The outcome of the UK’s referendum on membership of the European Union (EU) will shape the future of the country’s relationship with its largest trade partner – the EU.
Membership of the EU has reduced trade costs between the UK and the rest of Europe. Most obviously, there
is a customs union between EU members, which means that all tariff barriers have been removed within the EU, allowing for free trade in goods and services. But equally important in reducing trade costs has been the reduction of non-tariff barriers resulting from the EU’s continuing efforts to create a ‘single market’ within Europe. Non-tariff barriers include a wide range of measures that raise the costs of trade such as border controls, rules of origin checks, cross-country differences in regulations over things like product standards and safety, among others.
Reductions in trade barriers have increased trade between the UK and the EU. Prior to the UK joining the European Economic Community (EEC) in 1973, around one-third of UK trade was with the EEC. In 2014, the 27 other EU members accounted for 45% of the UK’s exports and 53% of imports (ONS, 2015). EU exports comprise 13% of UK national income.
Higher trade benefits UK consumers through lower prices and access to better goods and services. At the same time, the UK’s workers and businesses benefit from new export opportunities that lead to higher sales and profits and allow the UK to specialize in industries in which it has a comparative advantage. Through these channels, increased trade raises output, incomes and living standards in Britain. These standard ‘static’ effects of trade have been understood for many centuries since at least the work of David Ricardo. But in recent decades, studies of trade have revealed very large effects on well being through other routes such as higher productivity and innovation.
How would Brexit affect the UK’s trade, and what impact would this have on incomes in the UK? This briefing reports new estimates of how Brexit would affect UK living standards through trade (updating our earlier analysis in Ottaviano et al, 2014). We report a range of forecasts based on alternative estimation methods and different assumptions about how the UK’s relationship with the EU would change following Brexit. We primarily focus on the
narrow, static trade consequences of Brexit rather than other channels through which Brexit could affect the UK’s economy, such as investment or migration.
Although it is always hard to assess what the economic future may bring and there are many uncertainties, we consistently find that by reducing trade, Brexit would lower UK living standards. Importantly, the fall in income per capita resulting from lower trade more than offsets any savings that the UK obtains from reduced fiscal contributions to the EU budget.
Our baseline estimates imply that, after accounting for fiscal savings, the effect of Brexit is equivalent to a fall in UK income of between 1.3% and 2.6% – that is, a decline in average annual household income of between £850 and £1,700 per year.
Our baseline estimates come from a state-of-the-art static model of the global economy. We also present estimates using empirical evidence on the links between EU membership, trade and income. This ‘reduced-form’ approach captures the long-run effects of leaving the EU on productivity growth and leads to much higher estimates. In this case, we calculate that Brexit may reduce national income by between 6.3% and 9.5% – that is, about £4,200 to £6,400 per household per year.