11 March 2022

EIAG: The UK and the EU: Two years after Brexit and one year into the Trade & Co-operation Agreement

European & International Analysts Group (EIAG) looks at the consequences of Brexit and at the implementation of the TCA in its first year, including its economic impact, and current problems arising from the agreement and its implementation.

Introduction

On Christmas Eve 2020, the UK and the EU reached agreement on a trade and cooperation treaty governing their future relationship (the TCA).  This agreement came into force on 1 January 2021.¹

In this paper, we look at the consequences of Brexit and at the implementation of the TCA in its first year, including its economic impact, and current problems arising from the agreement and its implementation.

Although the Northern Ireland protocol, which governs the trading relationship between Northern Ireland and the EU and Great Britain and Northern Ireland, is laid down within the UK-EU Withdrawal Agreement and not the TCA, we nonetheless consider the negotiations around the implementation of the protocol since there is an interrelationship between the protocol and the TCA.

 

Background

The UK-EU TCA is a free trade agreement that provides for tariff and quota free trade for most goods between Great Britain and the EU (see below as regards Northern Ireland).  Rules of origin apply to goods exported from GB to the EU, meaning that (in simple terms) the bulk of any item being exported must have been made in the UK.  Services were largely excluded from the agreement because the UK prioritised regulatory autonomy over maintaining economic ties with the EU; this issue is dealt with below.  It is important to note that there is a distinction between effects of Brexit generally (e.g. that the UK is no longer in the Single Market) and those of the TCA in particular (e.g. the alternative trading arrangements replacing the UK’s former participation in the Single Market).

Leaving the customs union with the EU means the return of full customs controls on GB-EU trade for the first time since 1992.  Because of the short implementation time, the UK unilaterally delayed introduction of full customs controls on most imports from EU until 1 January 2022.  New sanitary and phyto-sanitary (SPS) rules governing the import of animal and plant products came partly in force from 1 January 2022; the remainder come into force on 1 July 2022.

The Government remains confident that Brexit was the right choice for the country.  It has published a paper on the benefits of Brexit and is consulting on a prospective Brexit Freedoms Bill.²  The Government has given examples of the greater flexibility the UK has outside the EU in some areas of public policy, including on VAT, migration in respect of EU/EEA citizens, in agriculture and in financial services.

The TCA is a large and complex agreement with major consequences for all businesses trading with the EU.  An example of that is that the UK trade guide to importing and exporting goods to/from EU runs to 160 pages.³  It has led to the reintroduction of a significant number of non-tariff barriers.  Further details of the TCA can be found in an earlier SEE paper.⁴

 

Economic impact

Assessing the economic impact of Brexit and the TCA is complicated by the near parallel event of the pandemic.  Nonetheless, the Office for Budget Responsibility (OBR) has estimated that Brexit will reduce UK GDP by four per cent in the long term, in addition to a two per cent fall in GDP as a result of the pandemic.⁵

There was a much greater fall of 15 per cent in UK trade with the EU in 2021.  UK goods exports to the EU (nearly half of total exports) fell by 45 per cent in January 2021 before recovering somewhat in the months afterwards but they were still in August around 15 per cent lower than in 2020.⁶  Goods imports from the EU also fell, by around 30 per cent in early 2021, recovering to 20 per cent below December 2020 in August 2021.  Trade with both EU and non-EU countries was still lower at the end of 2021 than it had been before the pandemic in 2019 but the fall in the case of EU countries was double that with the rest of the world.⁷

The impact of the TCA on trade can be seen by comparing the trade performance of the UK and that of the main EU countries: UK trade has not recovered after Covid in the way EU countries’ trade has.⁸  In addition, the UK is now more dependent on trade with non-EU countries; 52 per cent of UK trade in first 10 months of 2021 was with non-EU countries.⁹  While the UK has had some success in rolling over trade agreements between the EU and third countries, and has signed new FTAs with Australia and Japan, the modest growth in UK’s trade with non-EU countries doesn’t compensate for the fall in UK/EU trade.¹⁰  And the FTA with Australia shows the UK’s weakened leverage outside of the EU; the UK would not have agreed to such a deal before because the majority of the benefits will be to Australia and because it undermines UK animal welfare standards and SPS controls.

Part of the difficulty in maintaining UK-EU trade in the first year derived from supply chain disruption.  Global supply chains have been disrupted by the pandemic but Brexit has also been a factor.  It is difficult to disentangle the two as possible explanations but the loss of EU citizens in the UK to drive goods vehicles and to work in food processing (roughly 200,000 EU nationals left the UK in 2020-21¹¹), the impact of the restrictions on cabotage (the right to carry goods between more than one destination in the EU) in the TCA and the need to comply with customs and SPS controls at ports are all Brexit-related factors contributing to the difficulties.

The largest impact of the TCA on UK-EU trade has probably been in services.  The loss of “passporting”, that was the right of a UK-based company because it was regulated in one EU country to offer that service in all EU countries, was a significant blow to UK service businesses.  To trade with the EU now they must now have a subsidiary in each EU country they operate in and comply with host country regulations.  Prior to Brexit the UK had a large surplus in its trade in services with the EU and the EU Single Market was UK’s largest destination for services exports, amounting to 40 per cent of overall services exports.  After the TCA came into force, the fall in UK services exports to the EU in the second quarter of 2021 was at 30 per cent more than double the size of the fall in services exports to the rest of the world (14 per cent; the comparison is with same period in 2019).¹²

The impact of the TCA on energy has not been as great.  The UK prioritised energy trade in the TCA resulting in a minimal impact on energy prices from Brexit.  UK energy policies are (now) largely aligned with those of the EU.¹³  The UK’s current high energy prices are mainly due to global factors but also to some domestic ones such as the lack of gas storage capacity and the inadequate diversification of energy resources meaning that the UK is less resilient in energy supply.¹⁴  In the longer-term, the fact that the UK is no longer in the energy single market may adversely affect the security of supply.

Inward investment has been volatile since 2016 with an overall downward trend, especially in expansion projects, and a big fall in FDI-created jobs.¹⁵  The UK had been a major benefactor of inward investment while in the Single Market with non-EU companies often choosing the UK as a base inside the EU (for example, for vehicle manufacturing, pharmaceuticals and financial services).  The Government has created an Office for Foreign Investment and established hubs around the UK to promote it but it will be hard to reverse the downward trend since 2016 given the limitations of the TCA.

Brexit has been one of the factors in driving inflation because of its link to supply chain issues, to labour shortages pushing up wages and to reduced business investment.    The increase in inflation will affect the cost of living, will increase Government spending (through higher interest rates on debt, increase in costs of goods and services and linked increases in benefits) and potentially increase the cost of exports, leading to either reduced overseas sales or lower UK business profits.¹⁶

 

Current problems with the TCA and trade in goods and services

Customs controls on goods

It is now more difficult, more costly and slower for UK companies to trade with the EU because the UK is no longer in the customs union with the EU or in the Single Market.¹⁷  This is because although the burden of tariffs was avoided through the TCA, non-tariff barriers to trade with the EU are now in place.  These include customs documentation on exports including declarations on rules of origin, VAT now being levied on exports, the reintroduction of SPS controls on fish and food exports and the need for some UK exporters to comply with more than one set of sectoral, product or employment regulations.¹⁸  As a result the number of customs declarations made on GB to EU exports, and UK to the rest of the world, has increased sharply; it was 44 million for the whole of 2020 but 48 million for January to August 2021.¹⁹  The cost to business of this increased bureaucracy is another factor adding to inflation as businesses pass on these costs to customers.

The UK has twice delayed the introduction of full UK customs controls on EU imports.  This reflects the difficulties for UK business of adjusting to controls, especially those concerning animal products and delays in bringing new infrastructure and staff online....

much more at  EIAG

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