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Future trade arrangements are important

Brexit and the terms of the new UK-EU relationship could affect many different aspects of the UK economy, including trade and investment, immigration, regulations and EU budget contributions.

The UK’s future trading arrangements with the EU – the UK’s largest trading partner – and the rest of the world will likely play a crucial role in determining Brexit’s economic impact. At present, the UK is in the EU Single Market and Customs Union ensuring very low barriers to trading within the EU. Most economic research suggests that Brexit will lead to higher trade barriers with the EU. The degree to which this is the case is uncertain and will depend on the shape of the future trade relationship, yet to be determined.

As well as the Withdrawal Agreement setting the terms of the UK’s departure, the UK and the EU have agreed the Political Declaration which sets the basis for negotiations on the future relationship, including on trade. The Political Declaration is not legally binding and allows for a relatively broad range of trade outcomes to ultimately be agreed.

Generally speaking, previous economic modelling exercises from the government and others show that the higher the cost of trading with the EU (via tariffs and non-tariff barriers), the larger the negative impact on the UK economy. In other words, a scenario where the UK leaves without a trade deal with the EU and reverts to ‘WTO rules’ is likely to result in UK economic output (GDP) being lower in the long-term than a scenario where there are fewer barriers to UK-EU trade, such as in a comprehensive free trade agreement.

These “losses” could be mitigated by agreeing new trade deals with other non-EU countries and from other policy areas (such as growth-enhancing changes to regulation for instance). However, the vast majority of economic studies show that these potential benefits do not make up for the higher trade barriers with the EU (given its importance to the UK).

Government’s long-term economic analysis

Ahead of the ‘meaningful vote’ in the House of Commons on whether to approve the Withdrawal Agreement and Political Declaration, the Government published its analysis of the long-term impact of Brexit on the economy on 28 November 2018. It compares how big the economy is estimated to be – as measured by GDP – in five different future trading scenarios relative to a ‘baseline’ scenario of the UK staying in the EU. This is not a forecast as such as it doesn’t look at all the factors that affect GDP, just those related to Brexit.

The five scenarios are:

  • Government’s proposed deal (‘Chequers’) – based on the Government’s July 2018 White Paper and its preferred option. In this scenario, the UK is essentially in a customs union with the EU. Barriers to trade with the EU are fairly limited.
  • ‘Chequers minus’ – similar to the ‘Chequers proposal’ but incorporating greater trade barriers with the EU. Many commentators argue this is more in line with the parameters of the Political Declaration and therefore a more realistic outcome of a future UK-EU trade deal.
  • EEA (European Economic Area) – where the UK is a member of the EEA inside the Single Market (including free movement of people) but not in a customs union with the EU.
  • Free Trade Agreement (FTA) – a scenario where the UK and EU sign a free trade agreement. It is assumed there are no tariffs on goods and non-tariff barriers are equal to those in an average trade deal with the EU.
  • No deal – the future UK-EU trade relationship is based on World Trade Organisation (WTO) rules, rather than a bilateral trade deal.

The Government do not use the terms ‘Chequers’ or ‘Chequers minus’, instead referring to a ‘White Paper’ scenario. The Government assessed all five scenarios listed above with two different migration assumptions, neither of which is Government policy:

  • No change to rules – this assumes the current projected flow of EEA workers with no policy changes.
  • Zero net migration from EEA – assumes that there is no net migration of workers from EEA countries.

Impact on GDP

Each of these scenarios is compared with a ‘baseline’ scenario of the UK remaining in the EU. The main outcome of the analysis is that the higher the barriers to UK-EU trade, the lower GDP is. This is in line with other studies examining the potential impact of Brexit on the economy.

UK long-term GDP impacts under different trade scenarios

The results show that of the five Brexit scenarios modelled, the Chequers outcome leads to the smallest long-term negative impact on GDP, compared with staying in the EU.

Under the more restrictive migration scenario, Chequers Minus results in GDP being 3.9% lower – this figure has been used by some economists and commentators as the scenario closest to what is contained in the UK-EU Political Declaration.

The biggest single influence on GDP comes from non-tariff barriers to trade. This includes regulatory and administrative requirements that make it more difficult for businesses to export and import goods and services.

Public finances

The Government’s analysis also looked at how each scenario impacts on the government’s annual deficit, which is the difference between the government’s total spending and revenues from tax and other sources. Under each scenario, the Government estimates that the deficit will be larger compared with staying in the EU in the long-term. The deficit is expected to rise most significantly in those scenarios that introduce the greatest UK-EU trade friction. Scenarios which introduce fewer barriers to trade are estimated to have less of an impact on the deficit.

The Government’s analysis finds that in each scenario assuming lower migration leads to a higher deficit.

UK long-term deficit impacts under different trade scenarios

The Government’s analysis considers both areas that directly impact on the deficit – such as the savings made from no longer paying into the EU as a member state – and those related to the changes in the size and structure of the UK economy, which indirectly impact on the deficit. The Government’s analysis suggests that the economic impacts of the UK leaving the EU are likely to be the most important for determining the impact on the deficit.

Regional analysis

The Government’s analysis models the long-term impact of Brexit on the GDP of the regions and countries of the UK. This only considers the trade impact of Brexit and does not cover other potential channels by which Brexit could affect the economies, such as migration.

The same trade scenarios are used as for the UK, ranging from no-deal to Chequers as described earlier. For all scenarios, like in the UK analysis, the no-deal scenario results in the largest negative impact on economic output, while the Chequers scenario results in a relatively small negative impact compared with staying in the EU (apart from in Scotland where there is no difference).

Bank of England’s short-term economic analysis

In response to a request from the Commons Treasury Select Committee, the Bank of England published analysis of different short-term scenarios relating to Brexit on 28 November 2018.

The Bank’s analysis looks at two broad Brexit scenarios involving: (i) a deal and (ii) no-deal and how these might affect the economy over the next five years (up to the end of 2023). Each of these scenarios themselves have two different variations within them.

Under the two “deal” scenarios:

  • In the “close relationship” scenario GDP would be 1¾% higher by end-2023 compared to November 2018 Bank forecasts.
  • In the “less close relationship” scenario GDP would be ¾% lower by end-2023 compared to November 2018 Bank forecasts.

Under the two “no-deal” scenarios:

  • In the “disruptive no-deal Brexit” scenario GDP would be 4¾% lower by end-2023 compared to November 2018 Bank forecasts.
  • In the “disorderly no-deal Brexit” scenario GDP would be 7¾% lower by end-2023 compared to November 2018 Bank forecasts.

GDP is also compared to a pre-referendum trend path of GDP estimated by the Bank. This captures the impact of Brexit on the economy since the referendum, which the Bank believes has resulted in lower GDP growth than would have been expected following a ‘Remain’ outcome. In this comparison GDP at the end of 2023 is lower in all scenarios than this pre-referendum trend path.

The Bank’s analysis states that the worst case scenario of a disruptive no-deal would mean GDP falling by 8% at its lowest point, a greater decline than during the financial crisis. In addition, unemployment would peak at 7.5%, inflation would peak at 6.5% and sterling would fall by 25%.

However, in March 2019, the Bank’s Governor Mark Carney stated that due to increased preparedness for a no-deal outcome the expected negative shock on GDP has been reduced. These measures relate to customs procedures, rolling over free trade agreements and measures to ensure financial market stability.

In September 2019, the Bank wrote to the Treasury Committee with an update to their November 2018 analysis. The Bank stated its expectations of the worst case “no deal no transition” scenario has become less severe than in its original assessment. At its lowest point GDP was now expected to be 5½% lower in this “disruptive no-deal” scenario (unemployment peaking at 7% and inflation at 5¼%). More information in available in the Bank’s letter to the Committee.

Further information

Library Insight, Brexit deal: Potential economic impact, 18 October 2019.

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