IFS: Firms’ supply chains form an important part of UK-EU trade: what does this mean for future trade policy?

08 January 2018

Over half of the UK’s imports from the EU are of intermediate goods and services, as are nearly 70% of British exports to the EU. As a result, even if the UK decides to make its own way in striking future trade deals, it will still pay to coordinate its efforts with others – including the EU.

Supply chains play a particularly important role in UK-EU trade. Not only is the EU the UK’s largest source of imports (accounting for 54% of the total in 2016), but a majority of these imports now take the form of intermediate goods and services. These are goods or services that add to the value of a product which firms then sell either for further processing or for final consumption. Tin used to produce a can is an intermediate good. A tin of beans sold to a supermarket for sale to consumers is not.

Nearly 70% of the UK’s exports to the EU take the form of intermediate inputs to production of other goods and services. The relative importance of the EU in the UK’s trade thus largely reflects the role UK industries play in EU-wide supply chains. [...]

The share of intermediate inputs in imports from the EU is similar to (in fact slightly lower than) their share in imports from the rest of the world. However, intermediate goods and services tend to be more important in the UK’s exports to the EU than in its exports to other destinations. The share of the EU’s imports from the UK that were intermediate goods and services was 69% in 2014 (having increased from 61% in 2000). [...]

1) The increasingly interconnected nature of global trade means that a country’s imports and exports cannot be treated as independent quantities. A successful exporting country will also need to be open to imports. Exports embed imports, and so greater access to imports can boost the competitiveness and export performance of domestic firms. For example, according to the OECD TiVA database, 9.5% of the value-added embedded in the UK’s gross exports in 2011 was produced in the EU and a further 13.5% was produced in the rest of the world. These figures represented increases from values of 8.2% and 9.6% respectively in 2000. As a result, UK firms’ access to imports as well as export markets is an increasingly important consideration for future trade policy. The UK should take this into account before taking actions that would introduce or maintain tariffs or other trade barriers on its imports from the EU or third countries.

2) Demand for the exports of UK industry depends not only on the export access of UK-based firms but also on the export access of firms they supply.Since the UK is a relatively important supplier to EU firms, the trade deals the EU signs will continue to have relevance for the UK in the coming years, whether or not the UK leaves the customs union. This includes, of course, the access the EU has to the UK market.

3) The importance of international trading networks means that bilateral trade deals will tend to be of less value than multilateral deals. This is partly because of the importance of rules of origin requirements, which can create a complex ‘spaghetti bowl’ of overlapping agreements which firms involved in international supply chains must navigate in order to benefit from bilateral trade agreements. [...]

A final question is whether the current importance of inputs from the EU is likely to change following Brexit. If the EU’s own tariffs exclude competition from the rest of the world, then selective post-Brexit tariff reductions on imported goods could help to improve the competitiveness of UK firms.

This effect is likely to be small though. First, tariffs on the sort of intermediate goods the UK purchases from the EU (and indeed the rest of the world) already tend to be lower on average than those levied on goods used for final consumption – about 4% on intermediate goods compared with nearly 10% on goods imported for final consumption. These figures would be even lower if we took into account services inputs that essentially attract no tariff. Second, tariff reductions will not prevent the introduction of non-tariff barriers such as customs checks that would follow if the UK left the EU’s customs union and single market. These are especially important considerations for industries that value timeliness and flexibility in their supply chains (such as the car industry), and would be difficult to negotiate away in deals with third countries. [...]

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