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What is the likely impact of Brexit on inequality in household earnings?

Deal or no-deal, Brexit will have significant consequences for UK-EU trade, which will in turn have repercussions for the wider economy. The effects are likely to be highly unequal, with ‘blue-collar’ workers in the middle of the earnings distribution probably the worst hit.

The end of the UK’s transition period out of the European Union will have a significant economic impact. If the UK and the EU fail to strike a free trade agreement, trade will default to WTO (World Trade Organization) rules, requiring both parties to impose tariffs on each other’s imports. Even if a deal is struck, ‘rules of origin’ requirements on firms and regulatory differences will make trade costlier for exporters of both goods and services.

The effects of this will be substantial as the EU is the UK’s largest trading partner: exports to the EU are equivalent in value to around 14% of UK GDP; and imports are equivalent in value to around 17% of UK GDP.

The Office for Budget Responsibility (OBR) expects the long-run effect of Brexit on the UK economy will be to reduce real GDP by around 4 percentage points if a deal is struck and to reduce GDP by around 6 percentage points in a WTO rules/no-deal scenario. The majority of this impact is forecast to come in the form of many years of slower than normal growth rather than a sudden drop in output in 2021, although some significant short-term effects from border disruptions are also expected.

The effects of new trade barriers are also likely to be highly unequal across workers. The majority of exports to the EU – around 60% – are goods rather than services. Yet only 12% of UK workers are currently employed in manufacturing and other production industries.

This fact alone suggests that the effects of post-Brexit trade barriers will be concentrated among certain workers. Moreover, the manufacturing industries that tend to export relatively more of their output to the EU are concentrated in particular locations.

How will new trade barriers affect different industries?

The exact trade barriers that will apply to different industries in 2021 are difficult to quantify. Not only do we not currently know what sort of deal is likely to be struck, but we also do not know exactly how different types of trade barriers (customs delays, form filling and so on) will translate into pounds and pence for businesses.

Figure 1 shows how possible new trade barriers vary across industries in a particular WTO rules scenario, expressed as per unit of industries’ value added (Griffith et al, 2020). These include estimates of non-tariff barriers to trade as well as formal tariffs.

The size of these potential trade costs depends on the nature of trade barriers expected for different industries, the tariffs that might apply, and how much different industries import and export to the EU. Including the additional costs that industries might face in importing EU goods and services is important. Firms may not only find it costlier to access EU export markets once the transition period ends, but also more expensive to purchase production inputs from the EU. This will potentially force firms to source costlier or lower quality alternatives from the domestic market or elsewhere, reducing their competitiveness.

In addition, industries can be affected both directly or indirectly. A farm supplying inputs to a food manufacturer that sells its output in the EU might not be directly affected by new barriers to trade, but would suffer if the customer reduced its output. Similarly, the food manufacturer might be adversely affected if the farm’s costs of importing EU inputs increased, leading it to raise prices. Figure 1 splits the costs of new trade barriers into direct and indirect costs for both imports and exports.

Figure 1: Possible changes in trade costs per unit UK value-added by industry in a no-deal Brexit

Figure showing possible changes in trade costs

Note: See Griffith et al (2020) for details of calculation and no-deal Brexit scenario.

Figure 1 shows considerable variation in industries’ exposure. It suggests that UK goods industries such as clothing, chemicals and transport equipment are most exposed to new trade barriers with the EU, largely because these industries export more of their output there.

Which types of workers are most likely to be affected?

What do these trade costs imply for different workers? The costs shown in Figure 1 give one measure of workers’ exposure to new trade barriers based on current employment and trade patterns. They suggest that the effects are likely to vary considerably across different types of workers.

The industries that are most exposed are disproportionately likely to employ machine operatives or workers in skilled trades – ‘blue-collar’ workers (Griffith et al, 2020). These workers tend to be men who are in the middle of the earnings distribution and are relatively less likely to have a university degree.

Being employed in a highly exposed industry is not the only factor determining how workers will ultimately be affected by new trade barriers. This will also depend on the ease with which workers can find other jobs, which in turn depends on whether there are other firms that employ workers like them in their local area that are not themselves exposed.

This is likely to be easier for some workers than others. It may be particularly difficult for blue-collar workers, who are often employed in regionally concentrated industries, who tend to have fewer formal qualifications that would allow them to transfer across industries, and who tend to have fewer local, alternative employment opportunities.

One study looking at the impacts of rising import competition on Danish workers finds that those without formal education find it harder to adapt to new roles in less exposed industries (Hale, 2018). Other studies in the United States and Germany also find larger impacts of import competition for less skilled workers, and that workers are often either unwilling or unable to relocate in response to economic shocks (Autor et al, 2014; Dauth et al, 2014).

In our study of workers’ exposure, we analyse the wage impacts of new trade barriers, taking account of the mix of local industries, the kind of workers that local industries employ and possible responses of firms and consumers to changes in wages and prices (Griffith et al, 2020).

Our analysis suggests that high earning workers (such as managers) and less skilled workers (such as cleaners) who are currently employed in exposed industries are likely to experience smaller overall wage impacts than blue-collar workers in those same industries. This is because they often have more local opportunities for employment in the local services sector.

What does this mean for earnings inequality?

Figure 2 shows the relative impacts of post-Brexit trade barriers across different parts of the earnings distribution (Griffith et al, 2020). Our study considers two possible measures of exposure:

  • One is based on individuals’ current industry of employment, assuming that workers stay in their current roles and must accept wage reductions if their current employers contract.
  • The second allows for the possibility that workers might move across industries (but assumes workers must find new jobs in their current local area and the same broad occupation).

Both measures show relatively greater exposure in the upper middle section of the earnings distribution – where the blue-collar workers in exposed industries tend to be located. But workers at the top of the earnings distribution look much less exposed when we allow for the possibility that workers in exposed industries – such as managers and professionals – could change jobs if conditions in their current industry worsened.

Figure 2: Measures of individual exposure over the earnings distribution in a no-deal Brexit scenario

Figure showing measures of individual exposure over the earnings distribution in no-deal Brexit

Note: See Griffith et al (2020) for details of calculation and no-deal Brexit scenario.

Figure 2 shows how the effects vary across individuals. Another question is how the effects might vary across households. This depends on the exposure of individuals’ partners. Looking at household exposure, we find that individuals with lower earnings are more likely to be in more exposed households (Griffith et al, 2020). This is because workers at the bottom of the earnings distribution (who are typically women) tend to be less exposed to new trade barriers as individuals.

But since these workers are more likely to be partnered with more exposed blue-collar workers (typically men), they are also quite likely to be in more exposed households. This is particularly important for understanding the pattern of exposure by gender; accounting for partners’ exposure tends to mitigate overall exposure for men, but to exacerbate it for women.

What does this mean for policy?

Middle-skill, middle-earning blue-collar workers are most exposed to the effects of post-Brexit trade barriers, partly because they are more likely to be employed in exposed industries, but also because they may find it harder to find equally well paid work outside their current industries. Overcoming frictions that prevent these workers shifting across industries, regions and occupations will therefore be key to managing the impacts of Brexit.

A second consideration for policy is the extent to which some kind of insurance is provided to workers exposed to new trade barriers. There are schemes in other countries to help workers displaced by trade shocks. Evidence from the United States shows that grants provided under the Trade Adjustment Assistance programme for retraining and relocation can be effective at helping workers finding alternative and better paid work (Hyman, 2018).

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Author: Peter Levell, IFS
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