Why has the UK-EU TCA so far proven costly?
The introduction of the EU-UK Trade and Cooperation Agreement in 2021 severely constrained UK trade, argue Professor Jun Du and Dr Oleksandr Shepotylo, and they believe targeted aid to small and medium size firms must be a priority going forward.
As far as trade is concerned, the EU exit has been rather costly to the UK. At the Centre for Business Prosperity, we have been tracking the performance of UK trade in recent years. The UK trade dropped sharply during COVID, the global recession and supply chain disruptions just like others, but failed to recover and enjoy the boom like everyone else. Despite of the tariff-free terms of trade in goods set out in the EU-UK Trade and Cooperation Agreement (TCA), the UK now trades less with the EU, its largest trading partner, than in 2019. Over the same period, Germany and the Netherlands have grown trade with the EU by nearly a quarter. US trade with the EU has also grown considerably. Reports abound, including from the British Chambers of Commerce, that exporting to the EU has become much more costly, and in some cases unviable. It appears that the "certainty" provided by the TCA has not reversed the declining trend of the UK-EU trade so far.
Our new paper for the Enterprise Research Centre (ERC) has found that UK exports experienced a large, negative, statistically significant decline in 2021 at the end of transition after the EU-UK Trade and Cooperation Agreement (TCA) was put in force. We estimate that this amounts to a 22 per cent reduction in exports to the EU and a 26 per cent reduction in imports from the EU over the first half of 2021, relative to the counterfactual scenario of the UK remaining in the EU.
How did this happen? After all, the TCA ensures that goods moving between the UK and the EU have no tariffs or quotas so long as the rules of origin are complied. Our research discovers find that non-tariff measures (NTMs) are responsible for the adverse TCA effect on UK trade with the EU and that the magnitude of loss was significant. It was equivalent to a reduction of £12.4 billion in UK exports over the first six months period of 2021. This equals to 16 per cent of UK total exports in the first half of 2019, and 70 per cent of the documented total reduction in the EU exports in the same period.
In particular, the increased trade frictions due to sanitary and phytosanitary (SPS) and technical barriers to trade (TBT) measures as a result of entering the TCA played an important role in the decline of UK exports to the EU. On average for the first six months of 2021, a one per cent increase in ad valorem equivalent (AVE) SPS results in a 13 to 15 per cent reduction in exports to the EU, most notably in food and drink, wood and chemicals sectors. Further, a one per cent increase in TBT leads to a two to three per cent reduction in exports, especially in metals, equipment, machines and miscellaneous industrial products.
What next? Since the post-Brexit dysfunctions are diagnosed, in theory we could move on. The UK can directly tackle the trade challenges, so long as other things, such as politics, do not stand in the way. Fundamentally, what needs to happen is the removal or relief of the root causes coded by the TCA – the trade barriers newly erected. This is a key task, challenging but not impossible.
Trade frictions due to SPS measures are acute problems due to the EU exit. Reducing some of the NTMs between the EU-UK, by exploring mechanisms such as equivalence in SPS measures or other ways to reduce businesses' burden to the minimum level possible. More complicated and challenging are the technical barriers to trade, but they could potentially cause significant damage to the UK economy. Maintaining and broadening the established arrangements of the current TCA provision, despite of being limited, on some form of mutual recognition of specific practices or international regulations for selected sectors, should be the ambition of UK government to ease the TBT trade barriers. Future EU-UK co-operation is critical and mutually beneficial but require political will and strong leadership.
In the short and medium term, supporting firms should be the priority, especially small and medium sized firms that are productive enough to have exported to the EU in the past but facing hurdles to continue exporting. These firms tend to be resource constrained but have the infrastructure and ambition to internationalise.
Targeted supports for specific challenges could be fruitful. The UK Department for International Trade Export Support Service, British Chambers of Commerce, and local growth hubs have the expertise and experience to help firms to export. Resources should be made available to allow export support customised and responsive, taking advantages of technologies to identify, reach businesses who require supports, and collect feedbacks on the quality of supports for constant improvements.
Helping them to continue accessing to the EU markets, while enabling the economy to take advantage of the welfare-enhancing benefits from trade remains imperative.
Given the welfare gains of roll-out and new FTAs are expected to be limited and effective only in the long term, UK domestic policies should be the focus to improve the competitiveness of exporters and their ecosystem.
