In just a few weeks, Britain will begin what could be the country’s most momentous negotiations since joining the EU in the 1970s: talks on how it will trade with Europe for decades to come.
Both sides agree that the outcome is likely to be very different from Britain’s current EU membership, which will be replaced by some kind of free-trade agreement — unless the UK changes course and opts to stay in the customs union.
What would an FTA change from the status quo? Ahead of the likely start of negotiations next month, the Financial Times looks at the economics of such a deal — and who might be the winners and losers.
How is an FTA fundamentally different from the EU status quo?
Most economists agree that such an accord would increase barriers between Britain and its largest market — because of the nature of an FTA.
Hosuk Lee-Makiyama, a former EU trade representative who is now director of the European Centre for International Political Economy, a think-tank, says: “People grossly overestimate what FTAs can do legally.”
At the most basic, such agreements ensure that goods are not subjected to tariffs or quotas, although agriculture and food are sometimes omitted. (Services are generally only superficially covered).
Regulations, frequently the cause of non-tariffs barriers to trade, still often differ. It is also much more difficult than within the EU to ensure that both sides still stick to the deal.
“The fundamental difference is that FTAs are agreements between autonomous regulatory jurisdictions that want to stay autonomous,” says Stephen Adams, a former trade adviser to the European Commission.
If both sides insist on such autonomy in an EU-UK deal, it would limit the scope for Britain’s request for mutual recognition in goods and financial services.
FTAs tend to have an arbitration mechanism that allows sanctions to be applied if one side breaks the rules. But there is no power to force the other side to stick to the agreement. By contrast, the European Court of Justice has the power to force an EU member to stick to common rules.
What an FTA could mean for sectors and regions in the UK
Recent British government impact papers set out the UK sectors that would be hit hardest by shifting to an FTA: the country’s chemicals producers, the automotive sector and retail and wholesale services.
The greatest economic impact would be on those areas of the UK where such businesses are most heavily concentrated, such as the north-east of England. Other studies come to different conclusions, because of subtly different assumptions.
The UK Trade Policy Observatory has produced a model for the British manufacturing sector based on increased non-tariff barriers under an FTA.
Businesses with few exports to the EU, for example cheese and pasta producers, are likely to gain from additional protection. But export-intensive high tech businesses, such as the car industry and aerospace, are expected to lose.
A London School of Economics study also emphasises that parts of London and the UK south-east “specialise in [the] financial and business services that are predicted to be hardest hit by the increase in tariff and non-tariff barriers that Brexit could bring”.
And the impact in the EU
Because of its close integration with the British economy, Ireland would be the most affected EU member if trade barriers with the UK increased.
The CPB Netherlands Bureau for Policy Analysis, a Dutch think-tank, estimated that the hit to the Irish economy would be as large as that to the UK.
The CPB analysis also indicated that Malta, Cyprus and Luxembourg would be relatively heavily affected because of the importance of financial services trade for the countries’ economies.
In Germany, the EU’s biggest economy, the automotive sector is predicted to be the most adversely affected because of its reliance on UK suppliers, according to an analysis from Bertelsmann Stiftung.
The macroeconomic effect
With two exceptions, all publicly available forecasts suggest that UK economic output will be lower under an FTA than if Britain continued as a member of the EU. The estimated cumulative loss of gross domestic product ranges from a relatively low 0.6 per cent by 2030 to up to 7.8 per cent.
The evidence shows that removing trade barriers generally results in increased trade flows. That leads most economists to conclude that entering into an FTA with the EU will reduce the UK’s trade with the bloc.
“The reduction in trade with the EU . . . is by far the most quantitatively important channel by which leaving the EU affects the UK economy,” said researchers at the National Institute for Economic and Social Research (NIESR). It estimated that, with an FTA, UK GDP would be 1.9 to 2.3 per cent lower by 2030.
Since trade with the UK is a smaller share of EU national income than vice versa, the economic effects of moving to an FTA are predicted to be smaller for the EU.
The CPB estimates that EU GDP could be about 0.6 per cent lower by 2030 under an FTA than if the UK remained a member of the bloc. This compares to their estimate of a 3.4 per cent loss of GDP for the UK.
Why do some studies predict larger or smaller negative effects?
The NIESR estimated that the UK GDP loss could more than double if lower trade and foreign investment had a knock-on effect on productivity growth.
Some published studies suggest that such negative effects could be partially offset by changes to UK regulations or through new free-trade agreements with non-EU countries.
Open Europe, a think-tank, estimated that GDP could be boosted by about 1.3 percentage point by 2030 if swaths of labour, product standard, consumer protection and environmental regulations were repealed. The UK government denies that it seeks such a bonfire of regulation.
However, the latest British government modelling suggests that new FTAs with non-EU countries could boost GDP by up to 0.7 per cent after 15 years.
Why do some economists think Britain would gain?
The Brexit-supporting group, Economists for Free Trade, estimates that an FTA with the EU could contribute to an increase to British GDP of 2 to 4 per cent over the next 15 years.
But this forecast assumes that the UK government removes all tariffs and non-tariff restrictions on imports, whatever their origin, suggesting that the UK would accept any goods of any standard, as well as zero border costs with the EU.
Alasdair Smith, a fellow of the UKTPO says the modelling is “unrealistic”. “The simple arithmetic is that the reduction in costs on non-EU imports does not compensate for losing the easy access to EU imports that results from the customs union and single market,” he says.