Abstract
This paper looks at how Brexit has affected trade and foreign direct investment (FDI) between the United Kingdom and the EU. In 2020 the United Kingdom and the EU signed the Trade and Cooperation Agreement (TCA)1, establishing the post-Brexit relationship and, in particular, a tariff-free area for goods produced in either of the two economies. However, non-tariff barriers to the trading of goods and services have emerged. Moreover, the United Kingdom’s departure from the EU has affected its attractiveness as an investment target.
We analyse recent developments in UK imports and exports with the EU and the rest of the world, in both goods and services, including financial services and tourism. Our estimates suggest that, after the Brexit transition period, UK exports to the EU contracted by almost 40%, due to the emergence of non-tariff barriers with the EU, and the fact that no significant UK trade flows were redirected to other partners. Finally, the analysis of product-level data on German, French, Italian and Spanish exports to the United Kingdom has confirmed the significant negative impact of Brexit, especially for goods highly exposed or highly sensitive to increases in trade costs.
The FDI analysis begins with a conjunctural assessment that includes recent trends in EU-UK FDI at a broad level (including sectoral and geographical details), a breakdown of foreign affiliates and an investigation of new FDI projects and jobs in the United Kingdom. The analysis continues with developments in the UK financial sector in terms of the real economy, FDI flows, banks, insurance companies and pension funds, and the evolving status of the United Kingdom as a leading global financial centre. Finally, our analysis also provides an econometric investigation into the potential impact of Brexit on EU-UK FDI, using a gravity model approach. We find that Brexit contributed to a decline in EU FDI flows between the EU and the United Kingdom of around 4%, but business relocations involving temporary capital flows attenuated the overall FDI retreat. Large FDI flows among major European financial centres and the United Kingdom could potentially indicate some decoupling of London from the EU, marking the significant challenge that the departure of the United Kingdom from the EU posed for the financial sector.