National Assembly for Wales

Back to Search

Y Pwyllgor Materion Allanol a Deddfwriaeth Ychwanegol

External Affairs and Additional Legislation Committee

10/12/2018

Aelodau'r Pwyllgor a oedd yn bresennol

Committee Members in Attendance

David Melding AM
David Rees AM Cadeirydd y Pwyllgor
Committee Chair
Jane Hutt AM
Mark Reckless AM
Vikki Howells AM

Y rhai eraill a oedd yn bresennol

Others in Attendance

Gemma Tetlow Sefydliad y Llywodraeth
Institute for Government

Swyddogion Cynulliad Cenedlaethol Cymru a oedd yn bresennol

National Assembly for Wales Officials in Attendance

Alun Davidson Clerc
Clerk
Claire Fiddes Dirprwy Glerc
Deputy Clerk
Gareth David Thomas Ymchwilydd
Researcher

Cofnodir y trafodion yn yr iaith y llefarwyd hwy ynddi yn y pwyllgor. Yn ogystal, cynhwysir trawsgrifiad o’r cyfieithu ar y pryd. Lle mae cyfranwyr wedi darparu cywiriadau i’w tystiolaeth, nodir y rheini yn y trawsgrifiad.

The proceedings are reported in the language in which they were spoken in the committee. In addition, a transcription of the simultaneous interpretation is included. Where contributors have supplied corrections to their evidence, these are noted in the transcript.

Dechreuodd y cyfarfod am 14:00.

The meeting began at 14:00.

1. Cyflwyniad, ymddiheuriadau, dirprwyon a datgan buddiannau
1. Introductions, apologies, substitutions and declarations of interest

Good afternoon. Could I welcome Members and the public to this afternoon's meeting of the External Affairs and Additional Legislation Committee? Can we do some housekeeping as usual first? Can I remind Members that this is a bilingual meeting and, therefore, simultaneous translation from Welsh to English is available via the headphones on channel 1? If you require amplification, that's also available on the headphones via channel 0. Can I remind Members to switch their mobile phones either onto silent or off during the session, please, or any other electronic equipment that may interfere with broadcasting equipment? If there is a fire alarm this afternoon, please follow the directions of the ushers to a safe place. We've received apologies from Steffan Lewis and Joyce Watson, and no substitutes have been identified. We are aware that Michelle Brown is likely to be late this afternoon.

2. Deall effaith economaidd Brexit—sesiwn dystiolaeth
2. Understanding the economic impact of Brexit—evidence session

We move on to the item on our agenda, No. 2: the evidence session with the the Institute for Government. Could I welcome Gemma Tetlow this afternoon to the meeting? We've been looking at the paper that the Institute for Government has produced in relation to the economic impact, and, if it's okay with you, we'll hand over to you for presentation and then we'll go through some questions as we do so.

Dangoswyd cyflwyniad gweledol i gyd-fynd â’r drafodaeth.

A visual presentation was shown to accompany the discussion. 

Great, thank you very much. So, as you said, we put out a paper titled, 'Understanding the economic impact of Brexit', which attempted to round up a number of the studies that have been published looking at this question. The presentation I'm going to give today is based on that paper but also bringing in the analysis that was published by the Government the week before last to show how that fits in with the other analyses that have been made of this question.

Brexit obviously marks a step change in the UK's economic relationship with the EU and, potentially, also with non-EU countries. Economic considerations, I would say, are one part of the picture that's going to shape opinions on the benefits of Brexit—obviously not the only thing that shaped people's votes in 2016 or that shape views on any potential deal. I think it's worth distinguishing between two parts of the economic question. One is about the long-run impact of Brexit on the UK economy once the UK has adjusted to a new trading relationship with the EU and with non-EU countries, and that's largely what I'm going to focus on in my presentation today, and I'd say that's really where the economics have most to add in terms of the evidence base and theory.

There is also obviously an important question about the short-term impact of Brexit as we adjust to a new relationship, whether or not there is a transition deal with the EU. I think that is very important. It will matter a lot to MPs and to their constituents, because we care not just about the long term but the short term as well. However, I think that's where the exact predicted economic impact is much harder to predict, and perhaps I can say a little bit about that at the end, but I won't spend so much time on that.

My animation has gone a little bit funny here. A large number of studies have now been published in trying to answer the question: what will the long-run impact of Brexit be on the UK economy? The conclusion reached by different papers does vary quite significantly. The most negative I've seen is a prediction that the UK economy could be 18 per cent smaller outside the EU than it would be remaining a member of the EU, through to a prediction of a maximum possible gain of about 7 per cent of GDP. The reason that people come up with very different answers is mostly because they make different assumptions about how Brexit is likely to affect the UK economy, in particular through changes to trade barriers and changes to foreign investment and productivity growth. Also, important assumptions are made about what changes might be possible to regulation and migration policy outside the EU. I'll say a little bit more about each of those areas.

Just to give you a sort of overview of these studies that have been published so far—I've given you this in the handouts so you can look back at it once I've flicked off this slide—this chart just summarises the set of studies that were out before a couple of weeks ago when the Government put out its own analysis. This is what I was saying about the huge range from an 18 per cent hit through to a 4 per cent to 7 per cent gain, which the economists for free trade predict, on the right-hand side here. Just a couple of things to note here: when economists are talking about the impact on the UK economy of Brexit, what they are talking about is how much larger or smaller would the UK economy be at some point in the future outside the EU compared to remaining in the EU. That's typically the counterfactual question that these papers are asking themselves. As you can see from this chart, one of the things that drives the difference in those predictions is the nature of the trade deal between the UK and the EU post Brexit. So, with economists typically predicting that something like a WTO—sometimes referred to as a 'no deal'—scenario would have a relatively large hit to the economy, and closer trade links of the sort that EEA countries have leading to somewhat smaller economic hits on average, there is some variation even between papers that have looked at the same type of trade deal. Some are coming up with very different predictions, and that's because of slight differences—well, differences in the assumptions that they put in in those models.

So, the news that we had a couple of weeks ago was that the Government published its final analysis of the Brexit deal. So, this is a version of the previous chart but now putting in the new Government analysis as well as two other sets of analyses that tried to estimate the economic impact of the withdrawal agreement and the backstop arrangement. So, those two additional papers were from the National Institute for Economic and Social Research and the UK in a Changing Europe group based at King's College, London.

So, just focusing on the Government analysis in the middle there, the Government analysis included five different scenarios. Just to be clear about what those were, the purple dot there was the Government's final analysis of what might happen to the UK economy if we were to get essentially no deep trading relationship with the EU and trade instead just on the basis of World Trade Organization rules. The pink dot is a characterisation of a sort of free trade agreement that might be possible, perhaps along the lines of the sort of deal that Canada has with the EU. The blue dot there is the Government's final estimate of what the impact of joining the European economic area would be, and then, to the right of that, there were two alternative scenarios for what the Government characterised as Theresa May's White Paper proposal from the summer. It's worth noting that the Government final analysis really focused on the White Paper deal rather than actually what was in the withdrawal agreement and political declaration. The two ends of that range show the most optimistic end if all of Theresa May's White Paper aspirations were achieved, and very minimal barriers to trade with the EU; the more negative end of that is a sort of sensitivity analysis that was also included, which had a higher level of non-tariff barriers than in that more optimistic case.

The Government analysis also included two alternative assumptions about what could happen to future migration. It's worth saying that neither of these really reflect necessarily what Government policy is likely to be on migration. It certainly doesn't reflect the sort of proposals that the migration advisory committee put forward. So, on the two scenarios that were included in the Government analysis, one assumes no change to migration rules, so in other words, continuing to allow free movement from EEA nationals, and then the second scenario was assuming that you had zero net migration in future from the EEA, so a much lower level of net migration from the EEA. But in neither of these cases was an allowance made for any changes or liberalisation to non-EU migration arrangements, and obviously the migration advisory committee had suggested that you might want to shift towards a migration framework that allowed more high-skilled migration but clamped down on EEA lower skilled migration.

So, one important point to bear in mind when looking at the results that people come up with is that part of the result for what impact Brexit has depends on what you're comparing it to. As I said, most of these papers are asking the question: how much larger or smaller will the UK economy be, typically in 2030 or around 15 years' time, than it would have been if the UK had remained in the EU? Importantly, this isn't trying to answer the question of how fast economic growth is going to be, so there'll be all sorts of other factors unrelated to Brexit that will affect the UK economy, and all these papers are trying to do is say, 'Setting aside all of those other things that might go on in the world that might affect growth, let's just say how much faster or slower growth would be if we were in the EU versus not in the EU.'

The EU counterfactual scenario  here: some papers do make slightly different assumptions about that. You can essentially think of this as just being that the current state of play carries on going. Recent growth rates are projected forwards. That's basically how the Government have modelled this scenario. A few of the papers, particularly one by the London School of Economics, assumed in their stay-in-the-EU scenario that, actually, the EU would become more integrated. So, we'd have further completion of the EU single market in services. So, in a sense, by leaving the EU, the UK not only gives up the benefits it might have at the moment, but gives up some other future supposed benefits that are expected to come through. And, obviously, that matters as well for the answer you come up with. 

Just one small thing on the bottom of this slide here, there was obviously quite an important amendment passed to the Finance Bill, backed by Chuka Umunna and others, which required the Government in their final analysis to show what the economic impact of remaining in the EU would be. Had that not gone through, it would have been possible—we don't know quite what the Government's plans were—for the Government to have instead compared, say, Theresa May's type of deal to simply a 'no deal' Brexit scenario. So, that amendment potentially made quite a difference to the framing of the eventual discussion about the economic impact, because, obviously, if you compare Theresa May's deal to 'no deal', then it involves tighter integration and economic benefits, versus comparing it to remaining in the EU, which most of these other papers did. 

Very quickly, there has in the public debate been some discussion about the importance of different types of economic models. I've put up here the two broad approaches that have been taken. The Treasury pre-referendum analysis used the first broad approach, and the more recent Government analysis has used the second broad approach. For people who don't spend their lives thinking about economic models, the main point I would draw out is, actually, it doesn't seem that the differences in the underlying models are what are driving the differences in results that people come up with. It actually seems to be more to do with differences in the assumptions that you make about the size of trade barriers and other aspects. So, if you have one takeaway, I would say don't worry too much about the different details of the models; it doesn't seem that that's where the big differences are coming from. 

So, the major factor that feeds through to an impact on the economy from changes that might come about through Brexit is what happens to the closeness of trade links between the UK and the EU, and between the UK and other countries. And there is complete agreement amongst UK economic commentators that closer trade ties with other countries are good for UK economic growth. Everyone is actually agreed on that, and there are a number of theoretical reasons to think that, and there's a body of economic evidence that suggests that is the case. When we've seen countries sign closer trade agreements in the past, there is evidence that that has led to an increase in trade volumes and stronger economic growth.

The difference between the Economists for Free Trade, who I had on the right-hand side of my chart predicting a positive impact from Brexit, and many of the other studies that predict a negative impact is that the Economists for Free Trade think that Brexit will result in closer trade links between the UK and the rest of the world in general. All the other economists who have written about this predict that Brexit is likely to lead to higher trade barriers between the UK and the EU and that that would not be offset sufficiently by any reduction in trade barriers that might come about between the UK and non-EU countries. So, it's not on the theory that everyone disagrees, it's on what we think is going to actually happen to those trade barriers. 

The EU single market and customs union has reduced barriers to trade between member states. The question is: how might Brexit affect that? Most studies that have tried to answer this question have, as a starting point, tried to look at the sorts of trade barriers that exist between the EU and another country that doesn't have a deep free trade agreement with the EU. And, in particular, people have typically looked at the EU-USA trading relationship. There are a couple of reasons for this. One is that the US is a developed nation and one of the few that doesn't have a deep free trade agreement with the EU. Possibly more importantly, there's also a body of existing work that popped up when the trans-Pacific partnership negotiations were going on that attempted to look at what the benefits might be for the EU and the USA signing deep free trade agreements with one another. So, that was a body of evidence that people could draw on. That evidence suggests that non-tariff barriers between the EU and the US are around about equivalent to a 10 per cent tariff. So, non-tariff barriers are now much more important barriers to trade than tariff barriers are, which have largely been negotiated down. 

I'd say there are a couple of weaknesses in the economic evidence base to draw on to try and think about what the impact of Brexit would be. The first is that almost all the evidence comes from periods when countries have moved closer together in terms of dismantling trade barriers. We don't really know whether the impact of raising trade barriers would be exactly symmetric to the impact of taking them down and, certainly, you might think that, if there were to be any costs of raising trade barriers, it might take time for those to come through, in the same way that perhaps some of the benefits took time to come through as well. 

Secondly, a lot of the evidence in this area—because most of the action in past free trade agreements has been reducing barriers to goods trade, a lot of the evidence comes from what has happened when we've had goods trade integration. There's a lot less evidence on what happens with services trade integration. It's not completely obvious that the impact for services would be smaller than the impact for goods. It could be but, on the other hand, for services trade, there are some areas where, actually, rather than trade barriers creating a marginal increase in costs, in some service areas it can be literally a prohibition on serving a market at all, so it may be a bit more binary in some of the service trade areas. 

So, how will Brexit affect UK-EU trade barriers? Most papers start from that evidence of EU-USA trade barriers, and then assume that some fraction of that level of trade barriers will come into place if the UK leaves the EU. The assumed trade barriers are, obviously, higher in modelled World Trade Organization or 'no deal' scenarios, and lower in some of the more integrated close arrangements, as characterised by EEA or Theresa May's White Paper proposals. Most scenarios—. WTO scenarios in most of these studies assume that the UK and the EU would adopt the current EU most favoured nation tariff schedule, if they were to trade with each other on WTO terms. Typically, other scenarios are assumed to have no tariff barriers at all.  

Just to go back to the point that I was saying before about the big difference between the Economists for Free Trade's very positive prediction of the impact of Brexit compared to the other scenarios, it seems to have come about because they assume there will be absolutely no increase in trade barriers with the EU if the UK were to leave and adopt unilateral free trade, and, in contrast, there would be a big potential reduction in trade barriers with non-EU countries at the same time.  

This is just a very quick table—it may be a little bit too small to show you—just to draw out where the Government's final set of assumptions fits with what people have assumed in the past. What you can see here is that the modelled White Paper scenario assumed a 1 per cent increase in goods non-tariff barriers, and a 6 per cent increase in non-tariff barriers for services. That puts the analysis somewhere around the FTA scenario for services, but much closer to EU membership for goods trade, essentially—so, very low barriers to goods trade assumed in that White Paper scenario; somewhat higher barriers to services trade. And, in terms of the modelled 'no deal' scenario at the bottom, that's pretty much in line with what other studies have assumed for non-tariff barriers in that 'no deal', WTO trade relationship.     

Another important factor is, obviously, what happens to barriers to trade between the UK and non-EU countries. That's obviously one of the new powers that the UK Government would have outside the EU, assuming we're outside a customs union as well: to negotiate new trade agreements with non-EU countries. The final Government analysis assumed that a raft of free trade agreements would boost GDP by about 0.2 per cent—so, small in the context of the reduction in GDP that's predicted as a result of the higher barriers to trade with the EU. Looking across other studies, that 0.2 per cent figure is towards the bottom end of what other studies have assumed, although they're all sort of—most are up to about 0.5 per cent. The largest I’ve seen in any study was a prediction of a 0.9 per cent boost to GDP.

Another important question is obviously what happens to existing FTAs between the EU and non-EU countries and whether the UK can continue to benefit from those in future. The latest Government analysis, in common with most other studies of this question, has assumed that the UK would remain able to access all of those FTAs and, importantly, that we would continue to be able to count EU-origin content towards our qualification for those free trade agreements. There are only a few of the studies that assume that the UK loses some of that access. Obviously, because these FTAs cover about 12 per cent of our trade, they’re not trivial. It’s not a trivial assumption that we do retain this access, and it’s not 100 per cent clear at the moment that we would retain access, but most of the studies assume you would. This table, which is probably even harder to read, just summarises that point.

Beyond trade, there are four sets of assumptions that papers make that also impact on the eventual predicted Brexit impact on the UK economy. One of these areas is what happens to foreign investment. So, just as reducing trade barriers helps the flow of trade, it also helps the flow of money that accompanies that trade. So—

14:20

Could I interrupt here? I presume that, like other aspects of these studies, this isn't regionalised, because, traditionally, we've assumed that we do very well in Wales from foreign investment.

Yes, so, a column at the end—. No, it is not regionalised, and all of these macro models essentially take the UK as a whole and then the sort of regional/country-specific analysis has tried to take the big picture and then drill down into what it suggests—. No, it didn’t.

The final Government analysis actually didn’t put any impact on foreign investment into the numbers. They have a sensitivity analysis that looks at what could happen if there was an impact on foreign investment, but their main numbers assumed there would be no additional impact on foreign investment.

So, there could in theory be an impact on foreign investment. The Government analysis assumes there wasn’t and does a separate sensitivity, allowing for some impact on FDI. The other studies that have been published have predicted somewhere between an 8 per cent and a 26 per cent reduction in foreign investment, depending on how much trade barriers were increased by. This is quite a big hit to foreign investment, but it’s worth noting that, because investment is a relatively small part of the economy, actually, the GDP impact—the direct GDP impact—is pretty small.

The second non-trade area that matters in these studies is what happens to migration. As I said at the start, there is a body of economic evidence that suggests that, overall, migration is good for the economy. There is some evidence that, for particular groups of workers, particularly low-skilled workers in areas with lots of migrants, there has been some negative impact on their wages. Brexit obviously allows the UK Government to potentially do two things. The first is to potentially restrict EU migration, but there could also be a removal of some restrictions on non-EU migration. The Government, as I said at the beginning, simply model two options, neither of which perhaps you would characterise as likely future UK Government policy; they are presented just as scenarios. The difference between the scenario in which they have continued free movement and the scenario in which they have zero net migration from the EU is a difference of about 0.6 per cent further reduction in GDP per capita in the zero net migration scenario.

Some other papers have looked at scenarios where you restrict migration and specifically restrict it for low-skilled EU migrants. They tend to find that that might partially offset—. Any costs to GDP could be partially offset by imposing less restrictive rules on high-skilled non-EU migrants, but doesn't completely offset the trade impacts. 

Regulation is obviously another area that has been hotly debated, and, potentially, leaving the EU would allow the UK Government to adapt regulations to better suit the UK's needs. I guess it's worth saying that not all regulation is economically costly. We have some bits of regulation, like competition policy, that is there precisely to help the economy, because the sense is, without that sort of regulation, actually there would be economically harmful activities going on. There is clearly a question of, if the UK Government did go down a route of trying to adapt regulations to better suit the UK circumstances, whether or not that would raise barriers to trade with the EU if we diverged from the rules they were following.

Studies that have tried to quantify the economic impact of regulation, and therefore what benefits might be possible from deregulating, have typically focused on using the impact assessments that were published before new EU regulations came into force. I think one thing to bear in mind is that there are some cases there where the ex-ante impact estimates were that they would be quite costly, particularly things like the working time directive. But, actually, the ex-post evaluations of those policies have suggested lower costs than perhaps were initially expected. Obviously, another consideration here is that the UK Government has committed to maintaining many regulations, particularly around working conditions, environment and product standards, so we need to think a little bit about what is possible given the Government's commitments.

The final Government analysis predicted pretty small benefits to the UK of changes to regulation post Brexit of just 0.1 per cent of GDP. That's similar to what Oxford Economics put into their analysis published before the referendum. It's a bit smaller than what Open Europe and PricewaterhouseCoopers had assumed. So, Open Europe have a figure of 0.7 per cent GDP boost for what they describe as a politically feasible package of reforms, but that does still entail a number of changes—getting rid of the agency workers directive, changes to the working time directive, and some environmental regulation changes as well. 

One really—. The final really significant assumption that different papers make in addition to the trade barrier impact is what happens to productivity in the UK. And there are—. Economists believe there are strong theoretical reasons to think that trade and migration and foreign investment have positive boosts for productivity in the UK, in particular because, by trading with other countries you can increase the market that is open to you, so you can potentially benefit from returns to scale and production. You also get exposed to the best thinking from around the world, you're exposed to greater levels of competition, which drives you to try and make your businesses more productive, and migration obviously allows for the best talent from overseas to come and complement and teach existing UK workers. Those are the theoretical reasons why economists would predict that trade investment and migration should boost productivity growth permanently, which magnifies the impact of any changes to trade barriers. 

However, it's very hard to empirically estimate what the size of this impact is, and people come up with a huge range of numbers. So, for that reason, a number of the studies that have been published have made a cautious assumption that there would be no additional impact on UK productivity from reductions in trade. That very much diminishes what you might think of as the economic impacts of Brexit in either direction. So, if you think that Brexit boosts trade, that would tend to understate the potential benefits. Conversely, if you think Brexit is likely to lead to a reduction in trade, it would understate the economic costs. The final Government analysis was similar to some other studies, including the Treasury pre-referendum analysis, in assuming that there would be some sort of dynamic effect on productivity. That means that they've ended up with a larger hit to GDP than they would have done had they assumed a static impact instead. 

So, just rounding up all of those assumptions taken together, and what the Government study did compared to other studies, I would say that there were a set of assumptions made in the eventual Government analysis that weren't individually questionable but, together, made up a relatively rosy picture for Theresa May's White Paper proposal, compared to the other options that were on the table. That's perhaps not surprising. For a start, the Government analysis focused on the Chequers White Paper proposals rather than what was written in to the withdrawal agreement and political declaration—so, including the notion of a close facilitated customs arrangement that would pretty much minimise any additional barriers to goods trade.

One thing that external economists were a bit surprised by in the Government's final results was that the White Paper proposal was predicted to be better for the economy than remaining in the single market as a member of the EEA. The reason that they came to that conclusion was because the Government's analysis shows the facilitated customs arrangement having such a significant benefit to facilitating goods trade, with spill-over benefits for service providers who serve goods producers, that that facilitated customs arrangement outweighed the costs in the White Paper proposals of being outside the single market for services. So, somewhat higher barriers for services, but more than outweighed by the benefits of close goods trade relationships.

If you look at the assumptions made in the FTA or WTO scenarios in the Government analysis and the White Paper scenarios, there are two things that make the White Paper proposal look pretty good compared to either of those scenarios. The first is that the benefits of potential new free-trade agreements were assumed to be the same in the White Paper proposal as under an FTA or a WTO-type scenario. So, the implication of that is that the Government analysis suggests that you couldn't get any deeper free-trade agreement with non-EU countries in a scenario in which you had no special trading relationship with the EU than in a scenario in which you continued to have a common rule book for goods trade and a very close trading relationship with the EU. I guess that's not what some people would say. You might think that it would be easier to sign, for example, a deep free-trade agreement with the US if you were in a position to be able to move away from the EU approach to regulation in some areas than if you were still closely tied to the EU approach. Finally, as I said, the Government's assumption that there would be some knock-on effect of trade barriers to productivity magnifies the gap that's predicted between the relatively modest GDP impact under the White Paper proposal and the larger negative impact under the other scenarios.

All of these economic models focus on the macro impact. That is the nature of the model. But, MPs and, no doubt, you sitting here in the Welsh Assembly are interested in how it will affect particular sectors of the economy and parts of the country. Broadly speaking, all of the economic modelling, including the Government analysis, suggests that most sectors of the economy would be affected in the same direction as the aggregate impact. The exceptions are agriculture, fishing and food-processing industries. Those are three areas where, potentially, some of the harder forms of Brexit with a less close trading relationship with the EU could actually be beneficial for those sectors whilst it is usually predicted to have a negative impact on most other sectors of the economy.

14:30

But, again, this is macro, isn't it? At micro level, it could be moved comprehensively from a system that still has small farms that do—

Yes. So, agriculture's got clearly two important factors. In the macro models, the reason why a WTO scenario is predicted to be good for agriculture and food processing is because the imposition of EU most-favoured-nation tariffs, which are pretty high in those areas, would mean that there would be a big increase in demand for UK-produced food products. So, costly for consumers but good for those UK producers of food products.

Obviously, the second thing that matters—and I haven't talked about the, sort of, abstracted entirely from this—is what UK Government system of support would be brought in to replace current EU common agricultural policy payments, and that obviously matters a lot for the agricultural sector. None of these studies attempt to—. Essentially, they assume that the current system of support continues.

14:35

Can I just clarify this point, because it's important? Very often, we are told that agriculture, fishing and food processing are areas that would be badly affected, particularly here in Wales, because we have a high dependency on the EU marketplace. So, are you saying, therefore, that in fact it's an exception—that a hard Brexit, in a sense, or the Government's Brexit would not have an impact?

So, I'm singling these out as exceptions in the sense that in some of the trading relationships where you might get a negative overall impact, for those sectors you could get a positive effect. In particular this happens in models of a WTO trade relationship with the EU—so, one in which the UK imposes quite high tariffs on imports of food products from the EU.

Conversely, in the Economists for Free Trade model, where they predict a positive impact for the UK economy as a whole from adopting unilateral free trade—that would be a scenario in which the UK got rid of all tariffs on goods coming from anywhere in the world—in that scenario, they predict a positive impact for the UK economy as a whole, but a negative impact for the agricultural sector, because obviously UK farmers would be exposed to much greater competition from non-EU farmers if we abolished all of those tariffs

So, the argument is that the exception is because the tariffs on imports will be higher, so the UK manufacturers will look for UK markets.

Yes, exactly. So, if you imposed tariffs on imports of food products, UK consumers would be more likely to look to domestic producers of those products, and that would be a benefit for them, although obviously it comes at the cost of higher prices for consumers.

There could also be differences in the impact on services and manufacturing. The leaked Government analysis earlier in the year suggested that non-tariff barriers are on average lower for services trade than goods trade. It's also the case that services industries are less reliant on trade with the EU than goods producers are. However, it is obviously the case that the withdrawal agreement and political declaration, as currently drafted, say much more about a commitment to low barriers to trade for goods than they do about low barriers to trade for services. And indeed, the eventual Government analysis of the White Paper proposals suggests that the negative impact on services industries would be larger than the impact on goods industries, for precisely that reason.

I'm sure you're all focused on what the impact for Wales would be. In terms of thinking about how these sectoral impacts feed through into the Welsh economy versus the UK economy picture, obviously the big contrast between the Welsh economy and the UK economy as a whole is that the Welsh economy is more focused towards agriculture and manufacturing and less reliant on services than the rest of the UK economy is, including financial services. So, for that reason, particularly the White Paper modelling in the Government's analysis suggests that Wales would be one of the areas least impacted by that relationship, rather than being in the EU. 

In terms of the overall regional or country-specific impact that the Government and other studies have come up with, mostly what they have tried to do is to look at the impact on different sectors from the aggregate model, and then look at how different parts of the country are differently reliant on those sectors of the economy. That is one of the things that matters. It's not the only thing that matters, and because there are a couple of other factors that feed into the mix, different studies have actually come up with different answers to which parts of the country would be most heavily impacted by different forms of Brexit.

So, my reading of the various different studies was that people come to different conclusions, and this seems to be not because they take a different view of the current economic composition of the different areas, but because some papers have tried to distinguish the extent to which businesses, even within a given sector in different parts of the country, are reliant on EU trade. So, for example, if you are—I don't know—if you're a haulier or a global shipper based in Dover, you might think you are more reliant on trade with the EU than if you were running a shipping line out of Liverpool, for example, and if you were any form of manufacturer in Northern Ireland, you may well be much more focused towards the EU market than if you're a similar type of manufacturer in Scotland, for example. So, it's not just the sectoral make up of different parts of the country, but also the extent to which businesses in those areas are focused on the EU, and there isn't a lot of very granular trade data available to answer that question. 

It's not just the size of trade barriers that matter, but how responsive demands for different goods and services are to changes in prices. So, there are some types of products where there are lots of competing suppliers, they all look very similar, so even a small increase in trade barriers and a small increase in cost could cause consumers to just switch entirely away from that product. Conversely, there are things like, I guess, immediately post the referendum we saw Apple increase the price of its products on the UK market quite dramatically following the depreciation of sterling. They were able to do that because consumers don't really substitute away from Apple products. There is only one Apple iPhone that they want to buy.

And the fourth factor that will matter, and obviously there'll be a role here for Government policy, is the extent to which different areas are able to adapt to the changing economic circumstances. So, if the new trade relationship with the EU makes one type of business unprofitable, but another type of business newly attractive, then the impact of that on particular areas of the country will depend on whether the people in those areas are able to switch from what they're doing at the moment to what they want to do in future. For that reason, a number of papers have predicted that London might be less affected than other areas because even if the financial sector takes a big hit, some people predict that London has a relatively young, well-educated workforce, and that they could reallocate to doing something else. Conversely, the Institute for Fiscal Studies did some analysis in October pointing out the fact that, particularly in the midlands, the group of workers who are most exposed to increases in trade barriers for goods are typically older, less qualified men who have industry-specific skills that might be harder to redirect in other areas, and obviously the experience of the 1980s suggested that it can take a long time for different parts of the country to adjust when you have de-industrialisation. So, that will be one factor that is important. 

This rather hideous chart, which I've copied from the Government analysis—I don't know who allowed this to get through the publishing process—shows the Government's assessment of the potential impact of different trading relationships on different parts of the country. On the right-hand side, what you can see is for Wales, Scotland and Northern Ireland, actually, the Government's model suggests that Theresa May's White Paper proposals, with very limited changes in trade barriers for the goods sector but a greater increase in trade barriers for services, end up with Wales, Scotland and Northern Ireland doing better than other parts of the UK. Conversely, for London, you can see that London is predicted to be relatively un-affected in a 'no deal' scenario, but one of the most affected areas under the White Paper proposals because the White Paper did less to guarantee reductions in trade barriers for services rather than goods. 

The final micro split that you might be interested in is how different income groups would likely be affected by Brexit. Broadly speaking, the economic literature seems to conclude that all income groups will be affected relatively equally, but for different reasons. So, those on lower incomes are predicted to be more affected by increases in the prices of goods, and in particular food prices. We've already seen quite a big increase in prices as a result of the depreciation of sterling since the Brexit vote. On the other hand, it's higher income workers who are more likely to be working for firms that trade intensively with the EU, and, therefore, they're the ones who may be most affected by any economic hit to those types of sectors. And obviously they will see more of a increase in price from non-essential goods and services.

The short-term impact—as I said, I think this is where economic evidence has less to say. What happens in the short term is much more affected by sentiment amongst businesses and consumers, and economics doesn't have a lot to help predict that. The only thing I would say is that it's worth bearing in mind that the short-term impact could be either much more disruptive or much less disruptive than any of those long-term predictions suggest. So, a situation in which there's an amicable agreement, good progress in setting up new systems and infrastructure, a steady move towards a new relationship with the EU, may mean that it would take time for some of the costs of leaving the EU to become apparent, and the shorter term impact could be smaller than the longer term impact that's predicted. I think since I left London this morning at 11.15 a.m. the chances of that may be going down. On the other hand, some people who have advocated for a 'no deal' Brexit have pointed to the relatively benign predictions of the 15-year impact of maybe only 2 per cent reduction in GDP from some studies. You shouldn't think of that as being what is the short-term impact of a disorderly 'no deal', and the Bank of England analysis published a couple of weeks ago obviously went into a lot more detail on some of the scenarios that could play out in a much more disorderly short-term scenario, where the short-term hit could be much more disruptive than the longer term hit that some of these other papers suggest.

So, final conclusions: economic theory and evidence I would say provides more insight into the long-term rather than the short-term impact of Brexit. A variety of studies have come up with very different conclusions. Our reading of the literature is that, largely, this is not down to hard-to-fathom differences in the underlying models that people are using, but actually because of differences in the assumptions that are fed in, particularly about what would happen to trade barriers between the UK and the EU, and the UK and other countries.

Here I've just listed in order of size what assumptions are most important in driving the differences that people reach.

I think, on the Government final analysis, you can certainly quibble about the precise assumptions that they went with, and, as I said, there were a combination of assumptions that painted the White Paper proposals in a relatively positive light. Having said that, in advance of the publication we set nine tests that we wanted the Government to meet when it published its analysis, to at least allow people on the outside to scrutinise what had been said and have a sensible debate about where people agree and disagree. The Government met eight of our nine tests, which is not too bad. The one that they didn't meet—we said that they should say something about the short-term impact of Brexit. Their report didn't say much about that, but there obviously was the complementary Bank of England analysis that looked at that question in a lot more detail.

14:45

Thank you very much. There are some interesting points you've made. Based upon the last slide, where you said you did set out nine, and you said it met with eight—do you therefore consider the Government's recent analysis to be a fair analysis based upon the eight points you raised, and that they've met them?

I think it was a serious, comprehensive piece of analysis. It made a set of assumptions that I think are all individually plausible. I think reasonable people would quibble on the precise details, but it was definitely welcome that they at least spelt out in a lot of detail what those assumptions are, and they provided some alternative scenario analysis. In particular, I think presenting the White Paper proposal as the main characterisation of the proposed deal is probably pushing it a little. I think it was welcome that they presented an alternative in which there was a higher level of non-tariff barriers, because the withdrawal agreement and political declaration don't go as far as was envisaged in that Chequers White Paper proposals. So, I think it's good that they showed what would happen in a scenario where perhaps trade barriers were somewhat higher than was envisaged in that White Paper proposal.

14:50

Yes. Looking at the somewhat shorter term, clearly the long-term economists agree that free trade is good, but in a scenario where you have a country that has a substantial trade deficit in goods, if you move from—just to focus on the tariffs, if you move from no tariffs to WTO tariffs on the EU schedule, what is the near-term impact of that in terms of the import substitution that that would incentivise? Isn't that a really significant issue whereby, even if trade barriers are bad in the long term, in the near term, for a country with a substantial goods trade deficit with a particular area, suddenly putting up tariffs may actually pull some activity back?

Firstly, I wouldn't focus on the trade deficit as a measure of the negatives of trade. We think that trade is good for the economy. We sell things that we are good at selling and we buy things that we are less good at producing from other countries. So, trade isn't really a beggar-my-neighbour thing; it's not that, if we don't buy something from you, we get to create all of that economic value ourselves.

In terms of the short-term impact of raising tariff barriers, I think you also importantly need to think about non-tariff barriers as well. It's not just the tariffs that would have an impact in a WTO trade scenario. One question is clearly the extent to which UK producers would be able to step in and meet the full demands that would be diverted from elsewhere in the world. The economic impact projections—. The economic evidence base suggests that trade is good for the UK economy. So, if we raise tariff barriers and reduce trade with the EU, it may have positive benefits for some sectors of the economy—which is the discussion we had earlier—particularly areas where WTO most-favoured-nation tariffs for the EU are relatively high. That would come at the cost of other parts of the economy in particular. It would mean consumers paying more for the products that they would have been able to buy more cheaply from the EU—having to pay more for them from UK producers. If UK consumers at the moment don't choose to buy from UK producers, there must be a reason that they prefer what's currently being offered by the EU. So, yes, it would be a benefit to certain types of UK producers, but that must be at the cost of somebody else, and that's other UK consumers, who would face higher prices.

On the short term, since we are talking about the short term, if we are talking about WTO rules and we leave with no deal, have any of the analyses actually considered the implications for the exchange rate because, obviously, following the referendum, we dropped, the pound devalued? Perhaps I'm pessimistic, but I think if we have no deal, that might be another possibility. And do the short-term predictions actually also reflect that possibility, or are they just looking at the introduction of WTO rules?

Yes, the value of the pound at the moment, in principle, ought to be reflecting some sort of average expectation over the possible outcomes of Brexit, one of which is no deal, but also in play remains a much closer trading relationship. So, I guess we—. Currency markets: all sorts of things move them, but, in principle, one of the things should be the expected future trade relationship with the EU. I guess we saw this morning, when there was speculation around the meaningful vote being delayed, there was a further fall in the pound, perhaps reflecting a sentiment that that made some less positive outcome for the UK economy more likely. The Bank of England's analysis a couple of weeks ago, which looked at the short-term impact, did indeed look at what might happen to sterling, and it did predict a further devaluation of sterling in more disorderly, WTO, 'no deal' scenarios. 

[Inaudible.] Also, on the migration you talked about, you showed no change, effectively, and then with a slight change, but recent migration figures showed actually a drop in net migration from the EU but a rise in net migration from non-EU. So, in one sense, if we're seeing that now, how has that impacted, because that didn't actually fit into—? You said 'weakening the restrictions', but these restrictions weren't weakened; these were as they stand, and yet we still saw a rise in non-EU migration.

14:55

Yes, the migration we actually see is obviously a combination of both the rules that are in place and economic factors that either attract migrants to the UK or don't attract them. And, as you say, it's been fairly clear since the referendum result that net migration from the EU has fallen quite sharply, although, as you said, it's been somewhat offset by an increase in net migration from outside the EU.

The analysis that the Government presented in their paper was not a clear characterisation of a particular change in migratory rules. So, they either assumed that there would be no change in the rules for EU migrants are non-EU migrants at all. So, in that case, the actual modelling has some fall in net migration in those scenarios for economic reasons. So, because the UK economy would grow less quickly, there would be less inward migration for that reason. The other scenario that they presented just assumed zero net migration from the EU, but without a sort of bottom-up characterisation of how you would get to that point. So, presumably some sort of clamping down on EU migration, but they didn’t explicitly state what policy they thought would end up with zero net migration. And, as you say, there could be other factors, such as the UK being perceived to be a less welcoming work environment for people from the EU, which would also lead to a reduction in EU migration.

Is there any analysis of when the impact is most likely to be felt, because it seems to me that, in the medium and longer term, it’s very difficult to work out how the economy starts to redirect itself. You may get, actually, more innovation, although I think this model seems to suggest we wouldn’t, but, I mean, as we’re open to the world—. I’ve read some analysis that our overdependence on the financial sector will lessen, which could be good for the internal domestic economy, and all these things happening, but it does seem to me that the short term is going to be painful, and a lot of the economic hit occurs there. And, of course, in some regions, we reflect on losing coal very quickly in the 1980s. That had a huge impact on our economy. So, is it packed in in the shorter term, the loss?

So, this sort of long-term modelling doesn't in any sense tell you the path that you get to that end state. It just sort of tells you how different the end state is. In practical terms, going back to what I said right at the end, I think the short-term impact, if there is a relatively long transition period and a clearly defined new trade relationship, and steady progress in putting that in place, you might think that those economic impacts appear quite gradually and that people slowly redirect their efforts to the areas that become newly profitable. Looking back, we're never going to be able to observe the counterfactual world in which the UK had some other trading relationship with the EU. So, we're never going to concretely be able to answer this question.

But I guess the sort of scenario that you were painting is maybe more likely in a world in which there isn't a transition period, or not a long enough transition period, and in which the trading relationship with the EU changes quite dramatically. So, areas of economic activity go from being profitable to not profitable in quite a sharp way, meaning a much bigger reallocation of effort.

There, I think what actually happens in practice will be a combination of what happens to the trade deal, but also, obviously, what accompanying Government policies go alongside that. Your deindustrialisation of the 1980s was perhaps a clear example where, with the benefit of hindsight, perhaps not enough support was provided to those areas that were very adversely affected by that.

No further questions? We've come to the end of the time period. Can I thank you very much for your session this afternoon? It's been interesting to have an update as to the analysis and perhaps the factors for why we see so different sets of figures, from one extreme to another extreme, and the assumptions they make. It's been very helpful for us. So, thank you very much for that.

I'm going to be slightly cheeky and ask if it's possible to actually send us a copy of the slides as well.

15:00

Yes, absolutely. I'll make sure that Yan has a copy.

I thought the report was so clearly written; it's a great help, I think. I'm sorry I've only just seen it—it was published in October or whatever. I found it very helpful.

We've put out a shorter 11-page version for anyone who doesn't want to tackle the full 80 pages.

Well, it's also interesting that there's actually analysis on—. In your report, you reflected on your nine recommendations, and you've looked back at the Government's analysis and based an assumption on what they've done on your nine recommendations as well. So, that's been very helpful. 

You will receive a copy of the transcript for any factual inaccuracies, if there are, please let the team know as soon as possible. Thanks very much.

Okay, thank you very much.

3. Papurau i’w nodi
3. Papers to note

Members, we'll move on to the next item on the agenda, which is papers to note. We have one paper to note. That's a letter from the Llywydd to the First Minister regarding legislation for Brexit and the issues relating to bringing forward Bills in the Welsh Assembly and the ability to scrutinise legislation. Members are happy to note that, but, of course, I'm not sure whether the current First Minister or his successor will respond to this, because it was only sent last week, okay. But we'll note it for the moment.

Yes, it just struck me that we spent so much time worrying about the sift. Of course, if nothing gets to us, the sift is pretty irrelevant; what procedure is attached to the mechanisms they're legislating with is—

I think that's what the Llywydd was trying to get at, in a sense, and this was reflected in the discussion at the Chairs' forum, in which all Chairs basically agreed to it.

4. Cynnig o dan Reol Sefydlog 17.42(vi) a (ix) i benderfynu gwahardd y cyhoedd o weddill y cyfarfod
4. Motion under Standing Order 17.42(vi) and (ix) to resolve to exclude the public from the remainder of the meeting

Cynnig:

bod y pwyllgor yn penderfynu gwahardd y cyhoedd o weddill y cyfarfod yn unol â Rheol Sefydlog 17.42(vi) a (ix).

Motion:

that the committee resolves to exclude the public from the remainder of the meeting in accordance with Standing Order 17.42(vi) and (ix).

Cynigiwyd y cynnig.

Motion moved.

Okay. If we move on to the next item on the agenda, that's to move into private session. Are Members content to move into private session under Standing Order 17.42(vi) for the remainder of this meeting?

Members are, and therefore we move into private session.

Derbyniwyd y cynnig.

Daeth rhan gyhoeddus y cyfarfod i ben am 15:01.

Motion agreed.

The public part of the meeting ended at 15:01.

Explore the National Assembly for Wales