Brexit is finally done. It will leave the UK poorer

The United Kingdom and the European Union have agreed on a trade deal, closing the book on more than four years of uncertainty over how the country would conduct business with its biggest export market following Brexit.

UK companies are heaving a collective sigh of relief at retaining tariff-free trade with a market of 450 million consumers that buys more than 40% of Britain’s exports and provides more than half its imports. The country left the European Union on Jan. 31 but had continued to enjoy its previous trade privileges under transitional arrangements.

The deal spares the United Kingdom some of the most dire potential consequences from Brexit as it battles a crippling pandemic, and should give a short-term boost to the economy. But the trade agreement will still leave the country poorer at a time when it faces a jobs crisis and the worst recession in more than 300 years.

“The United Kingdom has chosen to leave the European Union and the single market, to renounce the benefits and advantages held by member states,” EU chief negotiator Michel Barnier told reporters. “Our agreement does not reproduce these rights and benefits, and therefore despite this agreement there will be real changes in a few days from now.”

The new relationship is expected to lead to a long-run loss of output of around 4% compared to remaining in the European Union, according to the UK Office for Budget Responsibility, which produces economic forecasts for the government. Leaving the EU’s single market and customs area means higher costs for UK companies, which could lead to higher consumer prices and even more job losses, as well as reduced export prospects, economists say.

Another drawback: The deal appears to mostly cover trade in goods, where the United Kingdom has a deficit with its EU neighbors, and excludes key service industries like finance, where it currently enjoys a surplus.

“The good news is that a disruptive and acrimonious ‘no deal’ has been avoided,” JPMorgan’s Malcolm Barr wrote in a research note Thursday before the deal was finalized. “The bad news for the UK, in our view, is that the EU appears to have secured a deal which allows it to retain nearly all of the advantages it derives from its trading relationship with the UK, while giving it the ability to use regulatory structures to cherry pick among the sectors where the UK had previously enjoyed advantages in the trading relationship.”

Here are some of the major challenges facing the battered UK economy when the Brexit transition ends on Jan. 1.

Truck are stacked along the M20 motorway as the border to France is closed on Dec. 22 in Sellindge, United Kingdom.

Trade barriers

UK companies are losing unfettered access to the European Union. While a deal means that exporters have been spared the pain of having costly tariffs slapped on their goods, new import and export declarations alone will cost UK companies ￡7.5 billion ($10.3 billion) annually, according to Britain’s revenue authority.

Costs will rise rapidly if new customs checks delay goods at the border and snarl supply chains, forcing factories to pause production. UK ports are already gridlocked, partly as a result of stockpiling ahead of Brexit, with industry groups representing retailers and food producers warning that pressure will only increase when the transition period ends.

04 November 2020, Brandenburg, Sch?nefeld: A Lufthansa passenger aircraft is parked on the apron of Berlin Brandenburg Airport "Willy Brandt" (BER). Photo: Patrick Pleul/dpa-Zentralbild/ZB (Photo by Patrick Pleul/picture alliance via Getty Images)

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Even before France abruptly closed the border following a warning from UK officials of a new, more infectious coronavirus variant, Honda was forced to halt production at a major plant in England for three days in December because it couldn’t get the parts it needed.

While the government will phase in border checks over the coming months to avoid choking off vital supplies, truckers and transportation companies are among those warning of dire consequences. Rod McKenzie, head of policy and public affairs at the Road Haulage Association, told CNN Business earlier this month that supply chain hiccups could mean that factories aren’t able to work. There could also be “gaps on supermarket shelves,” he added.

That situation could be made worse by backups from this week. While France has reopened ferry ports and the Eurotunnel rail link, thousands of trucks remained stranded Wednesday morning with their drivers waiting for the negative Covid-19 tests they need to travel. Supermarkets such as Tesco (TSCDY) and Sainsbury’s (JSAIY) were struggling to keep their shelves stocked with fresh fruit and vegetables, and Toyota (TM) closed its UK and French plants early for Christmas.

“The clock is still very much ticking for businesses,” Jonathan Geldart, director general of the Institute of Directors, a lobby group, said in a statement Thursday. “Digesting what the changes mean in practice and adapting, in the middle of a pandemic and the festive season while border disruptions continue, is a huge ask.”

Worker shortages

Britain’s new immigration system, which takes effect in January, is designed to reduce the number of unskilled workers coming to the United Kingdom and end what the government describes as the country’s “reliance on cheap, low-skilled labor.”

Immigration was a key issue in the 2016 Brexit referendum. As an EU member, Britain was part of a bloc that allowed the free movement of people. That meant companies were able to easily employ EU citizens in sectors such as farming, social care and the National Health Service.

The number of EU workers coming to the United Kingdom has fallen sharply since 2016, and employers are worried about labor shortages, even though immigration from non-EU countries has been on the rise.

UK farms need 70,000 to 80,000 seasonal workers each year for a successful harvest, according to the National Farmers’ Union. The NFU is lobbying government to introduce a seasonal worker program, without which some farmers have warned that in the worst case crops could be left in the fields to rot.

“Workers from outside the UK are absolutely vital to the success of our horticultural sector,” NFU vice president Tom Bradshaw told CNN Business last week. “We are at a critical time in recruitment for many growers. As freedom of movement ends on Dec. 31, [growers] still don’t know where they will recruit experienced workers from.”

Loss of investment

Years of uncertainty over the future terms of EU trade have already damaged the UK economy. GDP growth in the three years after the June 2016 Brexit referendum slowed to 1.6% as business investment stagnated, according to analysts at Berenberg.

Greater clarity over Britain’s future relationship with the European Union could help. A survey conducted by EY in April found that 24% of investors regard Brexit as a risk factor, down from 38% last year. According to EY, there was a slight increase in the number of inbound foreign direct investment projects into Britain in 2019, ending three years of decline.

“A deal [will] unlock significant investment in UK and support the recovery once the ongoing coronavirus shock starts to fade,” Berenberg economists told clients Thursday.

But there’s still a risk that foreign companies, including Japanese carmakers such as Nissan (NSANF) and Honda (HMC), will no longer view the United Kingdom as a launchpad into Europe.

That may already be happening. Chinese investment across the whole of Europe has increased since the Brexit referendum but declined in the United Kingdom, said EY. Global banks have been moving some of their operations out of London to cities in the European Union.

Financial services snags

Worries that London would quickly lose its status as Europe’s financial capital to the likes of Frankfurt or Paris after the Brexit vote in 2016 have turned out to be overstated.

The United Kingdom remains the world’s biggest net exporter of financial services, with its ￡60.3 billion ($81.6 billion) trade surplus in 2019 outpacing rivals including the United States, Switzerland and Singapore, according to a report by TheCityUK, a lobby group.

Still, international financial services firms have migrated ￡1.2 trillion ($1.6 trillion) worth of assets and relocated 7,500 jobs from Britain to the European Union since the 2016 referendum, according to publicly available data tracked by EY. Dublin, Luxembourg, Frankfurt and Paris have been the major beneficiaries.

The European Union and United Kingdom have not yet struck a deal that will give UK banks and asset managers access to European markets. EU regulators are unlikely to let London keep the benefits of the single market without its obligations.

“While a deal is welcome, financial and related professional services are clear-eyed about the need for both sides to continue to develop the relationship in services in the years ahead,” Miles Celic, CEO of TheCityUK, said in a statement Thursday.

Some outside countries receive preferential market access rights from the European Union, a standard known as “equivalence.” The level of market access is worse than what the United Kingdom currently enjoys, but it’s the best the country can hope for once outside the European Union.

Major banks say they have prepared for Brexit, and the new terms of trade with the European Union won’t disrupt their operations while negotiations continue over equivalence.