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Thursday 10 November

Tom Ferris is a Consultant Economist specialising in Better Regulation. He lectures on a number of PAI courses and contributes blogs regularly to PAI. He was formerly the Department of Transport’s Senior Economist.

ESRI Report

What impact will Brexit have on the Irish economy? The short answer is that it is much too early to say. However, a report has just been published by the ESRI that gives the first estimates of what the impact might be, based on a number of assumptions. The report is entitled “Modelling the Medium to Long Term Potential Macroeconomic Impact of Brexit on Ireland”[i]. The ESRI produced its report in conjunction with the Department of Finance.

The ESRI Report quantifies the potential medium- to long-term macroeconomic impact of Brexit. The analysis is part of the Government’s work on preparing for the impact of Brexit on Ireland. To read more, see my recent article in LINKLINE[ii], published by the Chartered Institute of Logistics and Transport (CILTI) and my three blogs published by PAI[iii].

 

Background to ESRI Report

The timing and nature of the impact of BREXIT will depend on when Article 50 of the Lisbon Treaty is activated and the subsequent negotiations between the EU and the UK. The UK Prime Minister, Teresa May, has recently stated that she will notify the EU of the UK’s intention to leave between January and March 2017. What is less clear is what kind of arrangement will be agreed for the UK’s departure from the EU. The ESRI has chosen three scenarios within a range of possible outcomes. Each of the scenarios combines a range of assumptions on trade, foreign direct investment and lower contributions to the EU budget to generate alternative paths for the UK economy and also for the wider international economy. As Ireland is the only country sharing a land border with the UK, it will be affected significantly by whatever scenario is adopted. Moreover, given the close cultural ties that have enabled considerable movement of people between the UK and Ireland over many decades, the impact of a changed relationship between the UK and the EU must affect the Irish economy, at least over the short- to medium-term. The impact may arise through various economic channels and might affect trade, financial flows, investment and the movement of labour.

The scenarios can be described as follows:

  1. European Economic Area (EEA) Scenario: a Norwegian-type solution whereby the UK becomes a member of the European Economic Area (EEA), with free trade and movement of workers;
  2. Free Trade Agreement (FTA) Scenario: a scenario based on the UK agreeing a bilateral trade agreement with the EU along the lines of the EU/Swiss trade agreements, where trade in services is not free; and
  3. World Trade Organisation (WTO) Scenario: a third scenario, whereby the UK and EU do not conclude a bilateral trade agreement and instead, the UK exercises its rights under the Most Favoured Nation (MFN) clause of the World Trade Organisation.

In short, the EEA Scenario, represents a “Soft Brexit”, the  WTO Scenario a “Hard Brexit”, and the FTA Scenario is somewhere in between.

 

Doing the Modelling

For its economic models, the ESRI first produced baseline economic projections against which the three scenarios could be compared. That baseline describes the evolution of the Irish economy were Brexit not to occur. Then, the three alternative Brexit scenarios are separately compared to the baseline thereby isolating the Brexit effects on the Irish economy. The results are presented in terms of the expected impacts will be at the end of ten years; this could mean the year 2029, if the exit happens in the year 2019 (two years after negotiations start).

The ESRI drew on other international economic research, as well as using scenarios developed by the UK’s National Institute of Economic and Social Research to create alternative scenarios for Ireland. These scenarios are incorporated into the ESRI’s economic model of the Irish economy in order to quantify the potential impact of Brexit. The results of the modelling exercise confirm that Ireland will be particularly badly impacted by Brexit.

 

The ESRI’s Results

The results of the simulations, of the impact of Brexit under different scenarios, are summarised in Table 1. As regards national output, the simulation results indicate that under the EEA scenario the level of Irish output will be around 2.3% below what it otherwise would have at the end of 10 years, while the longer term impacts are down 2.7% and 3.8% in the FTA and WTO scenarios respectively.

Table 1
Impact of Brexit on Ireland after 10 Years (change from the Baseline)
                   Scenarios 
% Change from Baseline level(1) EEA(2) FTA(3) WTO
 
Gross value added at basic prices-2.3-2.7-3.8
Exports of goods and service-3.0-3.5-4.9
Personal consumption of goods and services-2.2-2.5-3.4
Employed persons-1.2-1.4-2.0
Average wage €-2.2-2.5-3.6
 
Change from Baseline
Personal savings rate, %-0.3-0.3-0.5
Unemployment rate, %1.21.41.9
General Government Balance, % of GNP-0.6-0.8-1.0
 
Note: The scenarios EEA, FTA and WTO are defined in the text above
 
Source: “Modelling the Medium to Long Term Potential  Macroeconomic Impact of Brexit on Ireland” Working Paper No. 548, ESRI, November 2016

Exports of goods and services are seen as being most negatively affected – reductions of 3% (EEA scenario), 3.5% (FTA scenario) and 4.9% (WTO scenario). These reductions, if realised, would lead to labour demand being below base, which would then have knock-on effects for employment and unemployment rates. As a result of the loosening in the labour market, average wages are lower than in the base. This combination of lower employment and lower wage rates would lead to lower personal incomes and consumption. As a result, activity in the non-traded sector that is driven by domestic demand would be below base. The ESRI Report went on to point out that the fall in output and employment would reduce government revenue from a range of taxes while the increase in the unemployment rate would increase government spending on welfare payments; the net effect is a dis-improvement in the general government balance  over the long-term.

Some conclusions

The ESRI concludes that

“There is almost a complete consensus in the existing literature that BREXIT will have a negative effect on the UK economy both in the short-term (via uncertainty) and over the medium-to-long term (via trade, FDI etc,)”.

The scenarios explored by the ESRI as regards the impact of Brexit on the Irish economy reinforce that conclusion. In each scenario, the level of Irish output is permanently below what it otherwise would have been in the absence of Brexit. In any interpretation of these results, it must be recognised that the baseline chosen by the ESRI for modelling purposes had to assume no change in economic policy. In reality, successive governments, in the medium-term, are more than likely to introduce policies that help to ameliorate some of the adverse effects of Brexit. In welcoming the publication of the ESRI Report, the Minister for Finance Michael Noonan TD pointed out that

“…the assumption that Ireland remains in a standstill situation and does nothing to counteract the adverse effects [of Brexit]… is a theoretic assumption”.[iv]

The ESRI report is a welcome contribution to the on-going preparations for Ireland’s response to Brexit. It provides a useful benchmark for the Government in preparing its position for the negotiations that will take place at EU level. It confirms that there is a lot of work that still needs to be done, by all sectors of the economy, if Ireland is to minimise the negative impacts that are likely to flow from Brexit. The ESRI should continue to undertake research that will assist other sectors of the Irish economy to respond to the challenges that are arising under the Brexit agenda.

Notes


[i] ESRI Report, “Modelling the Medium to Long Term Potential Macroeconomic Impact of Brexit on Ireland”

[ii] LINKLINE: “Developing Ireland’s Response to Brexit”

[iii] “On Brexit: IMF Forecasts Slower Economic Growth”    “Brexit and the Bratislava Declaration”     “On Brexit: A Role for Ireland’s Export Trade Council”

[iv] Arrival and doorstep by Michael Noonan, Minister for Finance of Ireland, at the Eurogroup meeting on 7 November 2016, in Brussels.

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