Government to limit adverse effect from no deal tariffs - Capital Economics
UK Economics

Government to limit adverse effect from no deal tariffs

UK Economics Update
Written by Ruth Gregory

The government’s latest no deal tariff plans released yesterday provide us with some reassurance that although there will be some hit to the economy from higher tariffs it won’t be as big as most feared.

  • The government’s latest no deal tariff plans released yesterday provide us with some reassurance that although there will be some hit to the economy from higher tariffs it won’t be as big as most feared.
  • Although there’s little the UK can do to prevent the EU from applying import tariffs to the UK’s exports in a no deal Brexit, it can choose what tariffs to apply to imports coming into the country from overseas. At present, the UK applies a 0% tariff on imports from the EU, EFTA and countries that have a trade deal with the UK and a 4% average tariff on imports from countries that do not have a trade agreement with the UK. When weighted by the share of imports coming from the EU and from elsewhere, this equates to an average tariff of 1%. (See the “current situation” bars in Chart 1.)
  • If there were a no deal, WTO rules stipulate that the UK would have to apply the same level of tariffs to all countries unless a trade deal has been agreed. (See the “WTO rules” bars in Chart 1.) This presents the government with an unenviable choice of whether to impose tariffs on a wide range of imports (EU or otherwise) and therefore expose UK households to higher prices, or drop tariffs on imports from outside the EU and therefore expose some UK industries to greater competition from overseas.
  • The no deal tariff rates initially published by Theresa May’s government in April suggested that May opted for something in the middle for a temporary period of a year, and the updated plans released yesterday were similar. Whereas under the previous plans 87% of imported goods would enter the UK with a 0% tariff, the new plans just nudged up that share to 88%. There were some tweaks to individual tariff rates. But the broad picture was the same, namely that the average tariff (weighted by the share of imports from the EU and elsewhere) might rise from 1% now to about 2%. (See the “no deal tariffs” bars on Chart 1.)
  • This is clearly not the best case scenario of keeping the status quo and could cut UK GDP by 0.15%. That’s because it would boost import prices by 1.0%, add 0.2% to consumer prices and curb consumers’ real incomes by the same amount. UK exports in the sectors most exposed to new competition may also suffer, but the lower pound would help. But neither is it the worst scenario. If the UK were to apply WTO tariffs of 4% on average, that could add around 0.5% to consumer prices and knock 0.3% or so off GDP growth. (See Table 1 and our UK Economics UpdateNo easy choice on no deal tariffs”, 26th Feb.)
  • And the plans make a lot of sense since the government is able to protect certain industries, maintain its bargaining chip for future trade deals by temporary installing these tariffs for just one year and not expose consumers to much higher prices. Admittedly, the Chancellor would give up the £13.5bn per annum extra revenue that could be clawed back from the collection of WTO tariffs, providing him with less room to shore up the economy within the stricture of his fiscal rules. But the Chancellor would probably sacrifice those rules anyway (if they still exist by 31st October!) to compensate those sectors exposed by low tariffs.
  • Overall, given the government’s openness to cutting many tariffs to zero and the Chancellor’s probable willingness to step in to support those industries affected, any negative effects from a no deal Brexit (at least from this source!) may well be limited.

Chart 1: Goods Import Tariff (%)

Table 1: Impact of Different Tariff Regimes (%)

Sources: Department for International Trade, Refinitiv, Capital Economics

Source: Capital Economics


Ruth Gregory, Senior UK Economist, +44 20 7811 3913, ruth.gregory@capitaleconomics.com