As the UK’s business community anxiously follows Theresa May’s Brexit negotiations, a study has raised new concerns about the cost of trading tariffs after Britain leaves the EU.
Five major sectors will suffer the biggest fallout from Brexit, taking three-quarters of its financial impact, according to ‘The Red-Tape Cost of Brexit’, a new report by consultancy Oliver Wyman and legal firm Clifford Chance.
Financial services, automotive, agriculture, food and drink and chemicals and plastics are the sectors in the UK and EU most exposed to expensive red-tape, according to the study.
Analysts examined the impact of tariffs and non-tariff restrictions on companies if the EU27 and UK reverted to World Trade Organisation (WTO) trade relationships.
Red-tape will cost UK exporters £27bn
They calculated that direct ‘red-tape’ costs relating to Brexit would come in at £31bn for EU exporters and around £27bn for UK exporters. The report’s authors found that non-tariff barriers actually had a greater financial impact than tariffs.
The study did not track other Brexit issues, such as pricing changes, migration or third country Free Trade Agreements.
In the EU, automotive was found to be the most vulnerable sector, while Ireland’s agricultural sector is set to be hit hard given its high exposure to the UK market.
Meanwhile, the UK’s financial services sector could shoulder a third of the total Brexit red-tape costs, says the report, with Britain’s automotive, chemicals and plastics, aerospace and metals and mining sectors also in the firing line as they are so tightly integrated into European supply chains.
Small firms look vulnerable
Brexit red-tape costs are likely to be a particular problem for smaller firms who may find it harder to prepare, says Kumar Iyer, partner at Oliver Wyman and co-author of the report.
“We see the best prepared firms taking hedges now based on the direct impacts on themselves, their supply chains, customers and competitors,” he says. “Unfortunately, we see that small firms are least able to take these steps.”
Iyer says 65,000 small businesses in the UK and Bavaria could be disproportionately affected because they have no experience of trading outside the EU.
“The ability to mitigate the impacts of post-Brexit trade barriers will vary by sector and company size,” he writes. “Before designing their response, firms need to think through the impact on different levels: operations, supply chains, customers and competitors.
“Small firms will find this particularly challenging especially where they have no non-EU trade experience and may be rendered uncompetitive as they seek to make the changes needed.”
However, some smaller business groups disagree, arguing that the uncertainty overhanging Brexit makes it impossible to know if they will really face such difficulties.
“It’s not come across that small businesses are going to get the brunt of Brexit,” Ian Cass, managing director of the Forum of Private Business, a UK trade association for small firms, told Alvexo. “Large businesses have got larger infrastructure to deal with, for example, and nobody really knows what the outcome [of Brexit] will be.”
Manpower already an issue
However, even ahead of Brexit, Cass says many small firms in certain sectors are already struggling to retain EU staff.
“A lot of people have issues with manpower,” he explains. “The hospitality industry and construction have been hit already just by people pulling out of the workforce, as have to a lesser extent care homes. The majority of our members are saying [to the Government], ‘hurry up and do what you’re going to do’.”
Preparation for Brexit is ‘guesswork’, say small firms
Meanwhile, many smaller companies are sitting tight and waiting to see what the Government will announce rather than making any specific preparations for Brexit, says Cass.
“The feedback from most of our members is we’re playing it safe, holding onto cash and not investing,” he says. “It’s guesswork at the moment. The small businesses are saying, ‘hurry up and get on with it’ and there’s scepticism among them that [Brexit] will actually happen.”
However, a number of the Forum’s members are exploring the possibility of exporting their products beyond the EU. “We’ve had quite a bit of interest in China and India as export markets,” says Cass. “There has been interest in exporting in general so we’ve been helping businesses decide if they have a product worth [selling abroad].”
Fear of automotive ‘skills gap’
Manpower is also a major Brexit headache for the UK’s motor industry, which generates £80bn of annual turnover. According to the Society of Motor Manufacturers and Traders (SMMT), at least 10% of Britain’s automotive workforce is from elsewhere in the EU.
The industry relies on its ability to hire workers from across the EU to meet “urgent skill needs” it cannot fill locally, the SMMT says in its published ‘Brexit Priorities’ list: “UK automotive currently has over 5,000 vacancies in the sector and these positions need to be filled if growth is to continue.
“We need free movement of labour within European borders – any restriction undermines a global industry like automotive. For UK advanced manufacturing there is a shortage of qualified scientists, engineers and technologists. Government and industry needs to urgently address this skills gap.”
Red tape could ‘damage UK motor industry’, warns SMMT
What’s more, the association’s own analysis suggests that EU tariffs just on cars could add an additional £2.7bn to imports and £1.8bn to exports. If brands and their retail networks are unable to absorb these extra costs, it says import tariffs could hike the list price of vehicles imported to the UK from the continent by an average of £1,500.
“Barrier free access to the EU market and complete regulatory convergence have been the foundation of our success,” says Mike Hawes, the SMMT’s chief executive, in a statement.
“There is no escaping the fact that being out of the customs union and single market will inevitably add barriers to trade, increase red tape and cost. Settling for ‘good’ access to each other’s markets is not enough as it will only damage the UK’s competitiveness and reduce our ability to attract investment and the high quality jobs that go with it.”
Hawes calls for an urgent transitional arrangement to enable automotive firms to “continue as normal” while the UK’s new trade deal with the EU is agreed.
A major sticking point is that 60% of motor components are shipped in from the EU and could therefore attract expensive duties.
Brexit is expected to hit not just the UK automotive market but global car sales, with Britain previously seen as an important strategic base for worldwide car manufacturers, such as BMW, Ford, Toyota and Nissan to sell into Europe. Honda has already warned that a lack of certainty over trading with the EU is delaying investment. Analysts fear production cuts and job losses could ensue and the ultimate risk for the UK is that car makers could move production elsewhere.
Chemicals industry warns of regulatory concerns
Elsewhere in manufacturing, Britain’s chemicals industry has similar concerns to the motor sector, such as worries about a skills shortage, but executives were particularly alarmed by a recent Government report, leaked to Buzzfeed UK, claiming the sector will be the manufacturing industry hardest hit by Brexit.
“This report reaffirms everything we’ve been worrying about in terms of tariff implications, and non-tariff barrier implications, in the event of regulatory inconsistency and divergence. Also the extent to which there is a block on people and skills,” Steve Elliott, CEO of the UK’s Chemical Industries Association (CIA) told trade publication ICIS News.
Firms want to ensure that there is minimum disruption to supply chains following Brexit and that consistency with the EU’s REACH, the industry’s gold standard in chemicals regulation, is maintained. Insiders fear that failure to do so could risk the industry’s global reputation, as well as opening the floodgates to less scrupulous producers.
Financial services faces brunt of Brexit
Away from manufacturing, Britain’s flagship financial services sector could incur a hefty third of the red-tape costs of leaving the EU, according to the Oliver Wyman/Clifford Chance study. As such, London is likely to take a hit.
“Given that financial services firms will take by far the largest hit, London will feel the greatest direct effect equivalent to roughly 2.5 percent of its GVA [gross value added – GDP, plus subsidies, minus taxes] and accounting for approximately 40% of the national total,” says the report.
Worse still for Britain, Brexit could also see the UK losing its global prominence in the sector, with Frankfurt, Paris and even Dublin lining up to steal Britain’s crown as global financial centre. City job vacancies fell nearly 40% last year, according to recruiter Morgan McKinley, with foreign banks JPMorgan, Citigroup, Nomura and UBS all planning to relocate staff to Frankfurt, and Morgan Stanley, Bank of America and Societie Generale moving employees to Paris.
Research by accountants EY last year found that the City expects to lose 10,500 jobs on the first day of Brexit, with 31% of the companies it tracks moving staff out of the UK as a Brexit contingency.
Meanwhile, EU banks with branches in the UK will have been relieved by news in January that the Bank of England has unveiled plans to enable them to maintain their British operations without having to establish subsidiaries following Brexit.
Farmers give transition agreement ‘cautious welcome’
Britain’s food and drinks sector contributes £112bn in annual sales to the UK economy and is the biggest manufacturing sector, providing 3.8m jobs.
More than two-thirds of the UK’s food and non-alcoholic drinks are traded with the EU, meaning industry insiders are particularly concerned about the future of the sector after any new post-Brexit trade deals are signed.
Once again, manpower is a concern, given that 98% of the UK’s seasonal agricultural workers are sourced from the EU, while the sourcing of ingredients for the food and drinks industry could also be an issue, according to research by Willis Towers Watson. Raw material costs have already risen due to the weak pound.
The National Farmers Union (NFU), a UK-based trade association, says it gives a “cautious welcome” to the announcement of the British Government’s 21-month transition period but that there was “still outstanding vital information” that food and farming firms needed to grapple with.
“It’s vital that there is a smooth transitional period for the farming industry, avoiding any cliff-edge scenario,” says NFU president Minette Batters.
“This is best achieved by retaining membership of the EU Customs Union until a settled free trade relationship comes into force. The industry needs continuity after the date of withdrawal to ensure that farmers can continue to produce safe, traceable and affordable food and provide other environmental and economic benefits for the nation.
“The NFU has long called for frictionless trade with the EU, free of tariffs and non-tariff barriers. As our largest trading partner – over 70% of our exports of food and non-alcoholic drinks being sent to EU markets – access to the EU must be a top priority.”
Farming subsidies stay at EU rates, for now
Secretary for the Environment, Food and Rural Affairs, Michael Gove, recently told farmers that they will continue to receive subsidies guaranteed at EU levels until the 2022 election. Britain’s farmers currently receive £3bn in subsidies based on the size of the land they own. However, while Gove says that these levels may be maintained until 2024, the Common Agricultural Policy (CAP) will be replaced because it doesn’t “reward efficiency”.
Leaving the EU and CAP could have a “drastic impact on farming”, according to last year’s study by Willis Towers Watson into Brexit’s effect on the UK food and drinks industry. CAP makes up 40% of the EU budget, note researchers. In 2015, Britain’s farmers received nearly E3.1bn in direct CAP payments and access to a E5.2bn funding pot for rural development projects. Altogether, 55% of UK farming incomes comes from CAP support.
How firms could mitigate Brexit costs
Automotive and aerospace have the greatest opportunity to mitigate the cost, says analysts at Oliver Wyman and Clifford Chance, by making more use of domestic suppliers. Financial services firms will have fewer opportunities to do so, however, because their suppliers aren’t all UK-based.
“Our interviews show that there are steps companies can take individually to mitigate the costs of Brexit. For many companies mitigations will reduce ‘red tape’ costs by 10 to 30%,” says the report.
“This varies significantly by sector and company: for some no mitigations will be possible and for others much higher mitigation could be achieved. Achieving this mitigation is not trivial: it will take time, planning, resourcing, and investment for companies to deliver.”
The report suggests developing better IT systems, warehousing at borders and localising supply chains could help reduce the impact of Brexit red-tape, but admits “the scope to do so varies significantly by company, industry and geography”.
“While our analysis takes into account these first-order considerations, we believe this to be a starting point,” admits Kumar Iyer. “When planning for Brexit, companies need to be thinking beyond first-order mitigations and consider both the operational and strategic impacts. The best prepared firms are preparing contingencies.”
Staying in customs union could reduce the risk, say researchers
However, if Britain preserved a customs union with the EU the tariff red-tape could be avoided altogether, say authors of the study.
“If the UK remains in a comprehensive customs union with the EU27 that provides market access broadly equivalent to the EU Customs Union the costs arising from tariffs would be avoided and some of the border costs reduced,” says the study.
Nevertheless, this wouldn’t help the financial services sector. “The benefits would thus largely be felt by firms trading in goods rather than by firms providing services, as the provision of services is not covered by a customs union, says the report. “Notably such a customs union would not mitigate the potential impact on the UK’s financial services sector.”
Meanwhile, Cass says that irony of the anticipated bureaucracy on leaving the EU isn’t lost on his members who hoped Brexit would augur less. “I think a lot of members thought that when we left the EU the amount of red-tape would go down,” he says.