The welfare effects of leaving the EU: a first ex-post assessment

Abstract

I provide estimates of the ex-post welfare effects of the UK exit from the EU after one year. First, I estimate the increase in trade costs between the UK and the EU by looking at changes in trade flows between the UK and the EU and a set of comparator countries. Second, I estimate the trade elasticity exploiting the change in the UK MFN tariff accounting for the endogeneity of trade policy. I then feed the estimated trade cost increases and trade elasticities to a modern multi-sector general equilibrium trade model to compute the welfare effects. In the first year, the UK exit from the EU reduced real consumption by 1.1% for the UK and by 0.1% for the rest of the EU.

According to available estimates of the trade effects of Brexit, leaving the EU harmed UK-EU trade, but what about consumer welfare? This paper presents the first ex-post evaluation of the welfare effects of leaving the EU for the year 2021. The calculation accounts for changes in trade costs between the UK and the EU and changes in the UK Most Favoured Nation (MFN) tariff schedule.

The key pieces of information required to perform welfare analysis are the changes in trade costs imposed by leaving the EU, and the elasticity (the response of trade flows) to changes in trade costs. These two quantities of interest are estimated directly from data.

The Trade and Cooperation Agreement (TCA) that replaced EU membership for the UK introduced new trade costs between the UK and the EU. Most of these costs are arguably non-tariff barriers, which are hard to measure. We can estimate these new costs by comparing changes in trade flows between the UK and the EU before and after the TCA with UK and EU trade with other countries. This is done separately for different sectors, both for goods and services.

The trade elasticity is a crucial parameter in international trade, as it governs the response of trade flows to changes in trade costs. It is estimated by comparing changes in imports with changes in the tariff rates across sectors, following the cut in the UK MFN tariff schedule that occurred in 2021. However, a simple comparison of import and tariff changes might be too naïve. For instance, if tariffs were dropped in sectors where imports cannot grow very much, but kept in sectors where imports could rise quickly, we would find no response of imports to tariff changes in the data. This is addressed by adding additional information to the estimation procedure, namely, the rationale for the tariff change taken from UK Government documents together with information from the literature on the political economy of trade. This additional information is used to identify the drivers of trade policy.  Accounting for these determinants of the tariff change in the estimation leads to larger estimates of trade elasticity.

The results show that the TCA caused trade costs for UK exports to the EU to increase by about 1.7%. For EU exports to the UK, the increase in trade costs is 5.3%. The trade elasticity varies between 4 and 9.2 across sectors. These numbers translate into a loss of consumption of 1.1% for the UK and 0.1% for the EU in the first year of the TCA. The cut in the MFN tariff operated by the UK Government had only negligible effects, contributing at most by attenuating the loss of the UK by 0.1 percentage points.

The main driver of differences in welfare losses between the UK and the EU is country size. The EU is a large trading partner for the UK, while the UK is small when compared to the rest of the EU. Hence, increasing trade barriers between the UK and the EU has a larger impact on the UK than on the EU. Secondly, differences in trade costs across sectors and sectoral specialisation across countries contribute to differences in the welfare effects of the TCA for the UK and the EU.

Read Working Paper 009