on trade in goods and services strongly supports the notion that barriers to trade between countries reduces economic output. There are two important barriers to trade, the first of which is tariffs. A tariff is a tax on an imported good or service. Generally, the purpose behind tariffs is to raise the price and reduce the volume of imports. This is often undertaken to protect domestic producers against what may be seen as unfair competition. When prices are increased, the consumer is punished. In addition, the exporting country tends to dislike having barriers raised against it, and will often retaliate with a set of tariffs of their own. The second is non-tariff barriers, which restrict trade in a different way. An importing country can demand that products are produced and packaged to specific standards. Since these standards will already be in force for domestic producers in the importing country it means the exporting country has to modify its process to meet these standards, and this can be costly. Non-tariff barriers can also include such elements as intellectual property rights, product compliance and domestic subsidies

Since the UK is a trading nation with a significant proportion of its economic activity revolving around imports and exports with other countries, it is to be expected that tariff and non-tariff barriers will have an important impact on its trade. Brexit will give rise to new barriers to trade with the EU, which will reduce trade flows and consequently economic growth. In 2018, 53.1 percent of the UK’s imports of Goods and Services are from other European member countries, while its exports of Goods and Services to those countries amounted to 45.6 percent. The impact on trade of the UK withdrawing from a large market area that is so important to its export activity, and one with which it has established regulatory compliance, is bound to have adverse consequences; the extent of those will depend upon what conditions it negotiates when leaving.

Migration Channel

The economic output of a country is highly dependent upon the total number of people at work and the quality and mix of those employed. An inflow of productive workers adds to the total economic output of the country. What is more relevant, however, is the level of income per capita generated, since this is reflected in the living standards within the country. Migration that results in an overall increase in employment and an increase in income per capita is highly desirable.

The Migration Advisory Committee in the UK, an expert consultancy group on migration, concluded from its examination of several research studies that migration had resulted in a major beneficial impact on the UK. Research on the impact of the UK leaving the EU is sketchy, but it will almost certainly curtail migration from Europe. It seems likely, therefore, that there will, in the short-term anyway, be a reduction in economic output.

Foreign Direct Investment Channel

When economists speak of investment they are not talking of putting money into stocks and shares, but rather of governments building roads, hydro-electric schemes, schools and so on, and businesses spending on factory buildings, machinery and other means of production. Investment is central to future increases in GDP. Foreign direct investment (FDI) is when a company sets up and owns a company in another country. The key factor is that a company from outside the State brings in money, management, skills and technology. Most governments actively seek to increase (FDI) as they see it as a means of gaining access to foreign markets and promoting international trade.

Membership of the EU brings distinct advantages in attracting FDI. This arises because most large companies have complex supply chains that stretch across several countries, so there is a clear advantage in having all processes within a single common market area, thereby greatly facilitating production. In addition, the free movement of capital within the market area has made it much easier for investment to flow from one member country to another. Further, the UK is seen by countries outside the EU as an attractive base from which to access the export markets of Europe.

Data from the CIA World Facebook indicates that the UK in 2017 had the world’s third largest stock of FDI and this accounted for 70.5 percent of all FDI assets in the twenty-eight countries of the EU. A significant proportion, 43 percent of the UK’s FDI comes from other European countries.

Productivity Channel

Productivity is the rate of output per unit of labour or capital input. It is a means of measuring the efficiency with which labour and capital are being used in producing a given level of output. Increases in productivity are seen as central to improving living standards within a country. Such improvements imply that average income per capita has increased, and that there is now more money available in people’s pockets for expenditure.

Evidence shows that being part of a larger market helps companies to increase their productivity. This can happen because there are now opportunities to benefit from economies of scale, thus reducing the average cost of each unit produced. It is also the case that being part of a larger market, where barriers to trade have been removed, encourages research and innovation, leading to long-term increases in productivity.

Leaving the EU will leave the UK vulnerable to losing the benefits to be gained from being part of a large open market area.

Regulation Channel

Within the EU a regulation is a legal act which applies directly at the national level. This means that when a regulation is approved at the EU level and enters into force it becomes applicable within all countries of the EU. To divert for one moment, the notion, portrayed by much of the media, that the EU makes unilateral decisions and that countries in the EU must fall in line is simply not accurate. The process of drafting Regulations and having them adopted is one that involves detailed discussions with all countries over a protracted period of time.

The EU has introduced over the years regulations on a very wide range of issues that are designed, among other things, to encourage competition, protect consumers and ensure that imports from outside the EU meet certain standards. It might be thought that obtaining compliance from twenty-eight countries would be a near impossible task. However, because they are seen as necessary and beneficial to the population as a whole they have been readily adopted.

It has been argued that leaving the EU means the UK would not have to follow EU regulations and the restrictions they impose. However, the scope to do so may be limited since many of the regulations are designed to protect consumers, and also such areas as the environment. Any attempt to remove them would almost certainly be resisted by those living and working in the UK.

Currency Channel

Changes in the value of one currency relative to the value of another occurs when the market alters its view on the future economic prospects of a country. A decrease in the value of a country’s currency relative to that of other countries, results in an increase in the price that has to be paid by business for imported components. It also means that imported consumer goods will be more expensive, and this can lead to an increase in the level of inflation. On the other hand it now means that exports by that country will be cheaper since the exchange rate favours the importing country. An appreciating currency, of course, has the converse effects: imports now become less expensive and its exports more expensive.

Since the referendum there has been a steady decline in the value of sterling as the market has reviewed the future economic prospects of the UK. This, it is estimated, has led to an increase in inflation of 1.7 percent.

Economic Impact on Ireland

Ireland is, of course, remaining in the EU. This does not imply, however, that there will be no economic impacts on its economy. The strong economic linkages between the UK and Ireland can be seen from their trading relationship shown in Tables 1 and 2 below:

CSO Ireland

In 2018, Ireland exported Goods to the value of €140.835 billion, of which just over half went to other EU countries and 11.4 percent to the UK. Imports of Goods were substantially lower at €90.175 billion, and of this 21.9 percent came from the UK.

As can be seen from Table1, a high proportion of goods exported are to Europe. The most cost-efficient way to transport those goods is to use the UK as a ‘Landbridge’. The alternative is to use direct sea routes which would take longer and cost more. The circumstances that will face Irish hauliers after Brexit are uncertain.

In 2017 Ireland exported services to the value of 159.706 billion, of which 46.4% went to the EU and 16.4% to the UK. Total imports were 178.054 billion, and of this 9.3% came from the UK.

In Ireland the potential consequences of Brexit on the economy have been seen, in both political and economic circles, as a matter of critical concern. The Economic and Social Research Institute (ESRI) has given priority to this issue. It will be of no surprise to those familiar with their work to know that their analysis is of the highest quality. The following draws heavily on their work.

The ESRI have identified four areas of economic impact as particularly important.

Trade Channel

Trade flows between Ireland and the UK, as can be seen in Table I and 2 are of major importance, and these, it is estimated, could be impacted by as much as twenty percent. However, the average would be much greater for some products and less for others. Merchandise trade is highly concentrated in a few products, particularly chemicals and pharmaceuticals, and trade barriers here would have a significant impact.

Foreign Direct Investment Channel

The UK has been seen as an attractive destination for FDI because it has a developed financial sector, an efficient labour market and technological capacity. When the UK leaves the EU it becomes less attractive to FDI and this will likely result in lower economic growth in the UK, which will have an adverse impact on the economy of Ireland. The hope that Ireland might benefit by securing some of the FDI lost to the UK is unlikely to be realised as Ireland already has, for its size, a high level of FDI and companies are likely to consider alternatives within the EU.

Migration Channel

Irish citizens have unrestricted ease of movement into the UK and visa versa. The Common Travel Area (CTA), agreed between the two governments provides unrestricted migratory freedom between the two countries. The arrangement has the great benefit that it facilitates the flow of labour between the two countries, including that between the Republic and Northern Ireland.

When the UK leaves the EU there is always the possibility that the automatic right for Irish people to work in the UK could be revoked. The UK has in the past been an important escape valve when unemployment in Ireland increases. Between 2011 and 2013 some 60,000 Irish people migrated to the UK. Without that access there would have almost certainly have been an increase in unemployment in Ireland and downward pressure on wages. The ESRI has simulated the inflow of 60,000 labour force participants and concluded that it would result in a fall in wages of almost 4 percent.

Energy Channel

The integration of the energy market on the island of Ireland has been progressing for many years and there is now a high degree of interdependence. Northern Ireland relies on electricity imports from Ireland. However, Ireland is vulnerable because of its interconnectedness with the UK.

When the UK leaves the EU, and is no longer subject to regulatory measures, it is a matter of great concern as to what terms will be agreed.

Summary

This brief paper identifies the channels through which economic impacts on the economies of the UK and Ireland take place. It attempts to describe how those impacts arise and the effects they have. It seems certain, in the short to medium term at least, that both countries will see a decline in economic activity.

Brian Deane was educated at Blackrock College and Trinity College Dublin. He is an Irish-Australian economist whose career embraced working for GKN a large engineering company in Britain, Bord Fáilte, the Irish Tourist Board in Dublin, and later as an independent consultant undertaking assignments for governments all over the world, sponsored by the World Bank, European Union, African Development Bank and others. He lives in Sydney.