Brexit shows how firms react when restrictions are placed on the way they reach customers

“Brexit changed how British firms could sell services in the European Union. By studying how companies reacted, Holger Breinlich and Martina Magli show that many implemented workarounds, such as setting up affiliates abroad, but that those new models came at the expense of jobs in at home. Since January 2021, trade between the United Kingdom and the European Union has been governed by the Trade and Cooperation Agreement (TCA). The TCA replaced the UK’s membership of the EU single market, which had set out the rules for trade before Brexit. While the TCA maintained zero tariffs and zero quotas on goods, it introduced a range of new non-tariff barriers, for trade in both physical goods and services. On the services side, the TCA introduced new trade barriers, including tighter rules on the temporary movement of workers, through new visa and work-permit requirements, and additional barriers related to certification and licensing to operate across markets. In recent work , we study how British services exporters reacted to these barriers. To understand their reaction, one must first understand some of the key differences between goods and services trade in terms of how exporters can supply foreign markets. How services trade works There are four modes through which services can be supplied abroad: cross-border trade, consumption abroad, movement of people to provide a service and sales through local affiliates. Firms face different challenges and opportunities depending on which mode of supply they use. For instance, intellectual property services are primarily delivered cross-border, while health and education services often use all four modes (See Figure 1). Figure 1 Modes of services supply Source: TISMOS (WTO). Share of the mode of services World export supply by type of services in 2017. The shares are computed using the total services trade flows and modes of supply for the countries included in the TISMOS dataset. We find that firms reacted to the new TCA-induced barriers by increasingly exporting services to the EU market through affiliate sales. That is, they set up local affiliates in the EU and started serving their customers through these affiliates. This helped in circumventing the new trade barriers, which tended to be more substantial for other delivery modes. For example, while sending employees to EU countries became more difficult under the TCA, it remained relatively easy to set up an affiliate in the EU. Thus, a firm providing engineering services might have found it more difficult to send an engineer to the EU because of tighter immigration restrictions for non-EU workers after 2021, but setting up an affiliate and serving EU clients through that affiliate remained relatively easy. Getting ready to leave In our analysis, we show that this mode substitution already started to take place long before the actual changes in trade barriers introduced by the TCA, starting as early as 2017, one year after the Brexit referendum in 2016. We explain this by firms anticipating the eventual higher trade barriers and reacting pre-emptively to protect their services exports to the EU. Interestingly, we do not find a similar mode substitution for EU firms serving the UK. We conjecture that this is explained by the smaller relative size of the British domestic market, which is much less important for EU-based services exporters than the EU market is for British exporters. Thus, incurring the substantial investment costs of setting up a foreign affiliate is profitable for UK services exporters, but not for EU services exporters. We also find that different services sectors relied to different extents on mode substitution after 2016, with business services showing a greater tendency to switch delivery modes compared to other types of services. Exporting jobs In a final step, we investigate the consequences of mode substitution for services exports and employment, discovering two interesting patterns. On one hand, firms that could more easily change the way in which they delivered their services experienced smaller drops in overall exports to the EU after 2016. But these firms also saw lower growth in domestic employment. This shows that while British firms found a way to successfully circumvent expected barriers by switching to modes less affected by Brexit, this change resulted in lower UK employment growth , because services exporters now prioritised employment growth at their new foreign affiliates, rather than at home. Our findings reveal a subtle effect of the Brexit referendum. While UK services exporters were to some extent able to protect their services exports to the EU, this came at the cost of fewer jobs created at home. This blog is based on Should we stay or should we go? Firms’ decision on services mode of Supply , CEP Discussion Paper No. 2182. This article gives the views of the author, not the position of LSE Business Review or the London School of Economics. You are agreeing with our comment policy when you leave a comment. Image credit: IR Stone provided by Shutterstock. The post Brexit shows how firms react when restrictions are placed on the way they reach customers first appeared on LSE Business Review .

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