This week, the ESRC-supported project “UK in a Changing Europe” issued a new report on the economic and political effects for the UK of a No Deal. This project uses a collection of experts in law, politics and economics drawn from across the UK. Its members were selected on merit, not on their support or otherwise for Brexit. They had written extensively about trade, migration, agriculture, EU politics etc. well before David Cameron called the referendum.
The latest report by the UK in a Changing Europe focuses on the implications of a “chaotic” Brexit, in which the UK leaves the EU with no agreement at all: the status quo falls apart, largely because the legal framework that currently binds it together expires on March 29, 2019. Even if there is no comprehensive deal, some partial arrangements will likely be made, for example to keep planes in the sky over Europe. But British and European businesses cannot base their plans on guesses of what last minute deals might be cobbled together: their owners and shareholders need managers to maintain continuity of supply. Since for most businesses these arrangements take will time, this means acting now to mitigate the risks they face from a chaotic Brexit.
So what would a chaotic Brexit mean for the Scottish economy? In the run-up, there is likely to be further downward pressure on the pound which will increase prices, but make exports more competitive, though export volumes are unlikely to react quickly. The figure below shows that UK export volumes have been on a fairly steady upward trend since the bottom of the Great Recession in 2009: the marked depreciation that took place after the Brexit referendum has had little effect on that trend rate of growth. If expectations of a collapse in sterling caused capital flight, and a further depreciation occurs, these effects will be magnified. The Bank of England might then face the dilemma of whether to increase interest rates to protect sterling or to reduce them to stimulate growth.
It is difficult to know how households will react to a chaotic withdrawal. They may bring forward consumption by stockpiling food and other consumables. This would boost demand in the short-run. But higher inflation without any compensation in the form of higher wages could reverse this effect. The net reaction to the circumstances surrounding will be critical in determining whether UK growth rates fall further behind those of the other G7 economies.
Critics of Brexit raise the spectre of disruption to supply chains and sudden sharp increases in barriers to trade as another significant cost of a chaotic exit from the EU. It is difficult to predict how damaging these might be: modern economies have shown remarkable resilience in the face of unexpected natural disasters. So, UK businesses might well find ways to minimise the disruption caused by impediments to trade. Even with perishable goods, such as fish, Scotland manages to trade effectively with non-EU countries. The real issue is how costly these adjustments might be. Any increase in costs obviously opens the door to competition from elsewhere. The effects on the Scottish economy will then largely be determined by how price sensitive Scottish exports to the EU are. Luxury items, such as malt whisky, may be less price sensitive than goods and services where product differentiation is more difficult: but there is always a price at which consumers start to seek alternatives.
A chaotic exit with no deal has important implications for contracts arranged with businesses in other EU member states. Businesses in EU countries will not be able to make special arrangements to facilitate trade with the UK. That would be in breach of the WTO rule that all third countries should be treated equally. Without a specific trade agreement with the EU, the UK would have to charge the same tariffs on imports from France as those from Guatemala. Giving UK businesses preferential access to EU markets would risk prosecution by the WTO. This may not be too daunting a prospect, given the lengthy delays around WTO processes. Perhaps threats of sanctions from individual countries, such as the USA, due to perceived or real discrimination against their companies, might have more force.
Some Brexiteers argue that the solution to this dilemma is not to charge any tariffs at all. This would likely push down prices, particularly on foodstuffs. It might also reduce costs of at the border, but would not eliminate them if there was regulatory divergence between the UK and EU. However, zero tariffs would likely put a large swathe of Scottish farmers out of business relatively quickly. Difficult to see how this would be an easy policy choice.
Alternatively, the UK could charge the same tariff rates as the EU, applying these both to EU and non-EU states. This would mean no change as far as non-EU imports were concerned and increased revenues to the government from duties on EU imports. Government revenues would increase, but so too would retail prices. And the administrative delays would slow down the passage of goods, particularly around the main UK ports of entry and exit. The costs of such delays might benefit the Scottish economy if they attracted traffic away from southern ports to Scottish ports. On the other hand, the application of tariffs to food would have varying effects depending on whether the UK is a net importer or exporter. The UK imports a lot of beef from the EU: tariffs would raise the price of these imports, which would favour domestic production. The reverse is true for sheep meat. EU tariffs would likely have a very negative effect on the incomes of producers in some of Scotland’s most marginal farming areas. The net effects across all foods would be bad for poorer consumers: the estimates are that meat prices would rise by 7.3% and processed foods by 3.7%, and this would be made worse by any currency depreciation. It is difficult to escape the conclusion that the effects of a chaotic Brexit would be much worse for poorer Scots, who spend more of their income on goods that will attract higher tariffs post-Brexit.
All of these issues are focussed on the short to medium term. They do not cover the long-term implications of changing the costs of trading with our nearest major market. These were covered in a report produced for the Scottish Parliament by the Fraser of Allander Institute. This analysis was based on a multi-sectoral model of the Scottish economy and it predicted a decline of between 2% and 5% in Scottish GDP as a result of Brexit. The most pessimistic outcomes were associated with a trading arrangement with the EU based on WTO rules. The horizon for this study was 10+ years, which is a rough guide to the length of time that changes in the prices of exports and imports feed through to changes in employment and in family incomes. Getting the correct time frame so that these outcomes can be described as predictions is challenging, but they indicate a direction of travel that is shared by most serious analysts of UK-EU trade patterns. A completely chaotic Brexit will likely bring forward the horizon on these negative impacts.