Yves here. Note that this post considers the cost of hard v. soft Brexit, as in having the UK lose access to the single market versus remain within it. It does not consider the cost of what we have been calling a “disorderly Brexit” or what others have labeled “crashing out of the EU,” meaning a Brexit with no deal at all.

Note that this paper only gives some consideration to non-tarrif barriers, like divergence of technical standards. It does not appear to factor in things like massive lines at customs and documentation requirements in a hard Brexit scenaio. So if anything, the estimates are likely to be conservative.

By Hylke Vandenbussche, Professor of International Economics, University of Leuven, William Connell, Doctoral Researcher, Department of Economics, University of KU Leuven and Wouter Simons, Doctoral researcher, Department of Economics, University of KU Leuven. Originally published at VoxEU

Global value networks make it difficult to evaluate the trade impact of Brexit. Using a new model of trade that accounts for the indirect effect of these networks, this column delivers fresh bad news for the UK, and for the rest of Europe. Brexit cuts GDP more, and costs more jobs, if we also consider global value chains. A hard Brexit would destroy four times as much GDP, and four times as many jobs throughout Europe, as a soft Brexit.

Production processes are becoming increasingly global. Acemoglu (2012) and Johnson (2014) have argued that, as a result, we can no longer consider bilateral trade in isolation when we evaluate trade policy.

In a recent paper (Vandenbussche et al. 2017), we develop a new approach to evaluate trade policy when global value networks exist. It extends a traditional gravity model to include sector-level input-output linkages in production. This allows a more complete assessment of trade policy shocks.

Brexit’s Losers

While the framework is entirely general, we used it to evaluate the impact of Brexit on the UK and the EU27. Our world input-output model can be used to predict the trade impact of the UK’s withdrawal from the EU on the domestic value added, and employment for every individual EU country involved. The trade impact is arguably the most important effect and leaves aside less influential, channels such as foreign direct investment (FDI) effects, budgetary issues, or potential trade diversion effects.

Losses from the trade impact of Brexit vary by EU country, depending on its openness to trade, its trade intensity with the UK and vice versa, its sectoral composition, and the positioning of its sectors within the global supply chain. The conventional wisdom of Brexit is that the UK has a great deal to lose, but a sector-level input-output approach indicates that there are only losers from Brexit. Both the UK and each bilateral trading partner in the EU would suffer substantial losses if they were denied free-trade access to each other’s market.

Our analysis clearly shows that the EU27 stands to lose considerably more than previously thought. This is because EU27 production networks are closely integrated, which implies that tariff changes with the UK do not affect only direct trade bilateral flows, but also indirect trade flows via other EU countries. For example, the Belgian steel sector would suffer both through a direct reduction in exports to the UK, and also through a reduction in demand for steel that would have been used in German-built cars for the UK.

On average these indirect effects account for about 25% of the total effect of Brexit, although their magnitude varies across EU countries. For example, in Slovenia indirect trade effects account for 50% of the total impact of Brexit, while in Malta they represent only 5%.

To create these impact estimates, we take the predictions from our world input-output model to the World-Input-Output-Database (WIOD). This database makes it possible to identify production networks and current supply chains in the EU For every country-sector in the EU28, WIOD provides total production, the inputs needed from other country-sectors, and how output is subsequently used by other country-sectors in their production process. Using this, we can distinguish ‘direct’ exports to the UK from ‘indirect’ exports that were shipped to third countries, then to the UK. Including indirect exports provides a more complete assessment of Brexit by identifying the European production network and value chains in detail.

To empirically obtain the employment effects of Brexit, we consider trade in domestic value added rather than gross trade. The reason is that only domestic value added embedded in exports, matters for domestic employment.

We consider two hypothetical Brexit scenarios (summarised in Table 1). Dhingra et al. (2017) quantified the future costs of trade between the EU27 and the UK in a soft and hard Brexit scenario:

Soft Brexit : Import tariffs between the UK and the EU27 remain zero. Non-tariff barriers (NTBs), measuring divergence in technical standards and other factors, would increase to the equivalent of a 2.77% tariff.

: Import tariffs between the UK and the EU27 remain zero. Non-tariff barriers (NTBs), measuring divergence in technical standards and other factors, would increase to the equivalent of a 2.77% tariff. Hard Brexit: Import tariffs between the UK and the rest of the EU would rise to most-favoured nation (MFN) rates. NTBs would rise to 8.32%.

Table 1 Soft and hard Brexit

Source: Dhingra et al. (2017).

Domestic Value Added and Employment Losses Under Brexit

Figure 1 shows projected job losses for each Brexit scenario when both the UK and the EU27 raise their barriers. The bars indicate the normalised job losses as a percentage of a country’s active population. Figure 1 also reports, in brackets, the worst-case number of job losses in each EU country if there was a hard Brexit.

Our results clearly indicate that the UK would be hit relatively harder than the rest of the EU27 (except for Ireland) in both scenarios.

In either scenario, Brexit would lead to a relative reduction in economic activity in the UK and EU27.

Hard Brexit would cost 526,830 jobs in the UK, four times as many as a soft Brexit.

Hard Brexit would cost 1,209,470 jobs in the EU27, again, four times as many as for a soft Brexit.

Hard Brexit suggests a loss of 4.47% of UK GDP, again four times as much as a soft Brexit (1.21%).

The loss of UK value added would be about three times as large as for the EU27, which would lose 1.54% of EU GDP (0.38% for a soft Brexit).

Again, these impacts differ substantially across EU-27 member states. The EU-27 countries that lose relatively most are those with close historical and geographical ties to the UK (Ireland or Malta, for example) and small open economies (Belgium, the Netherlands, and the Czech Republic). While Germany would suffer the largest absolute number of job losses (291,930), as a percentage of the total active population its relative losses are more moderate when compared to the other EU27 countries.

Figure 1 Total job losses under Brexit

Source: Vandenbussche et al. (2017).

Note: Employment data in Eurostat is missing for some sectors in the following countries: Estonia, Latvia, Lithuania, Luxembourg, Malta and Sweden.

For each EU country, Table 2 shows which sector will be most affected under a hard Brexit scenario. For Germany, most jobs will be lost in motor vehicle manufacturing. For Belgium job losses are highest in the food sector. For countries such as France, most jobs are lost in administrative and support activities.

Again our results differ from other studies because our methodology additionally accounts for input-output linkages between goods and services sectors, and includes both direct and indirect trade with the UK.

Table 2 Most-affected sectors in the hard Brexit scenario (in value-added terms)

Source: Vandenbussche et al. (2017).

No Winners

Our findings indicate that both the UK and the EU27 would suffer substantial losses if they are denied free trade access to each other’s market when Brexit happens. While the current belief is that especially the UK has a great deal to lose from Brexit, our sector-level input-output approach clearly shows that the EU27 stands to lose considerably more than previous estimates. The reason is that EU27 production networks are closely integrated, which implies that tariff changes with the UK do not just affect each EU27 country’s direct bilateral trade flow to the UK but also the indirect trade flows (via third countries) that end up in the UK.

We estimate these indirect effects will account, on average, for about 25% of the total Brexit impact, but for some EU countries, these indirect effects would create 50% of the total employment effects. Compared to other studies, the inclusion of this production network structure increases the projected negative impact of Brexit on the EU27.

See original post for references