How is the Brexit trade agreement affecting the Welsh economy?

The new trading arrangements between the UK and the European Union have led to big disruptions for many businesses in Wales, particularly those in sectors that previously depended on seamless border processes, such as agriculture, automotive and aerospace.

New trading arrangements between the UK and the European Union (EU) are now in place as part of the trade and co-operation agreement signed in December 2020. They are already having a profound impact on the Welsh economy, with the effects being felt economy-wide as well as individually within key sectors.

The EU is the most economically valuable international trading partner for Wales and the UK, accounting for 43% and 52% of total UK exports and imports respectively in 2019.

Different features of the UK-EU trading system are important for sectors in a number of ways. Agriculture and fisheries rely on fast and seamless transport links. The aerospace, automotive and steel sectors rely on seamless border processes for international manufacturing arrangements and for the assembly of components arriving from different countries. Tourism relies on liberal visa access for holidaymakers. Smaller, innovative sectors like cybersecurity and life sciences rely on stable investment and regulatory alignment.

Since the referendum result in 2016, the UK government has faced a trade-off between retaining access to the EU’s single market and gaining greater regulatory autonomy. Throughout the Brexit negotiations, the Welsh Government preferred the former, while the UK government gradually shifted towards making the latter its priority. This means that the UK does not need to meet as many EU regulations as countries like Norway, but it is unable to access the EU market on as favourable terms.

Researchers from the Centre for European Reform have argued that the ‘desire for full control over domestic regulation and trade policy significantly limits the potential scope of the EU-UK relationship’. Indeed, the potential implications of the trade agreement – as well as some effects already being seen – indicate that commerce between the EU and the UK, including Wales, is becoming increasingly difficult.

Our research at the Wales Centre for Public Policy highlights some of the likely issues and opportunities that key sectors of the Welsh economy might face as the trade agreement is implemented.

How are different sectors coping with Covid-19 as well as Brexit deadlines?

Many sectors felt unprepared for the latest changes – less prepared, even, than with previous Brexit deadlines. This is due to a combination of the effects of the pandemic as well as a sense of ‘Brexit fatigue’. It is not yet clear how much of an impact this has had, particularly on sectors that previously depended on seamless border processes, such as agriculture, automotive and aerospace.

While tariffs are a key issue for many businesses, non-tariff barriers such as delays at the border and customs certification can have a substantial impact on importers and exporters – as is already being seen. As a result, it is likely that businesses are already breaking new, more complicated rules in order to continue their operations.

Businesses dealing in fresh produce such as agriculture and fishing are encountering problems with exporting goods to Europe. Previously, fishing companies could deliver produce via lorries without delay. Now, they need to fill in customs declarations that detail their catch as well as health certificates for export clearance.

While the UK government has provided short-term funding, it does not solve the actual problem that has been created. This issue has been particularly acute in Scotland, as well as in other parts of the UK.

Economic modelling suggests that Welsh exports could be reduced by 6% – or £1.1billion – as a result of leaving the EU, a result that is broadly similar to a different economic model looking at the UK as a whole. Prior to leaving the EU, a greater share of Welsh goods (61% in 2019) was exported to the EU compared with the rest of the UK (48%).

Machinery exports are particularly affected, due to ‘rules of origin’ requirements in sectors where products are made up of components from different countries, such as car manufacturing.

Rules of origin require exporters to prove the country of origin of its products and components. While this sounds straightforward, for products with long supply chains and many components, such as cars or aircraft, it is very difficult when a high proportion of a product has originated from other countries. Additional tariffs are incurred, which have a big impact on profit margins and firms’ ability to export.

The impact on Welsh ports has been highlighted in recent news reports, suggesting a significant fall in traffic through ports such as Holyhead and Fishguard. It is unclear whether the falls in volume will be sustained, particularly as the pandemic will have affected normal traffic levels, contributing to this decline.

The latest agreements give tariff-free access for goods moving from Great Britain to Northern Ireland via the route between Holyhead and Dublin. There are temporary agreements to prevent border checks. But a further agreement will be needed to ensure that no new administrative burdens are added in the future once these short-term agreements come to an end. An absence of effective legislation could lead to more European traffic bypassing the UK ‘land-bridge’ in the future.

Further, small businesses in sectors such as agriculture and tourism have relied on EU funding in the past. Declining investment will affect these businesses, as well as those in sectors like aerospace and steel – where investment has supported research, development and innovation. At present, it seems unlikely that domestic funding for Wales will match that previously provided by the EU.

How could trade agreements with other countries bring opportunities for Welsh firms?

If the UK government puts in place less restrictive state aid rules, this could potentially allow both it and the Welsh Government to support Welsh businesses, providing more opportunities for bringing innovative products to the market.

EU rules normally limit investment to research only, but a more permissive regime could allow investment at all levels of the development cycle. Less restrictive state aid rules, such as revising the ‘harm principle’ so it only focuses on demonstrable harm caused to competition rather than merely the potential for harm, could allow more targeted and strategic investment in industries like steel. This could also allow greater freedoms for businesses receiving state aid to use these funds.

Trade agreements could benefit Welsh agriculture by opening up new markets. For example, if the United States removed import barriers on products such as Welsh lamb, this could boost exports from Wales. Prior to leaving the EU, over 90% of Welsh lamb exports were to the EU. Opening other markets could provide vital new opportunities.

Similarly, new powers over agricultural subsidies could support Welsh businesses and allow for more innovative and sustainable forms of farming and land management. This may be a more flexible and environmentally sensitive system than the EU’s Common Agricultural Policy. Agriculture forms a proportionally larger part of the Welsh economy than in England (see Figure 1). Ensuring that it receives adequate support is a crucial challenge for policy-makers.

Figure 1: The contribution of agriculture to the economy in England and Wales

Source: DEFRA

Finally, some sectors such as financial services already have good connections with non-EU trading partners, making them better prepared for new barriers to UK-EU trade. Expertise could be shared with other sectors in Wales. This could help to reduce the amount of time spent getting to grips with the rules and regulations in place abroad, helping companies to continue to export their goods.

How might the Internal Market Act disrupt Welsh devolution?

The Internal Market Act aims to ensure that products produced or imported in one part of the UK can be sold across the whole of the UK. In theory, this allows the UK government to make new trade deals without differences in standards in each part of the UK causing obstructions. The original draft was controversial because it placed frictionless exchange between the four home nations above all other public policy aims and objectives, including devolution. This would have meant that Welsh standards could be overridden by UK-wide trade deals or decisions.

The Act was changed before it was passed. The revised legislation acknowledges the devolution settlement more effectively, allowing the Welsh Government to adopt different regulations to the rest of the UK where it serves a legitimate public policy objective (such as environmental standards).

But the Welsh Government maintains that the revised Act still undermines devolution by implicitly preventing the Senedd from passing legislation specifically for Wales if it conflicts with UK-wide standards. In light of this, the Welsh Government has submitted a request for a judicial review of the Act.

Whatever the outcome of the judicial review, it is likely that the UK government will be playing a more active role in the governance of Wales in the future. This is because the Internal Market Act also allows the UK government to invest directly in areas of devolved responsibility, such as economic development and infrastructure.

The Welsh Government has argued that it should be in charge of this money, but there remains a lack of clarity as to who will be responsible for what resources. This means that the replacement Shared Prosperity Fund – designed to redress regional economic imbalances after European funding is no longer available – is likely to be controversial, risking disagreements, for example, over the rejected M4 relief road around Newport.

The Internal Market Act and its implementation could have a substantial effect on the devolution settlement, particularly if the nature and extent of devolution becomes an important political issue.

More immediately, businesses that benefited from European funding delivered through the Welsh Government will want assurances that replacement funds will be available and that the UK government will be working to a similar set of priorities as the Welsh Government.

The agreed trading arrangements leave many questions unanswered. How these are resolved will have profound implications for Welsh businesses that rely on trading relationships and their suppliers. The outcomes will therefore have important implications for the Welsh economy as it rebuilds after the dual economic shocks of Brexit and Covid-19.

How can policy-makers support Welsh firms through funding and logistical guidance?

The capacity of businesses to deal with new barriers to trade will be the most important factor in minimising economic disruption. Due to the large number of small and medium-sized enterprises in Wales that may not have the same ability to respond to new rules as larger organisations, the Welsh Government may need to play a very active role in supporting these firms through the transition period.

Specifically, it could adopt the a number of interventions to support businesses more effectively in the coming months:

Guidance: supporting businesses by helping them work through the details of new regulations.
Customs: investing in customs intermediaries and logistical support to meet increased demand for these services.
Mitigating delays: maintaining funding for sectors affected by border delays.
Data from ports: collecting and analysing data to understand the impact of the Northern Ireland protocol on Welsh ports.

Longer-term support will also be needed to increase the resilience of key economic sectors, including encouraging collaboration between different areas of the economy, supporting investment in research and development, and targeting state aid to improve sectors’ competitiveness where possible.

Where can I find out more?

The UK Internal Market Bill and devolution: A report by the Centre on Constitutional Change, the Wales Governance Centre and UK in a Changing Europe.
The Northern Ireland protocol: An explainer by the Institute for Government.
The Welsh Government’s stated priorities for the future relationship between the UK and the EU.
The implications of Brexit for agriculture: A report by the Wales Centre for Public Policy.
The implications of Brexit for fisheries: A report by the Wales Centre for Public Policy.