This week’s local elections and the Assembly election in Northern Ireland were considered an important test for Johnson’s government, not least in terms of how Brexit is going. Indeed, especially the NI Assembly elections were very much dominated by the Brexit-related issue of the Northern Ireland Protocol (NIP). However, the week also brought some developments in terms of the impact of Brexit on trade. It becomes increasingly difficult to deny that the government’s handling of post-Brexit trade is turning into a disaster for many British companies. The question is: Have voters noticed?
Trade and post-Brexit Borders
A striking Brexit-related story that has developed over the past two weeks or so, is the government’s announcement to further delay the introduction of full checks on agri-food imports from the EU. Brexit Opportunity and Government Efficiency Minister (BOGEMin) Jacob Rees-Mogg freely admitted that introducing such border checks (which are a direct result of the type of Brexit the conservatives chose and not of the pandemic, or the war in Ukraine, or anything else) would be an act of self-harm by increasing living costs further. As Chris Grey has observed, it is astonishing that that admission evidently comes without any acknowledgement that it means that Brexit has generate a lot of problems and few benefits. Nowhere is this clearer than regarding Brexit Britain’s botched borders and the issue of trade.
In its attempt to pretend that Brexit is going well, the government simply ignores important issues such as the real health risks uncontrolled food imports represent for the UK population, the unlevel playing field it creates for UK producers (with farmers particularly aggrieved), and the sums of money that have already been spent to make the UK borders fit for the new Brexit red tape.
On the latter point, a remarkable development this week was that the UK ports are now demanding compensation from the government for the delays in introducing checks, which have led to massive amounts of money – some of it public – being invested in border infrastructure that now will become ‘white elephants.’ This case is a remarkable example of what happens when Brexit rhetoric meets reality. While the BOGEMin continues the Brexiter habit of selling the people unicorns – this time in the form of some nebulous transformative programme to digitise Britain’s borders’ and to create a ‘world-leading border’ by 2025 –, UK companies face the very real costs of an incredibly incompetent handling by the government of the transition from EU membership to third country status.
Indeed, the UK government’s approach to its post-Brexit borders leads to all sorts of distortions in trade. Most recent trade figures from Germany indicate according Ulrich Hoppe, director-general of the German-British Chamber of Industry and Commerce that “the UK is to some extent being taken out of EU supply chains.” In particular, Germany seems to reduce its reliance on imports from the UK due to “logistical problems related to Brexit.”
At the aggregate level, German data shows that exports to Germany have actually recovered significantly in March 2022 (up 41% on the previous month), while imports from Germany into the UK were down another 3.9% over the same month. Some observers may take this as a good sign, as a reduction in imports compared to an increase in exports redresses the trade balance, reducing the UK’s trade deficit. But of course, the 41% increase is a short term movement, which still leaves UK exports to Germany way below where they were before Brexit (see the relevant figure here). So, short term swings – especially in times of Covid and war – should not be over-interpreted. More importantly, however, the country-level figures may hide important differences across industries and types of companies that are differently affected by the new barriers to trade.
This is illustrated by a new study by the LSE Centre for Economic Performance, which provides a fascinating – although not entirely convincing – analysis of the impact of Brexit on UK trade.
The Brexit ‘export puzzle’
The key finding of the study is that while imports from the EU have fallen by 25% after January 2021 and stayed at that level, UK exports only experienced a temporary dip, but then recovered to a trend similar to pre-Referendum and pre-Covid levels. The study also finds that UK-EU trade did not decline between the date of the Referendum (23 June 2016) and the end of the transition period (1 January 2021), but only once the UK and the EU started trading under the terms of the Trade and Cooperation Agreement (TCA).
These are astonishing results for several reasons. Thus, the fact that EU imports have declined, but exports have not is difficult to explain given that the EU has introduced full border controls, while the UK has delayed them repeatedly. Partly, this may be explained by the very considerable fall in the value of Sterling since the Referendum, which makes UK goods relatively cheaper for importers. But more likely, the issue is one of methodology. The LSE study compares UK trade to rest of the world (RoW) trade. That is problematic, because other studies have shown that exiting the Single Market has not only affected UK trade with the EU, but with the RoW as well. This is in stark contrast with Brexiter common sense who sees UK-EU and UK-RoW trade as perfectly substitutable. Indeed, one of the key Brexit promises was that any loss in trade with the EU could be made up for by striking Free Trade Agreements (FTAs) with countries further afield. The real value of FTAs compared to the costs of Brexit has been debunked already; But what we are observing now is that not only is it impossible to strike trade deals of the size needed to compensate for a fall in trade with the EU, but in actual fact, Brexit also actively hurts that trade with the RoW.
In order to understand why that is the case we have to move beyond aggregate figures and look at what is being exported and how what is being exported is produced. Here Brexiter logic is flawed, because it does not recognise how goods are produced in the 21st world economy. As the Centre for European Reform’s (CER) John Springford points out, in the 21st century the production of goods is not a national affair anymore. Rather, as the IMF and others have shown, goods are produces in three main regions of the world (EU, East Asia, and North America), from which they are sold globally. Within those regions, however, production chains are broken up across national borders and the components making up the final product are ‘being traded within them multiple times across borders.’ Brexiters’ trade fantasies, on the contrary, were based on the flawed idea that Britain produces its export goods basically in autarky and then chooses to export them either to the EU or the RoW. The reality is, British firms are part of European value chains, which hard Brexit has now disrupted. So, British goods become more difficult and expensive to produce – because new red tape and additional costs are incurred at the Great Britain-EU border – making them less competitive not just in the EU, but in the world market. As such, ‘leaving the EU appears to have damaged the UK’s goods exporters serving markets both in the EU and beyond.’
As a result, what seems like a puzzle to the authors of the LSE studies is simply explained by the fact that the RoW is not the right comparison for post-Brexit trade patterns, because they too are affected by Brexit. Instead, the methodology that uses algorithms to construct a ‘doppelgänger UK,’ i.e. a counterfactual that estimates what the UK’s imports and exports would look like had it not left the EU. This counterfactual is based on how other countries have evolved that are most similar to the UK in terms of economic structure, population, etc., but not in terms of leaving the EU.
Using this approach the CER’s findings show a very different picture to the LSE report: Compared to where the UK most likely would have been without Brexit, exports are down 15.7% at the end of 2021 (chart 3 here). In particular, this methodology also shows that the UK has pretty much missed out on a big mid-2021 surge in exports, after the Covid pandemic restrictions had eased.
The LSE study finds another interesting effect of Brexit on UK trade, namely that while – according to their methodology – the quantity of exports may not have declined, the number of trade relationships has plummeted. They investigate relationships at the level of around 1,200 products and find a 30% drop in the number of trade relationships between UK exporters and EU importers. They conjecture that ‘the TCA has increased the fixed costs of exporting to the EU, causing small exporters to exit small EU markets, but not (or at least not yet) severely hampering exports by the large firms that drive aggregate export dynamics.’ That is a plausible explanation of the decreasing number of trade relationships, although an additional aspect may be that many companies – like British Corner Shop – have established warehouses inside the EU to avoid re-exporting from the UK.
Expecting Brexit
It is likely that the other surprising finding of the LSE study – that trade did not decline before the end of the transition period – is also explained by the methodological shortcoming of comparing the UK to the RoW. Indeed, virtually all other studies of trade patterns and other economic variables show that the prospect of a Brexit referendum and then of an actual existing Brexit has led to a reduction in trade, investment and other economic indicators as far back as the 2015 General Election. Thus, Terence Edwards and Mustapha Douch argue that the “UK goods exporters are highly dependent on EU countries as part of their supply chain. Even a modest increase in uncertainty surrounding such chains seems to have persuaded customers to look elsewhere.” Other studies, too, found an impact of Brexit before it actually happened; one study finding that the UK experience an output loss of 1.7% to 2.5% by year-end 2018, due to a ‘downward revision of growth expectations in response to the vote.’ Another study found that between June 2016 and March 2019, ‘the Leave vote had led to a 17% increase in the number of UK outward investment transactions in the remaining EU27 member states, whereas transactions in non-EU OECD countries were unaffected’ and ‘the number of EU27 investment projects in the UK has declined by around 9%.’ This evidence clearly indicates that firms were getting ready for Brexit by establishing new operations in the EU, while holding off on investments in Britain.
The ‘capital strike’ after the referendum had another interesting and unexpected effect: Rather than making capital investments at a time where it was unclear which side of the Single Market the UK would end up after Brexit, firms based in the UK would invest in labour, i.e. hire more people rather than buying new expensive machinery. This may also be part of an explanation of low unemployment figures and a tight domestic labour market, which has also led to some modest nominal wage increases. However, it also means that productivity increases are limited as investment in labour-saving machinery were put on hold. While in the short term this may lead to wage increases, in the long term this may have contributed to inflationary pressures as wage raises are due to high demand and restricted supply rather than to productivity gains. Therefore, at least in the manufacturing sectors, any wage rises that the Conservatives tried to sell to the British public as a Brexit benefit back in November 2021, may hence simply be a knock on effect of companies’ reluctance to make major capital investments in the UK. This is not good news for British workers.
Indeed, a study by Thiemo Fetzer and Shizhou Wang finds that tragically, the impact of Brexit on trade will make the socio-economic divisions in the UK, which explain the Brexit vote, worse not better. Despite all the bluster about ‘levelling up,’ what is happening in the country is that areas with large manufacturing sectors and high numbers of low skilled workers have seen a particularly important drop in output already before Brexit actually happened. Tragically, then, the flawed underlying Brexiter trade theory means that ‘Saturnian Brexit’ will make life harder for those who voted for it believing that the EU – rather than austerity – was to blame for their grievances. Instead of the unicorns they were promised, all they got are white elephants and an uphill struggle to recover the living standards they had as EU citizens.
The local elections, this week, however, show that this Brexit effect has not quite reached the people who voted for it yet.
Brexit divides and local politics
It was widely expected that the Conservatives would lose seats during the local elections, although the extent and reasons for possible losses were differed depending on who you asked. While the mismanagement of the Covid pandemic, Brexit, and the failure to deal with the cost-of-living crisis were explanations widely advanced by opposition politicians, Tories themselves preventively explained possible losses with a ‘mid-term’ effect, i.e. the fact that half-way through a Parliament, governing parties rarely do well. It is the latter, which lead BBC’s Laura Kuenssberg to suggests that the Tories’ losses of nearly 500 councillor seats – corresponding roughly with one in four of their contested seats – did not amount to a Tory ‘breakdown.’ That is a very charitable interpretation of one of the worst local election performances in a decade and led to a lot of outrage on Twitter. Yet, even more reasonable interpretations of the results show that the unquestionable rebuttal of the Tories by UK voters, is subject to important regional differences.
Thus, while the Conservatives faced heavy losses in England, Scotland and Wales, in some areas these losses did not primarily benefit Labour. Thus, in England in particular, Labour only made gains in vote share in London; everywhere else, its vote share declined. The real local election winners were the Green Party and especially the Lib Dems; the latter morphing into a serious competitor for the Tories for well-educated middle-class votes in the South of England. These results clearly show that an electoral pact between Labour and LibDems – and possibly the SNP – may be crucial if the opposition wants to win the next GE.
The local election results also show, however, that the Conservatives’ strategy to gain support in working class constituencies in the North of England continues to work well. Despite the cost of living crisis, all the scandals surrounding Boris Johnson and Starmer replacing Corbyn, voters in the Red Wall seats still defect from Labour to the Conservatives at the local level. Overall, Labour’s vote share has recovered from the 2019 GE, but did not make progress beyond its 2018 results. Partly, these results may be explained by the fact that the war in Ukraine (which the government and conservative media have extensively used to portray the UK as an internationally leading country and the PM as a respected and competent leader) have limited losses in some areas, while the ‘Beergate’ scandal (which I wrote about last week), allowed Johnson to distract from his own domestic issues.
NIP: From Article 16 to Article 18?
The Northern Ireland Assembly election, in turn, has provided a truly historic – albeit not unexpected – result. For the first time in history, Sinn Féin is set to become the largest party in the Stormont Assembly. However, like in Great Britain, Sinn Féin’s success was rivalled by a centrist force, with the non-partisan Alliance Party increasing its first preference votes by about 44,000 to 116,681. While it is unclear whether the Democratic Unionist Party (DUP) will agree to a power sharing agreement with Sinn Féin, the results potentially have important implications for the future of the Northern Ireland Protocol (NIP).
While some parts of the UK government fear an escalation of the conflict over the NIP (and the trade war it may entail), Sinn Féin’s success and the surge of the Alliance Party means that pro-NIP forces are now majoritarian in the Assembly. That implies that for Brexiters it becomes more difficult to call the NIP ‘undemocratic,’ given that a majority of people voted for parties who support the NIP. It also implies that when the NI Assembly will vote on the extension of the protocol in late 2024, it is unlikely a four-year continuation of the NIP according to Art. 18 will be rejected (although Unionists and Brexiters have started questioning the simple majority rule when it became clear that they may lose it in the NIA election). At the same time, given that according to Art.18(6) of the NIP the Assembly Party does not count as ‘cross community support,’ a longer continuation of eight years – which would require such cross-community support – is unlikely. The increasing pro-NIP majority in the NI Assembly will also increase the DUP’s incentives to refuse a power-sharing executive, thus leaving NI under direct rule by the UK government, which may make it more likely that the NIP will be suspended. If, however, there is a power-sharing executive, then the election may mean the NIP’s future is brighter than before May 5th.
In short, then, the elections this week show two things: firstly, Brexit truly has profoundly reshaped British politics by transforming the traditional party cleavages, with the Tories at the moment more the party of the Leave-voting areas in the North of England and the LibDems becoming the party of choice for the South; secondly, it does not seem like we have left the fantasies of unicorns grazing on sunlit uplands yet, even though ‘white elephants’ and other very concrete results of Brexit have started rearing their ugly trunks.