Scotland's place in Europe: people, jobs and investment

Chapter 2: Modelling the Impact of Leaving the EU on the Scottish Econ

48. The economic consequences of the UK leaving the EU have been analysed by several organisations and think tanks. ^[26] There is widespread agreement in the economic literature that Brexit will have a detrimental effect on the UK economy.

49. The Fraser of Allander Institute ( FAI) has produced economic analysis on behalf of the Scottish Parliament, which models the potential impact of Brexit on Scotland. ^[27] The analysis incorporates the economies of both Scotland and the rest of the UK, helping to capture spill-over effects arising from the high levels of economic integration between the Scottish and UK economies. The FAI have also presented the impact on jobs, suggesting Brexit could cost up to 80,000 jobs. ^[28]

50. In common with other studies, the FAI analysis examines the long-term impacts of Brexit by comparing a range of potential future trade scenarios (all characterised by less economic integration with the EU) to the status quo as a member of the EU. These scenarios are: participating in the European Economic Area, securing some form of Free Trade Agreement with the EU or a WTO relationship.

51. Their analysis concludes that the further removed Scotland is in future from EU membership, the more significant the negative impact would be to the Scottish economy. In short, membership of the EEA is not as economically beneficial as full EU membership, but is the least damaging of the three options by a significant margin.

52. The FAI modelling of the WTO scenario suggests that after 10 years:

• GDP is expected to be over 5% (£8bn in 2015-16 terms) lower than would otherwise be the case;
• real wages are expected to be 7% lower, equivalent to a reduction of around £2,000 per year; and
• the number of people employed in Scotland is 3% lower (around 80,000 jobs).

53. To further illustrate the costs of leaving the European Single Market, the remainder of this chapter presents new Scottish Government analysis using the Scottish Government’s Global Econometric Model ( SGGEM). ^[29] The analysis focuses on six economic areas that are impacted by the type of relationship the UK has with the EU:

• total volume of trade in goods and services with the EU;
• levels of trade tariffs with the EU;
• Foreign Direct Investment ( FDI) flows;
• productivity growth which is tied to the level of trade openness;
• levels of net migration; and
• the UK/Scotland’s net contributions to the EU budget.

54. In common with the majority of the literature on the economics of Brexit (including studies by the OECD, NIESR, Fraser of Allander, and the Treasury), the analysis looks at the impact on the Scottish economy under a range of possible established or “off the shelf” scenarios, ^[30] based on the EU’s existing trade relationships. ^[31] Further information is provided in the technical annex. The three alternative scenarios to EU membership examined are:

a. a World Trade Organisation style relationship;

b. a form of Free Trade Agreement: outside the Single Market and Customs Union; or

c. participating in the European Economic Area ( EEA).

55. The available evidence also indicates that a chaotic exit from the EU, including an unplanned reversion to WTO rules would be more damaging than a planned transition to WTO terms. ^[32] Notwithstanding this, it is also important to note that there is no longer any such thing as completely free trade. All trade is managed trade with benefits for both partners in any deal. A complete absence of any trade rules creates significant uncertainty and consequent economic damage.

56. Consistent with the literature, the modelling finds that each scenario examined results in a permanent decrease in GDP relative to continued full EU membership. The magnitude increases the looser the relationship with the EU becomes. In particular there is a notable difference in the impact of the FTA and WTO scenarios relative to that of the EEA scenario, as shown in Chart 4.

57. For example, should the UK pursue a WTO-style relationship, Scotland’s GDP would be around 8.5%, or £12.7 billion (in 2016 cash terms), lower by 2030, compared to continued full EU membership. This is equivalent to a loss of around £2,300 per year for each person in Scotland. A Free Trade Agreement relationship would mean Scotland’s GDP would be 6.1% (£9bn in 2016 cash terms) lower by 2030. Should the UK remain in the Single Market by participating in the EEA this impact could be significantly mitigated, with Scottish GDP estimated to be around 2.7% (or £4 billion in 2016 cash terms) lower.

58. Table 1 summarises the long term impacts on GDP and some other macroeconomic indicators by scenario.

Table 1: Headline Macroeconomic Indicators by 2030 relative to a baseline of Full EU Membership

	GDP (%)	GDP Per Capita (£) in 2016 Cash Prices	Real Disposable Income(%)	Business Investment (%)
EEA	-2.70%	-£688	-1.40%	-2.90%
FTA	-6.10%	-£1,610	-7.40%	-7.70%
WTO	-8.50%	-£2,263	-9.60%	-10.20%

Source: Scottish Government Global Econometric Model ( SGGEM)

Chart 4: Change in Scottish GDP (%) by 2030 - Relative to a baseline of a Full EU Membership

Source: Scottish Government Global Econometric Model ( SGGEM)

59. Table 1 shows that should the UK remain in the Single Market by participating in the EEA, Scotland’s GDP could be 5.8 percentage points (or around £8.7bn) higher by 2030, compared to the WTO scenario. It is difficult to identify the benefits of the Customs Union in isolation. Much of the economic literature on which the estimate of the benefits of EEA membership is based implicitly captures some aspects of the Customs Union, but not the full benefit. It is therefore reasonable to assume that were EEA membership to be attained alongside a Customs Union the economic benefits will fall between the EU and EEA estimates.

60. The results indicate that business sector investment is projected to be lower in all scenarios. For example, under a WTO scenario business investment is projected to have fallen by 10.2% by 2030. Lower levels of investment in the economy in turn leads to lower levels of capital stock which negatively impacts output per worker and the average real wage.

61. The impact of lower investment can be observed in lower real disposable income - a measure of consumer spending power after changes in the price level. This is also projected to be 9.6% lower in a WTO scenario, although again membership of the EEA mitigates this impact significantly.

62. Chart 5 shows the contribution to the difference in GDP between the Full EU membership and the WTO scenarios disaggregated by the impact of changes in migration, productivity, EU budget contributions, tariffs, volume of trade and FDI.

63. In the short to medium term, the impact of different levels of trade and tariff barriers explains a sizeable amount of the difference between a WTO scenario, and the full EU membership scenario. Over time however, the impact on productivity and net migration overtakes the trade effect as the main contributors to the difference between these scenarios.

64. For example, by 2030, productivity would account for 60% and migration 26% of the difference in GDP between the two scenarios. This is primarily due to the importance of both channels on the overall productive capacity on the economy. Over time these supply-side channels have a much greater and more permanent impact on the size of the economy and are where the greatest gains from a closer relationship with the EU can be found.

65. As chapter three explains, the Single Market is an evolving framework. As such, future improvements in the economic relationship with the EU such as the further deepening of the Single Market (particularly the future development of the Single Market in services) will result in further economic benefits for its members.

Chart 5: Contribution (%) to the difference in GDP between the WTO and full EU membership scenario over time

Source: Scottish Government Global Econometric Model ( SGGEM)