#Brexit Facts
Recent debate on Brexit has extensively discussed how badly would leaving the EU affect the UK services sector. Obviously, this is a worrying issue which could cause massive job losses, particularly in financial services sector. However, in this post, I would like to discuss the Brexit-related challenges to the UK manufacturing sector. This topic has received only limited attention despite the high economic cost it is likely to involve.
Why is the manufacturing sector important to the UK?
Manufacturing exports account for 45 per cent of total UK exports. Pharmaceuticals, aerospace, motor vehicles are the key export-oriented sectors of the UK. The EU is the largest export destination of the UK, accounting for 52 per cent of total exports. The UK manufacturers are strongly integrated into the EU supply chains where natural resources, raw materials and components cross the EU borders a few times before being transformed into finished products. To be more precise, nearly half of the UK’s intermediate goods imports and exports are with other EU countries. The EU27 supply chain also relies on the UK but to a smaller extent: The UK accounts for only 10 per cent of the EU27 intermediate goods exports/imports. The larger exposure of the UK to the EU27 supply chain as well as its relatively small size (only 17% of the EU27 GDP) suggest that any disruption to existing production networks after Brexit would be more harmful to the UK manufacturers (than to the EU27 ones).
Why is Brexit likely to disrupt the EU supply chain? After Brexit, the UK’s borders with the EU will all become external and will be subject to customs controls following the EU law/WTO rules. Under all possible Brexit scenarios (e.g. EEA, CETA, Customs Union, WTO) customs controls and non-tariff barriers are likely to imply additional costs to trade, also in terms of waiting time.
Why does the waiting time matter for the supply chain? The EU and UK manufacturers follow the ‘just-in time’ principle which makes it necessary to move parts and components quickly and efficiently around the EU. In this way, producers keep stocks at a minimum level to reduce costs. Let’s take the automobile sector as example: The Society of Motor Manufacturers & Traders, estimates that imported components from the EU account for 60 per cent of a ‘British-built’ car. In the same way, two-thirds of UK motor components, are exported to the EU producers to end up in ‘foreign-built’ cars. Even a few days of delays due to customs controls could severely disturb production networks of the automobile industry.
Currently, the Brexit trade debate focusses on negotiating Free Trade Agreements and disregards the additional ‘trade cost’ implied by borders controls, non-tariff barriers and bureaucracy. Most UK exports to the EU are operated through the Channel ports which currently lack the staff, physical infrastructure or software capacity to deal with all-encompassing border controls.
Moreover, even under a zero-tariff agreement with the EU, the re-introduction of ‘rules of origin’ could seriously harm the UK/EU supply chains. In short, ‘rules of origin’ refers to a cumbersome bureaucratic procedure where exporters will have to prove that their goods originated in the UK and that everything that enters the UK has a verified country of origin. All in all, the resulting paperwork, custom delays and compliance costs could seriously paralyse the supply chains by making the UK suppliers less attractive to the EU producers. Recent evidence shows that some companies have already started to replace their UK supplier by the EU ones.
Could the UK manufacturers dump existing EU supply chains and quickly set-up new links in the UK?
The short answer to this question is ‘NO’. The UK workforce is severely lacking ‘vocational’ skills highly required in sectors such as electrical and mechanical engineering. Without skilled workers in place, it will be almost impossible to build a self-sufficient infrastructure for the UK within a two-year period. Even with ‘good’ educational policies (which are rather unlikely to happen), it would take several years to train the UK workers. Moreover, restrictive immigration policies will not be of any help in filling the skills gap during this transition period.
All in all, my take is that even under a Free Trade Agreement with the EU, Brexit could severely harm the UK manufacturing sector due to the re-establishment of border controls. To minimise the adverse impact of Brexit on supply chains, targeted human capital formation policies should be quickly put in place in order to tackle the UK’s skills shortage problem after Brexit.