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Divorce and a new settlement

Divorce and a new settlement

Brexit’s trade consequences would be mild

by Brian Reading in London

Thu 31 Mar 2016

The European Union is Britain’s largest trading partner. In 2015 it accounted for 45% of British exports and 53% of imports. Departing from the EU would presumably diminish these shares. In the absence of a liberal divorce settlement, trade both ways would suffer. But it does not inevitably follow that reduced trade dependence is an unmitigated disaster. Indeed a case can be made otherwise.

This is not to argue black is white or vice versa. Conventional wisdom is often oxymoronic. In the Brexit debate all supposedly foregone conclusions require rigorous examination.

Proximity powerfully influences trade patterns. Use-by dates and transport costs are important as well as value for money. We don’t import freshly baked baguettes from China. Continental drift is rather slow. Brexit will make no difference to distance. In or out, continental Europeans will continue substantially to trade with their near neighbour.

The EU is a customs union with a common external tariff, currently 18% on agricultural products and less than 3% on manufactures. But imports of cars and trucks are more heavily protected. A free trade area in a protectionist world is suboptimal. It both creates trade (benign) and diverts trade (malign).

The EU buys British exports and Britain buys from the EU because these products are cheaper and/or better than the alternatives. Proximity lends a hand.

But value-for-money choices can either reflect genuine costs and benefits, or be distorted by tariffs (or exchange rate fluctuations). Brexit would correct some ‘artificial’ trade-diverting choices. It may substitute others depending upon the divorce settlement.

Other than agricultural products, it is hard to prove whether on balance EU trade creation or diversion is greater. However, Transatlantic Trade and Investment Partnership negotiations open the door to wider free trade and it would be hard to exclude the UK from any deal. Agricultural concessions in the Doha round of World Trade Organisation negotiations offer Britain benefits, regardless of Brexit.

Possible future British trade losses vis-à-vis the EU would not be new. When the euro was born in 1999, the EU’s share of British exports was 10% higher, at 55%, than it was in 2015. British non-EU exports grew twice as fast as EU exports between 1999 and 2015. The EU import share fell slightly, down to 53% from 56%.

This is explicable in terms of growth differentials between Britain and the rest of the EU. If import shares in final spending are unchanged, a faster growing economy’s trade balance will deteriorate with slower growing partners. During the past quarter century, Britain’s final demand has grown faster than the rest of the EU’s, and non-EU countries’ has grown faster than both.

Britain’s EU trade has been a mixed blessing in recent years. In 2010 George Osborne, chancellor of the exchequer, promised to eliminate Britain’s budget deficit by 2015. He failed. One excuse, not the whole story, was the euro debacle’s impact on UK growth. He now promises to eliminate the deficit by 2020. Anaemic EU growth may be cited as a future alibi. Brexit offers trade diversion to faster growing markets. It may be cathartic, but – as the gardeners say – harsh pruning leads to buds in May.

Brexit’s consequences are uncertain. They are certainly frequently exaggerated by those who wish the UK to stay in. Some say Brexit would condemn Britain to a decade in the doldrums. This is unlikely.

British total exports account for around a third of current price GDP, with exports to the EU roughly 15%. It is ridiculous to claim, as some in the ‘remain’ camp maintain, that Britain’s exit would result in the loss of all of this. Losing say 10% would reduce GDP by 1.5%. This is not so different from public spending cuts in recent years.

Imports from the EU would also fall. Part of both would be offset by trade diversion to non-EU countries. Diverted imports may exceed diverted exports. Unless trade both ways was severely reduced, to the EU’s disadvantage especially in agricultural products, the medium-term consequences must be mild. Historians reviewing Brexit in coming years may ask what all the fuss was about.

Brian Reading was an Economic Adviser to Prime Minister Edward Heath and is a member of OMFIF’s Advisory Board. This is No.22 in the series.

OMFIF’s series on the UK EU referendum presents a wide variety of perspectives from Britain and around the world ahead of the 23 June poll. We are assuring a balance between many different points of view, in line with OMFIF’s overall neutral stance on the issue.

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