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The winners and losers of post Brexit trade

Leaving the EU gives the UK much more autonomy over trade policy, and in particular offers the possibility of signing a ‘Free Trade Agreement’ with third countries. Indeed, on the 14th January, the Prime Minister Boris Johnson said on Breakfast Television that “we can do fantastic deals not just with the EU, but with countries around the world”. The government has made it clear that as well as negotiating with the EU, it wants to prioritise another ‘fantastic’ deal with the US. It is also hoping to negotiate with Australia and New Zealand. Curiously however, the government has been more muted as to what might be the economic impact of these deals with non-EU countries.

According to Professor Michael Gasiorek of the Economics Department at the University of Sussex Business School, this is where the application of analysis and modelling can be very instructive. He has helped develop a modelling tool designed precisely to provide assessments of the possible impact of changes in both tariffs and non-tariff barriers on exports, imports and output. “Our model is much more detailed than most comparable models” explains Professor Gasiorek who is also part of the UK Trade Policy Observatory co-founded by the Business School. “We look at 148 sectors including Agricultural and Food Processing industries, as well as Manufacturing and service industries. “We have also supplied a version of this model for use by the Department of International Trade for their own analyses, as well as to other government departments.”

Applying this model to the Withdrawal Agreement alone indicates that the impact on economic output could be as high as a decline of up to 4.3% within the UK . Of course the impact will vary enormously across the 148 sectors, and this can be seen even by looking at the differential impact for the broad sectoral aggregates: For agriculture and food processing (AFP), outputs increase very slightly by 0.23%; in contrast manufacturing output could decline by just over 14%, and services by over 2%. The reason for the differential impact is that non-tariff barriers are typically much higher in AFP, and so raising these offers domestic producers more protection. The consequence is also higher prices for consumers. In contrast, in manufacturing not only are the non-tariff barriers lower, but the patterns of trade and production is such that the decline in exports has a bigger effect on output.

Suppose we now add in an agreement with the US and remove tariffs and non-tariff barriers with them. UK output still declines, but by less than before. The US agreement does help to offset some of the losses of leaving the EU. However, the model reveals three interesting things. First, that the offset is very small. Output now declines by 3.7% so the difference is only 0.6 percentage points. Secondly, the distribution of the effects across the sectors varies considerably. AFP now declines by a small amount, the total impact on manufacturing changes little, and the decline in services is smaller (1.4%). This variation in changes is even more so for the 148 individual industries. Third, increases in non-tariff barriers on intermediate inputs considerably increases the costs of leaving the EU. If we run the model without the changes in intermediate costs the impact on output of leaving the EU is almost halved to a little over 2%.

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In some sense the explanation for all of the above is down to simple arithmetic, and two examples illustrate this. First, the UK is raising barriers with a set of countries it trades with a lot (the EU), and lowering barriers with a country (US) it trade much less with – this is why signing an agreement with the US does not make a big difference to the overall impact. Second, if you raise the cost of traded intermediate inputs you don’t just make exports and imports more expensive, you also increase the domestic costs of production which makes the UK less competitive in its own domestic market. This is why the impact on output is so much higher in this case.

The model helps us to understand these mechanisms much more clearly, and the relative orders of magnitude of the possible effects. The idea that a US deal would not compensate for leaving the EU, can be worked out by sitting in an armchair and reflecting on it. But having an estimate which suggests that the difference between the two effects is not much more than 0.5 percentage points requires a model; similarly for understanding the differential impact across different industries. And that is very useful for policy making.

Of course, such models are, as Professor Michael Gasiorek explains, “not designed to provide precise predictions or forecasts of future reality – they are not meant to do so”. They involve simplifications in the same way as different geographical maps. This is intentional, and that means the model cannot fully capture all the underlying economic mechanisms. However, they are an important part of the policy makers toolkit, because they try to capture a part of the reality and can give a sense of how significant the changes could be, as well as how they may impact on economic outcomes.

Michael and his colleagues at the University of Sussex Business School have been using this innovative model to assess the trade policy options facing the UK. They are helping the UK not only to understand the possible impact on output and trade, but through this, on prices and consumers, on regions or local areas, and the differential impact on UK industries based on their level of R&D and skill intensity. The model therefore provides a useful way not just of thinking of total effects, but also on who might be the winners and losers.

Michael Gasiorek is Professor of Economics at the University of Sussex Business School and Director of InterAnalysis, a university spin-out company through which the model described above was developed. He is a Fellow of the UK Trade Policy Observatory.

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