Research objective

The project is aimed at providing the comprehensive analysis of the economic effects that result from the departure of the United Kingdom from the European Union and exiting from the Single European Market (Brexit). In particular, we are interested in the effects of the potential increase of tariff and non-tariff barriers to international trade, as well as major macroeconomic and sectoral variables. We will focus on the fallouts for Poland, but also provide selected results for other New Member States, the UK and the rest of the European Union.

The project will answer the following research questions:

1. What are the potential scenarios of Brexit and how all these scenarios translate into the level of tariff and non-tariff barriers?
2. What is the level of intra-EU tariff and non-tariff barriers relative to their extra-EU counterparts?
3. What are the economic linkages between the economic sectors of Poland and production sectors in the UK? What is the relative importance of direct versus indirect linkages between Poland and the UK through the Global Value Chains (GVC)?
4. What are the economic consequences of trade-related effects of Brexit? What are the potential out-turns on productive sectors, as well as services, imports, exports, employment and wages?
5. What are the implications for the Polish food sector? 

The analysis will be focused around the following research hypotheses:

1. Brexit will likely lead to an increase of both tariff and non-tariff barriers as the extra-EU barriers are considerably higher than those inside the EU. The level of UK external protection can also be subject to changes as a result of Brexit.
2. While the UK is not the largest Polish trading partner, the both direct and indirect linkages between the UK and Poland are strong and trade with the UK has a significant impact on GDP growth in Poland. Breaking of trade linkages will have a non-negligible impact on GDP and welfare of Poland.
3. The bulk of the effects of Brexit will be concentrated on the sectors, where Poland has the strongest direct economic linkages with the UK, most notably the food sector.

Significance of the project

The potential economic consequences of Brexit have been receiving a great deal of attention since January 2013 when David Cameron announced the plan of the EU referendum, finally held on 23 June 2016. In particular, following Springford and Tilford (2014), economists broadly share the view that for the UK, the effects of Brexit will be a disadvantageous when it comes to international trade. The country is both an important global trade player, encompassing around 4 percent of world GDP, and has significant trade links with the EU. The UK is also strongly integrated within global value chains, with 41% of the value added coming from its EU exports and 1% coming from the US ones. Therefore, various scenarios of the Brexit process and its possible trade-related results, depending on the scope of de-integration, are being analyzed before the final deal is concluded.

The economic findings of such scenarios shed lights on possible welfare losses, the level of GDP decline or price changes that affect the households and enterprises. Further, the research also refers to sectoral net value added, openness, sectoral changes or the possible application of tariffs and non-tariffs barriers to trade (NTB) within the context of commercial links considered.

Most of the current studies focused on Brexit use a form of computable general or partial equilibrium models[1]. For example, KPMG (2017), Oxford Economics (2016), PwC (2016), Lawless and Morgenroth (2016) or Rojas-Romagosa (2016), using computable general equilibrium models (CGE), predict negative outcomes for trade and welfare as a result of Brexit. According to these studies the negative implications of Brexit will be especially important for the British economy, but will also negatively affect all present EU members, including Poland as well (Oxford Economics, 2016). As for the British economy, one of the first such studies estimated that Brexit would lead the UK to projected income cuts ranging between 1.1%, in the optimistic scenario, to nearly 10% in the most pessimistic scenario and a decrease of 12.6% in UK total trade, where the pessimistic option means that UK would join another form of supranational organization than the EU (Ottaviano et al., 2014). Moreover, Dhingra et al. (2017a) show that Brexit will likely lead to a long-term loss in the aggregate real consumption of 1.3% or 2.7% for ‘soft’ and ‘hard’ exit respectively. Another study points at the losses in GDP between 0.6% and 3% of GDP and total UK trade decline between 3% and 13% (Aichele, Felbermayr, 2015). The negative effects could also result from the various trade scenarios with different tariffs and NTB cuts/increases applied. However, there have been studies that show positive effects for the UK under certain conditions. For example, if the UK decides to lower the trading barriers towards all the trading partners, one could expect even a boost in output (Booth et al., 2015; Minford, 2018; see also Economists for Free Trade, 2017).

It has to be noted that while the studies focused on the impact of Brexit on the UK are numerous, the topic of the impact on Poland and Central and Eastern Europe has been relatively under-researched. Fundamentally, this is a serious deficiency in the research, given the fact that the UK has been gaining importance in as a Polish trade partner over time. Since 2000 the share of the UK in Polish exports has gone up from 4.2% to 5.6% in 2014 (according to the World Input Output Database, 2014 data covering merchandise trade and services). The share of Poland in world trade at the same time has gone up from 0.64% to 1.22% and trade with the UK has contributed to 7% of that increase. This makes the UK the third largest contributor to Polish exports (after Germany and Czech Republic) and at the same time, the third largest contributor to trade growth in the analyzed period. Therefore, trade collapse with the UK is important not only from the point of view of a one-off decrease in exports, but also in terms of future trade growth potential.

Similarly, Poland is a part of European global value chains. Most of trade with the United Kingdom (with the exception of the food and agricultural sectors, see later) is taking place within those global value chains. In particular over 60 percent of Polish exports are intermediate goods (see Hagemejer, 2018). Therefore, the traditional measures of gross exports do not reflect the importance of trade in creation of value added. In particular, in GVC-related trade, exports are increasingly import-intensive. Polish exports to the UK are concentrated in high-import intensity products and in sectors with high intensity of foreign direct investment inflow. Most important import-intensive products include: motor vehicles and parts (around 10% of overall export value in 2014), machinery and equipment, electrical equipment and computers, electronics and optics. In some of these sectors, import intensity exceeds 50%, ie. for 1 EUR of the value of Polish exports, 0.5 EUR of the value of imports are required, a lot of these imports coming from the UK. This may mean, that an increase in bilateral trading barriers between Poland and the UK can potentially disrupt the GVCs and would have both direct and indirect impact on the output of Polish industries. While the concept of GVCs have been widely elaborated upon in the literature (see eg. Johnson and Noguera, 2012) the importance of UK-Poland-EU trade was not analyzed in detail. What GVC-related analysis can provide is the assessment of the contribution of the Poland-UK trade relations to the Polish GDP growth (see Hagemejer, 2018 for the methodology, as well as Hagemejer and Mućk, 2018) and therefore an assessment of the loss of future trade potential.

Another basic consideration is that leaving the EU is likely to have significant implications for the agricultural sector and trade trends in agricultural products both in the UK and the rest of the EU countries, including Poland, where the agricultural and food sector is the second largest exporting sector to the UK (around 9% of Polish exports in 2017) and the food sector is the largest production sector of Polish manufacturing. Since Poland joined the EU, Poland and the UK have been more and more important trading partners for each other. Between 2004 and 2017 the value of export of agri-food products from Poland to the UK increased nearly 8 times and reached about €2.4 billion in 2017. In consequence, the UK became Poland’s second largest export partner after Germany, and the share of the UK in the structure of the total export of agri-food products from Poland amounted to nearly 9%. It is worth noting that Poland was a net exporter of agri-food products from the UK during the entire period under consideration. In 2017 agri-food export from Poland to the UK exceeded the value of import from that country by more than €1.9 billion (Eurostat, 2018). Although all these figures determine relatively high significance of the UK as a trade partner in the agri-food sector in Poland, there is a lack of analyzes which assess the implications of Brexit for the Polish agri-food sector and UK-Poland agri-food trade pattern. Nowadays, the relatively high value of agri-food trade between Poland and the UK is chiefly caused by the size of the UK market and consumers’ purchasing power, relatively small distance to the target market, similar way of doing business, as well as high recognition of Polish agri-food products in the UK, and high absorption of these goods among migrants from Poland. It should be noted that within the Single European Market the trade between Poland and the UK is tariff free, and NTB barriers do not exist, while imports from outside the EU are subject to tariffs and NTB’s which are very high in some cases. Leaving the European Union would imply that the UK has to redefine its trade relationship with the EU member countries. In consequence, the agri-food trade between the UK and Poland would be a subject to significant transformation and will probably be significantly reduced.

Taken as a whole, in the UK the agri-food sector accounted for more than 7.0% of the national value added, while the agricultural workforce accounted for around 431,000 people and the utilised agricultural area equalled to roughly 71% of land in the UK (Eurostat, 2018). For the UK, the EU is an important trading partner in agri-food products, accounting for 70% of exports and 50% of imports, while trade between EU member states is tariff free. After Brexit, the UK government will be able to decide the level of the tariffs it imposes on imports into the UK from the EU and third countries, as well as to negotiate its own free trade agreements. Matthews (2016) and Buckwell (2016) discuss the agricultural trade policy dimensions of a UK withdrawal extensively. There are some studies which attempt to estimate the potential effects of a UK exit from the EU for British agriculture. All of them predict lowering the value of agri-food trade between the EU and UK in both directions (around -62%). The highest decreases would potentially refer to trade flows for rice, white meat, sugar, dairy and red meat (Lawless and Morgenroth, 2016; Bellora et al., 2017). This result is in line with van Berkum et al. (2016) and Agra Europe (2016), who find similar trends in the UK’s net trade position.

Membership in the EU affects farming in a number of ways including through the Common Agricultural Policy (nearly €4 billion in 2017), trade arrangements and by allowing free movement of people (Potton and Webb, 2017). The food sector enjoys the greatest degree of support of all sectors in the EU and the level of extra EU trade protection in the food sector is the greatest. That is why the agri-food issues can be the most difficult subject of the EU-UK negotiations and potentially the post-Brexit policy changes can be the most significant. The importance of the agri-food sector for Poland and the severity of potential changes alone warrant a more detailed analysis of the food sector.

Consequently, our project will allow us to analyze in detail the trade relations between Poland and the United Kingdom in the context of Brexit. We will be able to present an all-encompassing analysis of the trade effects of Brexit. While the literature on Brexit is already ample, our contribution focuses on Poland and other New Member States where the evidence concerning Brexit effects is rather scarce. Our analysis will be more detailed than previous studies and therefore more suitable for policy advice in the countries analyzed. Moreover, this will be a sole analysis that will be done in the context of Brexit and the New Member States, that will provide individual estimates of non-tariff barriers, as well as the analysis of the linkages in the GVCs. It will also feature the most detailed Brexit simulation performed for the agri-food sector up to date. Given all the above factors, to our best knowledge, the approach applied by this project is novel as compared to the existing research. We plan to submit the outputs of the project to refereed journals and present the results in widely recognized international conferences.

Work plan

1. Scenarios of Brexit. Tariff and non-Tariff Barriers.

This part of the project will be partially based on literature review and partially on econometric work and data analysis. We will present the results of empirical studies that analyze economic implications of Brexit. We will discuss these results in the context of the literature on various forms of FTAs and discuss possible outcomes of the UK-EU negotiations both for the EU and Poland. The remaining work will be based on data analysis of tariff data, as well as econometric estimation of non-tariff barriers to merchandise trade and services trade.

• Intersectoral links between British and Polish economy. Importance of trade with the UK for GDP growth of EU countries and Poland.

This analysis will be based on international input-output tables and will use the methodology established by Hagemejer (2018) and Hagemejer and Mućk (2018). It will focus on the analysis of the share of Polish value-added exports in the UK final demand (and vice versa), content of Polish value added in the UK’s exports (and vice versa). It will provide an analysis of changes in the importance of UK-Poland trade in value added to identify the fastest growing export linkages and finally provide the estimates of the contribution of UK-Poland bilateral trade to the GDP growth of both countries.

• Simulations of Brexit scenarios using a general equilibrium model.

This part uses a computable general equilibrium model to assess the possible scenarios of the increase in bilateral barriers to trade between the UK and the EU, including Poland. The results will include changes in overall GDP and economic welfare, changes in overall sectoral output, imports and exports, changes in bilateral UK-Poland trade as well as effects on wages and terms of trade. 

The simulation scenarios will be based on the first part of the study and will, in general, include an increase in tariffs in merchandise trade, as well as an increase in non-tariff barriers on the part of the EU.

• In-depth analysis of the Polish agri-food sector and the effects of Brexit.

This part includes an analysis of possible Brexit implications for agri-food trade between Poland and the UK, based on partial equilibrium model and analysis of detailed trade data. Besides the detailed simulations of changes in international trade in agri-food products, some “key products” that are particularly sensitive to Brexit will be identified.

Methods of research

Brexit scenarios

29 March 2019 has been scheduled as the date of the official departure of the UK from the EU in accordance with the Article 50 of the European Union Treaty (TEU). Till the date of the submission of our project the transitional arrangement between the EU and the UK has been signed, though it has not yet been accepted by the British Parliament. Hence, there is considerable uncertainty concerning the economic aspects of Brexit. Namely, whether the transitional agreement will be respected by the UK or not and, eventually, how the trade related parts of this agreement will be concluded. For the moment it seems that some variant of the Soft Brexit scenario is much more likely than the Hard Brexit (Council of the EU, 2018 and EU Commission, 2018). In order to present a full picture of possible implications of Brexit (see e.g. Cambridge Econometrics, 2018; Gasiorek, 2016; Oxford Economics, 2016), we plan to analyze the following six scenarios of Brexit (and others that may emerge over time):

1. Canada solution: the UK would join a free trade agreement with the EU. It implies that no tariffs will be imposed on trade with goods, while product market regulatory harmonization will be continued to some degree.
2. Turkish solution: the UK would join the Customs Union of the EU. As a result, the UK would adopt the common external tariffs on imports and export without say on the tariffs which it would need to impose on goods it imports from non-EU countries.
3. Hard Brexit: a full exit of the UK by terminating all EU rules and regulations (WTO rules only). A return to WTO rules for the EU-UK trade means a return to the MFN tariff rate but is likely also to influence the trade restrictiveness of NTBs. Therefore, for the WTO scenario we assume two variants (similarly to Ottaviano et al., 2014; Dhingra et al., 2017a, 2017b or Bellora et al., 2017):
4. WTO – tariff rates between the UK and EU increase up to the MFN level, and trade restrictiveness of NTBs is increased at these borders;
5. WTO (tariffs only) – tariff rates between the UK and EU increase up to the MFN level, while the NTBs do not change; this scenario depicts the role played by NTBs (and the value of their estimated trade restrictiveness);
6. In addition, we plan to analyze a variant in which the UK decides to reduce MFN tariffs on agricultural products towards the third countries and EU members, while coordinating SPS and technical barriers with the EU
7. Continental Partnership: hybrid version of Brexit. It assumes the elimination of majority of tariffs and limited regulatory cooperation (coordination of technical regulations & other NTBs).

Tariff and non-tariff barriers

The initial non-tariff barriers present in trade in goods and services will be estimated using sectoral gravity models of trade. The tariff equivalents of non-tariff barriers to merchandise trade will be calculated using the estimated tariff elasticity of import and the importer-specific fixed effects. According to Anderson and Wincoop (2003) and Park (2002), the difference between the total actual and predicted value of country imports in a gravity model may indicate the level of distortion to trade caused by existence of trade barriers. However, the absolute differences should be normalized relative to a benchmark free-trade country case. We will obtain the tariff equivalents using the methods proposed by Fontagne et al. (2012), ie. by evaluating the difference between the fixed effects of a given country and the benchmark country (free-trade country). Our estimations will be based on the most recent trade data obtained from United Nations COMTRADE database augmented with the gravity variables obtained from publicly available databases (such as World Bank’s World Development Indicators for macroeconomic data, CEPII[2] database for geographic and political variables, as well as trading agreements and WTO/UNCTAD’s TRAINS/WITS database for protection data). We will obtain the estimates of tariff equivalents of non-tariff barriers for each of the manufacturing and service sectors, for Poland, the rest of the New Member States, UK as well as the EU-15. We will complement these results with a detailed analysis of the EU external effectively applied tariffs in the same sectors. This will allow us to quantify the tariff and NTB-related shocks, which will be analyzed later in the project.

Global value chains

This part of the analysis will focus on the intersectoral linkages between the economies of Poland and the UK. As bilateral exports between the two countries occur mainly in the framework of global value chains, analysis of trade in value added is more suitable than simple analysis of gross trade flows. Our work will closely follow the methodology established by Johnson and Noguera (2012), as well as Wang, Wei and Zhu (2013). We will be able to show the bilateral importance of Poland and the UK in their two-way trade. In particular, we will show the importance of the value added generated in Poland in UK’s final demand (and vice versa), which will give us the idea on the contribution of exports from Poland to the UK to the Polish GDP (and vice versa). Moreover, we will show the dependence of Polish exports on imports from the UK (and vice versa) by the use of the measures of foreign value added in exports which will allow us to assess the scale of the possible post-Brexit disruption to productive processes. This calculation will be done both at the aggregate level and at the sectoral level to analyze the strength of sectoral linkages. In addition, we will perform a dynamic analysis along the lines established by Hagemejer (2018). This will allow us to assess the contribution of Polish trade relations with the UK to the Polish economic growth and therefore assess the potential trade-driven growth effects of Brexit. Our primary source of data for the above exercise is the World Input-Ouput Database (WIOD)[3].

Computable general equilibrium simulations

The analysis of trade effects of Brexit will be carried out using the GTAP computable general equilibrium model (Global Trade Analysis Project, Hertel, 1997). GTAP is a multiple-equation, global general equilibrium model, where economic agents (enterprises and households) solve multidimensional decision problems.

The model will be used with the accompanying database. The GTAP database contains comprehensive and coherent data on national accounts, output of goods and services, household budgets, input-output tables and international trade in goods and services. The database contains information for 140 countries/regions and 57 sectors.

The GTAP model was extensively employed in impact assessments of trade liberalization scenarios, for example, to examine the implications of the accession of the new EU member states to the European Single Market (Hagemejer, Michałek, 2006), the potential effects of the Doha Round (Hagemejer, Michałek, 2008;  Hagemejer, Kaliszuk, 2007 or Hagemejer, Michałek, 2010) and effects of the introduction of the EU Service Directive (Hagemejer, Michałek, Michałek, 2014)[4].

The tariff-related scenarios will be based on the actual tariff levels taken from the IDB/TRAINS/WITS (UNCTAD/WTO) databases. The increases of non-tariff barriers will be imposed on the model using the iceberg transport cost concept (see Samuelson, 1954). The short run simulations will be complemented by their long-run version taking into account the additional capital accumulation (Francois et al., 1996).

The proposed simulations will allow for decomposition of the total impact of Brexit into the part attributable to changes in protection in manufacturing trade (including trade in intermediate goods within the framework of the global value chains), agricultural trade and trade in services. It will be possible to analyze the impact on international trade, factor allocation, output of goods and services and final and intermediate consumption. It will also be possible to assess the overall impact on the gross domestic product of analyzed countries and the changes in economic welfare (measured by equivalent variation).

Agri-food sector analysis

This part includes an analysis of possible Brexit implications for agri-food trade between Poland and the UK, based on partial equilibrium (SMART) model. The simulations will employ WITS/TRAINS data and will cover a selected number of 4-digit “key” products identified according to the nomenclature of the Harmonised Commodity Description and Coding System (HS) as particularly sensitive to Brexit.

We will perform a preliminary analysis of trade flows between Poland and the UK in order to present the importance of the UK to the agri-food trade in Poland, as well as the significance of Poland as the UK agri-food trade partner. We will analyze the commodity structure of bilateral agri-food trade at 2-digit HS product level and identify some “key products” (at 4-digit HS product level), that are characterized by a large share in mutual trade and the possible high level of barriers to trade.

We will evaluate the revealed comparative advantages in trade between Poland and the UK. We will use the following indicators to examine the competitive position of Polish agri-food products in the UK market: Balassa’s Revealed Comparative Advantage (RCA), Vollrath’s Revealed Competitiveness (RC), the Revealed Symmetric Comparative Advantage (RSCA), and the Lafay’s Trade Balance Index (TBI). We will also develop product mapping schemes based on Widodo (2009) approach.

Once the key products are identified, we will perform a number of simulations using a computable trade model for two-digit and four-digit categories of products. We will use a partial equilibrium trade model GSIM (Global Simulation Model, see Francois and Hall, 2009) based on the Armington (1969) assumption. The partial equilibrium analysis considers only the effects of a given policy in the market that is directly affected and does not account for the other economic interactions. This partial equilibrium model allows the simulation of the effects of changes of tariffs and non-tariff equivalents. The analysis can be performed at a high level of disaggregation (up to 6 classification digital position HS). Considering the potential trade implications of Brexit for Polish agri-food trade, we will assess both trade creation and trade diversion effects, resulting from tariff changes in the WTO scenario (Hard Brexit). For our simulations we will use standard elasticity parameters to obtain calculations comparable to the previous literature. In particular, we will use the Armington substitution elasticities from the GTAP database to provide results compatible with those coming from the general equilibrium model.

Moreover, we will also perform some GSIM simulations analyzing the impact of increasing NTB’s on bilateral trade between the EU and UK. The NTB’s tariff equivalents will be based on our own gravity model estimations. In line of our provision that the new scenarios may emerge over time (in particular, the Soft Brexit scenarios), the project will also examine them respectively.

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[1] However, at least one study uses purely econometric methods – ie. the gravity model of trade (Brakman, Garretsen, Kohl 2017).

[2] www.cepii.fr

[3] www.wiod.org, see also Timmer et al. 2015

[4] General equilibrium models are a standard tool used in assessment of the RTA-type agreements (for example, for EU-ASEAN, see Antimiani et. al. 2008; for agreements between the CIS countries and UE, see Francois and Manchin, 2009),