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The consequences of Brexit for UK trade and living standards

Author(s): Swati Dhingra, Hanwei Huang, Gianmarco I.P. Ottaviano, Thomas Sampson, John Van Reenen

The economic consequences of leaving the EU are at the heart of the Brexit debate. This column studies how changes in trade and fiscal transfers to the EU following Brexit would affect living standards in the UK. Across a range of scenarios, Brexit leads to lower income per capita, but the magnitude of the loss depends on what trade policies the UK adopts post-Brexit. To minimise the economic costs of Brexit, the UK would have to remain closely integrated into the Single Market.

From VoxEU:

What are the economic consequences of leaving the EU? This question is at the heart of the Brexit debate. Some studies address this question by analysing how countries fared after joining the EU (see Campos et al. 2014 or the survey by Crafts 2016). In recent work (Dhingra et al. 2016a, 2016b), we take an alternative approach that estimates the consequences of Brexit by directly modelling the effects of leaving the EU on the UK economy

Our work focuses on two channels: trade and net fiscal contributions to the EU budget. We present results using both a structural gravity trade model and reduced form empirical estimates. In both cases, we find that leaving the EU reduces living standards in the UK, although the exact magnitude of the loss is subject to considerable uncertainty as it is not known what policies the UK would adopt following Brexit.

Trade between the UK and the EU

Membership of the EU has reduced trade costs between the UK and the EU not only through the removal of tariff barriers, but also through reductions in non-tariff barriers as part of the European Single Market. Reductions in trade barriers have increased trade between the UK and the EU. Prior to the UK joining the European Economic Community (EEC) in 1973, around one third of UK trade was with the EEC. In 2014, the 27 other EU members accounted for 45% of the UK’s exports and 53% of UK imports. EU exports comprise 13% of UK national income.

Higher trade benefits UK consumers through lower prices and access to better goods and services. At the same time, the UK’s workers and businesses benefit from new export opportunities that lead to higher sales and profits and allow the UK to specialise in industries in which it has a comparative advantage. Through these channels, increased trade raises output, incomes and living standards in the UK.

Structural Brexit estimates

To estimate the effect of Brexit on the UK’s trade and living standards, we use a quantitative trade model of the global economy based on Costinot and Rodriguez-Clare (2013). Our model divides the world into 31 sectors and 35 regions. It allows for trade in both intermediate inputs and final output in both goods and services. The model takes into account the effects of Brexit on the UK’s trade with the EU and the UK’s trade with the rest of the world.

To forecast the consequences of the UK leaving the EU, we must make assumptions about how trade costs change following Brexit. It is not known exactly how the UK’s relations with the EU would change following Brexit, so we analyse two scenarios: an ‘optimistic’ scenario in which the increase in trade costs between the UK and the EU is small, and a ‘pessimistic’ scenario with a larger rise in trade costs.

The optimistic scenario assumes that in a post-Brexit world, the UK’s trade relations with the EU are similar to those currently enjoyed by Norway. As a member of the European Economic Area (EEA), Norway has access to the Single Market. But because Norway is not a member of the EU’s customs union, it faces some non-tariff barriers that do not apply to EU members, such as rules of origin requirements and anti-dumping duties. In the pessimistic scenario, we assume the UK is not successful in negotiating a new trade agreement with the EU and, therefore, trade between the UK and the EU following Brexit is governed by World Trade Organisation (WTO) rules. This implies larger increases in trade costs than the optimistic scenario.

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