IFS - Little scope for post-Brexit tariff reductions to cut consumer prices significantly

20 Mar 2018 09:44 AM

Leaving the EU Customs Union would give us the opportunity to have an independent trade policy and to cut tariffs on imports.

To understand the pros and cons associated with such a move, it is important to understand how large the benefits of such tariff reductions could plausibly be for UK consumers. New analysis of trade and tariff data, conducted at IFS and funded by the ESRC’s ‘UK in a Changing Europe’ initiative, shows that cutting tariffs would have only a limited impact on the cost of living of the average household.                                                                                                                   

This is because:

• The average tariff rates that the EU charges on the sorts of goods consumed in the UK are not particularly high. The average ‘most-favoured nation’ tariff that would apply to UK imports had they come from countries with which the EU has no trade agreements is 4.6%. If one accounts for the EU’s various trade agreements, waiving or reducing tariffs for imports from certain locations, the average tariff is 2.8%. The effect of tariffs on import prices could, in principle, be as high as the former of these figures, though in practice it is likely to be less than this.

• Of every £100 spent by UK households, only £26 is affected, directly or indirectly, by the import prices of goods on which tariffs are charged (reflecting the dominant role of services in the UK economy). This includes those goods produced in the UK whose prices may be raised by the existence of protective tariffs.

• Simple arithmetic suggests therefore that even cutting all tariffs to zero could only reduce prices overall by 1.2% at most. That assumes the full 4.6% tariff rate, that firms fully pass through the costs of existing tariffs to households, and that tariff rates are fully reflected in the prices charged by UK and EU firms. These are strong assumptions and, in practice, the impact of tariff cuts on retail prices is likely to be less than this.

As a result, cutting all tariffs to zero could reduce prices, in the short run, by a maximum of 1.2%. This compares with the estimated 2.0% increase in consumer prices that resulted from the depreciation in sterling that occurred in June 2016.

Cutting all tariffs could harm some parts of domestic industry – that’s why nearly all countries maintain at least some tariffs. An alternative policy would therefore be to cut tariffs only on those goods where there is little UK production – for example, where exports are less than one-fifth of imports. Such goods accounted for 22% of the value of UK imports in 2016.

Goods in this category that also bear relatively high tariffs include pasta, broken rice and cane sugar. Tariffs on these sorts of products are higher than average. But because they only account for a small fraction of imports, even under the same strong assumptions we made above, cutting these tariffs could result in an overall price reduction of 0.4% at most.

One reason the effects of tariff reductions on UK households are so low is that most spending by UK consumers is on services of one kind or another. Even when one buys an imported good, much of the cost of that good is accounted for by UK service industries (including the costs and profit margins of retailers and wholesalers, as well as the costs of distribution, marketing and storage). These costs are not directly affected by import tariffs.

There would be other long-run economic benefits from unilateral tariff reductions. But unilateral tariff reductions would also rob the UK of bargaining chips in future trade negotiations, potentially limiting the UK’s ability to obtain greater access to overseas export markets. And we could only gain control over these tariffs by leaving the Customs Union – a move which would make trade with the EU, by far our most important trading partner, more expensive.

Peter Levell, a senior research economist at IFS and the author of the analysis, said:

“One argument put for the UK leaving the EU Customs Union is the chance to reduce tariffs that the EU currently levies on imports in order to reduce prices faced by consumers. Complete abolition of tariffs would reduce consumer prices by at most 1.2%, a figure which is not large when compared with the estimated 2% increase in prices due to the sterling depreciation that followed the referendum result, and one that is likely to be an overestimate. This is because tariff rates are not particularly high on average, especially when one accounts for the EU’s various trade agreements. In addition, the costs of goods imported from outside the EU make up only a relatively small fraction of UK household spending. If tariff reductions were restricted to products that the UK did not produce domestically, as some have proposed, the impact on prices would be smaller still.”

Notes to editors

IFS Briefing Note “The Customs Union, tariff reductions and consumer prices” by Peter Levell was published on the IFS website at 00.01 on Tuesday 20 March 2018. If you have any queries, please contact Bonnie Brimstone at bonnie_b@ifs.org.uk / 020 7291 4818 / 07730 667013.

This work was funded by the ‘UK in a Changing Europe’ initiative under ES/R000980/1 and the Economic and Social Research Council (ESRC) under the Centre for the Microeconomic Analysis of Public Policy (CPP), ES/M010147/1.