Brexit & Covid: how will these factors interact?

2020 has been a year of change for the Scottish economy.

First and foremost, the pandemic has had a significant and wide-ranging impact on businesses.

Few firms have been fortunate enough to escape the economic repercussions.

The second change, coming up swiftly, is the new trading agreements between the UK and the EU, as well as countries further afield.

While this brings opportunities in new export markets, it also brings challenges to Scottish firms that export to the EU, rely on EU supply chains or, perhaps unknowingly, have EU firms several layers removed in their supply chains.

These challenges will likely be exacerbated by the pandemic. No matter the trading arrangement, many firms we have spoken to feel they currently have limited headspace to fully prepare for new trading relationships.

A feature of the pandemic has been the divergence in the experience of different sectors, the so-called “k shaped recovery”. Several sectors – hotels, bars and restaurants, through to gyms, libraries and museums – have borne some of the most severe reductions in levels of operation.

But a characteristic of many of these sectors is that they are not particularly focused on exporting. While many of the sectors that have had an “easier” time during the pandemic are much more export focused.

Looking at the downside risk of a disruption to trading relationships only – could we be seeing a second “k” emerge?

Is it therefore the case that many of the most affected sectors in the pandemic could be the least at risk from trade disruption? And, that some of the least affected sectors in the pandemic could also be the most at risk?

We’ve taken some clues from the latest monthly GDP data and our model of sectoral exposure to EU exports.

The (unequal) impact of the pandemic

Undoubtedly the Scottish economy has been hugely affected by the pandemic.

The Scottish economy shrank 5% between February and March. This followed with an additional fall of almost 20% in April. And output in the accommodation & food services sector in April was less than 17% of the size it was starting 2020.

Looking up until the latest available month of GDP – September – the economy is 7.6% smaller than it was in February.

Many sectors closely mirror this recovery in the whole economy. However, there are a number of notable exceptions (Chart 1).

Chart 1: Change in Scottish GDP by sector, February – September 2020

Source: Fraser of Allander Institute, Scottish Government

Two sectors have seen growth – computer, electrical, electronic & optical and textiles & clothes manufacturing. The latter only because it had already experienced a large contraction in February.

Meanwhile, five sectors are still significantly below their levels in February. Some of these sectors are perhaps unsurprising given their reliance on face-to-face interaction or commuting flows.

Table 1: Top 5 most and least affected sectors, % change in GDP, Feb – Sep 2020

Sector	% GDP change	Sector	% GDP change
Accommodation & Food Services	-30.6%	Textiles & Clothes Manufacturing	7.6%
Other Services	-20.7%	Computer, Electrical, Electronic & Optical	5.6%
Transport Equipment	-17.1%	Real Estate	0%
Transportation & Storage	-13.7%	Refined Petroleum, Pharma & Chemicals	-0.1%
Metals, machinery & equipment	-15.8%	Prof. Scientific & Technical	-0.9%

Source: Scottish Government, Fraser of Allander Institute

With the further restrictions put in place over the last months, these figures will have changed. This is likely to exacerbate several of these differences further.

Unlike the start of the pandemic, many firms in sectors such as manufacturing are now able to operate while firms in sectors such as accommodation & food services have large restrictions across most of Scotland.

And changes lie ahead for the Scottish economy with the transition period set to end on the 31st of December. How will this affect firms and sectors?

Normally, the first step to understand the future impact would be to understand how sectors trade with the EU now. But with the immense amount of volatility in the data currently, we have looked back to pre-COVID times.

Relative risks to EU export disruption

To understand the risks to the disruption of Scottish exports destined for the EU, we created a model of the Scottish economy. This model estimates the amount of economic activity in Scotland that is supported by exports to the EU.

Of course, after the transition period ends this activity will not all disappear. However, any disruption to EU export arrangements will affect the level of activity, with the effects compounding over time, and will affect sectors which more heavily rely on exporting to the EU.

Our estimates are based on the long-standing methodology of input-output modelling and include the spill-over effects of export supported activity.

For instance, on its own, the construction sector exports very little and so the risk of export disruption is small. However, heavily exporting sectors purchase goods and services from across Scotland to support their exporting. And the supply chains of the heavily exporting sectors also purchase goods and services to enable them to provide this supply. Some of these purchases will be from construction. And through this spill-over effect, a proportion of activity within construction will be supported by the demand from exports.

Throughout the supply chain, activity is supported by these exports. Employment is needed to generate this activity and the employees earn wages. These wages are spent on goods and services around the country. Therefore, export activity can support employment in many sectors which, in turn, supports wage spending in the economy – a further economic boost.

Our model of the Scottish economy captures these complex spill-over effects and, in doing so, allows us to better understand the complex economic relationships that are supported by exports.

The sectors with the most and least activity supported by exports to the EU are shown in Table 2.

Table 2: Top 5 sectors most and least supported by exports to the EU

Sector	% GVA Supported by EU Exports	Sector	% GVA Supported by EU Exports
Refined Petroleum, Pharma & Chemicals	34.4%	Other Services	2.9%
Computer, Electrical, Electronic & Optical	33.2%	Construction	3.9%
Textiles & Clothes Manufacturing	22.3%	Accommodation & Food Services	6.1%
Food & Beverage Manufacturing	21.7%	Mining & Quarrying*	6.4%
Metals, Machinery & Equipment	21.2%	Education	6.7%

Source: Fraser of Allander Institute

Notably, we can see that some of the sectors most affected in the pandemic have some of the least activity supported by exports to the EU.

Chart 2 visualises the activity supported by EU exports against the change in GDP since February. With a couple of exceptions – Food & Beverage Manufacturing and Metals, Machinery & Equipment – there is a relatively strong case for this relationship.

Chart 2: % GVA supported by EU exports (Y-axis) against % change in GDP between Feb-Sep 2020 (X-axis).

Source: Fraser of Allander Institute

Not included in the above diagram is the activity supported by tourism from the EU. This has been excluded as the extent to which Brexit could impact on tourism in the long term is uncertain, and this represents a different type of economic activity to what most people think of as exporting.

By far the largest recipient of tourist expenditure is accommodation and food services. Including this in the estimates raises its exposure to EU exports by 5% and does little to change the overall picture.

The impact of the pandemic and export disruption on Scottish Local Authorities

We have seen over the last few months that the economic burden of the pandemic has not been shared equally across all parts of the country.

Based on where different types of economic activity occur, we can regionalise our results to understand the impacts on the 32 Local Authorities in Scotland.

We find that no local authority has been immune to the economic effects of the pandemic, but some have been particularly exposed.

And, due to the sectoral makeup of the local authorities, it is likely that trade disruption with the EU poses more risk to some areas.

Chart 3 shows on the horizontal axis the estimated fall in output for the 32 council areas between February and September. On the vertical axis, it shows the relative reliance of the area’s economy on exports to the EU.

Local authorities in the top left quadrant are estimated to have been hit harder economically by the pandemic compared to Scotland as a whole, while also having more of their economy supported by EU exports than the Scottish average.

If trade disruption does occur after the transition period ends, then these areas face a larger than average shock on both fronts.

The output supported by EU exports estimates only includes onshore activity, and so areas such as Aberdeen may be more exposed to trade disruption than shown.

Chart 3: % GVA supported by EU exports (Y-axis) against % change in GDP between Feb-Sep 2020 (X-axis), by local authority

Source: Fraser of Allander Institute

Meanwhile, the areas in the bottom right quadrant have been least economically affected by the pandemic and are less reliant on exporting to the EU – both Glasgow and Edinburgh fall into this category.

Moray, North Ayrshire and Angus are the most reliant on EU exports. A large proportion of the local economy in these areas is manufacturing. Manufacturing sectors in Scotland account for a large amount of exports which explains the level of reliance on EU exports of these areas.

On the reverse are Orkney Islands, Na H-Eileanan Siar and East Renfrewshire which are less at risk to trade disruption due to smaller than average manufacturing sectors and a larger public sector.

And notably, cities such as Dundee, Glasgow and Edinburgh are less reliant on exports to the EU than the Scottish average.