Services are a vital part of the UK’s economy. They account for close to 80% of its GDP. Services exports are around 45% of total UK exports by value, and will in all likelihood overtake goods in the near future.
Over the last 10 years, services exports to the EU have grown at an annual average of 5.2%, compared to 3.5% for total trade. Services also play a fundamental role in supporting trade. Think about the role of transport and logistics services in getting goods and components to markets and through different links in the supply chain. Or the role of telecommunications and information technology in facilitating business transactions and electronic commerce. Services are also closely integrated with manufacturing: OECD data suggests that close to a quarter of the value added in UK manufacturing exports is attributable to services.
Services therefore matter. Their significance in the data sits uneasily with the way in which they have been treated in discussions on the UK’s future relationship to the EU. The position adopted by the UK Government was that it would trade off access to the EU single market for services if, in return, it could leave EU disciplines on free movement. That position was largely accepted by the EU and is reflected in the Withdrawal Agreement and accompanying Political Declaration. The fraught negotiations currently taking place between the Government and the Opposition focus primarily on the issue of committing the UK to a Customs Union on goods with the EU. Services have not featured much, if at all.
Liberalisation inside and outside the Single Market for services
Brexit will affect UK services trade because the EU single market for services – though far from complete – involves a much greater level of liberalisation than under any other trade agreement.
Data recently produced by the OECD allow us to measure the difference between services trade restrictiveness within the European Economic Area (EEA), and services trade restrictiveness that EEA members apply on a MFN basis.
Figure 1 captures the differences between what UK exporters would face under the EEA, as at present, and under a MFN regime. Levels of restrictiveness are represented as an index, with 1 implying totally restricted services trade and 0 implying total liberalisation. The results reported are by service sector and on a trade weighted basis (i.e. weighted by UK-EEA trade).
The results show that in general EEA countries have liberal services trade regimes. But also that there is a significant gap between what they offer each other, on one hand, and what they offer those outside the single market, on the other. Service suppliers outside the single market can expect to face more restrictions.
Figure 2 reports results for individual countries (country coverage reflects data availability).
The EU countries that matter most to the UK (in terms of shares of exports) are the Netherlands, Germany, Ireland and France. For the first three of these countries, the gap between MFN and EEA levels of restrictiveness is lower than the group average, which helps the UK.
What is at stake?
What are these differences worth? To find out we used a gravity model of trade that measures the responsiveness of bilateral flows in services between the UK and the EEA countries to changes in levels of restrictiveness. The results are very significant. UK exports to the EEA countries fall by around £53 billion per year or around 42% of current levels. Imports from the EEA countries fall by around £31 billion, or close to 38% of current levels. The bulk of the effect on UK exports comes from six countries: France, Germany and Ireland ( around £8 billion per year each), the Netherlands (around £7.5 billion), Italy (£4.5 billion) and Spain (£3.5 billion).
We can also break down these losses by sectors. The results are reported in Figure 3 below.
We observe a particular large effect on financial services and various professional services. Travel services is one area where the import effect (UK citizens travelling to EEA partners) significantly dominates UK exports.
The modelled impacts undoubtedly understate the true effects. We have not captured the effects of these restrictions on exports outside the EU. Exporters of both goods and services require enabling services, such as transport, logistics or telecommunications, and increasing the restrictiveness of these markets will affect exporters regardless of whether they export to the EU or outside this. Loss of access to labour skills, linked both to services trade and the wider concept of free movement similarly has effects that extend beyond UK EU trade.
Moreover, the results do not fully account for some other features of modern services trade. One of these is the extent to which being part of the EU’s single market can offer means of enforcing rules, and for redress, both vital conditions for modern services trade. Another is that these results do not fully capture the effects of policies towards data flows. As trade becomes more digital, the importance of regulatory frameworks affecting cross-border flows of data will increase in importance.
Read our full analysis at the Trade Knowledge Exchange.