Brexit and businesses: sectoral impact analysis

Executive summary

Background

The Scottish Government (SG) does not welcome Brexit and has consistently stated in its Scotland’s Place in Europe publications^[1] that Scotland’s future is best served by continued membership of the European Union (EU). Failing that, SG considers that continued membership of the European Single Market and Customs Union remain viable alternatives. However, the SG recognises the need to support Scottish businesses and other stakeholders to mitigate the impacts of Brexit, if and when it happens. Accordingly, this report sets out the results of a Sectoral Impact Analysis and Brexit Readiness Assessment commissioned by the SG’s Directorate for International Trade and Investment (DITI). It summarises the risks to Scottish businesses from a “no deal” Brexit (i.e. on WTO terms) and captures the views of over 80 businesses and trade associations from a cross-section of sectors who participated in a dynamic consultation.

Key findings

• Brexit-related uncertainty was a major concern for all the businesses and trade associations consulted. Businesses highlighted the risks this posed to their competitiveness, profitability and, in some cases, their viability. Two-thirds of participants, many of whom are key players in Scotland’s economy, were not confident that the UK would secure a Brexit deal by March 2019.
• Amongst businesses polled in consultation^[2], only 8% felt fully ready for Brexit, although the majority (74%) said that they had taken steps to prepare. Most worryingly, the remainder of businesses (18%) reported that they did not feel ready for Brexit at all.
• Tariffs and non-tariff barriers will clearly make it harder for Scottish businesses to trade with the EU, and will likely reduce the volume of trade. The sectors that appear most vulnerable include food and drink, chemicals, life sciences and other manufacturing sectors. Impacts are likely to be felt quickly, although longer-term there may be opportunities to explore alternative international markets and rebuild domestic supply chains.
• Representatives from financial services, chemicals, life sciences, creative industries and food and drink sectors also emphasised the importance of regulatory alignment (e.g. via agreement on equivalence or mutual recognition) with EU standards in facilitating trade, not only with the EU, but also with non-EU countries where EU standards are widely accepted.
• Businesses felt that EU funding has contributed to Scottish economic productivity and has played a part in creating Scottish jobs and leveraging investment. Exit from the EU threatens this funding, with the greatest impacts likely to be in agriculture, fisheries and aquaculture, construction and life sciences.
• A risk of higher consumer prices was identified, particularly for food and drink and energy, from short-term currency risks and from tariffs and border disruptions. Although it was recognised that this provided an opportunity to pivot to the domestic market, and longer-term Scotland could switch to alternative sources of supply from non-EU markets (depending on UK trade policy).
• A recurrent theme was concern about reduced access to talent at all wage and skill levels. Sectors that were particularly concerned included food and drink, financial services, life sciences and creative sectors.
• Scottish-specific risks included business demography (e.g. smaller native enterprises, the importance of clusters and integration with EU value chains) and the logistical challenges that stemmed from Scotland’s geography and location.
• A number of businesses are already reporting negative impacts in the shape of delayed investment plans from foreign-owned parent companies, the cost of allocating resource to Brexit planning, and heightened challenges in recruiting EU staff with key skills.

Brexit risks

The analysis considered the following potential Brexit risks^[3] and feedback from businesses consulted focused on these categories:

• Tariffs and non-tariff barriers that will disrupt the frictionless and tariff-free movement of goods between Scotland and the EU.
• Sourcing and supply resilience – trade frictions, corresponding disruptions to supply chains, and potential changes in the value of Sterling will impact Scottish companies and their supply chains.
• Legal and regulatory compliance – leaving the EU will result in the UK leaving a number of regulatory regimes (e.g. REACH in the chemicals sector, and Clinical Trial Regulation EU No. 536/2014 in life sciences), and the end of passporting in financial services.
• Workforce – the end of free movement will exacerbate the challenges Scotland already faces to attract and retain talent in the context of an ageing population. Weaker Sterling may create disincentives for workers to come to the UK and Scotland.
• EU funding and finance – Scotland will no longer benefit from EU funding beyond 2020.
• Foreign Direct Investment (FDI) – Brexit may also reduce the attractiveness of Scotland as a destination for FDI; however, a weaker Sterling may increase Scotland’s attractiveness for FDI.

Sector RAG ratings

A Sectoral Impact Analysis Rapid Synthesis Survey of existing analysis on Brexit impacts and mitigation strategies, across key sectors of the Scottish economy, was conducted in September 2018. The output of this review was a brief report that summarised findings on Brexit risks for key Scottish sectors. Findings were presented via a “RAG” rating that captured the scale of the impact of Brexit by sector and Brexit risk category.

Table 1 updates these risk impact category RAG ratings. It summarises evidence from consultations with businesses and trade associations which explored the impact of Brexit on key sectors in the Scottish economy. The RAG ratings by Brexit risk category were validated and moderated by dynamic consultation participants.

Thereafter the findings from in this report are presented by theme rather than by these risks.

Table 1: Sector RAG ratings^[4]

Implications and policy response

The SG and its agencies have taken action^[5] to address some of the risks that arise from Brexit. Programmes include the multi-partner, pan-Scotland Prepare for Brexit campaign, designed to help businesses prepare for Brexit and to act to secure continued business growth. More broadly, the SG recently published an Economic Action Plan, which sets out a vision for achieving sustainable and inclusive economic growth in Scotland. This is complemented by the Scotland is Now campaign, which seeks to attract people to Scotland as a place to visit, live, work, and invest.

Together these measures will help build a strong, vibrant and diverse economy and should mitigate some of the impacts of Brexit. However, the analysis conducted for this report highlighted a number of Scottish-specific themes that should be considered in further detail. These themes are used to structure the rest of this report. These themes are:

• Theme A: Implications for trade, inward investment and EU funding.
• Theme B: Access to talent.
• Theme C: Impact on SMEs.
• Theme D: Routes to market and logistics.

Below, each of these key themes is summarised and corresponding recommendations for SG, the UK Government (UKG) and business are set out.

Theme A: Implications for trade, inward investment and EU funding

Scotland is a small, open economy with several sectors that are heavily export orientated. It has benefitted from many aspects of EU membership including tariff-free and frictionless trade with the EU and countries with free trade agreements (FTAs) with the EU, and successful attraction of inward investment and access to EU funding. Brexit is therefore a risk to the profitability and viability of key activities in Scotland across all sectors in some form.

Tariffs and non-tariff barriers

• Trade barriers are a particular concern for food and drink given their impact on the level of exports. In primary producing sub-sectors, e.g. meat (particularly lamb) and seafood, tariffs (EU average tariffs between 50% and 100%^[6] for the former and between 2% and 20% for the latter^[7]) threaten the competitiveness of Scottish produce. Indeed, businesses felt that the viability of some of the trade itself may be endangered, specifically by non-tariff barriers, given the requirement to get fresh produce to market quickly to maximise its value.

Legal and regulatory compliance

• The need for regulatory alignment, and for that alignment to be recognised by the EU, is of particular importance to a number of Scottish industries, including chemicals, life sciences and financial services.
• For example, in chemicals and life sciences, failure to agree equivalence/alignment with EU regulations (e.g. REACH for chemicals and for Clinical Trials Regulations in life sciences) could see activity move outside Scotland.

EU funding and finance

• Scottish businesses have benefitted from EU funding that has supported productivity, e.g. the Common Agricultural Policy (CAP), Horizon 2020 and other targeted EU funding programmes.
• Losing access to EU funding could affect levels of demand in some sectors, e.g. construction, and affect the viability and investment environment of some businesses, including many rural firms. The rate of start-up and innovation spin-outs from universities and innovation centres could also be impacted.

Scottish industry characteristics

• A number of sectors of the Scottish economy, such as financial services, chemicals, life sciences and key parts of the creative industries sector, are located in geographic clusters. There is a risk that, if businesses move activity out of Scotland, this could start to undermine the agglomeration benefits of these clusters.

Impact on consumers

• The impact of Brexit on consumers in Scotland could be significant through price rises on all traded goods as a consequence of tariffs, border frictions and a weaker currency. This would likely be felt in food and drink most prominently, but also through higher energy prices, which would be of concern to energy-intensive businesses as well as to consumers.

Key recommendations

Table A: Recommendations on trade, inward investment and EU funding^[8]

Theme B: Access to talent

Scottish businesses already face challenges in attracting and retaining talent at all skill and salary levels. According to official data in 2017, there were 18,000 vacancies in Scotland relating to specific skills and a further 23,000 hard-to-fill vacancies due to general labour shortages. This is in part driven by demographics, but also by the smaller size and scale of Scottish sectors. For example, the larger life sciences clusters in Cambridge and London can provide greater career opportunities for in-demand talent.

Brexit will make these challenges harder for Scottish business as a consequence of formal limitations on immigration from EU markets and potentially a declining perception of the UK (and as a consequence, Scotland) as an attractive place to live and pursue a career.

Workforce

• EU migrants make up a notable share of employment in a number of sectors, including in agriculture and life sciences. Scotland’s Rural College (SRUC) estimates that there were 9,257 seasonal migrant workers employed in Scottish agriculture in 2017 with a significant majority (78%) originating from three EU countries (Bulgaria, Romania and Poland) and employed in the East Coast soft fruit sector during the summer months^[9]. In life sciences almost 17% of the workforce are EU nationals^[10].
• There could be a challenge in attracting temporary migrant labour in agriculture to Scotland post-Brexit if there are limitations on numbers of temporary visas and high levels of demand in England for the same workers. Further concerns in food and drink include shortages of official veterinarians in agriculture, and workers in food processing.
• Although the construction sector in Scotland is less dependent on EU workers than the Scottish average, there could be significant indirect impacts given the higher reliance on EU workers in the rest of the UK. Skills shortages in England, particularly London, could push up wages for construction workers in England. As a result, this could put upward pressure on construction wages in Scotland to prevent workers from migrating south.
• Scottish workers have also benefitted from free movement, enabling them to gain experience and opportunities overseas. This advantage was seen as being particularly important for workers in creative industries who may not be able to sustain livelihoods in the sector were it not for these international opportunities.

Implications for productivity

• Limitations on the ability to recruit non-UK EU nationals will have a significant impact on the productive capacity of a number of key sectors, including food and drink, but also higher value-add sectors such as life sciences and financial services. This may also be a determinant of the ability to attract FDI, as evidenced by results from EY’s Attractiveness Survey where gaps in skills availability were raised as a significant worry for investors.
• There remains uncertainty regarding visas for UK citizens working in the EU post-Brexit and vice versa. The UK has committed to respecting the rights of EU citizens currently in the UK, while the EU has indicated that policy regarding UK nationals will be the responsibility of individual member states. SG recently announced that it would pay the cost of settled status applications for NHS workers, and that Scotland's Citizens Advice network will provide a new advice service to European citizens in Scotland affected by changes in the immigration rules as a result of Brexit^[11].

Key recommendations

Table B: Recommendations to address workforce issues

Theme C: Support SMEs in Scottish key sectors through Brexit

The larger firms consulted as part of the dynamic consultation exercise indicated that they had undertaken preparations for Brexit and had developed an understanding of the potential impacts of a no deal Brexit on their business. For example, 9 out of 10 firms who attended financial services, life sciences, chemicals, energy and high value manufacturing workshops indicated that they had undertaken preparation of some form^[12]. This included practical steps to assess the readiness of their supply chains, e.g. supplier surveys, moving annual maintenance periods into April 2019, and/or stockpiling of supplies and finished products. Small and medium enterprises (SMEs) were far less likely to have assessed the extent of their Brexit risk or undertaken any contingency planning. For example, a survey conducted by the Federation of Small Businesses Scotland indicated that 1 in 7 small businesses has yet to make any preparations for a no deal Brexit^[13].

Capacity constraints

• In Scotland, 98% per cent of enterprises are classed as small, having between 0 – 49 employees^[14]. SMEs are unlikely to have the capacity to prepare contingency plans. As a consequence, there is a risk that these businesses will not be ready for Brexit with consequent disruption to their activities, and the supply chains they support.
• SMEs (and indeed larger businesses) may well face cash flow challenges immediately post Brexit, particularly where supply chains are disrupted as a consequence of additional border checks.

Key recommendations

Table C: Recommendations to support SMEs

Theme D: Review routes to market in light of Brexit

Scotland’s transport infrastructure is configured on the basis of free movement of goods between the UK and EU. A significant proportion of goods are transported by road between the EU and Scotland via roll-on-roll-off (RORO) ferry services at ports outside Scotland with few, if any, checks at borders^[15]. The same applies for the rest of the UK but, given Scotland’s geography, products have longer to travel by road to the EU compared to England.

Brexit will challenge the viability of existing logistics models due to the need to re-establish border controls for customs processes and other checks (e.g. sanitary and phytosanitary checks). This will lead to border delays, threatening the competitiveness and viability of existing trade routes.

Sourcing and supply resilience

• The imposition of border controls in a no deal Brexit (or indeed even under a Canada-style free trade agreement) would increase firms’ logistics costs and risk perishable goods expiring. It is seen as a particular threat to businesses that export perishable goods.
• It is also of particular concern for manufacturing businesses – especially for high-value just-in-time producers integrated in EU supply chains. Businesses in this sector are already reviewing supply chains and processes as a means to mitigate border disruption.
• For imported products, Scotland may need additional customs and phytosanitary Border Inspection Posts (BIP) to accommodate extra checks, especially for animals and animal products. It should, however, be noted that the UK Government has stated that it would continue to recognise Transporter Authorisations, Certificates of Competence, Vehicle Approval Certificates and Journey Logs issued by other EU Member States for an interim period^[16].
• The dependence on transport by roads is driven by the longer transit times, and often higher cost associated with alternative forms of transport. A trade industry body in this sector indicated that ports in Scotland are on a smaller scale than in the UK and competition among the ports is relatively low, reflecting limited demand.

Key recommendations

Table D: Recommendations to build on Scotland’s direct physical trade routes to support trade