When it comes to trade in services, leaving the Single Market will result in increased regulatory costs and could have significant effects on the volume and composition of UK services exports, writes Olga Pindyuk.
In the Brexit debate, trade in services has been largely overlooked in favour of trade in goods. This is despite the UK being the second biggest exporter of services in the world and having one of the highest shares in total exports among leading economies (Figure 1). Moreover, the EU is a major market for UK services, having accounted for about 49% of the country’s total services exports in 2017.
When talking about sector specialisation of services exporters, London as the UK’s financial hub comes to mind. But the UK is competitive in a broad range of services, with ‘other business services’ – a combination of legal, accounting, management consulting, and public relations services – being most prominent in cross-border trade, having accounted for 33.5% of the sector’s total exports in 2016 according to WTO data. The second biggest subsector is architectural, engineering, scientific, and other technical services (14.6%), followed by advertising, market research, and public opinion polling services (10.1%). In the transport sector, air transport accounts for almost two-thirds of exports.
As a member of the Single Market, the UK has access to a market of over 500 million consumers, to the free flow of data between EU members, and to passporting rights, which allow financial companies to sell services in any EU country without having to set up a branch there. In other words, the Single Market allows the UK to supply more services through cross-border trade rather than through costly commercial presence. Passporting rights are also a very important reason why the UK has been used as an EU base by US and Japanese financial firms.
Important for the professional services sector is also the free movement of people. For example, UK companies can employ European staff in the UK or send their workers on trips to the EU to consult clients, provide technical support to users of their products, broker and draft contracts, and so on. As migration concerns were crucial for the Brexit vote, movement restrictions are probably the most binding constraint on the government, making free movement unlikely to be a part of any deal, which significantly limits the options available for the services trade.
If the UK opts for a divorce that precludes it from participation in the Single Market in services, it will inevitably face increased regulatory costs: relevant providers in the UK will face heterogenous regulations in each Member State, which implies an increase in trading costs. With a rise in cross-border trade barriers there would also be a relative increase in the proportion of services provided via a more costly commercial presence within the EU. The process has already started due to the political uncertainty that has surrounded Brexit since 2016, and has so far been most visible in the financial sector where more than 250 firms have moved or are moving business elsewhere.
The biggest losses would take place if the country crashed out of the EU without any agreement and had to trade with the bloc on WTO terms, which envisage a very limited scope of liberalisation under the General Agreement on Trade in Services. Even concluding a free trade agreement with the EU will result in a significant rise in the barriers to services trade – the EU’s recent agreement with South Korea and Japan, for example, does not address regulatory issues around authorisations and licensing, with processes varying between Member States.
It is nonetheless possible that Brexit could result in more advanced services liberalisation than previous EU agreements. But in order to achieve this, any preferential access to the EU market that the UK might seek will need to be part of a comprehensive agreement, otherwise the EU may be obliged to extend more favourable conditions to its other trading partners according to the most favoured nation principle. Politically feasible options of such an agreement are deals similar to the Comprehensive Economic and Trade Agreement or CETA+, which offer limited scope of liberalisation. The UK could possibly secure mutual recognition that would cover some professional qualifications and licensing for various sectors. Still, the scope of a deal will most likely be limited.
Comparison of the values of the OECD Services Trade Restriction Index for intra- and extra-EEA trade (Figure 2) shows that countries outside the Single Market face the highest barriers to trade with EEA members in air transport and a range of professional services: legal, accounting, architecture, and engineering. It is in these sectors that the UK is likely to experience the highest increase in trade costs.
The US is the most important market for UK services exporters outside the EU (20.5% of total services exports in 2017), but substantial reorientation of British services exports to this and other non-EU markets is unlikely as geography matters to services trade almost as much as to trade in goods. This is due to factors such as the need of face-to-face interactions, the inconvenience of operating in different time zones and so on, all of which tend to result in services exports being quite localised geographically.
Just how severely Brexit will affect the services trade will depend on the form it takes; however, it seems increasingly likely that under all feasible options the UK will face increased regulatory costs.
This post represents the views of the author and not those of the Brexit blog, nor the LSE. The full report on which the above draws can be read here. The post appeared first on LSE British Politics and Policy. Featured image credit: Pixabay (Public Domain).
Olga Pindyuk is an Economist at the Vienna Institute for International Economic Studies.
To be honest, I think that at least for most big companies in the service sector Brexit is not going to be such a showstopper. The fundamental difference between services and manufacturing is that in services there is no physical product which crosses borders, instead things already happen due to complicated interactions across borders. Who cares where the servers which processed your last Google search, or the analysts in the back office who help your bank to plan its credit policy, are located?
Of course rules like passporting rules, in those few sectors where such things apply, are forcing UK institutions to create front office operations inside the EU27. But front office is only a tiny part of the services industry. Thus even now it is the case that while your UK bank may have a branch somewhere near you, which sometimes, rarely, you actually visit, most of your contacts will be with an Indian call-centre while the financial wizardry and IT could be anywhere in the world.
There are serious issues with data protection across borders but I think these might be not that bad. Even if GDPR gets interpreted to mean that no personal data is ever allowed to leave the EU, there aren’t many people in the back offices of this world who need personal data including names and addresses, credit bureaus excepted.
I think there are many parts of the service industry which will be almost completely unaffected by any kind of Brexit. A lot of it consists of professions like IT or advertising or specialists in international contract law where, so long as you can get the right people with the right cultural background, being in or out of the EU is irrelevant.
The article rightly highlights dangers because of movement restrictions. I think it’s pretty safe to assume that the EU is not going to start demanding visas obtained in advance for short-term business trips by UK citizens. That leaves the danger of a stupid UK government preventing people needed by the service industry from working in the UK.
It is stated in this comment that “there aren’t many people in the back offices of this world who need personal data”.
I would have thought that this is an over-optimistic reading of the current situation. Certainly in the leading services sector of “legal, accounting, management consulting and public relations” personal data is self-evidently of key concern.
Hi Friedrich, nice to hear from you again. Can you be a bit more specific? I admit I don’t have any experience of say, UK legal firms specialising in international contract law. What kind of personal data would they have? Of course things like contact details for the various people in the companies they are dealing with, but if the EU is going to stop that kind of information leaving the EU they might as well cut the EU off from the Internet altogether.
I don’t want to turn this blog into a technical discussion of GDPR, but I think that, when an EU company engages lawyers in London who need to contact certain employees to do their job, it is OK for the employer to pass the contact details to the lawyers, and for the lawyers to hold that information, as there is a legitimate interest. Of course GDPR still applies, as it applies to all data about EU residents who are natural persons, whether the data is held inside or outside the EU. But I don’t see here any obstacle to the company employing lawyers based in the UK.
The kind of information the lawyers will not need, which is GDPR sensitive, is for example detailed information with names and addresses of natural persons who are the company’s clients.
The same goes, so far as I can see, about the other fields you mention (accounting, management consulting and PR). Management consultants need aggregate figures, but they don’t need to know how many widgets Mme X from Lyon ordered to brighten up her garden.
I am also no expert on the GDPR. I see however from the internet that international law firms have prepared pages and pages of guidance on the impact on the UK if it leaves the jurisdiction of the GDPR.
I also came across the following info from the European Commission ;