Rob Welham/Camera Press/Redux

Brexit Chickens Come Home to Roost


bob looney teaches economics at the Naval Postgraduate School in California.

Published June 7, 2022


It seems like a thousand years ago. On June 23, 2016, UK citizens voted by a 52-48 percent margin to leave the European Union. At the time, just how this withdrawal, which came to be known as Brexit, would be accomplished was still (to put it kindly) undetermined. And only recently has some clarity emerged about the economic consequences.

While the picture’s hardly pretty and certainly not what advocates of Brexit envisioned, none of it surprises economists. As a former Bank of England official observed: “You run a trade war against yourself, bad things happen.”

The Long and Winding Road

The two sides in the Brexit referendum pursued markedly different strategies. The Remain side focused on the economic costs, citing lost income, jobs, productivity and, most important, influence over future decisions of Britain’s largest trade partner, the EU. The Leave side stressed populist issues such as the presumed threat of immigration to UK workers and the need to free Britain from the EU's “oppressive” rule-making. Summed up by the nativist slogan “taking back control,” these arguments struck a note with unhappy voters — just as similar arguments did and do win over voters in North America and Europe — and ultimately turned the election in Leave’s favor.

Neither the Leave side nor the Conservative UK government that had called for a referendum in the cynical expectation it would lose badly, had a credible plan to deal with the adverse effects of Brexit, in part because it was unclear what kind of withdrawal to plan for. Would it be a “hard Brexit” with all trade ties with the EU cut, or a “soft Brexit” with the UK keeping many trade links and advantages in the EU market? Brexit represented a leap in the dark: the only real question was how significant its costs would be.

As the UK government repeatedly pushed back the deadline for reaching an exit agreement, uncertainty over the way Brexit would play out spooked foreign investors. Foreign direct investment, always risk-averse, dropped from $259 billion in 2016 to $45 billion in 2019. In December 2020, Boris Johnson’s government finally signed the EU-UK Trade and Cooperation Agreement determining the new rules of trade. And the best one can say is that the consequences could have been worse: by December 2021, the UK’s goods trade had shrunk by only 15 percent.

But give it time. Beginning in January 2022, UK importers were hit with new customs declarations and safety checks, particularly on agricultural products. Exporters, for their part, now must prove that the UK contributed the majority of value-added for goods to qualify for tariff exemption in the EU, which effectively requires each exporter wishing to remain competitive to track the international supply chain. Instead of freeing UK producers from EU regulations, Brexit generated a net increase in red tape, with a disproportionate burden on small- and mid-sized firms.

The resulting loss of trade has been especially devastating to already depressed agricultural and small-manufacturing regions, notably the northeast and west Midlands, that were especially dependent on EU trade. Ironically, the Brexit referendum has inadvertently undermined the Johnson administration’s signature “leveling up” strategy, intended to reduce income disparities between the rich south and poor north.

Between the second quarters of 2019 and 2021, non-EU exports of financial services increased by 5.1 percent. But over the same period, exports of financial services to the EU swooned by 31 percent.
Money Business

The UK financial sector, which long dominated Europe, has been similarly hard hit. Since the referendum, about 7,000 jobs have moved from London to continental financial centers. That figure is substantially lower than the number anticipated at the time of the Brexit vote — but mostly because COVID-19 travel restrictions suspended relocation plans. The reprieve, however, appears to have be over: the European Central Bank recently began to reexamine the “back to back” model, which allowed EU entities to continue to manage risk from a UK base during the pandemic.

Figures from the UK government’s Office for National Statistics offer insights into the costs of realigning financial services trade away from the EU toward other markets. Between the second quarters of 2019 and 2021, non-EU exports of financial services increased by 5.1 percent. But over the same period, exports of financial services to the EU swooned by 31 percent. Though the government recently threw the sector a bone in the form of reduced regulation, it won’t restore financial services output to its pre-Brexit levels.

Wait; it gets worse. While investment is expected to increase from pandemic-era lows, uncertainty surrounding the delayed implementation of the Northern Ireland Protocol continues to feed investor wariness. The NIP, hammered out as part of the Brexit accord with the EU in 2019, would allow Northern Ireland (part of the UK) to continue to trade freely with the Republic of Ireland (a member of the EU). But in exchange, goods shipped to Northern Ireland from other parts of the UK would be subject to inspection at the border.

Free flow of goods is critical to both Irelands, and a barrier between their shared border could trigger a return of Northern Ireland’s sectarian violence — not to mention a serious break with the Biden administration. Boris Johnson’s government, which championed the NIP, is reluctant to implement it over objections from Northern Ireland’s Protestant pro-Brexit Democratic Unionist Party (DUP), whereas the EU would consider any attempt to recant a breach of the hard-won agreement. And the two sides now seem to have come to an impasse, with the UK apparently poised to modify the deal unilaterally. The recent stunning electoral success of Northern Ireland’s Catholic Sinn Fein Party adds yet another complication.

Circuses, not Bread

Then there is the long-standing problem of declining productivity. Labor productivity, which grew at an average annual rate of 2.5 percent in the 1980s, fell to 2.0 percent in the 1990s, 0.9 percent in the 2000s and 0.7 percent from 2010-21. Rather than take advantage of the country’s ballyhooed new freedom to relax regulations in order to reverse Brexit’s effects on labor productivity, the government argues instead that the lower availability of foreign workers will force businesses to shape up on their own. While this may occur in some sectors, the government's own research emphasizes the positive productivity effects of migrant labor.

Trends in total factor productivity, the broad measure of productivity that economists rely on, are even more alarming. Average annual TFP growth decreased from 1.6 percent (1980s) to 0.4 percent (1990s) to -0.3 percent (2000s) to -0.2 percent (2010-21). TFP normally accounts for half the economic growth in advanced economies — the other half is linked to accumulation of capital and growth in the labor force. Doing the math, it seems that TFP’s negative values from 2000 on reduced the UK’s potential growth rate from 2.1 percent in the 2000s to 1.5 percent from 2010-21. With the post-Brexit fall in investment and population growth well below 1 percent, potential economic growth could decline to zero by 2030.

Rather than implement changes to improve productivity and spur investment, the government instead chose to tinker. There have been relatively minor reforms to various taxes, including a simplification of alcohol duties and ship tonnage duties that favor UK-flagged vessels. Then there was the decision to abolish tax-free shopping for international tourists beginning in 2021, which will raise a few pounds but could cost Britain its position as a favored destination for high-spending international tourists — an estimated 20,000 jobs will be lost nationwide.

The UK’s Office for Budget Responsibility estimated that the deterioration of the potential growth rate would more than offset any rewards from positive regulatory changes thus far. The agency also concluded that trade with the EU has permanently declined by 15 percent, alongside a 4 percent hit on overall productivity. Even if the OBR's projections prove overly pessimistic, it is hard to see how, without realistic targeted initiatives, Johnson can create the high-wage, high-skill economy he promised to deliver.

• • •

In the meantime, Jacob Rees-Mogg, Minister for Brexit Opportunities (who needs Orwell?), has begun the process of reintroducing imperial measurements (ounces, gallons, etc.), which fell out of business use in favor of the metric system when Britain joined the EU. Business minister Paul Scully said reintroducing imperial labeling would be “an important step in taking back control” and that a planned “assessment of the economic impact on business will be carried out in due course” as part of an effort to “capitalize on new Brexit freedoms.”

In other words, give ‘em circuses and maybe they won’t miss the bread.

main topic: Region: Europe