Impact of Brexit on Ireland's Economy: Economic and Social Research Institute

I remind witnesses and those in the Public Gallery, in the interest of the orderly conduct of proceedings, to ensure their mobile phones are put into airplane mode as they affect broadcasting quality.

No. 4 on today's agenda is the impact of Brexit on the Irish economy. To assist us in considering this matter, I am pleased to welcome Professor Martina Lawless and Professor Kieran McQuinn from the Economic and Social Research Institute.

I draw the attention of witnesses to the fact that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to the committee. However, if they are directed by the committee to cease giving evidence on a particular matter and they continue to so do, they are entitled thereafter only to a qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and they are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person, persons or entity by name or in such a way as to make him, her or it identifiable.

Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the House or an official either by name or in such a way as to make him or her identifiable.

Dr. Martina Lawless

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.

I thank Dr. Lawless for including the small silver lining at the edge of a very large and dirty cloud called Brexit. At least seven members will be involved today so I propose initial 15-minute segments, and if there is time at the end we can bring in people for a second round if required.

I will try to be as brief as possible. I thank the witness for presenting to the committee. There is not much of a silver lining when we are coming at Brexit and the tables in the presentation are quite clear in that respect. I was trying to see a positive indicator in any of the data but they are all negative or neutral. Is it the view of the ESRI that a deal scenario is the most likely outcome, which would mean there would be an orderly Brexit with a free trade agreement following the end of the transition period? Is that the best position from which the Government should forecast its budgets?

Dr. Martina Lawless

That is slightly difficult to answer as much depends on the UK election that is happening in two weeks' time. It is probably now the case that a deal and transition agreement to negotiate a free trade agreement is the most likely scenario. The transition period as currently instituted, which is to conclude at the end of 2020, is extremely tight for the negotiation of a free trade agreement. I foresee considerable pressure to extend that arising over the next year. Having less than a year is an extremely short period in which to negotiate a free trade agreement. To what extent the risk shifts to another no-deal scenario at the end of 2020 if a free trade agreement is not in place will depend on how those negotiations go over the next year.

Much has changed with respect to the budget because of the October deal. At the time of the budget forecasts being formulated, the size of the risk meant it was sensible or prudent to base the budgetary forecasts on those formulations. Fortunately, that risk of a very disorderly no-deal scenario that everybody was concerned about at the end of October seems to have receded considerably.

Dr. Kieran McQuinn

To echo Dr. Lawless's point, the stated position is as outlined, with the agreement followed by a free trade agreement afterwards, and the authorities must plan accordingly. There is no doubt that the possibility of securing a free trade agreement in the period announced just does not seem to be entirely credible. It is very unlikely that this time next year there will be a full free trade agreement in place. This again gives rise to the spectre of the uncertainty arising from a potential no-deal crash-out Brexit this time next year.

The people in the institute have looked at the short-term consequences as, logically, most analysis tends to look over a longer term and seeing the impact of Brexit ten years down the track. What is apparent when considering the implications of Brexit for the here and now is that it has already had a negative impact. It has had that negative impact through a variety of channels, including consumer and investor sentiment and the exchange rate effect, for example. That has happened even before Brexit has occurred. We used to have a consumer sentiment indicator.

It is notable how that indicator simply fell off a cliff from November of last year. One of the issues is that the underlying economy has been performing relatively strongly, so the impact tends not to be seen, although it is there. Therefore, as we move into the new year and there is further scope for uncertainty, that will continue to have a negative impact on the economy.

I spent the start of this week campaigning in the North with our candidate, Elisha McCallion, in advance of the elections. We visited a number of businesses and could clearly see that major contracts had been lost. Other businesses had to secure premises on the other side of the Border at considerable expense in the event of a no-deal scenario. The lack of consumer confidence in smaller businesses meant they were not willing to take a risk because they did not know what the product would look like when it was delivered to them in a number of months. There has already been a genuine impact.

Dr. Kieran McQuinn

We also see that effect in the macro aggregate data for the UK, which shows that investment data are very weak. That is a clear indication of the impact in the UK.

Table 3 gives detail on expectations in a deal, no-deal and disorderly Brexit scenario. I agree that the most likely outcome is a deal scenario, although one should never second-guess what can happen across the water and how they may approach things in the future. Let us look at the deal scenario. There is no good news story in a deal scenario other than that it is significantly better than the alternative cases. The most severe impact after two years will be on the gross value added traded sector, with a predicted 0.9% reduction in a deal scenario compared with a 2.1% reduction under a no-deal scenario and a 3.9% reduction in the event of a disorderly Brexit. Will our guests expand on the impact that would have on certain regions, if that information is available to them? Will particular sectors be hit? Do our guests have a view as to supports that could be offered by the Government and policymakers, such as ourselves, to offset that impact on the traded sector?

Dr. Martina Lawless

As I alluded to in my opening statement, the impact will largely hit the agrifood sector, which is the sector most tightly linked to the UK economy. It is the sector most likely to be impacted, whether the UK imposes tariffs or opts for a low-tariff regime but one which lowers tariffs to countries across the board. There is big exposure for the food sector in that context. To that extent, the sectoral impact will land quite heavily on agrifood.

The most affected types of firms will be smaller Irish firms. Most of our analysis would suggest that the multinational sector, which accounts for most of our overall exports, would be relatively unaffected, or affected only to a very small degree, because those multinationals are not so reliant on the UK as a market. Many service sectors would not be particularly affected in a no-deal scenario.

Accepting that the agrifood sector will be mainly affected moves us on to a regional impact assessment, which suggests that the impact will be spread according to where these sectors are located. That will mean a more negative impact on rural counties that are heavily dependent on agriculture and food processing. We have not specifically mapped that out in detail but that is a logical conclusion.

Dr. Kieran McQuinn

Dr. Lawless did quite a lot of work in this area some time back. We speak about the clear impact on agriculture, and one would instinctively think of Border counties and parts of the north west, but there are other anomalies. For instance, north Cork, where I am from, has a considerable reliance on agrifood and agricultural activity. There is quite a regional spread, albeit outside of urban areas, as to where Brexit will have an impact.

My colleagues from Teagasc have looked at this and would be able to comment in far greater detail, but there serious and obvious implications for certain key sectors of the agricultural economy. The beef sector, which is facing challenges aside from Brexit anyway, is particularly vulnerable, especially if free trade measures are introduced in the UK and more cheap beef and meat produce come into the UK market. The figures show that the Irish beef sector is struggling to be profitable and viable outside of the support payments it gets as things stand, so the prospect of a substantial reduction in the price the sector could get from the UK market compounds the difficulties the sector is already facing.

Budget 2020 was presented and voted upon a couple of weeks ago. It looked at a no-deal scenario, examined Brexit contingency and mitigation measures, and made significant funding available. We are discussing a deal scenario as opposed to a no-deal scenario and a deal is probably the best-case scenario for this State aside from reversing Brexit. Our guests are clearly outlining that these sectors and particular rural regions will be seriously affected. Is it the view of our guests that there will be a requirement for mitigation in a deal scenario? Our guests are clearly outlining that there will be significant impacts on investment and trade that will be concentrated, to a certain degree, in particular sectors that would require State intervention.

Dr. Kieran McQuinn

That is a difficult question. We stated in our most recent commentary that framing budget 2020 was difficult and complex, given the uncertainty that prevailed at the time. In general, we supported the measures that were announced from a broad, macro perspective. On the one hand, funds were put aside, as the Deputy said, to address certain sectors that would be particularly hit by a no-deal scenario, but on the tax side, few changes were made and we, broadly speaking, welcomed that as the most prudent outcome.

As to the appropriate budget strategy for 2020, if the economy continues to perform strongly into the new year, and it is on course to record a significant growth rate this year, and the UK leaves the EU with a deal of some sort, it is debatable if Ireland should be spending those funds in an aggregate sense. The beef sector will be particularly impacted by Brexit, but it has underlying issues that need to be addressed and discussed separately from Brexit anyway. We must be careful about spending the pot of cash, the money that has been set aside, outside a no-deal scenario and if the economy continues to perform strongly.

Our assessment was that, outside a no-deal scenario and if the economy continued to perform strongly, the best outcome of the budgetary package would be neutral or contractionary. We felt that some heat should be taken out of the economy because it is performing very strongly and there is a good possibility that it will continue to perform strongly in 2020 in a deal scenario.

The Deputy has asked a difficult question. It would be a balancing act under a no-deal Brexit and the impacts it would have, or even the uncertainty around a no-deal even if it does not happen, because the impacts would still have to be quantified. In general, under a deal scenario, the economy is likely to continue to perform very strongly in the short term, in 2020, and as such it is debatable as to whether it would be prudent to spend the sums that have been set aside for the no-deal scenario.

The withdrawal agreement will result in a border in the Irish Sea. There will be a significant impact on imports and exports to and from the North if Brexit is followed by deviations between the British and Irish markets.

Will this result in a shift in the trading and economic relationships between the North and Britain and between the North and the South? How could policy responses from us help northern businesses to adjust to this change? While there is special status, as has been mentioned, there will be a significant barrier that will have a cost implication for east-west trade. I have seen some of the research done by the ESRI on the integration between the northern economy and Britain that was interesting and it probably dispels some of the myths about east-west trade being far more integrated than North-South trade. How do we deal with that? I come from a Border county and a place such as Derry or Strabane that is not functioning or has higher unemployment affects Donegal and vice versa, and as someone who believes in a united Ireland, I want the economy of Ireland to be thriving anyway. Does the ESRI have any view on that impact as a result of what is seen as the border in the Irish Sea and what could be done to help businesses to adjust to the changes that may be coming down the line?

Dr. Martina Lawless

It is a little difficult to answer those questions because we know there will be some level of documentation required to declare that goods coming into the UK from the rest of Britain will not be sold on. If they are sold on, the tariffs have to be paid, and if they are not, either the tariffs can be claimed back or paid later. At this point, it is unclear what level of documentation and checking will be required and to what extent that will be a burden on businesses. It is certainly an increase in cost for businesses.

Looking at the types of firms that trade in Northern Ireland, and we have done some work on this with InterTradeIreland, it is typically the larger firms in Northern Ireland that do most of the trade with Britain and the smaller firms that do a lot of cross-Border trade, which tends to be regular and frequent transactions of quite a low value. The administrative burden being on the sea border would probably largely impact the larger firms. They make up more of Northern Ireland's overall exports but it tends to be more concentrated in the larger exporters, whereas the smaller exporters, such as firms with fewer than 20 employees, tend to export only to Ireland. More of that administrative burden, therefore,will fall on the larger firms that are probably more able to cope with it and the smaller firms will be kept out of that loop.

It very much depends on how the documentation checks are put into place, however. It seemed there was even some confusion in the days after the deal was made on whether the checks would operate in both directions on the Irish Sea or just on goods coming from Britain to Northern Ireland. There is still a lot of uncertainty on exactly how they will be put in place.

Dr. Kieran McQuinn

In addition to that issue and going back to what we were saying about the agricultural sector, the implications for the agricultural sector in the North are almost identical in the context of a free trade agreement. If the UK were to have a free trade agreement and, as a result, substantial amounts of cheaper products were to come into the UK, that would have huge ramifications for the agricultural sector in the North. The political economy issue that struck me from my previous time in Teagasc is that agriculture in the context of the UK is nowhere near as important as what it is for us in Ireland. Consequently, in any future negotiations that take place between the UK and North American countries or wherever, agriculture will not have the same kind of importance and significance attached to it that it does when Northern Ireland is part of the European Union in those trade negotiations. That is a relevant point. We know Brexit has been more of an English phenomenon than anything and, consequently, it is a political likelihood that, in any negotiations, it will be issues that are of particular interest to the English economy that will predominate in any discussions and negotiations. That could have far-reaching consequences for the agricultural sector across the UK, particularly in Northern Ireland.

I mention the figures the ESRI has put for a deal scenario and a no-deal scenario with Brexit. The ESRI looked at the modelling and found GDP could be approximately 2% lower in the long-run and 4.8% lower in a no-deal scenario. The first-year impact would be that the level of real input into the Irish economy could be approximately 0.6% lower in a deal scenario. I am surprised in one sense that the margin between a deal scenario and no-deal scenario is relatively small. It is 0.6% or 1.2% depending on whether there is a deal, but I thought the margin would be higher and that in a no-deal scenario the reduction would be exponentially higher. I am surprised it is only double. I would have expected that in a no-deal scenario there would be a far larger drop. Dr. Lawless also said that, "if these estimates turn out to be extremely accurate, there is uncertainty about the adjustment path". The witnesses might expand on that. They may have already dealt with what they anticipate to be the likely outcome of Brexit with the deal that is before the British Parliament at the moment. Do the witnesses believe there will be a free trade deal between the UK and the EU? I wanted to make that technical point because I am surprised the difference in margin is not higher.

Dr. Kieran McQuinn

The Senator is right and we should say clearly that, without getting too technical, what happens is the detailed modelling in looking at Brexit tends to be more long-term work. It looks out over a ten to 15-year horizon to capture the full implications of Brexit. That work is robust and is done to high standards. The subsequent work Dr. Lawless has been associated with revolves around that.

Tracing through the more short-term implications is particularly hazardous and difficult. Our colleagues who work in the Central Bank and the Department of Finance and others who do short-term forecasts would all say that. It is particularly hazardous to do that work because we are essentially trying to trace through the long-term trade implications through the short-term. By definition, we are potentially not taking into account distortions that are hard to envisage, namely, the unknown unknowns such as, for example, financial sector meltdown, congestion at the ports and large-scale disruption of that sort. In that situation, the implications will be much more significant.

In our last commentary, we did a forecast for 2020 to the effect that the economy would grow in the region of 3.5%, and if a no-deal Brexit came to pass somehow in 2020, that growth rate could be down to less than 1%. Given there are large confidence intervals around those forecasts, it is not inconceivable the economy could contract next year if there is a no-deal Brexit. It is fair to say that modelling and charting through the short-term implications of Brexit is particularly hazardous and those models come with large confidence intervals. If anything, we tend to be a little bit on the optimistic side in our forecasts on the short-term implications, but if we were to factor in the unknown unknowns, there could be a significant downside effect.

The second question was on the adjustment path. Again, it is the issue of trying to deal with the long-term whereas it is more focused on the trade implications and then looking at the short-term. If there is a no-deal Brexit, the implications of that would be at their most adverse in the short term, and as we move out over the adjustment period, the impact would be less and less each year.

We assume a linear progression such that the effects would become less and less in the future. It all revolves around trying to map and take from the longer run back to the shorter run the issue of the magnitude of the impact. It is quite difficult to capture the short-term impacts in a really precise manner.

I would like to drill down a small bit. What percentage of the exports of indigenous Irish export firms go to, and what percentage of the imports to Ireland come from, the UK? I have a view that the indigenous sector is far more exposed to the potential impact of Brexit than the much larger multinational companies. Dr. McQuinn referred to the FDIs. If there was a no-deal Brexit, would many of those not relocate some of their operations to mainland UK, which is such an enormous market? We have had a worry that some of our FDI sector would feel compelled to locate some of their operations in the UK. There has been a lot of abstract discussion on this area. The witnesses have done the detailed research and I would like to know how exposed the indigenous sector is.

Dr. Martina Lawless

That is very important because the exposure is very different for the Irish indigenous sector compared with the economy overall. The reason some of the magnitudes between a deal and no deal do not look that far apart is that close to 90% of Irish trade is coming from multinationals-----

Dr. Martina Lawless

-----and they are very diverse.

That is why I want to strip it out.

Dr. Martina Lawless

Taking away the multinationals, the work we have done on the export patterns on indigenous Irish firms shows that approximately 50% of exports from Irish indigenous companies go to the UK, compared with 11% of total Irish exports going to the UK. That shows how much less the multinationals trade with the UK compared to the domestic Irish firms. It shows that although the total GDP figure impacts may not be so enormous, the exposure on the type of firms is.

Dr. Lawless is basically saying that 50% of the exports of Irish export firms go to the UK but how much of the overall export figure for the 11%, which is the total amount of exports, is made up of indigenous companies?

Dr. Kieran McQuinn

The number of Irish firms that we would class as non-indigenous would be relatively small so we could argue that a relatively high proportion of that is coming from the indigenous sector.

Is there a value on that 50%, in billions of euro per annum?

Dr. Kieran McQuinn

We can dig that out very easily. The other point is that there is far more employment associated with the indigenous firms.

Dr. Kieran McQuinn

Multinationals account for 15% of the workforce. The majority of those not in the public sector are in indigenous firms. We could come up with some figures.

Perhaps the witnesses could provide the analysis. I hear much of the discussion and I know intuitively that the bulk of the exports go from the indigenous Irish sector. What percentage of that 11% is from the indigenous sector? To reverse that, what percentage of our imports come from the UK?

Dr. Martina Lawless

Quite a significantly higher percentage of our imports are coming from the UK relative to our exports, in the order of 24% to 25%, largely because of the integration of the retail network. There is a much higher exposure on the import side compared with the export side.

Following on from that, in a no-deal Brexit what would be the exposure to multinationals moving some of their base from Ireland to mainland UK? In many cases Irish-based multinationals would export through the UK. They would get a ferry there and drive through. Has that been much of a factor?

Dr. Martina Lawless

We have generally looked at the impact being the other way around: although there may be some incentive for particular firms for which it is important to relocate in the UK, the greater likelihood is that access to the much larger EU market is a factor for multinationals. Therefore there is possibly more of an incentive for firms currently located in the UK, particularly in the financial sector, where access to the EU market would be very important, to relocate. We have already seen a number of financial companies make announcements about relocation and setting up offices. It is probably more likely that the multinational move would be into Ireland rather than outwards, apart from individual firms; we cannot rule them out.

That is good to hear. What do the witnesses believe will be the outcome in terms of a trade deal between the EU and the UK and its implications for Ireland? What is their overall view of the state of the Irish economy? The Irish Fiscal Advisory Council report came out today. The witnesses might give their perspective on how the Irish economy is doing in respect of employment, the fiscal budgetary process, where they see gaps and where they would like to see improvements.

Dr. Kieran McQuinn

I will take the second question first, our overall assessment would be that the economy continues to perform very strongly this year. In the first quarter of the year it was performing exceptionally strongly, we had employment growth year on year of over nearly 3.5% which is very strong. As we moved into the second and third quarters it seemed to be softening slightly, some of the indicators were suggesting that, but some of the trade statistics for the third quarter have been very good, particularly on goods. The two basic indicators that we tend to look at for the underlying performance of the economy are the tax take across the different headings and the labour market and both of those have been performing very strongly. The tax take has been increasing across the different headings. We know that the corporation tax issue is separate and that the strength of returns in that area does give rise to some concerns. All the other headings, VAT, income tax, stamps etc., have been performing very strongly. The unemployment rate is now down to less than 5% which is very low by historical standards. Our expectation is that in the absence of a no-deal crash-out Brexit next year, the economy will continue to perform strongly into 2020. There are other factors such as the perceived global slowdown and the moderation in growth rates of our major trading partners, which will undoubtedly have an impact. We do not think the economy will grow as strongly next year as it has this year.

Housing is always the major issue or one of the big issues. This year we expect to see in the region of 21,500 units but our estimates have consistently shown we need somewhere in the region of between 30,000 and 35,000 units to meet the underlying demand in the economy. As long as there is that gap between supply and structural demand, we will continue to see strong pressures, particularly in the rental market, and we see rental rates continuing to increase very sharply.

We have done a lot of work looking at the affordability challenges and issues associated with it, and the amount of money people are spending on rent. The amount of income people have left after they have paid for their rent is diminishing. Those are the key challenges that need to be addressed. In terms of the overall economy, our assessment is that it is likely to perform very strongly again into 2020.

Would Dr. McQuinn give his view in terms of the final part of my question?

Dr. Kieran McQuinn

That was about the outcome of the trade deal with the UK and the EU. To echo the points we made earlier, it is very difficult to see a free trade agreement being signed within 12 months. As Dr. Lawless outlined in the opening statement, given the preponderance of trade deals of such magnitude that have been done, it is very difficult to see it. As a result, given that there is likely to be a lot of difficulties in any trade negotiations which take place, uncertainty is going to be a continued feature in the Irish economic landscape going into 2020. As we said earlier, even though the economy has performed very strongly over the last years, there is no doubt that uncertainty around the Brexit issue has impacted adversely on consumer sentiment, investor sentiment and so on. If we continue to see that kind of uncertainty about the Brexit outcome, the danger is that it will continue to weigh down and have a negative impact on the economy. As the economy slows down, as it inevitably will in the years to come because it cannot keep growing at the present rate, the negative impact of that uncertainty may become more apparent. More generally, as others have discussed, if we have a free trade agreement or negotiations, the potential for disruptions across the European Union could be quite significant in terms of any negotiations with the UK. There could be a scenario where countries are being pitted against each other in terms of the conditions and negotiations that take place. There could also be tensions within countries. For example, if there is a deal on the table that is well disposed towards our agricultural sector but not as well disposed towards, for instance, our fisher people, how are we going to react to that? There is going to be a large amount of uncertainty in these negotiations. Unfortunately, I think it is something that will run for quite some time.

Over the last number of years we have not had the border controls in place. The Single Market has developed and the barriers have been removed to trade. My concern is that we have not been able to measure the complexity of the supply chains, economic relationships, or even the labour and the raw materials and components that are being used, in terms of it being counted. It is much more complex than we are seeing. How can we be sure of the integrity of the data? How much is this being measured in such a way that we can rely on the forecasts and predictions we are making around the impact of Brexit?

Dr. Martina Lawless

Supply chain integration is certainly something that has increased very dramatically over time. We do know that there are a lot of movements, imports and exports within the same narrow sector, where firms appear to be moving things around at different stages of production. We talked a little bit about the forecasts having quite a significant downside risk to them and how they are a little bit too optimistic. We really cannot tell, if one item in a supply chain is disrupted, how it will knock on to the future stages. There is a little bit of an "all for the want of a horseshoe nail" problem there. Although we can see that all of the disruptions should be, on average, a particular amount, if one product from one sector is held up, the question is how will that have trickle-down effects. We do not really know. Our level of information on imports and exports from and to the UK is quite good. Because statistical agencies and the Revenue Commissioners do not want to put undue burden on smaller firms, the amount of specific detail we get on precisely what smaller firms are importing and exporting is not as great. We do not want to ask them to specify every single item they have brought in. They usually just have to report totals. There is extra information that we could have. It is certainly the case that this gives rise to a more negative impact than we have estimated in the overall models.

Dr. Kieran McQuinn

To give one further example in that regard, we appeared before the Oireachtas Joint Committee on Housing, Planning and Local Government and were asked about the impact of Brexit. We did some work looking at where some of the basic raw materials in the construction of a typical house came from. A large proportion comes from the UK in terms of the standard materials that are used. Some of the implications we may not have factored in totally are that if there disruptions in the trade relationship in the housing market, for instance, it will become much more difficult to source these materials and more costly to get them. We know already that the cost of building a house in this country is very high. People are constantly complaining about the cost of building a house and the knock-on implications for housing supply. The danger is that it may become even more costly to do so in that situation. There are many unforeseen consequences that we have not totally factored in to the overall macro, aggregate assessment but that could undoubtedly impact on people.

My concern is the integrity of the data and what we are doing on a continuous basis to try to make up for not measuring it all along when we did not need to, because we enjoyed the comforts of the Single Market and everything that went with it. In terms of companies freezing investment because they are waiting to see the decisions made after the Article 50 negotiations, has the ESRI done a measurement of the cost of such freezing as it is at present? I am referring to non-investment and expansion by companies.

Dr. Kieran McQuinn

Certainly in an aggregate sense we have not quantified that type of impact in terms of trying to quantify how much Brexit specifically has impacted investment decisions by firms. We did a piece in our commentary in the summary where we examined the impact of policy uncertainty generally. There are now indicators of what they call policy uncertainty if governments announce different types of policies or there is a large degree of uncertainty about what they may do. My colleague, Dr. Conor O'Toole, looked at this in the context of the different aggregate investment categories such as machinery and equipment, buildings, constructions and so on. We found that there was a very negative impact between policy uncertainty in the US, for instance, and investment decisions here, which is not unsurprising given that a large amount of investment at an aggregate level is driven by multinationals, which are very conscious of what is going on in the US economy. We have done that kind of work but, at an aggregate level, we have not really tried to quantify the impacts of Brexit on investment in particular. We looked at it in the context of consumer sentiment, where we tried to model the impact of Brexit. We saw the way in which consumer sentiment was falling off a cliff since last November and suggested that Brexit had to be the main reason for it as many of the underlying conditions that typically drive consumer sentiment, such as employment, unemployment rates and inflation, are all still very favourable.

Dr. Martina Lawless

We looked a little at why more firms were investing less than we would expect, given the current strong performance of the economy and based on some survey data on how firms' profits were going and how their sales were growing. That was earlier this year. We found there seemed to be a fairly substantial gap between what we would expect firms to invest given the positive state of the economy and what they were actually investing. We did not have Brexit in there as a specific question. However, when we tried to drill down into it to see if it was being caused by problems with finance, uncertainty and so on, we largely found that uncertainty in a very general sense, or aversion to risk, seemed to be more important than some of the other factors we might expect such as raising finance in terms of having firms hold off on investment decisions.

We could not, however, link that specifically to concerns about Brexit.

That is the concern. If that uncertainty lasts for the seven to ten years the negotiations will take, the cumulative effect of investment being frozen will be ferocious.

I wish to ask about how goods and services are impacted differently in terms of the Single Market.

Dr. Martina Lawless

The difference between goods and services is that the services trade relies strongly on mutual recognition of standards and, in some cases, licences, particularly in the financial sector. We have done less work on how services might be affected. When it came to goods, we had an explicit benchmark that we could use, that being, the EU tariff, which is published with the WTO and is listed product by product. Hard data were available on that front. On the services side, though, it is much more difficult to get an estimate. Either one gets access and an agreement or one does not. There is potentially more of an on-off market access element. Some work we did suggested that being a member state of the EU increased trade in services by approximately 20% compared to the amount of trade in services the EU does with non-member states. If we make the assumption that the UK leaving the EU loses that benefit, there could be something like a 20% reduction in trade in services. Some services are more sensitive to that than others, financial services in particular. Dr. McQuinn referenced this. In free trade negotiations between the EU and the UK, one would expect financial services to be a high priority on the UK's side, given that they are such an important part of the UK's overall economy. When it comes to various trade-offs and negotiations, a great deal of emphasis is likely to be put on continued services access, particularly financial services.

Dr. Kieran McQuinn

There was a landmark ruling some years ago when the European Central Bank took a case against the City of London arguing that trading houses in London should not be able to deal in euro-denominated bonds because the UK was not a member of the euro area. I believe the case went to the European Court of Justice, ECJ. Ironically, given how the ECJ is perceived in the British media, it found in favour of London and stated that, as long as the UK was part of the EU, it could continue to deal and trade in these products. That gives rise to the question of what the outcome will be if the UK leaves the EU and the case is brought again. If the outcome is that trading houses are not able to deal, it will affect a substantial proportion of financial sector activity in the City of London. The implications of that moving elsewhere will be huge.

It might move to Ireland. That would be some development.

Dr. Kieran McQuinn

There is no doubt part of it could. The Central Bank has published the fact that there has been a substantial increase in the number of firms that are registering an interest in coming to Dublin. Anecdotally, one hears lots of evidence of firms establishing a foothold in Dublin with a view to possibly trading up and increasing their scale of activity depending on how the negotiations proceed.

There certainly is potential, but we would need to consider our investment in infrastructure-----

Dr. Kieran McQuinn

Of course. That is the other-----

-----and problems like housing, broadband in more rural areas, how to expand the economy, etc. Do we have in place the governance mechanisms to mitigate against the losses that firms North and South are facing? I am referring to appropriate management being in place that will make this work and provide a secure governance framework in light of the changes that will be necessary.

Dr. Kieran McQuinn

At micro level, there are schemes concerned with small loans, increasing credit and so on.

Dr. Martina Lawless

At a firm level, a great deal of work has been done by various agencies, in particular those that operate on both sides of the Border, for example, InterTradeIreland, on trying to give firms access to information, loans and grants that will help them to assess their exposure and devise ways of dealing with it. There would be a significant increase in demand on the supports provided by the agencies if there was a dramatic exit by the UK. Since it is difficult to foresee, it is difficult for firms to put their plans in place. If there was about to be a crash-out Brexit, one could expect a rush of firms all looking for quick supports together.

That is a problem. It is why I am trying to highlight that there is a governance deficit. Governance needs to be put in place. In the face of all of the other variables, we need to have a constant for companies.

Dr. Kieran McQuinn

If there is a radically different trading relationship between the UK and Ireland, it will clearly give rise to the need for significant investment in those types of service and that type of governance structure, as the Senator suggested.

It may be something that is being overlooked.

I wish to ask another question. We spoke about agriculture, which is in a frightening position. I come from the west, and the beef situation in particular will have an impact on counties like Mayo. Many of the small businesses I know at home and around the region are importing cars. The UK motor industry has estimated that it will face £40 billion in losses by 2024. Here, it is estimated that 12,000 jobs could be lost just within the motor industry. Connected with that is the question of what the Government will lose. The figure cited was of €231 million in tax losses. What is being put in place to mitigate against that? The impact of Brexit on the motor industry alone is scary. Has the ESRI examined this issue?

Dr. Martina Lawless

We have not specifically examined the motor industry. It has been examined in quite some detail from the UK perspective, given concerns there that car parts and final cars attract a tariff of approximately 10%, which is one of the highest among all manufactured goods. There are concerns in the UK that much of that business might relocate to mainland Europe, which would have a significant impact.

Since Ireland does not have domestic manufacturing of cars, we have not examined that matter. I could see there being more of a re-orientation. If car manufacturing is moving from the UK to mainland Europe, there probably will be much more direct purchasing in Ireland of cars from mainland Europe versus the UK. That could involve an increase in costs, given that steering wheels would be on different sides and so on. What is being manufactured on mainland Europe is not identical to what is being manufactured in the UK. There is a potential knock-on in the form of increased costs for the Irish motor industry, but it is not one that we have examined in detail. The exposure is not quite on the same scale as that of agrifood.

It needs to be examined because it is being overlooked. From a consumer point of view, how much more will people end up paying for their cars? Most people buy cars that are not new.

It is a good point, but I ask the Senator to conclude.

I thank the witnesses for their answers.

I thank the witnesses for their presentation. I will start with a question towards which Dr. McQuinn was pointing. Let us say that Britain exits on the Johnson deal and opens negotiations for a free trade agreement with the US. I was a member of the trade committee of the European Parliament. We know the kind of trade agreement the US would seek to do. It would have the outlines of the Transatlantic Trade and Investment Partnership, TTIP, but possibly worse because the US would be negotiating with a weaker partner. Let us say included in that deal is a significant reduction in standards - sanitary and phytosanitary, SPS, labour and environmental. Let us focus on agriculture, which is a major offensive interest for the US in such trade negotiations. It wants access for chlorine-washed chicken, hormone-fed beef and ractopamine-fed pork.

Let us say that a future, presumably Tory, Government negotiated such a deal. How would that play out? What impact would that have in Ireland?

Dr. Kieran McQuinn

The initial impact would entail a substantial increase in imports of agricultural produce into the UK, particularly meat produce from the US. That would have substantial implications for the domestic sector here. There are no two ways about it. I am drawing on my past experience and history with Teagasc, and many of my colleagues from Teagasc would be much better able to comment on this issue. However, key sectors of the Irish agricultural sector, such as the beef sector or those at the commodity level, have had difficulties generating a sustainable income without structural aid payments from Brussels for a long time. That was the case even when I was working in the area years ago. Many beef producers use those structural payments not just as their profits but also to cover some of their costs. That is the kind of structural difficulty being faced in the Irish market, and that is the premise from which we are starting. If those farmers faced a sizeable reduction in the price of their products, which is inevitably what would happen as far as the UK economy is concerned, it would put even further difficulties and pressures on that sector. All I can foresee are very negative implications for the sector over a long period of time, which would compound pre-existing difficulties in the sector. As we know, the sector is facing many other pressures, but sizeable price reductions in what it gets from the UK market would be a huge pressure on a sector that is already struggling.

Dr. Martina Lawless

In terms of the UK negotiating simultaneous free trade agreements with the EU and the US, there is quite a strong disconnect between the types of deals both those partners would seek. A political trade-off would need to be made on which one to prioritise. If the UK agreed a free trade deal of the type described by the Deputy with the US, that in any way lowered standards - particularly on food - EU negotiators would put an increased burden on checks and requirements for goods entering the EU market. While the UK Government claims to want both those free trade agreements, the types of policies and negotiations involved are quite strongly in conflict. We spoke earlier about how long free trade agreements take to negotiate, and that not all free trade agreements actually come to an agreement. The proposed deal between the EU and the US was never signed because of fundamental disagreements, particularly on food standards. It is very difficult to imagine the EU being any more sympathetic to imports from the UK which might potentially risk lower standard products as part of its supply chain.

Dr. Kieran McQuinn

More generally, there has been almost universal unanimity on the European side during the negotiation process, which I touched on earlier. The EU has very much stood with Ireland and has taken a unified stance. However, if the UK were to consider reducing standards, particularly when it comes to agricultural produce, that could potentially give rise to all sorts of tensions within the European Union. For example, how might the French negotiators respond to that situation if there were a better deal on the table for German car manufacturers? Many potential tensions within the European Union could be awoken if the UK were to follow that course of action, particularly as far as food and agriculture are concerned.

Deputy John Deasy took the Chair.

That speaks to my point that we should view the hardness of borders as something that can change over time as regulatory standards diverge. If Britain were to leave the EU on, say 1 January 2022, at that point in time standards between Britain and the EU would be quite similar. However, they would diverge over the course of the next five or ten years. What impact would that have on our borders over time? I am referring to both the Border between the North and South of this island the border between Ireland and Britain.

Dr. Martina Lawless

There could be an increase in checks over time. At the moment, the Revenue Commissioners carry out checks on the basis of risk assessment, even for products coming into Ireland from outside the EU where there are some regulatory differences. They do not open every single parcel that comes in from outside the EU. They have trusted relationships with traders that import regularly, or they might check different products depending on where they are from. On day one, assuming the UK does not sign a free trade agreement with other countries allowing products banned by the EU into the UK, there might only be light checks initially. If standards then diverge, the risk assessment of different products not up to EU standards will increase, and the level and intensity of checks and documentation could evolve over time. Much of that will depend on when the UK signs other free trade agreements that vary from EU arrangements. The quickest and easiest way for a UK-EU trade deal to be done would be for the UK to agree to keep its current standards in place going forward. That is somewhat unlikely given that the UK has explicitly said that part of its reason leaving the EU is so it can set its own standards, but it will not do that from day one. There would be a time period during which the level of standards and risks might evolve.

Dr. Kieran McQuinn

If that kind of regime came into play in the UK, it would have significant implications for our own agricultural sector. However, one could argue that it would have even more profound implications for the agricultural sector in the North. It would face much the same pressures as those faced by agricultural producers in the South, if not greater. It would be interesting to see the reaction to that. At the time of the BSE crisis, even Ian Paisley was quick to point out the clear blue water between Britain and Ireland when it came to the health of the beef herd. If lower standards were introduced as part of the overall negotiations, I am sure most political representatives would be keen to ensure they were confined to the mainland and not brought to Northern Ireland.

I have a few further questions. The ESRI forecasts different drops in GDP as a result of a deal, no deal, or various other options or deals. Have the witnesses calculated how that fall would impact our debt-to-GDP ratio or whether it would have any impact on future public spending?

Dr. Kieran McQuinn

It would have an impact in that lower GDP will have an impact on the debt-to-GDP ratio. I do not know the figure off the top of my head but we could easily work it out. We looked into the impact of Brexit on the public finances when it first arose a few years ago. If one thinks of the fiscal space in simple terms, the Government is allowed to increase the fiscal space in line with the underlying growth rate of the economy, or the potential output growth rate of the economy. That is the kind of metric used by the European Commission. We pointed out that as Brexit will have a negative impact, not only on actual output but also on the potential Irish output over the medium term, it will consequently impact the fiscal space available to the Exchequer. That was over two and a half years ago, but at that time we quantified that it could have an impact of up to €600 million over three years. Brexit operates in a variety of different ways, and through the public finances in particular. If one considers it in terms of the metrics used, it could adversely impact the potential output growth rate, which would impact the fiscal space available to the Government and affect whatever expenditure plans it might have.

I thank Dr. McQuinn.

Our guests have highlighted that, for example, the increase in grocery prices has hit those on lower incomes substantially harder because of the percentage of their incomes they spend on those products. Similarly, 1.2 million workers on incomes of €30,000 or less will be affected by that. Certain groups of workers in the agricultural sector and other sectors will be hard particularly hit. Are there policy measures that our guests consider should be implemented in order to mitigate the impact of Brexit on the less well paid and those in receipt of benefits to ensure that they do not pay for the price of Brexit?

Dr. Martina Lawless

On grocery prices, we emphasise that would be if we took tariffs and applied them directly to what people are currently purchasing. It would not provide for people changing behaviour depending on the price increases. It is probably very much an upper band and, with competition in the grocery sector, we would probably see a fair degree of switching behaviour, particularly on the side of the supermarkets with the sourcing of some products more directly from mainland Europe than via the UK market. Therefore, the final impact would probably be somewhat lower than what we have stated in the presentation.

Dr. Kieran McQuinn

In terms of a policy response, the best thing I could do at this stage is to point the Deputy towards the discussion and research in which some of our colleagues have been engaged in examining the issue of carbon tax and the most effective measures to offset the impacts of its introduction or increases in it, particularly on those on the lower end of the income distribution. Our colleagues in the tax welfare benefit team have done quite a substantial amount of work in indicating the areas and policy measures which are most efficient in tackling those types of issues for people at the lower end of the scale with respect to identifying what policy measures would be the most impactive in terms of the scale and the number of people who would be impacted upon. If we were to pinpoint policy measures, that type of work would be useful in identifying those measures.

I thank our guests.

I have a brief question before I call Deputy Burton. It relates to the Irish Fiscal Advisory Council’s analysis a few days ago. I apologise if somebody else has asked this question but I am curious about it based on the ESRI's analysis. Effectively, the council examined consumer spending and employment and found the impacts of a no-deal Brexit or a disorderly exit would be in line with what the Government had said but it felt it might not even be as bad as that. I note the ESRI's analysis with regard to a 4.8% figure in a no-deal scenario. Do our guests have any comment on what the council reported versus the ESRI's analysis?

Dr. Martina Lawless

In terms of full disclosure, I must state that I am a member of the Irish Fiscal Advisory Council.

I know we had asked the ESRI to come before the committee well before the council reported?

Dr. Martina Lawless

It is a coincidence that it was the same day as the report came out.

We have two groups. Is there agreement generally with what the council has reported? Obviously, Dr. Lawless is on the board.

Dr. Martina Lawless

The baseline forecasts the Government put forward as the basis for budget 2020 were examined and endorsed by the council. One of its roles is to check that the budget is based on macroeconomic projections that are reasonable, use good methodologies and are based on sensible assumptions. The baseline numbers feeding into both the budget and the council’s assessment are quite similar. What we did more was focus on the downside risks.

Was Dr. Lawless a dissenting voice within the council?

Dr. Martina Lawless

No. The Irish Fiscal Advisory Council’s report published this morning very much looks at the overall picture of the economy. There was no disagreement that the basis of the budget being the risk of a hard Brexit was not a sensible thing to do. The criticisms were slightly more on the spending control side of the Government’s accounts and the risk associated with both corporate tax and, as we spoken about, that the forecasts of Brexit are a central scenario and that various elements in terms of supply chains will hit some particular sectors that are very difficult to measure.

Dr. Martina Lawless

As a result, there is a downside risk.

Dr. Kieran McQuinn

We made the point earlier that Dr. Lawless and other colleagues in the institute tend to look at Brexit from the longer-term perspective, which is the natural way to look at it because, obviously, Brexit will unfold over many years. If we were to look at the measure when it comes in particularly through the trade channels, those of us who look more at the shorter-term aspects of it and try to map, through the short term, the longer-term implications of it, would hold up our hands and say there are very large confidence intervals about trying to measure the short-run impacts of Brexit. In a sense, what we are doing in the short term is mapping through the trade channel effects but obviously there is a whole series of other effects which are very difficult to quantify.

Dr. Kieran McQuinn

These things do come with confidence intervals to be fair, particularly in the short-term analysis.

The ESRI's budget assessment was that the budget was regressive and significantly likely to adversely affect people on low incomes and social welfare recipients. I note in this paper the ESRI expects the impact of a more difficult Brexit to be borne more significantly by people on lower incomes than any other category in Ireland. Does this mean that our guests anticipate that, unless there is some type of concession in terms of both budget and in other policies, the situation for very poor people in Ireland is likely to get a lot worse.

Dr. Kieran McQuinn

On the impact of the budgetary measures - of course, there is the vexed issue of indexation on how to capture it - our colleagues would have said that relative to a position whereby if welfare bands had been fully indexed, people were not as well off as what was the case before the budgetary measures were introduced. Our overall assessment of the budget was that, on the tax side in particular, we would have welcomed the fact there were not any significant changes made and, in fact, we would probably have welcomed a type of stealth increases because the tax bands were not indexed. We felt the economy overall is not doing very well and, therefore, if anything, we needed the budget to be somewhat contractionary in terms of its impact. However, on the other hand, because we had the prospect of a no-deal Brexit looming, we welcomed that it was a wise and prudent strategy to divert funds that could be used to tackle the various different sectors which may be impacted if we have a no-deal scenario. In fairness, it was a very difficult budget to frame but, on balance, we probably would have felt it was a prudent budget but the one dissenting issue would probably have been that we would have advocated welfare bands be indexed to minimise the impact.

The ESRI referenced the fact that for people on modest incomes, the forecast increase in wages was likely to be 2% to 3% but it was closer to 3%. It noted that if tax bands, allowances and so on for people, particularly on lower incomes, had not increased, that would have been a tax hike on people on lower pay.

Dr. Kieran McQuinn

Yes. It was a very difficult budget to frame in the context of the challenges we faced. In terms of our overall assessment, it would have been to keep the tax take relatively neutral or even mildly contractionary. Within that one can argue as to where the increases should come about and we would broadly argue there should be less of an impact on those at the lower end of the scale. However, in terms of the overall macro assessment, we would have been, broadly speaking, in support of it because, as I said, the other part of the strategy was to divert funds that could be used to tackle those areas and sectors of the economy which would be most adversely impacted by a no-deal scenario.

In terms of the concession, and this touches on my response to Deputy Paul Murphy, if policy is to intervene in the context of a no-deal Brexit to mitigate the impacts on households that are likely to be impacted, the research our colleagues are doing on the carbon tax issue in examining the offsetting mechanisms that can be used to reduce the impact of carbon tax on lower income households is possibly a way to proceed.

Senator Horkan resumed the Chair.

The ESRI has a figure here for €892 and €1,360 as the likely cost to poorer households. When one adds that to the budgetary impacts in terms of welfare and of no indexing of tax allowances and no indexing in any way of welfare allowances, both impacts are not too far away from each other, so it is a fairly big combined hit to poorer households.

Dr. Kieran McQuinn

Certainly if the no-deal Brexit comes to pass, there is no doubt about that. I suppose Dr. Lawless would argue as well, in terms of quantifying the impacts on households, that is under the assumption that there is no substitution. It is like an upper bound on the negative impact, but it certainly would have a very adverse impact on households at the lower income side of the distribution.

Coming back to earlier comments, which I do not think anybody could contest, about there still being physical checks on the border between the EU and Turkey and about Switzerland and Norway, Turkey is in the customs union while Switzerland and Norway are in the Single Market. It was just said that it is going to be difficult to have an exit of the UK from the customs union and Single Market without necessitating checks along the Irish Border. In the context of the extreme lawlessness we are all aware of along the Border region, with what happened to Mr. Kevin Lunney of Quinn Industrial Holdings, QIH, does the ESRI have any sense of what actions are likely to be taken? I know many people in business, particularly in smaller businesses, which were referenced earlier, who are utterly confused. The ESRI pointed that out. Northern Ireland firms will be allowed to import goods from Great Britain without tariffs, as though they were still in the customs union and the Single Market, provided they can demonstrate that these goods will not pass into the EU. Given the particular characteristics of the Border region - myself and the Chairman have backgrounds in accounting - how is that going to happen? As I said, we have had an extraordinary education in recent months on what life along the Border can be like, and we all know there is significant smuggling in particular products. There has been an attempt to crack down on it. In terms of how successful it has been, it has probably reduced it somewhat. Has the ESRI offered advice to the Government on how this might be addressed, particularly in relation to smaller businesses? I refer to a pub operating 30 miles from the Border and the issue of supplies. There are a string of towns ten to 15 miles from the Border. Does the ESRI have any sense of how that might be done?

Dr. Martina Lawless

There is great uncertainty about how this plan for moving the border to sea checks is going to work in practice. All we know at the moment is that the proposal is that EU tariffs would not need to be paid by Northern Ireland firms as goods enter Northern Ireland. They would need to be declared at some point later. In respect of the greater risk that the EU would see, the goods coming into Northern Ireland would pretty much all have to be up to EU regulations. Even if some of them passed into the EU market, the loss would be purely the monetary cost of the tariff that was due, rather than the risk that products not up to EU standards would get into the EU. From the EU perspective, that integrity of the Single Market is much more about standards, and in particular standards for food products, than it is about collecting tariff revenue. In terms of how exactly-----

We have experience of this in terms of our economic history. Let us say one is in business in Sligo and one is extremely law-abiding, but there may be other operators and businesses in the town that are less picky. What happens along the Border region is that the businesses that would like to be law-abiding are simply undercut to a very significant degree by the businesses that might not be so law-abiding in taxation terms. Does the ESRI get any sense that there has been any kind of thinking around this?

No Brexit, followed by a customs union and a Single Market are these least worst things. Although no Brexit is the best thing, but that does not look like it is likely to happen. Does the ESRI have any sense of how there might be, if necessary but hopefully not necessary, some development of structures that would seek to protect the law-abiding traders on both sides of the Border?

Dr. Kieran McQuinn

The short answer is it certainly does not seem to be apparent that any such structures are there yet. Obviously, they are not in place. Whether they are being considered, much will depend on the outcome of the UK election and if the agreement goes ahead. Presumably at that stage, we will begin to see a lot more flesh on the bones in terms of how the arrangements will work out. Then one would expect to see a response from policymakers about how to assist and aid people to deal with the various different complexities. At this point in time, the agreement is by definition high-brow and high-level in nature, which is understandable as it is a political agreement devised by politicians. In respect of the practicalities, from a trade perspective, we will have to see the details before one can begin to think about what the appropriate response should be and how the Government should try to aid small traders, in particular, and businesses located along the Border. Clearly, it just goes back to the basic point that the imposition of a Border and a hard border introduces so many different frictions into people's trading activities. Ultimately these all bring about substantial costs for people.

Dr. Martina Lawless

Just to follow up on the question from Deputy Murphy, many of these requirements for how many checks will need to be done and how complicated the system will be will depend on the next stage of negotiations on the free trade agreement. It is very difficult to get a good picture of how the sea border will look until we know how divergent the two entities will be after the free trade agreement or the second stage of the negotiations. I am not sure how much work has gone into how to operationalise the current agreement, because so much of it is still contingent on the outcome of the next phase of negotiations.

There have been frequent references in the current UK Prime Minister's speeches, both when he was elected Prime Minister and subsequently, about the development of a string of what are called freeports in the UK, and there have been three locations spoken about in the North, namely, Derry, Belfast and Larne. Does the ESRI have any experience of how this kind of freeport arrangement would be likely to operate? In other countries, it is viewed with quite a lot of trepidation because of not just its impact on trade but its broader implications. I do not know if this would be a negotiating point, but he has already promised this right along the coastlines of the UK. As I said, there have been references to three potential locations in the North.

Dr. Martina Lawless

There is limited evidence that free ports do much to improve overall trade. Largely, they move trade to the location of the free port, where goods can come in, not have to pay further tariffs, and be further processed by firms in the region and re-exported. For firms in that area, there is a potential benefit, given that they can take in their goods tariff free and re-export them without having to deal with tariffs. That requires, however, an extreme level of checks around the free port to ensure that the goods being unloaded and processed tariff free within the location will not enter general circulation or be sold to firms not in the region. The benefit is very much a distributional issue to firms within the location but it comes with a significant cost for the checks required to keep the free port activity separate from the rest.

Moreover, free ports are allowed in the EU and the policy could have been applied in any event. Rotterdam is a free port, where goods come in and are reprocessed, put on separate ships and moved on-----

Is Shannon Airport similar?

Dr. Martina Lawless

Yes. The policy was never prohibited under membership of the EU and, therefore, I am not sure why it is a big response to the UK exiting the EU.

I turn to labour standards. We have a minimum wage and there is something of a movement to the introduction of a living wage, for which we have structures. Is Dr. Lawless concerned that that could be put under great pressure by the type of Brexit deal that has been discussed? Some of the more recent discussions have been associated with a race to the bottom in respect of labour standards and matters such as money laundering. Many free ports nowadays are associated with highly efficient money laundering from the drugs trade or oligarchs from various jurisdictions parking their money at such locations.

Dr. Martina Lawless

It is relatively clear, from the EU negotiation perspective, that protecting labour standards is an important part of what it will bring to the negotiation table. Divergence on a range of issues, including labour, environmental and food safety standards, are all aspects that the EU side is determined to protect. That will put pressure on the UK side in regarding how much it is willing to compromise for market access, or whether it is willing to continue signing up to EU-level deals or whether it will be determined to sign global deals that will allow it to reduce standards. The level playing field is an important feature of EU negotiations. Many of the other free trade agreements the EU has signed in recent years contain clauses on environmental and labour standards. While the traditional picture of a free trade agreement might be that people negotiate tariffs, recent free trade agreements, not least those negotiated by the EU, tend to go well beyond that in setting standards.

I thank our guests for their opening statement. I listened to their comprehensive views, and while I had to step out of the meeting for a few moments to attend the Seanad, I heard the vast bulk of their and members' contributions. Hardly a debate goes by in which Brexit is not mentioned, and it has become part of our being, our fibre and everything we do and think about, whether that is flights, roaming charges, exports or operations. We all know people who work in multinationals and small businesses, and the revenue of the State will be affected one way or another by it.

Forecasts are forecasts and models are models, but will our guests give us some insight into how the modelling works? What are the variables that produce the outputs?

Dr. Kieran McQuinn

In general, the way we have done it since the start - and it is the way in which most institutions that examine Brexit tend to do it - is by considering it through the prism of a large-scale structural model of the economy. We try to capture the various impacts on the headline indicators for the economy. In our case, we did that through our use of COSMO, which is the standard model of the economy. Crucially, we have had a close relationship over the years with the UK National Institute of Economic and Social Research in London, which maintains a large suite of models that model the western world and its overall impacts. From our perspective, it is important that we link into that framework, given that many of the impacts of Brexit will come through trade channels, as we have articulated. To capture that, models of the EU and UK are needed and our macro model links in to that. The analysis is mainly used to examine issues from a longer-term perspective, to consider the impact of Brexit in the next ten-year horizon. It is interesting that the work we have done more recently has built on much of the sectoral, micro-level work that Dr. Lawless has done, tying it in with the overall, broader research. In the latest analysis, we built a great deal on the trade work she has done.

Dr. Martina Lawless

We take the estimates built from the micro-analysis of which products are affected and how we expect that to affect demand. We produce estimates of the extent to which trade, foreign direct investment and consumer prices will be affected. The macro model takes all those inputs and feeds them through all the other channels through which they affect overall employment, other sectors of the economy and so on to give an overall, macro number.

It is well informed but, ultimately, it is a guesstimate.

Dr. Kieran McQuinn

We make a distinction, as we outlined earlier. I hold my hands up because I mainly work on short-term forecasting, but the longer-term work, in which Dr. Lawless has been involved, is comprehensive, robust and rigorous, and it will not get any better at predicting the impact on the economy. The issue is when that is mapped through to the short run, that is, how a no-deal Brexit at the start of 2020 will impact the economy that year. That is when we start getting into the realm of guesstimates, because it is a matter of mapping the longer-term trade implications onto the short term but nobody has a good quantification of the unknown unknowns. We do not know what will happen if there is a complete meltdown of financial markets or severe tailgates at Dover and Calais, and subsequently at Irish ports disruptions of supply chains and so on. It is difficult to assess the impact of that in the short run. When it comes to estimating the short-term impacts, the forecasts come with sizeable confidence intervals.

The ESRI examines Brexit as Brexit, which is what they have to do. It is not Brexit in the context of a global economic meltdown or of some other shock that might happen. Nobody anticipated what happened in the period 2008 to 2010, inclusive. While there may have been a few people and occasional naysayers - one might say a broken clock is right twice a day - nobody anticipated the scale and speed at which the slowdown happened, although not many people anticipated the robustness and speed of the recovery either. The ESRI's figures are based on a relatively steady economy, all other things being equal. Guests appearing before the committee in the past six months or year, including chief executives of some of the five main banks, stated we are closer to the next recession than we are to the previous one. I acknowledge that Dr. McQuinn stated he expects the economy to be okay, and I do not think anybody wants it go any other way, but has the ESRI examined the impact of Brexit in the context of a slowing down of the economy, a recession, a trade war between China and the EU, or with the US, or whatever?

Dr. Kieran McQuinn

Typically, when we discuss the outlook of the economy, we have a baseline forecast, which is our forecast of how the economy will evolve if Brexit does not happen.

As I said earlier, we think the underlying economy and the headline economy have both grown strongly in 2019. While we expect that the economy will continue to grow quite strongly next year, we do not think it will grow as strongly as it has this year because of some of the issues that have been touched on, including the global slowdown. Some of our major trading partners are experiencing weaker growth than we would have expected six months ago. Such factors are incorporated into our baseline assessment. When one applies the impact of the Brexit scenario, it is applied with respect to that baseline. When we outline our forecast under a no-deal Brexit scenario, by definition it incorporates the impact of Brexit but it also implicitly incorporates our assessment of how we think the global economy is likely to evolve in 2020.

Has the overall baseline assessment looked at or anticipated a forecast that the world economy might slow down?

Dr. Kieran McQuinn

Yes, exactly.

Perhaps it has not anticipated the worst-case scenario, in which everything goes badly.

Dr. Kieran McQuinn

No. At this stage, we do not see a 2008-09 global meltdown on the cards. There is no doubt that there is a great deal of talk about-----

We are all happy to hear that.

Dr. Kieran McQuinn

Sure. There has been an increased discussion about the impact of a possible global slowdown or a potential recession in the US. There are many indicators which suggest that we are not terribly far from such an eventuality. At the same time, we have to weigh everything up and try to get a balanced view of what we think the most likely outcome for our economy will be in 2020. There is no doubt that some of our major trading partners are confronted by structural issues. Along with my colleague, Professor Karl Whelan of UCD, I have been looking for a long time at the growth prospects of the EU over the medium term. Our assessment of how we see the economic performance of the EU evolving over the medium term is quite pessimistic. Some of the difficulties in the EU economy are also witnessed in the US economy, the UK economy and the major western economies generally. I refer to demographic issues such as population ageing, for example. The slowdown in productivity that has been observed in many western economies is a puzzle that has been confounding macroeconomists for quite some time. When these factors are put together, a slower growth trajectory across all of these major economies over the next ten, 15 or 20 years becomes evident. We incorporate all of these factors when we are making our assessments. In the main, we are still reasonably confident that the economy is likely to grow quite strongly and robustly in 2020.

I was probably thinking about people such as Professor Whelan when I referred to those who, correctly, were more pessimistic in their observations ten or 12 years ago.

Dr. Kieran McQuinn

Yes.

He was proven right. I ask Dr. Lawless to elaborate on services. We were talking about goods, which are very quantifiable and very easy to see. What kinds of services do we mainly trade with the UK? When we talk about the main services that Ireland, as an economy, trades with the UK, are we talking about financial services or insurance services?

Dr. Martina Lawless

I do not have a precise breakdown of the numbers. I believe insurance services, financial services and business support services are-----

Are we talking about such services being exported to and provided to the UK, or the other way around?

Dr. Martina Lawless

Basically, it operates in both directions.

I accept that. Who provides the bulk of the services? I know that just one of the big six insurance companies is indigenous. The other five are owned by UK or German entities, in the main. I presume that means they are providing services to us. Are we providing many financial services or other services to the UK? Does the balance of trade between the UK and Ireland, or the balance of services if we want to use that phrase, involve them selling more to us or us selling more to them?

Dr. Martina Lawless

I am not sure of the absolute numbers, but I have an idea of the balance. I think we export more to the UK, in terms of services, than we import from the UK. That is partly because our services imports depend heavily on royalties and intellectual property imports coming from the US into the multinational sector. Pretty much all of the services trade between Ireland and our main trading partners comes largely from the multinational sector.

I ask Dr. Lawless to give us an understanding of whether we are talking about services in the way that we understand services - I refer to accountancy and legal services, etc. - or we are talking about issues such intangible intellectual property, royalty payments, head office fees and logo fees. What do we really mean when we talk about trade in services?

Dr. Martina Lawless

In terms of overall Irish services, a large role is being played by intangibles, royalties and rights.

It is not necessarily the case that a great deal of employment is being created there, or that any great level of work is being done. It is a case of the big inflows or outflows, mainly inflows, of-----

Dr. Martina Lawless

I would draw a distinction in this regard. Trade between Ireland and the UK is probably more likely to be in-----

Real services.

Dr. Martina Lawless

-----real services than in the more intangible financial flows that are not associated with this. As we said when we were discussing overall goods and services, this tends to be more prevalent in the Irish-owned indigenous economy than in the multinational sector, where the numbers are slightly more nebulous.

We did not necessarily look at figures today. Ireland is the only country in the EU that buys more goods from the UK than it buys from us. I understand that the opposite is the case in most other European countries. The UK buys far more French produce than France buys UK produce. The UK buys far more German produce than Germany buys UK produce. Ireland is quite unusual in this regard. We are the other way around. I emphasise that we appreciate every bit of business we get from the UK. Is it true that we buy more from the UK in goods than-----

Dr. Martina Lawless

It is true. In the UK's ordering of export partner countries-----

We are fourth or fifth in the world.

Dr. Martina Lawless

We buy approximately the same volume as France, despite the-----

Apparently, we buy more from the UK than Brazil, India and China combined. There are many reasons for this. We are the UK's closest neighbour, we use the same language for labelling, and we probably have similar cultural tastes in various areas like biscuits, chocolate and all kinds of spices. Equally, we are at the end of the supply chains of companies such as Tesco, Lidl and Aldi that operate in both jurisdictions. It is unlikely that the UK will start exporting cream crackers to China, where they make their own crackers. It is very likely that we will continue to buy cream crackers from the UK. We are the UK's fourth or fifth largest goods trading partner.

Dr. Kieran McQuinn

As Dr. Lawless said in her opening statement, much of the initial discussion on the impact of Brexit on the economy, particularly in the indigenous sector, focused on the export implications. Given that so many Irish firms are importing from the UK-----

No, I captured that. Equally, many companies are importing to re-export.

Dr. Kieran McQuinn

Exactly.

We have had discussions on the fact that we make a lot of bread, but most of our flour comes from the UK. We have not had such a discussion today.

Dr. Kieran McQuinn

At a presentation on the impact of Brexit, we were told how many times the various components of the famous fig rolls that are produced just outside Sheffield go back and forward across the Border before the final biscuit is produced. This highlights the hugely integrated nature of the supply chains and the extent of the disruptions that could occur under a free trade agreement.

When I was growing up, I watched the famous Jacob's advertisement about how to get the figs into the fig rolls. I never thought I would end up discussing it at an Oireachtas committee meeting. Now I am in the Chair discussing the complicated process of making fig rolls in the context of Brexit.

The UK has made a big fuss about its intention to cut its corporation tax rate to bring in lots of industry. Is it not fair to say that access is a significant factor for a company when it is deciding to locate in a country in the EU or in the European region generally? I ask the witnesses not to misunderstand me because I am aware of the importance of our corporation tax rate as part of a suite of measures. We have other disadvantages that mean we need our corporation tax rate. Access to the Single Market means access to the 430 million people who will be living in the EU if the UK leaves the Union. Surely it would be relatively unattractive for a company to leave the EU to go to the UK to avail of a lower rate of corporation tax, given that it would mean facing various barriers, tariffs and charges. Is that a fair point? Mr. Johnson and others have said that by cutting corporation tax, they will attract a great deal of industry to the UK from other European countries. Do the witnesses envisage that this will happen?

Dr. Martina Lawless

I do not particularly envisage that it will happen. One of our colleagues, Dr. Iulia Siedschlag, has done a great deal of work on what attracts foreign direct investment firms to locate in certain locations. Market size and access to the EU market are very important factors when companies from outside Europe are deciding where to locate.

Within Europe, corporate tax rate might become an element but the fact that they come to the EU initially relates to market size.

I get that, within the EU, a company will look at the corporation tax. If Malta, Poland or Portugal wants to go to a rate lower than Ireland, that is one issue but the big attraction is the Single Market and the customs union. I thank Dr. Lawless for clarifying that in her opening statement, as many people are not that sure about the difference between the Single Market and the customs union and how Switzerland has one but not the other, as is the case with Turkey, and so on.

Dr. Kieran McQuinn

As Dr. Lawless said, this is borne out by some of the estimates we have seen. While corporation tax rate is certainly an important factor and its importance cannot be diminished, it is clear, thought, from some of the empirical work, particular that undertaken by Professor Ronald Davies, that there are many other aspects for firms locating here such as Ireland being English speaking, and the relative ease of doing business as well as the attractiveness of being in the EU, which is a huge factor.

I am sure being in the eurozone is also a major factor.

Dr. Kieran McQuinn

Yes. We touched on that earlier in the potential implications for the financial services sector in London if the UK leaves the EU. There was an important court ruling some years back where the European Central Bank tried to prevent London-based firms from dealing in euro denominated bonds because the UK was not in the euro area. The European Court of Justice ironically ruled that they could continue to do so because the UK was in the EU. If the UK leaves, it is likely that such a case will be brought again and that might have substantial implications.

The UK has never acknowledged the usefulness of the European Court of Justice.

Dr. Kieran McQuinn

Exactly.

That is an important point. People might be fearful that companies might leave Ireland to go to the UK because of corporation tax. However, I have always felt that market access, the Single market and the customs union are very important. That means that we must be competitive with the other 26 remaining countries in our general performance and competitiveness.

Brexit is a very fluid. We all still hope that it was all a bad dream and we will wake up and it will not happen. Unfortunately, it probably will but we hope that it will be the least worst of all the options. I thank all the witnesses for their opening statements and contributions. We have had a good attendance over the course of the morning and many members contributed.

The joint committee adjourned at 12.13 p.m. until 2 p.m. on Tuesday, 3 December 2019.