Assess the economic effects of Britain’s decision to leave the EU (25)

Time taken: 26 minutes

The UK’s decision to leave the EU in 2016 and subsequent exit from the EU in 2020 had two key effects on
the UK economy. Leaving this customs union meant that it no longer imposed a common external tariff on
members outside the EU leading to trade creation - moving from a high cost supplier within a trading bloc
to a low cost supplier outside the block. It also led to an increase in economy growth as government
spending increased as they no longer spent money contributing to the EU.

When in the EU, the Uk had a common external tariff on all countries outside the EU. This raised prices of
global goods significantly. Once the Uk left the Eu however, global prices decreased as the tariff was removed.
This led to a fall in import prices from World price + tariff to World price (a). The consequence of this trade
creation would be an increase in international competitiveness for the UK and export-led growth. A decrease
in the price of imported goods would lower the costs of production for UK firms because we tend to import
raw materials and goods required in the production process such as Steel because the UK does not specialise
in these productions. Consequently, these imports would become cheaper meaning that the main costs of
production would decrease leading to an increase in SRAS as firms can now produce more for the same
price as before. This results in lower prices of PL1 (b) increasing the international competitiveness of UK
exports as our exports would now appear relatively cheaper internationally and this would lead to an
increase in demand for exports. This increase in demand for exports would lead to an increase in the size of
the circular flow of income as exports are injections and consequently AD shifting outward as (x-m) would
increase, meaning that the UK has benefited from both an increase in international competitiveness and
export-led growth due to the trade creation.

A B

However, there is no guarantee that the UK’s imported goods will decrease in price. Gravity theory suggests
that countries trade with the other countries that are closest to them. This means that the UK may continue
to trade with the Eu as they are geographically closer to them then they are to e.g. USA. Consequently, they
will continue to import the same goods from the same countries resulting in no change to international
competitiveness and no export-led growth. Moreover, even if the UK found cheaper suppliers than within
the EU, the transport costs may be larger than if they remained in the EU leading to further decreases in
international competitiveness. Moreover, cheaper imports for the UK could actually hinder economic
growth as financial services account for 12% of our GDP and they have income inelsatic demand so cheaper
financial services would actually reduce the income that the UK receives from exports and could lead to an
inward, rather than outward, shift in AD and economic decline of Y to y1 (c).

Leaving the EU would also increase economic growth because the government would be able to spend more
on targeting the structural issues in the UK like the productivity puzzle. When the UK was in the Eu it had
to pay £12.6 billion. After leaving, this significantl opportunity cost (the value of the next best alternative
forgone) disappeared. Consequently the UK government could now spend this money, that they were
previously spending on being a member of the EU, on their economy. If the Uk had continued to grow at
the same rate as pre-2008, productivity would be 24% higher. The government can tackle this ‘productivty
puzzle’ using the funds that it no longer needs to spend on the EU. This means that the government could
spend hugely on subsidising education or offering more education such as through T-Levels. The result of
this increase in the provision of education would be a decrease in the occupational mobility of labour and
higher levels of human capital as more people are in education. These higher levels of human capital could
then lead to increased productivity and efficiency, especially in the financial sector where high levels of
human capital are required, leading to decreased costs and an increase in LRAS as UK firms can now
produce more at the same cost as before. This outward shift in LRAS would bring economic growth of Y to
Y1 (d). This money could also be used to counter the obesity issue in the UK which curerenyl costs the NHS
6 billion a year. If the government spent the money providing better information or healthcare to counter
obesity, workers would become more productive and would miss less days off work (12 million days are
missed yearly due to health-related issues) increasing both the quantity and quality of labour and leading to
further shifts in LRAS and economic growth.
 D

However, this economic growth due to increased government spending may only be seen in the short run.
Ricardian equivalence theory states that the government spending will only be beneficial in the short run
because in the long run the government will have to increase their direct and indirect tax rates in order to
maintain a balanced budget and to prevent an increase in the national debt which already standsa at 85% of
GDP. This means that in the long run, companies will see decreased profits so investments will decrease
leading to an inward shift in AD as investment makes up 14% of Aggregate demand, leading to a decrease,
rather than increase, in Real GDP. furthermore, the decision to leave the Eu may not cause economic
growth because the government spending that increased as a result of the referendum may encourage
crowding out. Crowding out occurs when government spending discourages private investment.
Consequently, the impact of the government spending may be minimal and not enough to cause significant
increases in growth.

In conclusion, the largest economic effect of the UK’s decision to leave the Eu is trade creation leading to an
increase in international competitiveness. The UK no longer imposes an external tariff on goods from
outside the EU meaning that it has began to trade with cheaper countries than before e.g. importing steel
from china instead of germany, leading to significant increases in our international competitiveness. Overall
however, the impacts would depend on whether the UK continues to trade with primarily Eu countries.