12 December 2017

A recent report published by Rand Europe on the implications of different Brexit scenarios on the UK economy brings into question the relevance of a debate that has been dominating over the past months: should the UK be aiming to build its future trading relationship with the EU based on a CETA+ or an EEA- model? With the upcoming European Council expected to give the green light for Brexit negotiations to proceed to the next stage, the discussion on future trading arrangements will likely continue to divide opinions. However, the Rand findings suggest that in economic terms this debate could be largely irrelevant, as the difference between a CETA-style model and the Norway scenario is 0.2% of GDP in ten years.

The Rand report examines eight different Brexit scenarios for trade in goods and services, ranging from membership of a Customs Union to trade under WTO rules. For each one, it calculates the effect of changes in trade on GDP over a time horizon of ten years, taking into account potential differences in tariffs and non-tariff trade costs. Their findings are summarised in the following table:

The effects of scenarios 2-8 on GDP (Panel B) are presented as percentage point changes in relation to the baseline scenario 1 (Panel A), under which GDP is expected to be 4.9% lower relative to remaining in the EU. In essence, this means that a (CETA-style) UK-EU FTA would see GDP drop by only 1.9%, as the FTA is expected to boost GDP by 3% in relation to the WTO scenario (-4.9%+3%).

First, the findings suggest that trading with the EU under WTO terms (a no-deal scenario) would have a bigger negative impact on the UK economy compared to any of the scenarios presented in Panel B. At the other end of the spectrum would be a trilateral Free Trade Agreement between the US, the EU, and the UK, which is expected to boost UK GDP by 2.2% compared to EU membership, as presented in Scenario 3.

Second, the report finds a rather negligible difference between the much debated options of CETA and Norway, as explained below:

Scenario 2 examines the impact of a UK-EU Free Trade Agreement (FTA), which resembles the so-called CETA model. Under this scenario, tariffs on trade in goods and services between the EU and the UK would remain at zero. On Brexit day, non-tariff barriers (NTBs) would incur additional trade costs, for instance because of the introduction of rules of origin and customs checks. These are expected to reach one-quarter of the NTBs on US-EU trade for goods, agriculture and services, and three-quarters for trade in financial services. In addition, regulatory divergence between the UK and the EU is expected to raise NTBs annually by 0.06% for goods and services and by 0.01% for agriculture. Based on Rand’s methodology and calculations, this scenario would see GDP at 3% higher than the WTO scenario.

Scenario 6 assesses the impact of a Norway-style trading arrangement, under which tariffs would also remain at zero. The projected increase in NTBs is the same as in the CETA scenario (one-quarter of US-EU NTBs), but assumes no further impact on financial services. NTBs would not increase over time, as the Norway model largely requires continued regulatory alignment. This scenario would see GDP at 3.2% higher than the WTO scenario.

Scenario 8 assesses the impact of participation in a Customs Union for trade in goods, but not services (a Turkey-style option). For this scenario, they assume that there would be no tariffs and NTBs on trade in goods. NTBs on trade in services would increase to three-quarters of US-EU NTBs, and would see an annual increase of 0.06% for goods, 0.01% for agriculture (as in Scenario 2) and 0.08% for services (as in WTO). This scenario would see GDP at 3.1% higher than the WTO scenario.

Regardless of the methodology employed by Rand, their research explicitly addresses the fact that CETA excludes financial services, which is often cited as its main drawback as a post-Brexit option for the UK. Even when accounting for high NTBs on financial services, the report finds a negligible difference between a CETA model and a Customs Union for goods on the one hand, both of which exclude financial services, and a Norway model on the other hand. It is to be expected that the difference between any CETA+ and EEA- would if anything be even less. This suggests that the debate surrounding the UK’s options should not be primarily guided by economic considerations, as these are likely to prove less important for the UK in the long-term than the degree of freedom the country can acquire under each of the potential scenarios for its future relationship with the EU.