Brexit

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Main Findings

• Brexit has had a significant impact on the UK economy, mainly through its effect on trade with the EU, which accounts for about half of the UK's exports and imports.
• The EU-UK trade deal has avoided a no-deal scenario, which would have been much more damaging for both sides, but it has also introduced new barriers and costs for trade in goods and services.

Brexit is the term used to describe the withdrawal of the United Kingdom (UK) from the European Union (EU).

The UK officially left the EU on 31 January 2020, after a referendum in 2016 in which 52% of voters chose to leave.

However, the UK remained in a transition period until 31 December 2020, during which it followed most of the EU rules and regulations. Since 1 January 2021, the UK and the EU have been trading under a new agreement that covers areas such as trade, security, fishing, travel and data.

Why does Brexit affect finance?

Brexit affects finance because it changes the relationship between the UK and the EU, which are two of the largest economies and financial markets in the world.

The UK and the EU have a high degree of financial integration, meaning that they trade a lot of goods and services, invest in each other's assets, borrow and lend money, and share common rules and standards.

Brexit creates new barriers and uncertainties for cross-border financial activities, such as tariffs, quotas, customs checks, regulatory divergence, legal disputes, and political risks.

These could have implications for the efficiency, stability, and competitiveness of the financial sector, as well as for the consumers and businesses that rely on it.

Formula for measuring the impact of Brexit on finance

There is no single formula for measuring the impact of Brexit on finance, as it depends on many factors and assumptions. However, one possible approach is to use a gravity model, which is a common tool in international trade analysis.

A gravity model estimates how much trade or investment between two countries depends on their size, distance, common language, historical ties, and other factors. By comparing the actual trade or investment flows with those predicted by the gravity model, one can estimate how much Brexit has affected them.

How to calculate the impact of Brexit on finance using a gravity model

To calculate the impact of Brexit on finance using a gravity model, one needs to follow these steps:

1. Collect data on bilateral trade or investment flows between the UK and the EU countries for a period before and after Brexit (e.g., 2015-2020).
2. Collect data on variables that affect trade or investment flows, such as GDP, population, distance, common language, common border, common currency, etc.
3. Estimate a gravity equation using a statistical method (e.g., ordinary least squares), where the dependent variable is the logarithm of trade or investment flows, and the independent variables are the logarithms of the explanatory variables.
4. Include a dummy variable for Brexit that takes the value of 1 for the period after Brexit and 0 otherwise.
5. Interpret the coefficient of the Brexit dummy variable as an estimate of the percentage change in trade or investment flows due to Brexit.
6. Calculate the absolute change in trade or investment flows by multiplying the percentage change by the average level of trade or investment flows before Brexit.

Examples

To illustrate the impact of Brexit on the UK economy, we can look at some examples of how different sectors and regions have been affected by the changes in trade rules and regulations.

Fishing Industry

One example is the fishing industry, which has faced significant disruptions and losses due to new customs checks, paperwork, and delays at the border. According to the National Federation of Fishermen's Organizations, some fish exporters have seen their sales to the EU drop by 80% or more in January 2021, compared to the same period in 2020.

Some have even stopped exporting to the EU altogether, due to the high costs and risks involved. The UK government has announced a £23m compensation scheme for the fishing sector, but many fishermen have criticized it as inadequate and too slow to deliver.

Automotive Industry

Another example is the automotive industry, which is one of the most integrated and interdependent sectors in the UK-EU trade relationship. The UK exports about 80% of its car production, and about half of that goes to the EU.

The EU-UK trade deal has avoided tariffs on cars and car parts, but it has introduced new rules of origin requirements, meaning that only products with a certain percentage of local content can qualify for tariff-free access.

This poses a challenge for car manufacturers that rely on complex global supply chains and source components from various countries. According to the Society of Motor Manufacturers and Traders, UK car production fell by 29% in 2020, the lowest level since 1984, and is expected to recover only partially in 2021.

Financial Services Industry

A third example is the financial services industry, which accounts for about 7% of the UK's GDP and employs over one million people. The UK has lost its passport rights, which allowed UK-based financial firms to offer their services across the EU without needing additional authorizations.

The EU-UK trade deal does not cover financial services and instead relies on a separate process of equivalence decisions, whereby each side can grant access to its market if it deems the other side's regulatory standards to be equivalent.

So far, the EU has granted only a limited and temporary equivalence to the UK in some areas, such as clearing houses and derivatives trading. This means that many UK-based financial firms have had to relocate some of their operations, staff, and assets to the EU to continue serving their clients there.

Limitations

The analysis of the impact of Brexit on the UK economy is subject to several limitations and uncertainties, such as:

The difficulty of isolating the effects of Brexit from other factors, such as the Covid-19 pandemic, the global economic slowdown, the energy crisis and other shocks that have affected the UK and the world economy in recent years.

The lack of reliable and timely data on some aspects of trade, such as services, investment, and non-tariff barriers, which makes it hard to measure the full extent and nature of trade frictions and costs.

The possibility of future changes in the UK-EU trade relationship depends on how the trade deal is implemented, enforced, and updated over time, as well as how both sides adapt to the new rules and opportunities.

The potential for further divergence or convergence between the UK and the EU on regulatory standards, policies, and institutions, could affect the level of market access, cooperation, and competition between them.

The scope for alternative trade arrangements with other countries, such as the US, Australia, India, and China, which could offer new markets and sources of growth for the UK economy.

Conclusion

Brexit has had a significant impact on the UK economy, mainly through its effect on trade with the EU, which accounts for about half of the UK's exports and imports.

The EU-UK trade deal has avoided a no-deal scenario, which would have been much more damaging for both sides, but it has also introduced new barriers and costs for trade in goods and services.

The impact of Brexit varies across different sectors and regions of the UK economy, depending on their exposure and dependence on the EU market. Some sectors, such as fishing, automotive, and financial services, have faced more challenges than others.

The long-term impact of Brexit will depend on how both sides manage their trade relationship over time, as well as how they adjust to changing global economic conditions.

References

• BBC News (2021). What impact has Brexit had on the UK economy?. https://www.bbc.co.uk/news/business-64450882
• BBC News (2021). Impact of Brexit on economy 'worse than Covid'. https://www.bbc.co.uk/news/business-59070020
• Statista (2024). Brexit and the UK economy - Statistics & Facts. https://www.statista.com/topics/3154/brexit-and-the-uk-economy/

FAQ

Brexit is the term used to refer to the United Kingdom’s decision to leave the European Union (EU) following a referendum held in June 2016.

Supporters of Brexit argued that it would free the UK from EU regulations and bureaucracy, allowing it to forge its own trade agreements and control immigration.

Concerns about Brexit included potential damage to the UK’s economy due to loss of access to the EU’s single market, uncertainty over trade agreements, and a potential decrease in foreign direct investment.

The impact of Brexit on the UK’s economy has been mixed and is still unfolding. It has led to changes in trade patterns, currency fluctuations, and economic uncertainty.

The future economic impact of Brexit on the UK is uncertain and will depend on a range of factors including the terms of the UK’s future relationship with the EU and the policies the UK government implements post-Brexit.