Since the announcement of the EU referendum we have been producing analysis and writing about the potential effects of Brexit on the economy and public finances. We have compiled our assumptions, judgements and analysis on this page.
This Forecast in-depth page has been updated with information available at the time of the March 2021 Economic and fiscal outlook.
This page sets out our assumptions related to EU exit that underpin our latest March 2021 forecast. Specifically, our latest economy forecast assumes that:
- In the near term, trade disruption associated with the implementation of the new trading relationship (the ‘Trade and Cooperation Agreement’ or TCA) will temporarily reduce GDP by 0.5 per cent in the first quarter of 2021. Box 2.2 of our March 2021 Economic and fiscal outlook (EFO) sets this analysis out in more detail. We also assume the disruption will generate some cost pressures for UK importers, adding around a quarter of a percentage point to CPI inflation by the end of 2021.
- The new trading relationship will reduce long-run productivity by 4 per cent relative to remaining in the EU. This largely reflects our view that the increase in non-tariff barriers on UK-EU trade acts as an additional impediment to the exploitation of comparative advantage. In order to generate this figure, we looked at a range of external estimates of the effect of leaving the EU under the terms of a ‘typical’ free trade agreement (see Box 2.1 of our March 2020 EFO for more information). Our assessment is that the the TCA looks broadly similar to the ‘typical’ FTA that was assumed in those studies and reflected in our forecasts since March 2020. We estimate that around two-fifths of the 4 per cent impact has effectively already occurred since the referendum as a result of uncertainty weighing on investment and capital deepening (see Box 2.2 of our March 2021 EFO for more information).
- Both exports and imports will be around 15 per cent lower in the long run than if the UK had remained in the EU. The size of this adjustment is calibrated to match the average estimate of a number of external studies that considered the impact of leaving the EU on the volume of UK-EU trade (see our November 2016 EFO for more information). With similar impacts on export and import growth, the downward revisions to gross trade flows are broadly neutral in their effect on the current account over the medium term.
- New trade deals with non-EU countries will not have a material impact. This is because most of these largely replicate deals that the UK already had as a member of the EU and, in any case, they are likely to have only a very small and gradual impact on GDP (see our 2018 Discussion paper for more detail). By way of illustration, the Government’s own economic impact assessment of one of the most important agreements concluded to date, the UK-Japan Comprehensive Economic Partnership, suggested that this agreement would increase the UK’s GDP by 0.07 per cent over the next 15 years (see the Government’s October 2020 UK-Japan CEPA: final impact assessment). This estimate is relative to not having a trade deal with Japan, whereas the UK would have been part of the EU-Japan Economic Partnership Agreement had it not left the EU.
- The Government’s new post-Brexit migration regime will reduce net inward migration to the UK. We assume that these changes will reduce the future size of the population and also result in a small reduction in the labour market participation rate (due to the population effect being concentrated among those of working age). The combined effect is to reduce our forecast for total employment, partly offset by a small increase in productivity via a ‘batting average’ effect as some low wage – and, therefore, lower productivity – workers will no longer be able to enter the country, thereby raising average productivity relative to the current regime. Box 2.4 of our March 2020 EFO sets this out in more detail.
The key assumptions regarding our fiscal forecast are that:
- The savings associated with expenditure transfers to EU institutions (after factoring in the cost of the financial settlement) are now entirely captured within the Government’s departmental spending (DEL) plans. Box 3.5 of our March 2020 EFO explains this judgement in more detail.
- The ongoing costs associated with the EU financial settlement are published in the expenditure supplementary tables alongside the latest forecast on our website. Annex B of our March 2018 forecast explains the financial settlement in more detail.
- Our revenue forecasts include the tariff revenue collected on both EU and non-EU trade based on the UK Global Tariff introduced on 1 January 2021. Annex A of our November 2020 EFO sets out more detail on the fiscal implications of the UK’s new customs regime for both EU and non-EU trade. Paragraph A.19 sets out the assumptions underpinning that estimate in more detail.
- The Government’s chosen approach to EU exit means that many aspects of the VAT and excise duty regimes will change during 2021. We assume that these changes will lead to a temporary rise in the level of tax non-compliance. Paragraphs A.28 to A.32 of our November 2020 EFO set out the detail behind this assumption, which reflects the readiness of both Government and firms for the upcoming border changes as well as evidence from past episodes of tax non-compliance.
- Paragraph 3.8 of our March 2021 EFO sets out a variety of other fiscal implications related to EU exit policy, such as the implementation of the new UK emissions trading scheme, a variety of changes to the VAT and duty regimes, the fiscal implications of the new points-based immigration system and eligibility rules for EU citizens accessing student finance in England.
There remains significant uncertainty both around some of the outstanding elements of our future economic relationship with the EU as well as the response of firms and households to the new trading arrangements. We will continue to update our forecast assumptions as existing arrangements are revised, new agreements are reached, and new data emerges, in our Economic and fiscal outlooks and other publications. Some of these issues include:
- Financial services, where the UK and EU have made a joint commitment to agree a ‘memorandum of understanding’ (MoU) over the coming months that will establish a framework for regulatory cooperation. For now, the UK Government has unilaterally decided a package of equivalence decisions, allowing UK and EEA clients to continue their current activities in a number of areas. So far, the EU has granted four central bank exemption decisions, and time-limited equivalence decisions for central counterparties and central securities depositories. At the end of March, the Government announced that technical discussions on the text of the MoU have now been concluded.
- The Government’s ‘border operating model’ introduces measures to ease the initial burden on businesses of new border controls by delaying their full implementation. This includes provisions to delay the declaration and payment of some customs duties, as well as the postponed accounting of import VAT until firms complete their usual VAT return. The model also delays the introduction of some checks and customs procedures. In March 2021 (after the publication of our March 2021 EFO), the Government announced a further extension to some of these measures.
Since the referendum in June 2016, the OBR has conducted a range of analysis on the economic and fiscal implications of EU exit. This section sets out a summary of analysis that was undertaken to inform our previous forecasts:
- Our November 2016 forecast incorporated initial estimates of the effect that the vote to leave the EU would have on the economy and public finances. We incorporated a series of broad-brush assumptions about the economic and fiscal impact of Brexit that would be consistent with a variety of future trading relationships with the EU, given the absence of a meaningful basis upon which to predict the precise outcome of the negotiations. The most important assumptions were initial downward revisions to our trend productivity growth and net migration forecasts. We evaluated these initial judgements in Box 2.1 of our March 2018 EFO.
- Annex B of our November 2017 forecast set out our initial ‘top-down’ approach to forecasting post-Brexit financial flows between the UK and EU budgets. In the absence of firm policy detail, we assumed that the net fiscal savings associated with these flows would be recycled into domestic spending in the UK. Box 3.5 of our March 2020 EFO set out how the savings associated with these flows were eventually rolled into the higher departmental spending (DEL) forecasts.
- Annex B of our March 2018 forecast included an initial ‘bottom up’ estimate of the UK’s financial settlement (the so-called ‘divorce bill’) with the EU. We produce updated estimates of this settlement alongside each EFO, please see our supplementary fiscal tables: expenditure for more information.
- Our October 2018 Discussion paper on Brexit and the OBR’s forecasts explained how we expected to approach the task of making forecasts and projections in the pre- and post-Brexit environment. We also discussed how we would approach incorporating some associated policy decisions, including those related to migration, third-country trade agreements, regulatory changes, and tax and spending policies.
- Chapter 10 of our July 2019 Fiscal risks report included a stress test which explored the economic and fiscal implications of a ‘no deal, no transition’ outcome to the EU exit negotiations. We also produced an alternative ‘no deal’ scenario that explored the economic and fiscal implications of the UK’s trading relationship with the EU defaulting to World Trade Organization (WTO) terms in Annex B of our November 2020 forecast.
- Our March 2020 forecast incorporated estimates of the effect that trading under the terms of a ‘typical’ free trade agreement would have on productivity in the long run. We assumed that this channel would reduce long-run productivity by 4 per cent relative to remaining in the EU, with around one-third of this effectively already seen in the data due to post-referendum uncertainty weighing on business investment. Box 2.1 sets this analysis out in more detail. We also assumed that the new migration regime would reduce output at the forecast horizon. Box 2.4 sets this analysis out in more detail.
- Our March 2021 forecast included an assessment of the Trade and Cooperation Agreement (TCA), as well as estimates of the economic and fiscal impact of its first two months of operation. We forecast that the associated short-term disruption would temporarily reduce GDP by 0.5 per cent at the start of 2021. Our estimate of the impact of the TCA on long-run productivity was unchanged from the 4 per cent reduction incorporated into our March 2020 forecast, as we judged that the content of the TCA was broadly in line with the assumption of a ‘typical’ FTA that underpinned that earlier estimate. Box 2.2 sets this analysis out in more detail.
The box sets area of our website also sets out other previous pieces of analysis related to Brexit and the EU.
It is not within the OBR’s mandate or resources to discern and separately estimate the impact of the UK’s exit from the EU and related policies on all the elements of our forecasts on an ongoing basis.
Instead, our forecasts are produced in an iterative manner, incorporating policy and other developments as they materialise. When we update these forecasts, we aim to be as transparent as possible in explaining how and why we think the outlook has changed since our previous forecast, including where this relates to the changing nature of our economic relationship with the EU. Often our estimates draw heavily upon academic research and analysis by other institutions, including the EU exit: Long-term analysis produced by HM Government in November 2018.
The economic and fiscal shock associated with the end of the Brexit transition period has occurred as the country is still dealing with coronavirus. This comes on top of the stagnation in productivity seen since the global financial crisis. These factors mean that it will, in practice, be very difficult to isolate the effect of the new trading relationship with the EU on the medium-term economic and fiscal outlook.
Within each of our key publications we include topical ‘boxes’. These self-contained analyses are unique to this publication and tend to cover recent developments in the economy or public finances that complement the main discussion of our analyses.