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This report was produced on 2 September 2020 with ICAEW's partner Oxford Economics, one of the world’s foremost advisory firms. Their analytical tools provide an unparalleled ability to forecast economic trends.

3. Prospects for the UK/EU trade talks

3.1 Developments to date

On signing the withdrawal Agreement in January of this year, the Government said clearly that it would spend no more than a year negotiating a Free Trade Arrangement (FTA) with the European Union (EU), to be implemented on 1 January 2021, and that if necessary it was prepared for the UK to trade with the EU on World Trade Organization (WTO) terms—something that would mean both tariff and non-tariff barriers on UK exports to the EU.

However, until recently it seemed likely that the Government would, in reality, compromise, and delay implementation until a later date—probably 2022 or 2023. In the meantime, existing trade arrangements would apply. One reason was simply that FTA agreements tend to take many years rather than months to settle. Another was to enable the UK to address some of the logistical issues surrounding the introduction of border and other controls, and to give businesses more time to prepare for the structural changes to the trading environment. The onset of the coronavirus pandemic has provided further weight to this position, with the Government having to redirect a tremendous amount of its resources and energy to tackling the virus.

However, the Government has not shifted from its original position, and an extension now seems very unlikely. The Government has justified its approach by saying that it provides more certainty for businesses, despite survey evidence that suggests that businesses need more time to adjust to new regulatory and customs changes, and would prefer an extension to the timeline; and despite the ongoing uncertainty as to whether an agreement will even be reached.

3.2 What if a trade deal is agreed?

There is of course still a possibility that an FTA will be agreed in time for implementation on 1 January 2021, and that is indeed our baseline expectation. We think that the UK Government will decide to make whatever concessions are needed, in order to achieve an FTA—rather as it did for the Withdrawal Agreement in late 2019. A key reason for this is that the Northern Ireland protocol, contained within the Withdrawal Agreement, states that under all circumstances Northern Ireland will remain part of the EU regulatory framework for traded goods. If an FTA was not reached, this would result in large trade frictions between Northern Ireland and the rest of the UK, something that would create serious economic and political difficulties that the Government is highly likely to want to avoid.

In addition, the UK has several sectors where the EU is by far the most important export market, and where the potential barriers to trade would be very high under a no-deal scenario. We discuss this in detail in Section 4. The key point here is that sub-sectors of manufacturing such as motor vehicles and aerospace have powerful lobbying voices, and are hugely important for particular regions of the country. So, it is likely that the Government will want to cushion the impact of the Brexit transition rather than expose sectors such as these to serious trade challenges. That is likely to affect its decision-making.

With or without an FTA, the Government has acknowledged that the UK will not administer custom procedures on imports from the EU over the first six months of the new relationship. The likely aim of this statement is to encourage the EU to adopt a similar tactic. However, the EU have insisted that they will not do so, and will apply full customs and regulatory checks from the beginning of next year. This combination will place the UK in a difficult position, and could lead to a ‘worse case scenario’ of impaired exports and unfettered imports, for a short period of time, regardless of any FTA being struck. Exports from the UK will immediately be impacted by the introduction of border controls and other non-tariff barriers, whereas imports will continue to flow freely.

3.3 What if there is no agreement?

Should the end of 2020 come about with no FTA, then the UK will automatically revert to trading with the EU under WTO rules. This would result in a substantial increase in trade frictions through the imposition of tariffs and non-tariff barriers on EU-UK trade, severely hampering the competitiveness of UK exporters. We have modelled such an outcome, and also a situation where a FTA is implemented on 1 January 2021. We project that UK GDP would be 1.0% higher by the end of 2022 under the FTA, compared with the WTO regime.

Figure 7: GDP under different Brexit outcomes

3.4 What about trade deals with other nations?

Simultaneously, the UK is seeking to make trade arrangements with third nations, which might result in UK businesses being able to trade with those nations on better terms than at present. However, these look unlikely to be sufficient in offsetting any losses from withdrawal from the EU trading bloc. Analysis by the Department for International Trade indicates that the complete removal of tariffs and a 50% reduction in non-tariff barriers with the US (a very unlikely outcome) would increase UK GDP over the next 15 years by just 0.16%. And it is a similar story with Australia and New Zealand, with the likely boosts to GDP from agreements a mere 0.02% and 0.00% respectively. And if trade deals cannot be agreed, then once again the UK will need to trade on WTO terms, with adverse consequences for businesses and consumers.

3.5 The decisions that businesses will need to take

Companies will therefore need to prepare for some temporary trade disruptions under a FTA deal or permanent problems under WTO. This essentially replicates the story a year ago, in the build-up to the 2019 Brexit deadline. Accordingly, it is likely that over the remaining months of 2020 businesses will replicate the strategies that they adopted then. In particular, they will seek to front-load both orders of imported items and export deliveries, sending orders earlier where possible, and building up stocks of raw materials, components and finished goods.

The complication is, of course, the coronavirus pandemic, the restrictions which that places on businesses’ freedom of action, and also the damage that the coronavirus crisis has done to company finances, and hence the ability of businesses to finance the early placement of orders, the early delivery of sales, and the maintenance of high levels of inventories. Many companies have spent several weeks, indeed months, partially or fully shut down, and while the Government has typically paid a high proportion of wages via the furlough scheme, other costs like rent and utilities will still have been paid, often with little or no revenue in return. Similarly, many companies that have reopened have done so at vastly reduced capacity, but with little reduction in their cost bases.

Even if companies do not seek to frontload exports and imports, the simple practicalities of having to manage border controls or equivalent arrangements will itself create some costs for UK companies, which will need to invest in systems to cope with customs changes and train staff at a time when they struggle to be able to raise the cash. Therefore, UK businesses may be forced into a game of ‘catch-up’ in the new trading environment, struggling to operate under the new arrangements. That is likely to harm their competitiveness, even if only temporarily.

Longer-term, if the UK faces increased trade frictions with the EU, and perhaps with other nations, either under the WTO or the FTA scenario, there may also be adverse impacts on the attractiveness of the UK as a destination for Foreign Direct Investment, and on the home versus foreign location decisions of UK-owned or managed firms. A key implication of this may be to limit the potential for productivity improvements, which in turn could damage competitiveness on an ongoing basis. Thus, the combination of the coronavirus pandemic and the planned ending of the UK’s current trading arrangements on 1 January 2021 seems likely to be a challenging one.

3.6 Forecasts for trade and the balance of payments under a FTA

In the light of the above, Oxford Economics expects that exports of goods and services, having fallen 11.0% in 2020, will rise in real terms by only 5.3% in 2021, while imports will rise by 15.5% having fallen 17.5% this year. The impact of that on the balance of payments will depend on movements in both relative prices and the exchange rate, and also on whatever happens to financial flows in the firm of interest payments, profits and dividends. The likelihood is that the deficit will rise a little, as a percentage of GDP, having been artificially reduced this year by the effects of the pandemic, but it is unlikely in itself to become a major cause of concern for policymakers. If there were to be no FTA, however, and UK companies had to trade under WTO terms, the figures could be significantly less favourable, with some sectors and some UK regions experiencing particular difficulties.

Figure 8: UK exports and imports and balance of payment, 2019-21

   2019 2020 2021 
 Exports of goods and services, real terms, %y/y  5.0  -11.0  5.3
 Imports of goods and services, real terms, %y/y  4.6  -17.5  15.5
 Current Account Balance of Payment, % of GDP  -4.0  -2.0  -3.5

4. Sectors and regions most affected by trade issues

4.1 Recent exporting patterns by sector, for the UK

The challenges posed by the shift to a new trading regime, along with the current coronavirus crisis, will clearly affect export sectors differently. The data for this year, shown in Figure 9, underlines the difficulties that many exporters are already facing—but also the fact that in some sectors, exports have been growing.

Figure 9: UK volume of goods and services exports

UK exports of goods and services Level, £bn
Growth, (%y/y) 
   2019 2019 2020 Q1  2020 Q2
Total exports – Goods 331.9
5.0 -8.3 -6.2
Food and Live Animals
Beverages and Tobacco
Crude Materials
Mineral Fuels
Animal and Vegetable Oils
Manufactured Goods
Machinery and Transport Equipment
 -1.0   -13.7
Miscellaneous Manufactures
Total exports – Services
 -4.8   -23.8

Source: HMRC

Particularly striking is the contrasting performance of the UK’s two largest sectors for goods exports: machinery and transport equipment, and chemicals. In Q2 2020 exports of the former were down 32.6%, y/y; among the most severe falls of all sectors of traded goods. This reflects the range of challenges facing the sector, including huge disruptions to supply-chain networks upon which the sector relies, as well the direct closure of factories, the closure of car showrooms, the extreme problems of the airline sector and hence a collapse in the civil airliner market, and so on. The last of these is likely to be particularly slow to unwind, with widespread expectations of a near-permanent downward adjustment in the market.

In contrast, the chemicals sector has seen a sharp rise in exports, relative to a year ago. The sector is particularly benefitting from strong international demand for cleaning products—soaps and detergents—together with plastic items including personal protective equipment, containers and wrappings, and of course pharmaceuticals, in which the UK has a specialism.

The beverage and tobacco sector also saw a large fall in export demand, probably reflecting a collapse in whisky sales as a result of the closure of bars around the world, while the miscellaneous manufacturing sector also saw a big decline, with the closure of non-essential shops in most countries reducing the demand for consumer goods, and factory closures reducing the demand for industrial equipment.

The other important movement has been in service sector exports—down 23.8% in Q2 2020, compared with a year earlier. This broad category includes the airline sector, which has been severely damaged during the crisis, with demand for air travel collapsing. The sector also includes creative exports such as film production, now almost entirely suspended, and of course financial and business services, which are hurt both by the falling away in global trade and by declines in international financial deals and financial market trading.

4.2 The potential impact of a new trade deal on exports by sector

Many of these recent movements are likely to unwind, at least in part. However, and as discussed in Section 3, exports of goods are likely to be impacted to some degree by the shift to a new trade regime, probably on 1 January 2021. How this affects different sectors will depend on both the tariff and non-tariff barriers that they might face. Figure 10 provides Oxford Economics’ estimates of the level of tariff barriers and also the non-tariff barriers, including customs controls, that different sectors would face under WTO arrangements.

Figure 10: Increase in tariff and non-tariff barriers for UK exports to EU by sector under WTO rules

It can be seen that the average tariffs that might be levied on exports are relatively low across sectors. But many sectors will face additional costs from exporting. The food & beverages and chemicals sectors would face particularly steep increases, stemming from regulatory changes and customs-checking procedures.

One complication is that while the UK Government may well sign an agreement that is described as ‘Free Trade’, there may be exceptions for some items, as mentioned in Section 3, but also the introduction of non-tariff barriers for some or all products. In particular, sectors that have low levels of exports overall, and low levels of exports compared with the EU in particular, may secure weaker deals than others that are regarded as being of greater economic (or political) significance. Figure 11 shows the extent to which different types of exports of goods are focused on EU markets.

Figure 11: Volume of UK goods exports to the EU and rest of world, 2019

Given the scale of its exports, the machinery and transport equipment sector is clearly particularly important to the UK. Not only is it by far the UK’s biggest goods exporter; in 2019, 43% of its exports went to the EU. Within the total, aerospace and motor vehicles are likely to see particularly large cost increases under WTO, due to tariff and custom changes, unless a deal can be struck to avoid that.

It is also striking that the EU is the destination for just under 50% of all chemical exports. These are on a lesser scale compared with machinery and transport equipment, but they are still large, and risk facing some of the steepest increases in non-tariff barriers.

The impact of future deals on the UK’s large services export sector is clearly also important, with the EU accounting for more than 40% of all UK service exports in 2017. A quarter of the UK’s service exports to the EU stem from financial services, and there has been significant public discussion about how the sector’s position might change under the new UK-EU relationship. One possible way forward is called a ‘passporting system’, under which UK-based companies are able to export their services into the EU without needing regulatory approval or licences—but only as long as the EU authorities agree. Another possibility would be ‘regulatory alignment’ in which the UK simply adopts EU regulations. The Bank of England has argued against this, on the basis that EU rules will not be designed to suit the particular needs of UK businesses, which have very different global trading profiles to those of other EU countries. Instead it favours an arrangement called ‘equivalence’, in which both parties agree that the other’s arrangements are acceptable. This, however, is a particularly hard arrangement to settle on.

Given the complexities, there is a strong chance that the UK Government will simply put the financial services sector to one side, and rely on temporary passporting arrangements, with the intention of returning to the matter at a later date. In practice even this could be hard to settle satisfactorily in the time available, and in some sub-sectors, exports of financial services are likely to fall, with customers sourcing from EU suppliers instead.

4.3 The relative importance of exporting, for different UK regions 

These sectoral factors are important to different degrees across the various regions and nations of the UK. As Figure 12 shows, in 2019 the South East was the region that accounted for the largest share, 13.4%, of UK exports of goods. However, that is more than explained by the fact that the South East is a large region, in terms of output, measured by Gross Value Added (GVA). Hence the region’s reliance on exports of goods is slightly below the national average. There is no up-to-date information on the value-added component of exports by region, and hence it is not possible to calculate what share of a region’s output is attributable to exports.

In contrast, Scotland, Wales and the North East both accounted for larger shares of UK exports of goods in 2019 than their shares of UK output, indicating that their reliance on exporting is much higher than the UK average .The same is true for the East and West Midlands. The latter two are particularly exposed to the machinery and transport equipment sector. In the case of the West Midlands it accounts for 70% of the total value of goods exported from the region, comfortably the highest share across the UK.

Figure 12: UK regional share of total UK GVA and total value of exported goods, 2019

This overall picture is, however, probably shifting in 2020’s extraordinarily unusual circumstances. Data for Q1 2020 (the latest period for which we have information) suggests that the South East has experienced the fastest decline of any UK region or nation in the value of its goods exported: down -17.0%, compared with a year earlier. Much of this weakness stems from difficulties facing the region’s high value machinery and transport equipment sector. The region has a particularly large presence of internationally significant engineering companies. The situation would have been much worse, except that the South East has a large pharmaceuticals sector, with the region accounting for almost 20% of all UK chemicals exports in 2019. This has clearly been important as the pandemic has taken hold, globally, and has helped the region’s overall export performance

Elsewhere, Scotland has also seen a steep fall in the value of goods exported, with a contraction in Q1 2020 of 15.0% (y/y). This largely relates to especially large declines in the oil sector, which is relatively more important to Scotland than elsewhere in the UK. Export performance in Yorkshire & Humber and West Midlands was also among the weakest across the UK, with both regions being hurt by much reduced demand for manufactured goods and machinery and transport equipment.

Where exports of services are concerned, regional data is currently only available up until 2017. However, the main story here is long established: service exports from London dwarf those from all other regions, accounting for over 40% of the UK’s service sector exports. This reflects London’s global strength in three key areas: information & communication, finance & insurance and professional, scientific and technical activities. Collectively, these three sectors comprise 70% of London’s service sector exports. Given how these sectors are relatively more resilient to the current crisis, due to their office-based structure and hence their capacity to shift to homeworking, it is likely that London’s service sector exporters are probably able to weather the current storm more easily than those in other regions. That is despite the capital also having, in absolute terms, the UK’s largest accommodation and food sector, with 16% of that sector’s exports originating in the capital.

Figure 13: Regional shares of total value of UK service exports, 2017

4.4 The importance of EU exports, across different UK regions

Clearly, an important question is to what extent different UK nations and regions are reliant on trade specifically with the EU, rather than with the rest of the world. In terms of goods exported, Wales is very vulnerable to any future difficulties in UK-EU trade. In 2019, 61% of goods exported from Wales went to the EU, the highest share of any nation or region within the UK. Almost as vulnerable to tensions in EU-UK trade are the North East and Yorkshire & Humber, at 60% and 58% respectively.

At the other end of the spectrum is London, which has a low reliance on exports of goods and in 2019 had the lowest proportion of exported goods sent to the EU of all UK regions.

However, for exports of services, London’s position is very different and not nearly so comfortable. In 2017 just over 40% of its service sector exports went to the EU, by far the highest percentage of any UK region. So, the uncertainty over whether a trade deal will encompass services is likely to weigh heavily on the capital. This is especially true for the city’s information & communication and financial services sectors, which together accounted for over a fifth of the UK’s service exports to the EU in 2017.

Figure 14: Percentage of region’s total goods exports that go to EU, 2019

4.5 Imports across UK regions

While reliance on exporting receives a lot of attention, reliance on imports is also important, especially when such imports serve as inputs into the production process, as is particularly the case with raw materials and components. Inevitably in that regard, some regions are more import-dependent than others. For 2019, the South East had a much larger share of total UK imports relative to the region’s share of national output. The region is a particularly big importer of machinery and transport equipment. To a lesser extent, the East of England also has a larger share of imports compared to its share of national output.

In contrast, Scotland, South West and North West all accounted for smaller shares of total imports in 2019 than their respective shares of national output. This indicates that these areas are less reliant on imports than elsewhere in the UK.

Figure 15: UK regional shares of total UK GVA and total value of imported goods, 2019

As we noted in Section 2, the current health crisis has had a significant impact on the levels of imports of goods coming into the UK and some output has been lost because the necessary inputs have been unavailable. Inevitably some regions will have been more affected by this than others. However, where imports are concerned the consequence is potentially different because many imports are accounted for by consumption, and we do not have up-to-date information on how that varies by region. So, the extent to which output has been affected in different regions is not clear.

What we do know is that in the first quarter of this year, Yorkshire & Humber and the West Midlands experienced the steepest falls in the values of their imports, when compared to a year earlier. For both regions, this largely reflected a fall in the value of machinery and transport imports. For the West Midlands, the sector accounted for 45% of the total value of imports into the region in 2019, reflecting substantial supply chain linkages, especially within the automotive sector. But as early as the first quarter of this year, the value of the sector’s imports into the West Midlands fell by 20% y/y, reflective of lockdowns in many overseas supplier economies, notably China. And during April and parts of May the situation will have deteriorated markedly, although hopefully with activity beginning to recover at the end of Q2.

4.6 The importance of EU imports for UK regions

As far as imports from the EU are concerned, and the potential disruption caused by a poor outcome for the UK-EU trade negotiations, the East of England and the South East and West Midlands look particularly exposed. The shares of their total imports of goods that came from the EU in 2019 were 64% for the East of England and 62% for both the South East and the West Midlands. In contrast, Wales had the smallest share of its imports accounted for by EU suppliers of any nation or region whilst being the place with the highest share of its exports destined for the EU. Scotland, the South East and London also had less exposure, with less than half of their imports of goods coming from the EU.

Figure 16: Percentage of region’s total good imports from the EU, 2019

Summaries of each UK region's economic outlook

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