I thank the Chairman for the invitation to the ESRI to appear before the select committee. I am joined by my colleague Dr. Kieran McQuinn who is head of economics at the ESRI. We have been asked to discuss a recent paper entitled, Ireland and Brexit: Modelling the Impact of Deal and No-Deal Scenarios, which was published in the spring 2019 quarterly economic commentary. The paper attempts to quantify the macroeconomic impact of Brexit on the economy. I will start by summarising the range of scenarios considered and then outline some of the key findings for the macroeconomy, trade, the labour market, households and the public finances.
Owing to the current heightened political uncertainty in the United Kingdom, we consider a range of Brexit scenarios. We also acknowledge the uncertainty surrounding any assessment of the economic impact of Brexit, as there is no precedent for a country leaving a major and closely integrated trading bloc such as the European Union. The paper considers three scenarios which we describe as deal, no-deal and disorderly no-deal. To estimate the economic impact of each scenario, we compare them to a counterfactual scenario where the United Kingdom remains in the European Union. In the deal scenario the United Kingdom makes an orderly agreed exit from the European Union. This involves a transition period to the end of 2020 and a free trade agreement between the United Kingdom and the EU 27 being in place thereafter. In the no-deal scenario the United Kingdom exits the European Union without a deal, but there is an orderly period of adjustment for trade. Ultimately, World Trade Organization tariff arrangements will apply to goods trade, there will be non-tariff measures and the services trade will also be negatively impacted on. In the disorderly no-deal scenario the United Kingdom exits the European Union without a deal and there is additional disruption to trade in the short run, above that considered in the no-deal scenario.
Our analysis focuses on the best understood channels through which Brexit will affect Ireland, namely, though lower trade, incorporating the impact of tariff and non-tariff measures and the potentially positive impact of foreign direct investment diversion to Ireland. Our approach is to build estimates for each of these channels from a range of recent Brexit microeconomic studies; therefore, our estimates are anchored in empirical literature. We use these microestimates to calibrate macroeconomic scenarios. Specifically, we generate alternative paths for the UK and international economy using the national institute global econometric model, NiGEM, of the National Institute of Economic and Social Research in the United Kingdom and assess the impact on Ireland using the ESRI's core structural model, COSMO, macroeconometric model. The impact of each Brexit scenario is considerable and will have negative effects on the macroeconomy and throughout the economy on trade, the labour market, the household sector and the public finances. I will briefly outline the key impacts for each of them.
The macroeconomic effects of Brexit are significant and negative for the economy. We find that GDP, the level of output in Ireland, in the longer term could be approximately 2.6% lower in a deal scenario, 4.8% lower in a no-deal scenario and 5% lower in a disorderly no-deal scenario, compared to a situation where the United Kingdom stays in the European Union. While some of the effects may not appear substantial, it has to be borne in mind that the impacts will cumulate over a long period of time. In each scenario the level of Irish output is below where it otherwise would be. The negative impact on Irish output in the long run in the deal scenario is approximately half that in the no-deal scenario. Although these are substantial relative reductions in the level of output in the long run, the economy will continue to grow but at a slower pace as a consequence of Brexit. If we assume the economy would grow by an average of 3% per annum in the long run if the United Kingdom were to stay in the European Union, the impact of Brexit is roughly equivalent to a 0.3% reduction in the long-run growth rate in the deal scenario and around 0.6% in the long-run growth rate in the no-deal and disorderly no-deal scenarios.
There is more uncertainty surrounding the short-run impact of Brexit as it depends on how smooth any transition to the future arrangements between the United Kingdom and the European Union is. Our results suggest that, by 2020, the level of real output in the economy could be approximately 0.6%, 1.2% and 2.4% lower in the deal, no-deal and disorderly no-deal scenarios, respectively. These results are compared to a situation where the United Kingdom remains in the European Union.
On trade, our results also indicate that firms will be negatively affected as a result of Brexit. The negative trade shock will reduce the demand for Irish exports and Irish firms will be affected by the depreciation in sterling, which will reduce our competitiveness. Our results indicate that exports, in the long run, will be 4.6% lower in a deal scenario, 8.1% lower in a no-deal scenario and 8.3% lower in a disorderly no-deal scenario, compared with a situation where the UK stays in the EU.
On the labour market, lower output in the long run, compared with a situation where the UK remains in the EU, will result in lower labour demand, which has knock-on impacts for employment and the unemployment rate. Our results indicate that employment, in the long run, would be 1.8% lower in a deal scenario, 3.2% lower in a no-deal scenario and 3.4% lower in a disorderly no-deal scenario, compared with a situation where the UK stays in the EU. This represents around 40,000 fewer jobs created in the long run in a deal scenario and around 80,000 fewer jobs created in the long run in the two no-deal scenarios. Again, it is important to state that employment will continue to grow in each scenario but at a slower pace than compared with a situation where the UK remains in the EU. In the long run, the unemployment rate is 1% higher in the deal scenario and roughly 2% higher in the two no-deal scenarios, compared with a situation where the UK stays in the EU.
For households, the impact of Brexit will be severe. Our results indicate that real personal disposable income, in the long run, would be 2.2% lower in a deal scenario, 3.9% lower in a no-deal scenario and 4.1% lower in a disorderly no-deal scenario, compared with a situation where the UK stays in the EU. This is driven by lower employment, lower wages and higher prices. As a result, consumption will be lower in the long run. Furthermore, households will face higher prices as a result of the imposition of tariffs or other increases in trading costs that could be passed on as increased prices for Irish consumers.
On public finances, with both output and employment below where they otherwise would have been in the absence of Brexit, Government revenue from taxes will be lower and the increase in the unemployment rate would lead to higher Government spending on welfare payments. The net effect is a deterioration in the general government balance, GGB, as a percentage of GDP. In the long run this could reduce the GGB by around 0.5% in a deal scenario and by around 0.9% in a no-deal and disorderly no-deal scenario. We have also looked at the short-term forecasts for the public finances from the spring 2019 quarterly economy commentary, QEC, and have examined the implications of Brexit for the public finances in the short run. The short-term forecasts for the public finances in the recent QEC are done on the basis of a no-Brexit scenario. They show a deficit on the GGB of 0.3% of GDP in 2019 and a deficit of 0.4% of GDP in 2020. This is equivalent to €900 million in 2019 and €1.5 billion in 2020. Our results suggest that for 2019, the impact of our deal and no-deal scenario is more limited on the GGB. However, the deficit on the GGB could be 0.2% higher, which is roughly €700 million in the case of a disorderly no-deal scenario. In 2020, the deficit on the GGB could be around 0.1% higher in our deal or no-deal scenarios, which is equivalent to €200 million and €400 million, respectively, and 0.3% higher, or €1.1 billion, in the disorderly no-deal scenario. In each of these scenarios, we assume there is no explicit fiscal policy response to the change in the economic environment.
I thank members for their attention. My colleague and I would be delighted to take any questions they may have.