The United Kingdom’s exit from the European single market and the customs union on 31 January 2020 caused a significant economic shock which has had an adverse impact on growth and inflation in the UK, particularly on foreign trade. Since 1st January 2021 and the coming into effect of the post-Brexit Trade and Cooperation Agreement (TCA), bilateral trade in goods between the United Kingdom and the European Union has fallen sharply. The United Kingdom has made changes which mean that some of its imported goods now come from countries outside the European Union.
Brexit is an unprecedented event, with the UK leaving such a major and important area of deep economic integration as the European single market. This break-up is having very significant effects on the UK economy at multiple levels.
Firstly, the significant uncertainties that were in evidence throughout the negotiations on the exit from the EU have weighed on corporate investment and, as a consequence, on economic growth. According to a study carried out by the think tank Centre for European Reform (2022), UK GDP in Q4 2021 was 5.2% lower than it would have been had Brexit not happened.[1] This lower growth can be explained in part by a drop in productivity, as a result of Brexit, in the region of 2 to 5% between 2016 and 2019[2]. Among other things, companies will have spent a significant amount of time planning ahead and reorganising their activities with a view to leaving the EU, to the detriment of the rest of their business activities.
Secondly, while Brexit drags growth down, it also pushes inflation up. The introduction of customs and non-customs barriers with the UK’s largest trading partner has inevitably led to an increase in import costs, which has had an impact on UK consumer prices[3]. According to the think tank The UK in a Changing Europe, this increase would be around 6% for the food sector alone.[4] Furthermore, the exit from the single market has reduced supply in the UK labour market. In 2020 around 94,000 European workers left the country, which has led to labour shortages, particularly in low-skilled jobs. More broadly, the ageing of the population is leading to a structural decline in the size of the active workforce, which is not being compensated by immigration and which is having an adverse impact on potential growth[5]. Finally, the withdrawal from the EU limits the United Kingdom’s ability to make use of the European workforce, which also increases the strain on the labour market.
Trade balance in goods and servicesThirdly, and this is the central topic of this article, Brexit has had a significant adverse impact on UK foreign trade. Effective from 1st January 2021, the Trade and Cooperation Agreement (TCA) sets out the new regulatory framework for future trade between the UK and the EU.
While the EU is the UK’s largest trading partner, the TCA introduces trade barriers (implementation of quotas, introduction of regulatory and health standards, etc.) which not only hinder trade but also increase the cost.
However, the United Kingdom’s exit from the single market has made it possible for new trade agreements to be negotiated between the United Kingdom and countries outside the EU[6], which over time could counterbalance the effects of leaving the single market and strengthen non-European trade relations.
A decline in trade between the UK and the EU has already become very apparent since the TCA came into effect, a fall that can be attributed, at least in part, to the TCA, although the difficult economic context (health crisis, consequences of Russia’s invasion of Ukraine) may also be a contributory factor.
Prior to the implementation of the TCA the impact of Brexit on foreign trade was difficult to determine, but the effects on investment are clearly evident
Since the early 2000s, UK trade has primarily been with the EU. However, the gap between trade with European and non-European partners has tended to narrow since the 2010s, and it reversed in 2021.
From the point of view of the external trade balance, i.e. exports less imports of goods and services, the situation of the United Kingdom vis-à-vis the EU on the one hand and non-EU countries on the other has changed significantly (chart 1). On the one hand, the external balance with EU member states was largely in deficit and has tended to widen since the 2000s; exports of services were not enough to compensate for the high levels of imported goods. On the other hand, the external balance in relation to non-EU countries was in surplus, with a clearly upward momentum. Indeed, exports, mainly of services, easily counterbalanced the import of goods.
United Kingdom: trades in goodsThe vote in favour of Brexit in 2016 was a major political and economic shock (see Box 1). Given the numerous uncertainties surrounding the future negotiations, the United Kingdom experienced a drop in private investment of around 11% between 2016 and 2019[7]. However, this decrease in investment, significant as it was, took longer to materialise than was anticipated when the referendum result was announced, suggesting that the scale and persistence of the uncertainties may have delayed corporate investment choices. On the other hand, the high degree of uncertainty and the expectation of future customs and non-customs barriers resulted in an increase in the number of foreign direct investment (FDI) from the UK to the EU of around 17% (equivalent to around GBP 21.2 bn)[8]. Conversely, FDI from EU member countries to the UK fell by 9% (GBP 13.1 bn).
BrexitIn terms of British foreign trade, the referendum had an apparently limited impact until the actual implementation of Brexit in 2020-2021[9]. The external trade deficit with EU countries fell slightly to below GBP 20 billion, while the surplus with regard to non-EU countries fell significantly, to under GBP 10 billion. Given the uncertainties of the terms of the agreement for exiting the EU, imports from the EU contracted more strongly than exports to the continent, which explains the reduction in the imbalance in the external balance.
During negotiations on the exit from the single market (2020), the deficit in the balance of goods and services reduced to a low level, a development that was difficult to interpret in terms of Brexit given the concurrent health crisis and the resulting disruptions to global trade.
The Covid-19 pandemic and the restrictive measures taken by the United Kingdom largely explain this misleading improvement in the trade balance: imports of goods fell more sharply than exports of services. At the end of 2020, however, the approaching effective exit from the single market heightened concerns about a withdrawal without an agreement[10]. Against this backdrop, companies stocked up very significantly, leading to a sharp rise in imports, mainly from Europe (but also from non-European countries), in Q4 2020[11].
Since the TCA, trade between the UK and the European Union has contracted more sharply
The actual withdrawal of the UK from the single market (2021) resulted in a more obvious shock to trade with EU countries. The withdrawal from the European customs union has been accompanied by non-tariff trade barriers, such as health and phytosanitary checks, as well as checks on origin and destination. Although UK customs do not yet apply to all the checks provided for by the TCA (unlike European customs), the introduction of these barriers has already reduced trade considerably (longer delivery times, increased costs, etc.).
United Kingdom: trades in servicesAs regards the external balance (trade in goods and services), the TCA has resulted in lower trade with EU member states to the benefit of other countries. Overall, exports of goods and services have fallen sharply from their pre-Brexit level in 2018[12]. Exports of goods to both EU and non-EU countries were 8.3% below their pre-Brexit level in 2021 (chart 3). According to the INSEE[13], the fall is more pronounced for the export values of goods to the EU (-14.3% between 2018 and 2021) than to non-EU countries (-9.8%).
This significant fall in UK exports of goods to the EU was due mainly to the impact of the health crisis, but can also be attributed to the coming into effect of the TCA. While exports of goods from the main Eurozone countries bounced back in 2021, UK exports have continued to fall.
According to a recent study by the London School of Economics, this decline in exports of goods to the EU may only be temporary[14], except for certain products which are subject to particularly significant non-customs barriers.
British pound exchange ratesIn terms of trade in services (chart4), the consequences of Brexit are less detrimental than for goods, but they are still significant. Exports to non-EU countries are continuing to grow while exports to EU countries are falling sharply. This decline can be explained in part by the transfer of business activity from the UK to the EU, particularly in the finance and corporate services sectors.
The consequences of the TCA on trade with the EU are even more significant in relation to UK imports. The reduction in imports of goods and services from the EU is particularly substantial (-19.8% between 2018 and 2021) while imports from outside the EU are increasing (+10.9%).
Northern Ireland protocolAccording to a counterfactual study, the introduction of the TCA is likely to have reduced UK imports from the EU by 25% in 2021 compared to UK imports from non-EU countries[15]. Also according to INSEE, imports of goods from the EU have fallen sharply (-18.4% compared to 2018) in favour of imports from non-EU countries (+6.3%). In terms of services, the transfer of the sourcing of imports to non-EU countries is also evident. By Q4 2021 imports of services from non-EU countries had increased to almost their pre-crisis level (Q4 2019). By contrast, imports of services from the EU have failed to recover since the Covid-19 crisis and remain well below their pre-Brexit level.
The small decline in exports compared to imports can be explained by a foreign exchange effect, benefiting from the depreciation of the pound sterling following the referendum . The National Institute of Economic and Social Research (NIESR) points out that this depreciation has also made the UK more competitive in terms of exports, while reducing domestic demand due to the increased cost of imports[16].
Behind the general decline in trade with the EU, bilateral trade between the United Kingdom and the various European partners has not evolved in the same proportions. Imports of goods from Germany and France saw the largest falls, -18.6% and -14.1% respectively between 2018 and 2021 (compared to -10.7% on average for the EU as a whole). Conversely, British exports to France fell less (-13.5%) than those to the rest of the EU (-25.2%).
Ultimately, the implementation of the TCA has had a significant negative impact on the UK’s trade with the EU, particularly in goods. The introduction of non-customs barriers with its main trading partner has also caused an increase in import costs and a drop in UK growth, both actual and potential.
While the previous Prime Ministers, Boris Johnson and Liz Truss, had stated their willingness to renegotiate the TCA (or to withdraw from it in the event of refusal by the EU), the subject is still on the table for the new Prime Minister, Rishi Sunak. Will he decide to reopen discussions on the TCA and the Northern Ireland Protocol (see Box 2)? What new commercial, industrial and budgetary measures could be put in place to mitigate the impacts of Brexit on the economy? So Brexit is far from complete.
