Brexit formally took effect two years ago this week, but the economic and political consequences are still unfolding. It is clear that the UK has manoeuvred itself economically into a difficult situation by leaving the single market. Now, in addition, recent numbers show dramatic consequences for a country that is struggling to recover from the pandemic. In October 2021 trade in the eurozone exceeded pre-Covid December 2019 levels by 4%, whereas the UK stagnated at a much lower level.
UK trade had shown signs of a strong recovery from the coronavirus shock by the end of 2020, but this fell back significantly in 2021. Research undertaken by the IFO (Institute for Economic Research) in Munich suggests that further negative effects have materialised as the British economy adjusts to an array of non-tariff barriers ushered in when the Brexit transition period ended on 1 January 2021.
These figures reflect the continuation of a trend that had been predicted. In a report for the German government published in 2020, the IFO quantified the effects of Brexit for Europe. We forecast GDP losses for the EU and much more significant losses for the UK, even in the scenario of a Brexit agreement. Some of the negative effects on GDP and trade kicked in even prior to the withdrawal agreement in 2020, as uncertainty increased and business adapted to the new environment after the 2016 referendum.
The UK’s share of EU exports fell from 7.1% in 2015 to 6.2% in 2019 while its share of imports fell from 4.4% to 3.9% – these statistics include trade between EU member states. Over the course of the pandemic, we saw additional trade diversion away from the UK, estimated at a further fall of more than one percentage point.
More red tape is part of the problem. Whereas the terms of the Brexit deal allowed Britain to avoid higher trade tariffs, most products now face at least one new “non-tariff barrier” to enter the EU market. Certificates of inspection, new customs requirements and a large volume of new paperwork all increase the time and complexity of crossing the border and push up the costs of trading. These barriers are devastating for EU-UK business during a pandemic, as it is harder for firms to find alternative markets, even more so for small and medium-size enterprises.
For the UK, non-tariff barriers are even more problematic than for the EU. Even if the UK signs trade agreements with other countries, the idea that deeper economic exchange with the US, India, Australia, New Zealand, Canada or Japan could offset lost trade with the EU is misleading.
One important lesson of the pandemic is the importance of diversified supply chains. But another is the importance of geography: countries trade primarily with their immediate neighbours. In 2019, 50% of UK imports were sourced from the EU and 47% of its exports went to the bloc. In a study on product dependencies, we show that these linkages are particularly strong for goods imported into the UK from five or fewer suppliers: 64% of them come from the EU. Most of these are intermediate goods (such as raw materials) which means that higher trade costs due to Brexit may also increase the costs of final production in the UK and exert additional inflationary pressure – on top of a global trend of rising prices and already distressed supply chains.
For Europe, the negative consequences and challenges of Brexit go way beyond the GDP effect: the EU lost about one-sixth of its economic power and a far greater share of its foreign and security policy weight with the exit of a country which has considerable global influence. Brexit leaves a financing gap that will have to be met in part by higher budget contributions from the remaining 27 states. Moreover, the shift of power after Brexit means the EU in future risks becoming more protectionist and less inclined towards reform.
The protracted nature of the Brexit negotiations should also act as a warning to EU countries. The agreement done with the UK could never eliminate all trade uncertainty as the conditions mean some critical issues will sooner or later be up for renegotiation.
The final day of January 2020 marked the end of a more than half-century-long trend toward greater political integration in Europe. The consequences will affect us for a long time to come.
Lisandra Flach is director of the Center for International Economics at the Munich-based IFO (Institute for Economic Research) and professor of economics at Ludwig Maximilian University
