The economics of a “no deal” Brexit

Question

A "no deal" Brexit is presented in negative terms.

In such a scenario the UK would set tariff schedules in line with trade strategy and protect domestic industry/agriculture with tariff rate quotas.

The UK would lose tariff-free exports into the EU and the markets with which the EU currently has free trade agreements (the two main ones being Japan and Canada).

The non-weighted average MFN global tariff is 9%. The weighted average tariff for UK exports into the EU is estimated to be around 4.5% in this scenario. Natural movements in currency value are of this order of magnitude.

There would be increased trade friction for the 44% of our exports that are sent to the EU. British exporters would have to follow the customs rules used by other 3rd-country exporters to the EU like China and the USA.

This would be a major change. Most countries export to the EU under these terms. Our reliance on services mean this change would be economically bounded.

The productive base of the UK would re-orient around the new status-quo with some sectors decreasing in competitiveness and diminishing and some increasing and expanding.

The overall success/failure of the new status quo would be determined by the wider economic strategy rather than tariff changes that are mostly small.

Why is a negative long-term forecast necessitated?

Answer 1

Brexit economic forecasts usually assume that Brexit will happen and nothing more than Brexit. In other words forecasters will not assume other changes which may be pro-growth. For example they will not likely assume the "Singapore on the Thames" outcome because we do not know if it is politically feasible or realistic.

All else equal, countries tend to trade near rather than far so Brexit may be a welfare reducing event.

Link to Wikipedia on the so called gravity model of trade.

This is why a post-Brexit forecast of GDP in 2030 will tend to be less than the non-Brexit forecast.

Of course in the very long run the tendency to trade near rather than far becomes less significant. More trade will occur over greater distances because of decreasing transportation costs and convergence in cultures and convergence in per capita incomes between countries, even distant ones.

Between now and say, the year 2030, transportation and culture will probably still matter a significant amount so the proximity and cultural similarities with the EU suggest GDP will be higher in the "remain" scenario. If the Brexit scenario has less trade, as is likely, then you have an explanation for an adverse GDP forecast.

Link to a description of Singapore on the Thames.

Answer 2

Maybe someone can get into more details, but generally speaking

The range of estimates is large, from a loss of GDP of nearly ten percentage points (in the least attractive trade and inward investment scenarios modelled by the Treasury, NIESR and the Centre for Economic Performance at LSE) 1 to a gain of four points (Minford, for Economists for Brexit – a clear outlier) – see figure 1.

The main reason for the differences lies in the assumptions made about shifting from the current access that the UK has to the EU single market to a new regime in which the UK faces restrictions.

Those were from 2016 estimates/papers.

Also, economists were not terribly good at predicting Brexit-related effects insofar, at least short term; see https://economics.stackexchange.com/a/27492/6210 While the gloom and doom may have been overstated, some effects are apparent already, in some analyses:

Apparently the chilling effect of Brexit on investments may have been a real thing (but that assumes the counterfactual dotted trend was a sure thing).

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As a sort of an update, some days ago (Sep 3, 2019) UNCTAD has posted an article on the narrower issue of potential UK losses in a "no deal" scenario due to continuity trade agreements with other countries not yet agreed.

In relation to exports to countries with which the UK has not yet secured the continuation of preferential access, the UK could face substantially higher MFN tariffs, especially on agricultural products. For example, processed food products could face an average increase in tariffs of about 17 percent. Similarly, apparel, textiles and motor vehicles would also face substantially higher tariffs. In value, most of the losses would be concentrated in motor vehicles (about USD\$750 million) and in chemicals (USD\$200 million).

[...]

Among the countries which currently grant preferences to the EU but for which the UK has not yet reached an agreement to grant continued preferential market access, Turkey, South Africa, Canada, Mexico, Japan, Egypt and Morocco are the markets where the UK is expected to have larger export losses. In particular, the UK is expected to lose about USD\$500 million of exports in the Turkey market, about 5 percent of its exports to Turkey. In South Africa, the UK is expected to lose about USD\$240 million, equivalent to about 9 percent of its exports to South Africa.

There's an update to the update as well. On Sep 11, the UK has announced an "agreement in principle" with South Africa and with a few other, smaller countries from Africa.

Answer 3

I decided to edit the post to bring it in line with my area of expertise.

The question is, why the UK will be worse off after a no deal Brexit. Why could it not be economically favorable?

The answer is simple: by leaving the EU, the cost of doing business will rise in all cases and lower in none. The default tariffs are higher than existing tariffs. They are a sales tax. The loss of cooperative agreements in service industries is the functional equivalent to tariffs and are probably more damaging.

You may ask, “why could we not just create a new trade deal?” You can, but trade deals are very slow things to construct. It is miraculous that Theresa May’s government had anything at all to show Parliament.

All major global firms run optimization routines, and they will shift those routines by the amount of the new tariffs. It is a mistake to look at the average tariff rates. They do not matter. For some types of goods, the tariffs are not going to matter, but for others, it is likely the entire flow will stop. The UK will have the default tariffs, and everyone trading with the UK will be required to use the generic tariffs. They are item specific. It is incredibly dangerous to speak in terms of average tariffs. That is a meaningless number.

If I wore the average clothing required in most cities in temperate zones around the world, I would freeze to death or die of heat exhaustion in many of them. The issue is variability, not the central tendency. The question is how much of a percentage shift in tariffs will happen minus the effect of added transport costs and the impact of changes in rental spaces for warehousing.

What will happen is that the entire world will be kicked out of equilibrium. The UK will have to compensate for the higher costs by cutting other costs such as wages. In other words, there will be more lower paying jobs to compensate for the added costs created by Brexit. There also could be shifts in interest rates, but it isn't clear without a model as to which way it would go.

For the UK to expand in real terms, rather than nominal terms, it will have to create technologies not present anywhere else. That will require an increase in immigration. All cities of large size require constant immigration. For geographically large countries like the United States and China, much of the immigration comes from within the country. They are also constantly suffering from emigration out as people are constantly moving to new places once they are no longer in the city of best fit. It is why there is so much fight in the heavily populated places in the US against the Trump administration. The lifeblood of all major cities is the constant movement of people in and out to make the city relevant. God save you if you are Detroit USA, and you only have outflows.

The problem is that what most people want are high skilled workers, but that is costly. It costs a lot to hire a general when there are many privates who can eventually be trained to be generals. Plus, high skill immigrants often prefer to live in communities with people of their country of origin. Genius is randomly and uniformly distributed in any population group and is independent of parental income. Also, if you hire someone who has already developed technologies, it is unlikely the marginal gain to the UK will be much as that marginal gain was likely captured by prior employers. For the UK to grow, it is going to need robust immigration at all levels of skill.

For the UK to grow in real terms, it needs to negotiate trade deals after the equilibrium shifts. Imagine, for example, all sheep herding in the UK ends due to tariffs. Imagine it shifts to France, Germany, and Austria. Those three countries will not allow a trade agreement which will take away their newfound income. It isn't possible to enact trade deals until someone sees which industries in the UK go away forever and the low wage workers created from the former high wage workers expand an industry that previously was not that important. It may be that furniture making will increase, though I doubt it.

The UK will need to enculturate innovation. The UK needs to make sure that it is the destination for the new industry, whatever it may be. The UK is likely to have a cadre of highly trained former bankers running around. With a pay cut, all that skill is going to be useful to someone.

In short, Brexit with no deal has no upside for the UK. There will be a handful of individuals who will be better off, some may be much better off, but most will be worse off. The UK has historical competitive advantages, on a comparative basis, in several industries. The changes are going to knock those out, and the UK will need to rebuild.

To use an American analogy, the UK needs to learn to play baseball and give up the advantages of playing basketball. Basketball is a cooperative game. If one viewed the other European countries as members of the team, then in basketball, you gain the strengths of the other members. That is surrendered. Baseball requires everyone to execute their skills with excellence at every point in time. It doesn’t require any cooperation and requires an enormous amount of autonomy.

The UK will need to execute with excellence. It will have to find ways to excel on its own and it will have to find a way to do so without slowing down.

Answer 4

How much is sovereignty worth?

This should be balanced against potential short-term costs of Brexit.

Among other things, one will retain the ability to purchase "champagne" from its region of tradition, cultivation and origin in France (but only "sparkling wine" if produced outside of that region). But, will be assured of access to a veggie "burger" and also to grains and pulses reformulated into "fake meat".

A negative long-term forecast would be largely due to assumptions inherent in many economic models that the world after a specified change will function identically to the world before the specified change, with the exception of the one or handful of changes specifically modelled. It is one thing to change a 0 to a 0.09 (9%) in an existing model. But reality may evolve differently than what can be readily modelled empirically using economic theory.

Answer 5

Here's one way to look at it: The NPV of a rapid X% hit to GDP exceeds the NPV of a rapid increase of +X% some years in the future, given a constant discount rate.

Let's say the additional one-time increase to GDP needed to get Britain back on its current growth path is Y%. So just to break even on Brexit, you need to believe that growth on the scale of X+Y% will happen, ideally quickly (the longer this takes, the bigger Y% will have to be).

On top of that, global growth is Z%, which in the current pessimistic environment, is not expected to be large.

So if X is large (and it's expected to be), and if Y is large (because it will probably take a while for Britain's economy to reorganize itself), then a positive outlook requires believing that Britain will experience a very large surge to GDP in an environment where overall growth rate forecasts are pessimistic.

You can certainly have that outlook, but I'd be interested in hearing how you think it will happen. :)