How is Brexit affecting Northern Ireland’s economy?

Northern Ireland and Great Britain have long been a single highly integrated internal market. With Brexit and a new Protocol to ensure no hard border on the island of Ireland, the UK’s internal market is disrupted, creating complications around taxes, tariffs and regulatory compliance.

Nineteenth-century Prussian chief of the general staff Helmuth von Moltke declared, ‘No plan survives contact with the enemy’. Only weeks after the end of the Brexit transition period on 31 December 2020, plans for handling Brexit in Northern Ireland (NI) have been bruised by contact with reality.

Northern Ireland’s trade flows

Figure 1 summarises NI’s pre-Brexit trade flows in terms of purchases and imports coming in and external sales going out. The largest of those flows are those east-west (to or from Great Britain, GB) and north-south (to and from the Republic of Ireland, hereafter Ireland):

Figure 1: Northern Ireland’s external trade flows in 2018, £billion

1a: External sales

1b: Purchases from elsewhere

Source: Northern Ireland Statistics and Research Agency (NISRA), 12 March 2020 and 21 May 2020

Northern Ireland’s most important trading partner is Great Britain. As we consider any frictions for those trading between NI and GB – the so-called ‘border in the Irish Sea’ – it is notable that in 2018, NI sales to GB were about two and half times greater than those to Ireland. In terms of purchases and imports, the flow from GB to NI was more than four times greater than the flow between Ireland and Northern Ireland.

Economics provides us with some clues about how to interpret the real-world impact of a wedge in the UK’s internal market through the creation of a border in the Irish Sea. Transaction costs are the frictions associated with using the market. Such costs affect both buyers and sellers, as they exist on both sides of the market. Previous empirical work notes that when such frictions have been introduced into either side of the market, the organisational forms of businesses change with consequential effects on the economy (Williamson, 2008).

NI’s Brexit defined by a new Protocol

Alongside the Withdrawal Agreement of 2019, the UK and the European Union (EU) agreed a Protocol outlining special arrangements for NI. The EU’s red line in the negotiations had been that there should be no ‘hard border’ between NI and the EU – and especially that there should be no hard border on the island of Ireland.

The EU’s negotiating line reflected the stance of the Irish government. Both the EU and Irish government perceived that customs formalities along NI’s land frontier and any associated infrastructure would breach the 1998 Belfast Agreement and would also invite attacks from dissident Republican paramilitaries. Whether their perceptions were accurate remains unclear.

To avoid a hard land border, the Northern Ireland Protocol implies that NI’s departure from the EU differs in many important respects from what has happened to the rest of the UK. NI remains within the EU’s ‘sanitary and phytosanitary’ (SPS) system for animals and food products. It is still part of the EU’s single market for goods. In a practical sense then, NI remains within the EU customs union. In other words, NI’s status is a hybrid combining GB as well as EU features.

The UK’s internal market disrupted

NI and GB had previously been members of a single highly integrated UK market. That has now been disrupted. By reversing the process of economic integration, frictions have been introduced by adding EU regulatory compliance issues into the UK’s internal market.

Goods moving from GB to NI may be liable to tariffs; ‘country-of-origin’ formalities apply to GB-to-NI movements of goods; animals and food products moving from east to west are liable to be checked; and some VAT procedures in NI differ from those in GB. To give an indication of the scale of the challenge: before Brexit, ferries from GB usually brought about 175 roll-on/roll-off lorries into NI every day. Around 20-25% of these will need to be physically inspected, a time consuming and costly process.

Attempts have been made to mitigate these frictions. The EU has agreed some dispensations for NI. Notably, NI firms ‘exporting’ goods out of the single market and into GB will not be required to file an export declaration.

The Trade and Co-operation Agreement between the UK and the EU helped. It ensures that most trade between the UK and EU is tariff-free. But a GB firm sending goods to NI still needs to demonstrate that the product meets the required country-of-origin thresholds. Firms will need to prove that at least a certain percentage of the content is British to be eligible: for most manufactured goods, that threshold is 50%, but for dairy products, it is 80%, and for white chocolate, 60%.

The UK government has declared some grace periods. Supermarkets have been allowed a further three months to import some food products – especially sausages and chilled meats – notwithstanding the EU’s SPS and export health certificate requirements. On 31 December, the UK government issued guidance stating that online shopping by NI households would be exempt from customs requirements until 31 March 2021 (HM Revenue and Customs, HMRC, 2020). The UK government allocated £200 million of funds to a ‘trader support service’ to assist firms to prepare paperwork relating to sales to NI.

What has happened so far?

To date, there have generally been more difficulties in terms of movements of goods from GB to NI than in the other direction. But some of these problems may have negative knock-on effects on sales going back in the other direction.

Some GB-based suppliers have reacted to the border in the Irish Sea by refusing to accept orders to send goods to NI. This has involved food products and some mail order items: the temporary customs relief for online shopping was only announced on 31 December, and NI businesses are required to submit a customs declaration relating to any parcel worth more than £135.

There has been a reluctance to engage in ‘groupage’, whereby a lorry coming from GB to NI would pick up a series of pallets for various customers in NI, the latter being probably smaller firms, especially in retail. In some cases, the country-of-origin procedures have been judged too onerous. One haulage firm claimed that booking ten trailers onto a ferry used to take minutes but now occupies two people for a whole day.

Businesses perceive that the trader support service has been overwhelmed, while the UK government suggests that many businesses have failed to produce the right paperwork. It was reported by NI haulage firms that whereas their trucks were full when leaving NI for GB, some of the same lorries were empty on the return journey. This would reduce the profitability of such freight services, and if this situation continues, the likelihood is either that some haulage firms will collapse or the price charged for goods leaving NI will rise.

The costs for businesses operating in NI are likely to increase too, as many may face higher charges for freight services and high prices paid for inputs and materials coming from GB. A small leather retailer reported that the cost of a parcel from England had increased from £16 to £90. Admittedly, there are opportunities for NI suppliers to substitute for those in GB. By mid-January, Sainsbury’s had replaced many of its own-brand food lines by those supplied by the NI independent retailer Spar.

But from the perspective of consumers, the penalty is reduced variety alongside the probability of higher retail prices in the future. One market that may be particularly damaged is that for second-hand cars. Most second-hand cars in NI have been ‘imported’ from GB. Under the old rules, VAT (levied at 20%) was only paid on a dealer’s profit. Since 31 December, it must be paid on the entire sales price of the car. This switch – from profit to revenue – is a substantial change in tax treatment; it has been suggested that HMRC will revert to the old system.

What are the longer-term challenges?

Optimists argue that the NI economy will eventually be buoyed up by having the best of both worlds: ‘unfettered access’ to the GB market while still being part of the EU’s single market. This becomes less likely to the extent that persistent frictions GB-to-NI lead to higher costs associated with the new regulatory environment.

Admittedly, in the long term, some cost disadvantages could be mitigated through shifting supply chains from GB to Ireland or the rest of the EU (although such shifts could be costly). Such potential effects remind us of the importance of the relationship between transaction costs and real-world organisational forms.

In some cases, the business changes induced by Brexit will, at best, bring a small benefit or at worst a cost:

The NI fishing industry has gained a larger share of the quota, but for at least the next five years, that gain is quite small. This sector is, in any case, comparatively small: it contributes about £40 million to NI’s GDP in 2018, 0.1% of the region’s economy.
Like the rest of the UK, NI is out of the single market with respect to services. NI workers will not enjoy mutual recognition of professional qualifications.

Northern Ireland’s semi-detached status relative to both GB and the EU produces the following challenges:

The region has become a rule-taker: it must apply EU rules but has minimal input into the formation of such regulations.
Legal complexity: NI’s position within the single market probably implies that European Court of Justice (ECJ) rules still apply. That in turn implies that EU state aid rules apply. At some point in the future, the UK government could choose to raise the UK rate of corporation tax, perhaps as part of post-Covid-19 fiscal repair work. If the NI regional government decided to stick at the current 19% rate, the application of state aid rules would compel the NI Executive to surrender a compensating sum of money from its block grant from the UK government.
Questions over trade agreements: if the UK government does succeed in striking a series of post-Brexit free trade agreements, will NI be able to enjoy the benefits? It seems likely that the United States, for example, will make any deal conditional on very strong rights of access for US food products. Such access would fly in the face of NI’s application of EU SPS standards. The United States may end up making a free trade agreement with GB rather than the entire UK.
Financial services: it remains to be seen how UK financial services will fare post-Brexit – and whether, for example, the loss of ‘passporting’ rights of access throughout the EU27 will be compensated for by the UK’s newfound ability to set its own regulations. Hitherto, NI has been relatively successful in attracting back-office financial and IT services: it remains to be seen whether this will continue.

Looking further ahead, big questions loom. First, what happens when the grace periods end? Second, there is the political question of what happens in four years time when the NI Assembly has to vote on whether to renew the Protocol arrangements. Of the longer-term impact on the NI economy of the Protocol, as Chinese foreign minister Zhou Enlai said of the French Revolution, ‘It is too early to say’.

Where can I find out more?

A week into the Irish Sea border, it is already clear that Northern Ireland will be profoundly reshaped by Brexit: Sam McBride sets out the immediate effects of the new Irish Sea border and the political ramifications.
Article 16 of the Ireland/Northern Ireland Protocol offers no ‘quick fix’: Katy Hayward and David Phinnemore discuss why triggering Article 16 of the Northern Ireland Protocol does not provide an immediate solution to Northern Ireland’s current trade difficulties.
https://www.economicsobservatory.com/why-are-supermarket-shelves-in-northern-ireland-empty David Bogle and David Jordan discuss disruption to supermarket shelves in Northern Ireland in terms of the Brexit transition period and disruption to the UK’s internal market.