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Brexit Will Lead to a Wider than Expected Fall in Cross-Border Trade

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Written By: Adrian Moore – Forex Focus

The United Kingdom will formally exit the European Union in March 2019. Both the UK and the countries representing the euro area are expectantly readying for the massive changes that are likely to follow once Britain exits. In addition to the larger than expected fall in cross-border trade, which is likely to result owing to the hard border that will separate the UK from EU markets, international relations between the UK and EU member states are also likely to be affected to a certain degree.

Value of cross-border trade

According to “Brexit – the Voices of European Business”, a 2017 report from the council representing the British Chambers of Commerce, the UK is presently one of the top three export markets for at least 10 of the member states in the EU, which include Italy, Germany, Denmark, Ireland, Netherlands, Sweden and Spain. Brexit is set to impact existing business models, leading to supply-chain disruptions, longer border lines, additional documentation and higher customs duties.

Present state of negotiations

While there may have been hope for a soft exit from the European Union, current developments suggest that UK withdrawals will proceed as planned. Brexit implementation moved forward in early December, with the UK set to pay EU member states between 40 to 60 billion euros to settle long-term commitments. The question that arises is how the 27 member states will respond once Article 50 is invoked. Will there be an EEA (European Economic Area) model, a WTO (World Trade Organization) model, or something entirely different? New tariffs and taxes on UK exports to the EU also need to be considered as top priority. In addition, the outcome of the trade barriers that will be set in motion in the future and how the UK manages its separation from EU’s largest trading bloc also matter. 

Impact on trade

According to the OEC’s (Observatory of Economic Complexity’s) trade data for 2016, the UK is the tenth largest exporter and the fourth largest importer in the world. Its top five export destinations include the United States, Germany, France, the Netherlands and Ireland respectively, while the country’s imports originate from Germany, China, the US, the Netherlands and Belgium. Britain’s impact on trade will depend on the outcome of businesses that expanded as a result of the single market, such as automobiles, packaged medicines, gas turbines, gold and aircraft parts, while imports into the country are composed of most of the similar items being exported, with the exclusion of gold and inclusion of vehicle parts.

The immediate question is what Brexit will translate into in terms of the longer-term mobility of the country’s workforce and the general implications for trade across Britain and the EU, although there are large-scale expectations that some of the key elements that benefit both sides of the border may not be affected upon conclusion of the ongoing trade negotiations.

The financial cost of Brexit

As far as the financial cost of Brexit goes, costs could cover trade tariff changes, customs-handling fees and more. Depending on the trading model with the EU, additional costs such as those arising from withholding taxes on cross-border flows of interest, royalties and dividends are also a possibility.

In the absence of a clear-cut trade agreement and new tax treaties, which would be required to be framed before the UK officially exits the single EU market, the economies of the UK and its trading partners across the border would be affected negatively. 

The end of the single market

The UK as a member of the EU is currently completely integrated with the single EU market and customs union. This has ensured unimpeded access to markets for goods and services across the 27 countries in the EU. Currently, the EU is the UK’s largest trading partner, with total trade valued at £554 billion, comprising about 43 percent of the UK’s total international trade in 2016. In addition, the UK is the single largest exporter of services to the Union, accounting for more than a fifth of the total value of services sold in the EU. Likewise, in addition to being the third largest importer of services from the EU, the UK also has the largest trade deficit in terms of goods with EU countries, amounting to £204 billion in 2016.

What will change?

Brexit will initiate changes such as acquiring new licenses for cross-border trade between the EU and the UK, and updating IT (information technology) systems to cope with the demands of paperwork and supply-chain issues. Additionally, UK ports will experience delays in export- and import-declaration numbers after Brexit. Increase in lead times, disruption and increased volatility will result in the holding of additional inventory. Import VAT (value-added tax) cash permanent flow differentials will require VAT to be paid and recovered for EU imports in the UK. Moreover, the terms of the EU-UK trade contracts will be reexamined at some stage during the Brexit talks.

According to a study conducted by ESRI (Economic and Social Research Institute), if the WTO tariffs are adopted, the €2.6 billion cross-border trade could fall by 17 percent in the event of Brexit without a trade deal. Countries with deep trade ties to the UK will be affected the most. Key among them would be the Western European countries such as Belgium, Germany and the Netherlands, which will most likely experience deteriorating terms of trade with the UK (based on price elasticity of the exported products).

Some sectors will be hit harder than others post-Brexit, especially those with the biggest export contribution, such as motor vehicles, electronic equipment, motor parts and processed foods. The automobile sector in particular stands out as the one market with the highest value in terms of cross-border trade between the EU and the UK. For the UK, on the other hand, the services sector is likely to be the most impacted post-Brexit.

With a comprehensive FTA (free trade agreement) or WTO, the cost of trade between the neighbors is expected to rise, although it is too early at this stage to comprehend the precise value. Costs include market-access measures such as quotas and tariffs, increased administrative burdens including customs formalities and VAT, and behind the border rules. In the event of a WTO kind of setup, in which tariffs impact trade flows among the new trading regimes, cross-border trade will be impacted further. However, Eastern and Central European nations that are less connected with the UK in terms of trade may not only not feel the impact, but on the contrary, may benefit from Brexit.

Clearly, as a hard border forms post-Brexit, the common regulatory and legal frameworks governing UK-EU trade will be eliminated, leading to a fall in cross-border trade between the once closely knit member states.

 

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