27 November 2017

VoxEU: Global value chains, trade shocks and jobs: An application to Brexit

Brexit cuts GDP more, and costs more jobs, if we also consider global value chains. A hard Brexit would destroy four times as much GDP, and four times as many jobs throughout Europe, as a soft Brexit.

Brexit's losers

While the framework is entirely general, we used it to evaluate the impact of Brexit on the UK and the EU27. Our world input-output model can be used to predict the trade impact of the UK's withdrawal from the EU on the domestic value added, and employment for every individual EU country involved. The trade impact is arguably the most important effect and leaves aside less influential, channels such as foreign direct investment (FDI) effects, budgetary issues, or potential trade diversion effects.

Losses from the trade impact of Brexit vary by EU country, depending on its openness to trade, its trade intensity with the UK and vice versa, its sectoral composition, and the positioning of its sectors within the global supply chain. The conventional wisdom of Brexit is that the UK has a great deal to lose, but a sector-level input-output approach indicates that there are only losers from Brexit. Both the UK and each bilateral trading partner in the EU would suffer substantial losses if they were denied free-trade access to each other's market.  

Our analysis clearly shows that the EU27 stands to lose considerably more than previously thought. This is because EU27 production networks are closely integrated, which implies that tariff changes with the UK do not affect only direct trade bilateral flows, but also indirect trade flows via other EU countries. For example, the Belgian steel sector would suffer both through a direct reduction in exports to the UK, and also through a reduction in demand for steel that would have been used in German-built cars for the UK.

On average these indirect effects account for about 25% of the total effect of Brexit, although their magnitude varies across EU countries. For example, in Slovenia indirect trade effects account for 50% of the total impact of Brexit, while in Malta they represent only 5%. [...]

Domestic value added and employment losses under Brexit

[...] Our results clearly indicate that the UK would be hit relatively harder than the rest of the EU27 (except for Ireland) in both scenarios.

In either scenario, Brexit would lead to a relative reduction in economic activity in the UK and EU27.

• Hard Brexit would cost 526,830 jobs in the UK, four times as many as a soft Brexit.
• Hard Brexit would cost 1,209,470 jobs in the EU27, again, four times as many as for a soft Brexit.
• Hard Brexit suggests a loss of 4.47% of UK GDP, again four times as much as a soft Brexit (1.21%).
• The loss of UK value added would be about three times as large as for the EU27, which would lose 1.54% of EU GDP (0.38% for a soft Brexit).

Again, these impacts differ substantially across EU-27 member states. The EU-27 countries that lose relatively most are those with close historical and geographical ties to the UK (Ireland or Malta, for example) and small open economies (Belgium, the Netherlands, and the Czech Republic). While Germany would suffer the largest absolute number of job losses (291,930), as a percentage of the total active population its relative losses are more moderate when compared to the other EU27 countries. [...]

No winners

Our findings indicate that both the UK and the EU27 would suffer substantial losses if they are denied free trade access to each other's market when Brexit happens. While the current belief is that especially the UK has a great deal to lose from Brexit, our sector-level input-output approach clearly shows that the EU27 stands to lose considerably more than previous estimates. The reason is that EU27 production networks are closely integrated, which implies that tariff changes with the UK do not just affect each EU27 country’s direct bilateral trade flow to the UK but also the indirect trade flows (via third countries) that end up in the UK.

We estimate these indirect effects will account, on average, for about 25% of the total Brexit impact, but for some EU countries, these indirect effects would create 50% of the total employment effects. Compared to other studies, the inclusion of this production network structure increases the projected negative impact of Brexit on the EU27. [...]

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