Some critics of Brexit would argue that Wales has far more to lose than any other part of the UK if leaving the European Union means there is no access to the single market. Here, Professor Kent Matthews evaluates the economic implications for the Welsh economy of non-access to the EU single market, and concludes that Wales has nothing to fear from a ‘hard Brexit, and could benefit from lower costs of living.
How would Wales fare in a post-Brexit world without a Free Trade Agreement – in other words a ‘hard Brexit’?
The Jeremiahs would tell us that the UK would fare badly and Wales even worse if Brexit meant non-access to the single market. Why? Because 61 per cent of Wales’ exports go to the EU, (which is around 13 per cent of the economy directly affected) which compares with less than 50 per cent of for the UK as a whole.
A Brexit without a Free Trade Agreement with the EU means that the UK will be treated the same as other Most Favoured Nation countries exporting to the EU under World Trade Organisation rules. Wales will face the Common External Tariff that other non-EU countries face in trading with the EU.
Of course this does not mean that Welsh exporters cannot sell into the EU. It means that they will face tariffs ranging from 2.3 per cent for manufactures (which is roughly 70 per cent of all exports), 10 per cent for automotive products, through to 42.1 per cent for diary products.
A bigger threat is non-tariff barriers that will emerge a few years after Brexit. However, an even bigger threat to the Welsh manufacturing sector will be the loss of EU customs union protection, which means that they would face competition from suppliers from outside the EU. Additionally, the loss of EU protection, without offsetting Treasury compensation would in all likelihood eliminate Welsh hill farming.
But is there no silver lining in all this pessimism?
The negative effects of increased trade costs with the EU would need to be balanced with a number of mitigating factors.
First, we know that the tariffs do not come in to play until the completion of Brexit which could take up to two years.
Second, the 10 per cent or so depreciation of sterling against the Euro has improved the immediate competitiveness of the export sector and increased orders. This will cushion the effect of tariffs when they are imposed.
Third, the complexity of supply chains will make it harder for EU companies importing components from Wales to substitute in the short-term, which means that Welsh exporters have up to two years to explore alternative markets. According to standard trade theory they will divert trade to world markets at world prices. Indeed Welsh exporters will face lower world prices when they lose EU protection. The depreciation of the pound will cushion the impact but in the longer term they will have to raise productivity and move up the value chain to compete effectively.
Finally, we know that non-tariff barriers impose much higher costs on trade than tariffs, but since the UK is currently in the single market, the EU cannot use non-tariff barriers to restrict Wales’s goods exports into Europe, in the near future.
The effect of not having free access to the single market on the rest of the Welsh economy will depend in part on how the manufacturing and agricultural sectors respond to the prospects of tariff impositions.
The depreciation of the exchange rate has seen a strong improvement in competitiveness of the export sector in Wales. While data of the production sector (which includes manufacturing) for Wales does not as yet exist post-Brexit it would be reasonable to assume that the improvement in competitiveness will stimulate export orders in Wales, help to find new markets, and also promote tourism.
Potential gains to consumers and lower of living
Critics of the ‘hard Brexit’ strategy concentrate their arguments on the potential losses to producers but fail to see the potential gains to consumers.
The removal of non-tariff barriers and the common external tariff on imported agricultural goods following the completion of Brexit will have a major effect on reducing the cost of living in the UK, even allowing for the rise in imported prices following the depreciation.
The gains to households from the removal of trade barriers to the rest of the world could reduce the cost of living by as much as 8 per cent over the long term. Wales being one of the poorer regions of the UK would benefit enormously.
Since the instant downturn in the economy following the vote for Brexit failed to materialise, the pundits have been revising their forecasts for the economy upwards, led by the IMF and the Bank of England.
The consensus forecast is closer to 2 per cent for 2017. What is driving this buoyant forecast is the reaction of the exchange rate and the assumption of a ‘hard’ Brexit policy being adopted. There is no reason to believe that Wales will not share in this robust growth outlook. Indeed research using an econometric model for Wales suggests that the local economy is more responsive to UK exchange rate shocks.
A Free Trade Agreement with the EU may be a desirable objective for political reasons but if it is unattainable, Wales has nothing to fear from a ‘hard Brexit’.
This post represents the views of the author and neither those of the Welsh Brexit blog, nor Cardiff University.
Professor Kent Matthews is the Sir Julian Hodge Professor of Banking and Finance in Cardiff Business School.