CER: What can we know about the cost of Brexit so far?
15 June 2022
Disentangling the economic effects of Brexit and Covid-19 is difficult. But now that most advanced economies have surpassed their pre-pandemic level of output, we have a basis of comparison for the UK economy.As with my earlier modelling exercises, I construct ‘doppelgängers’ – each of them a basket of countries whose economic performance closely matches the UK’s before the Brexit referendum and the end of the transition period. They provide a counterfactual UK that did not leave the EU. I estimate doppelgängers for GDP, investment (gross fixed capital formation), total services trade (exports plus imports) and total goods trade (ditto).
- The results are sobering. In the final quarter of 2021, UK GDP is 5.2 per cent smaller than the modelled, doppelgänger
UK; investment is 13.7 per cent lower; and goods trade, 13.6 per cent
lower. The UK’s poor economic performance in the pandemic may be partly
to blame for the weakness of GDP, but its early vaccination campaign
meant its restrictions ended earlier than those of many peer economies.
And over the period from the referendum to the pandemic, a sizeable
shortfall – 2.9 per cent – had appeared between the UK and the doppelgänger. Investment also began to lag at the point of the referendum, and goods trade when the UK left the single market.
- The estimate for services trade is that the UK’s level is 7.9 per cent higher than that of the doppelgänger, but the estimate is not robust: for now, we cannot know what the impact of Brexit on services trade has been.
- The
impact of Brexit on inflation is small in comparison to global price
hikes in manufactured goods, energy and other commodities. The end of
free movement has reduced labour supply, but the number of British
workers becoming inactive over the pandemic has had a much larger
effect. Import price inflation has been similar in the eurozone and the
UK, despite the large decline in Britain’s goods imports from the EU
after it left the single market and customs union.
- This is the
backdrop – and one that is largely unmentioned in the UK political
debate – for the big tax rises that the Chancellor has announced over
the last year. A smaller economy means higher taxes are needed to fund
public services and welfare. The Office for Budget Responsibility
forecasts that the scarring effects of Brexit will be larger than those
of Covid. Our own estimates are in accord with that view.
In
May 2020, the well-connected journalist James Forsyth wrote in The
Spectator that the British government was comfortable about Britain
leaving the EU with no deal. That was because advisors thought that
“coronavirus has collapsed world trade and travel, dwarfing any changes
Brexit might bring.” As my series on the impact of Brexit on goods trade
has shown, this turned out to be wrong: leaving the single market and
customs union has reduced UK goods trade by around 15 per cent.1
Yet the government was right about one thing: the pandemic has made it
hard to isolate the impact of Brexit on other economic indicators, like
GDP, services trade or investment. Now that many advanced economies have
recovered and are close to – or above – their pre-pandemic level of
output, we can compare Britain’s economic performance to its peers. The
results are troubling.
This policy brief provides doppelgänger
estimates for the impact of Brexit – and the pandemic – on Britain’s
GDP, on gross fixed capital formation (GFCF, a broad measure of
investment across the economy), on services trade and on goods trade,
for the last quarter of 2021. The estimates are shown in Chart 1. UK GDP
is 5.2 per cent lower than that of the doppelgänger. Investment is 13.7 per cent lower; goods trade, 13.6 per cent lower; and services trade 7.9 per cent higher.
These
estimates are based upon separate quarterly GDP, GFCF, services and
goods trade models, which compare the UK’s performance to that of its
peers up to the last quarter of 2021.
In each case, an algorithm
compares data on the UK’s economic performance with that of 22 other
advanced economies. It selects a subset of those countries and allocates
each a weighting, to create a basket of countries that minimises the
difference between their data and that of the UK. The algorithm matches
the growth rate of real GDP, GFCF, services and goods trade, from Q1
2009, as well as the inflation rate, industrial production as a share of
GDP, average years of schooling and other variables. We can then
compare the performance of this doppelgänger against that of the UK. ...
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