I thank the Vice Chairman for the ESRI's invitation to appear before the joint committee. I am joined by my colleague, Professor Kieran McQuinn, who is head of economics at the ESRI. I will start briefly by mentioning some new elements of the deal reached last month between the UK and European Union that were not factored into our more detailed pieces of analysis and then will give an overview of the work the ESRI has undertaken on the impact of Brexit on the Irish economy.
To set the scene, it is worth recalling that for the EU, trade is governed by free circulation of goods with mutual recognition of standards and a common external tariff. It is worth distinguishing the two separate elements of this arrangement; the first is the customs union, which removed all tariffs and charges on goods circulating between EU member states. Any tariffs applied to goods entering the EU from other countries are set at EU level and have no variation across member states. Once a good enters any EU country it therefore pays the tariff due at this point, which can vary depending on the origin country and product in question, and can then be moved and sold on in any EU country. However, this means that there is no possibility for EU countries to have an independent trade policy. The second related but distinct element underpinning the free movement of goods is the Single Market, which entails common recognition of standards and broadens freedom of movement beyond goods to apply to services, capital and workers.
Physical checks remain on the border between the EU and Turkey, which has a customs union but is not in the Single Market, and the borders of the EU and Switzerland or Norway, which are in the Single Market but are not part of the customs union. This shows that completely frictionless trade flows require a very high degree of integration and alignment. While either one of the Single Market or customs union can reduce trade costs, some restrictions remain unless both are in place. Hence the dilemma facing negotiators of how to achieve an exit of the UK from both the customs union and Single Market without necessitating checks along the Irish Border.
A central element of the deal reached at the EU Council summit on 17 October is special status for Northern Ireland as a means of bridging this impasse. Unlike the original backstop, which if put into effect would have treated Northern Ireland as entirely within the EU customs union and Single Market, the October 2019 deal includes some additional features that allow Northern Ireland firms to import goods from Great Britain without any tariffs provided they can demonstrate that these goods will not pass into the EU. This allows Northern Ireland to avail of both the UK and EU trade arrangements in many ways, although the administrative cost of this somewhat complex system remains unclear, both for firms within Northern Ireland and firms in Ireland either trading directly with Northern Ireland or moving goods to Great Britain by way of Northern Ireland.
Assuming that it is passed in its current form by the next UK Government, the deal makes no change to the end date of the transition period, set as 31 December 2020, despite the delay in the intervening withdrawal negotiations. This date puts reaching an agreement on a future relationship on a very tight timetable, although there is a clause allowing for an extension up until 2022. Regarding the feasibility of this timescale, research by economists in the United States and Switzerland examining how long trade negotiations take has come up with varying estimates with one piece of research finding an average of 28 months to the time of signing a deal and others increasing the estimate to close to six years if time needed for ratification and implementation is factored in. The shortest negotiation time in their examination of about 80 trade deals was seven months. There has been a suggestion that starting from a position of perfect alignment as EU members should make this element of a free trade agreement more straightforward to negotiate than is commonly the case. However, this is only the case if a commitment to continued alignment is made.
Moving on to ESRI research on the potential impacts of Brexit on the Irish economy, I first need to stress that there is no precedent of a country leaving a major trading bloc such as EU. To some degree most of the research is therefore grounded on measures of the positive impact of EU membership and an assumption of symmetry whereby these gains would be largely lost on exit. Second, most estimates apply to the long run; they compare a pre-Brexit trading world to a post-Brexit world with new trade arrangements in place. Even if these estimates turn out to be extremely accurate, there is uncertainty about the adjustment path.
In our modelling of the macroeconomic effects of Brexit, our colleagues have found that GDP could be approximately 2.6% lower in the longer run in a scenario with a deal and 4.8% lower in a no-deal scenario compared to a situation where the United Kingdom stays in the European Union. Although these are substantial relative reductions in the level of output in the long run, we should emphasise that the economy will continue to grow, albeit at a slower pace. While these are impacts over the longer run, much of the negative impact of Brexit would be likely to be felt in the first year or two, particularly in the more negative scenarios where no deal is in place. Our estimate of the first year impact is that the level of real output in the economy could be approximately 0.6% lower in a scenario with a deal or 1.2% lower in a no-deal scenario. Earlier this year, we also estimated a potential reduction of 2.4% lower growth in the event of a disorderly no-deal scenario, although the probability of this now seems to have receded considerably.
In addition to modelling the impacts of Brexit at this aggregate level, the distribution of the impact of Brexit across sectors and regions has also been the subject of much research at the ESRI. As is now fairly well known, EU external tariffs can vary dramatically across products. For most manufactured products the tariffs average around 4%, with higher rates of up to 8% on vehicles. A very different pattern applies to agricultural and food products which account for almost all of the highest tariff bands. The highest sectoral average is just under 50% for meat but behind this also lies considerable variation, with rates on some beef products reaching over 80%.
Our research has found that Ireland would be the most negatively impacted of any of the European Union 27 countries by post-Brexit tariffs because it trades more with the United Kingdom as a share of overall trade but also because the composition of that trade includes more of the agricultural and food products that would face higher than average tariffs if the United Kingdom mirrored the European Union tariff schedule for third countries.
In the absence of any alternative information on the matter, this work largely assumed that tariffs would be applied symmetrically, with the same basic rates applying for United Kingdom trade with the EU as the EU would charge on products originating in the United Kingdom. Whereas the UK has submitted a maximum tariff schedule to the World Trade Organization, WTO, that mirrors that of the EU, the UK government also published details of a temporary tariff and quota schedule in the event of EU exit without a deal. This can probably be taken as the most likely current baseline for tariffs the UK would charge if there is no trade agreement or extension in place by the end of the transition period.
This schedule would reduce tariffs to zero for 87% of UK-level imports from the EU as a whole with tariffs remaining on the other 13% of imports. Although this may sound like a reduction in exposure for Irish firms trading with the UK, it merely changes the risks from direct tariff costs to less direct but potentially significant changes in competition, particularly in the food sector. This is because the UK temporary tariff schedule applies not just to the EU countries to for all other countries as well. This constitutes a fairly large reduction in tariffs for importing into the UK for many countries, which is likely to incentivise entry to the UK market. As the reductions in tariffs are large for agrifood products, particularly for beef products, these sectors are especially vulnerable to the risk of increased competition from lower-cost producers from outside the EU.
An aspect of ESRI research on the cost of Brexit that has been significant is that direct tariff costs are just one element in which trade barriers can be imposed. Even with a comprehensive free trade agreement being signed by the UK and EU to minimise tariffs, trade costs could still increase after Brexit if non-tariff barriers are put in place. Non-tariff barriers are any measures that act to restrict or inhibit international trade flows such as technical requirements like licensing, labelling and standards, as well as sanitary and phytosanitary rules relating to food and plant health and the direct costs of customs inspections and documentation. Some of these costs, such as customs procedures, have been shown to have a large negative effect on export participation, although relatively little on average trade values per firm. This is because they operate as fixed costs, which imply larger impacts on smaller firms. Although it is more difficult to estimate the impact of non-tariff barriers in advance, as many of the costs will depend on the extent to which regulatory standards diverge post Brexit, our work has shown that the distribution of the impact of tariffs and non-tariff barriers tend to be similar in terms of the sectors that they affect. This is driven mainly by the costs associated with validating standards of food products, which are where tariffs also fall most heavily.
Concerns about the impact of Brexit on the Irish economy have tended to focus on the challenges to exporting firms. However, the UK is also a significant source of imports into the Irish economy and many imported products are used as intermediate inputs for further processing within Ireland, so increased cost could affect domestic competitiveness and the export performance of Irish firms. Whereas foreign-owned firms are more dependent on imported inputs overall, Irish-owned firms are more dependent on the UK as the source of imports. Over half of total imports used by Irish-owned firms are sourced in the UK and of these, approximately 20% are either completely or very highly reliant on products coming from the UK.
Also on the import side, we have examined the potential for the imposition of tariffs or other increases in trading costs to pass through to increased prices for Irish consumers. Absent any change in consumer behaviour, our approach generates an estimate of potential increases in the level of consumer price index of between 2% and 3.1%. In the estimated scenarios, these increases are the equivalent of between €892 and €1,360 in the annual cost of its consumption basket for the average household. As I said, this assumes that there is no switching or change in expenditure patterns in response to the cost increases, so this should be thought of as an upper bound to the cost increase effects. Perhaps more significantly, we also find that these effects are unevenly distributed across households. Households with lower income levels face considerably higher percentage increases as they tend to consume a higher share of products, most particularly groceries, that would be most affected by increases in tariffs and trade costs.
To end on a slightly more positive note, one potential offsetting factor to the negative impact of Brexit on Ireland through the trade channel that we have examined is the potential for an increase in foreign direct investment, FDI. Foreign direct investment that might otherwise have been destined for the United Kingdom may get diverted to other EU countries, including Ireland, if access to the broader EU market is one of the factors being considered by investors, particularly by those from outside the EU. The existing literature suggests that EU membership increases FDI from outside the EU by 28% and our work suggests that this would result in a reduction in the negative impact of Brexit on Ireland, although one that is not nearly large enough to offset the negatives of the trade reductions.
I thank members for their attention and my colleague and I are delighted to take any questions they may have.