While the European Union (EU) is the UK’s most important trading partner, direct exports to the region have become a less significant proportion of total exports over the years. Since the turn of the century, the percentage of total UK export going to the EU has declined from 55% to 44% in 2015. More recently, the fall in EU’s share of UK exports can be attributed to the enduring economic weakness in the eurozone, following the Great Financial Crisis and the eurozone debt crisis. More positively, however, the longer-term trend highlights the UK’s ability to increase export exposure outside the EU area.
In the context of the Brexit debate, it may be noted that membership of the EU has not been an impediment to the UK achieving export success outside the borders of the single market. More importantly, with the EU accounting for a steadily declining share of a growing world economy, there remains considerable potential for the UK to develop non-EU export markets. If the UK ceases to be part of the EU, it will need to focus on negotiating bilateral trade agreements with, for instance, the US, China and India (which are currently not in place), and introduce policies to promote export activity. If sterling were to remain weak, this would be a boost to exporters and would facilitate the realignment.
Even in the shorter term, sterling weakness could result in an appreciable ‘J’ curve effect on the trade deficit. Although, higher import costs can be expected to result in a widening trade gap over the next few quarters, thereafter the benefits of improved competitiveness should provide a significant stimulus to exporters and to companies competing with imports. Over time, sterling will act as a pressure valve. This is an advantage to the UK compared to, for instance, peripheral eurozone countries where the much needed adjustment mechanism is precluded by the euro.
Longer term, the UK’s trading patterns will be heavily influenced by the outcome of negotiations with its former EU partners. It is impossible to be certain what the final trade model will look like, given the complexity and prolonged nature of the negotiations. Ultimately, we think it is not in the EU’s interests to impose detrimental terms on the UK given the bi-lateral nature of trade flows. On the other hand, we will not be able to escape entirely the impact of a protracted period of uncertainty. Nonetheless, our overall assessment is that the negative impact on trade of leaving the EU will not be as significant as many claimed during the Brexit campaign.
As a final observation, it is worth noting that in 2015, the UK had a trade deficit with other EU countries of £68 billion, but a surplus with non-EU countries of £30 billion.