Modelling the long-term impact of Brexit on the Scottish economy

The Fraser of Allander Institute was commissioned by the Scottish Parliament’s Europe Committee to provide a modelling assessment of the potential long-term impacts on the Scottish economy of Brexit.

Our modelling results are summarised here with the full report available at the following link.

Over the long-run (i.e. 10+ years), most economists predict that the decision to leave the EU will have a negative impact on trade, labour mobility and investment.

To date studies have tended to concentrate on the UK as a whole. At the same time, they have tended to focus on the aggregate economic impact, with little assessment of the different impacts by sector.

Our analysis attempts to answer two sets of questions.

Firstly, is there likely to be a common ‘UK-wide’ impact of Brexit? And crucially for our interests, what is the possible impact on Scotland? If the effects of Brexit differ across the UK, then this would suggest that there may be challenges in securing a consensus over the terms of any Brexit deal across English regions and devolved nations.

Secondly, we ask the same question but this time on a sectoral basis. Can we expect to see some sectors more or less impacted than others? If certain parts of the economy are relatively more exposed, then this suggests that understanding the implications for businesses here, and possible mitigating policy responses, should be an important priority.

To undertake this analysis we examine the geographical pattern of Scottish international exports to identify the sectors most exposed to any changing trading relationship with the EU.

We then make use of our inter-regional macroeconomic model of Scotland and the rest of the UK to examine the long-term impact on the Scottish economy.

It should be noted that we assume that all other aspects of policy do not change – i.e. we don’t model 3rd party trade agreements, different fiscal responses etc – as our analysis simply aims to isolate the impact of Brexit.

Our conclusion is that under all modelled scenarios, Brexit is predicted to have a significant negative impact on Scotland’s economy – see table below for long-term impact under even more optimistic scenarios such as a stylised ‘Norway’ model. To put these numbers in some context, a 1-2% reduction in employment is equivalent to the loss of around 30,000-40,000 jobs in the long-run. 

norway-model-1_a

Unsurprisingly, we find that the range of impacts is driven by the nature of any post-Brexit relationship between the UK and the EU – the weaker the economic integration with the EU, the greater the negative impact (as demonstrated by our WTO simulations).

norway-model-2_a

Overall, we find that the impact on rUK is stronger than on Scotland.

Some, including HM Treasury, have argued that there are potentially additional dynamic effects to incorporate– for example, if labour productivity is positively linked to the openness of an economy. These will increase the scale of the impact.

We also estimate the potential benefits to Scotland from an increase in government expenditure as a possible consequence of no longer making payments to the EU. Overall we find that whilst having a positive impact on the economy, the magnitude is not sufficient to offset the wider slowdown in the economy.

From a macroeconomic perspective, our modelling suggests that ultimately, the size of the relative impact by sector depends on a complex interplay between the EU-export intensity of trade and how responsive particular industries are to changes in competitiveness.

While the sectoral distribution of effects does vary with the precise form of Brexit, typically, those sectors that contribute most to the decline in GDP are: Wholesale & Retail Trade, Transportation and Storage; Professional Services & R&D; Public Administration and Other Primary. The first three of these also tend to register the greatest falls in employment.

Figure 1:  Long-term level change in value added in the ‘Norway’ scenarionorway-model-3

While the sectoral impacts are of interest, they merit careful interpretation. In particular as we are undertaking a macroeconomic assessment, the sectoral differentiation of the shocks are therefore driven by a complex combination of factors, including direct EU-export intensity, size, sensitivity to competitiveness effects and interregional linkages.

The exact impact by type of product will in practice be driven by a number of additional complex microeconomic factors such as the specific individual non-tariff and tariff barriers relevant not just for sectors but individual products. Our analysis should be seen as a helpful guide to what individual sectors are worthy of particular detailed examination.

We recommend that focus is now given to sectors that have close trading links to the EU – e.g. food & drink and some manufacturing sectors – to fully understand the particular issues facing them on a product-by-product basis. And consideration also be given to sectors affected by wider linkages including into rUK.

Overall the one conclusion that our analysis makes clear is that Brexit is not going to be straightforward. The focus therefore, needs to be on supporting firms, industries and those sectors most affected by Brexit alongside seeking out new opportunities both here at home and internationally.