Dr. Swati Dhingra Associate Professor At The LSE Writes Exclusively For Fashion Roundtable on Fashion And Brexit

Dr. Swati Dhingra Associate Professor At The LSE Writes Exclusively For Fashion Roundtable on Fashion And Brexit

How would Brexit impact the fashion industry?
 
Josh De Lyon and Swati Dhingra
 
Centre for Economic Performance, London School of Economics
Prepared for the Fashion Round Table
October 2018
 

The fashion industry contributed £28 billion to UK GDP in 2016, employing 880,000 people and experiencing growth in recent years. This puts it at a similar size to other key sectors, such as land transport and publishing and broadcasting.
 
The UK fashion industry is deeply integrated with the EU's Single Market. Brexit will therefore have important implications for firms and workers, as well as consumers across the UK. Issues will begin at the production stage – where increasing barriers to trade will disrupt highly integrated supply chain processes – through to changes in the price of clothing and footwear faced by high street consumers. Brexit will also affect the large number of people who travel across Europe to exchange fashion services, such as designers, consultants and stylists.
 
Economic analysis from the Centre for Economic Performance predicts that the Textiles, Clothing and Footwear industry will be among the top five hardest hit of all 31 industries in the UK. Brexit is likely to reduce the gross value added in the industry by 5 to 7 percent, depending on post-Brexit trade policy. Cities like Leicester and Manchester that have important clothing and fashion businesses are likely to see negative effects on their local economies. These long-term projections account for trade barriers – tariffs, customs checks, regulatory divergence – that are likely to arise from exiting the EU. 
 
The production process of textiles spans across multiple borders and therefore relies on the EU’s near-frictionless movement of goods and services – both for final output and for intermediate inputs. For fashion brands, even those who design or manufacture their products in the U, up to 75% of their components will be from outside the UK, with Ireland being the UK’s largest European exporter.
 
When the UK leaves the EU, goods entering and exiting the EU may face tariffs, depending on the details of the final agreement. This would directly affect the competitiveness of UK exporters – not only to the EU but also to non-EU countries, because some intermediate inputs will still come from the EU, meaning an increase in the price of final output.
 
Unless the UK can agree to remain in a customs union with the EU and maintain its current level of zero tariffs, it would face the same tariffs that the EU currently imposes on external countries. This is because the World Trade Organisation (WTO) Most Favoured Nation (MFN) principle states that a country’s tariff rates cannot vary across exporters, unless they are a developing country or part of a trade agreement. The EU currently imposes external tariffs of 5% on cotton yarn, 8% on woven fabrics of cotton, up to 6.5% on some leather and up to 17% on some footwear items. The UK would also have to adhere to the MFN principle as it sets its own tariffs on imports; it must set the same rate for the EU and for other exporters of textiles, such as Bangladesh. The UK will therefore face a trade-off between increasing the costs of production and consumption in the UK and exposing its producers to intense foreign competition.
 
Non-tariff barriers to trade such as standards and regulations are likely to be even more important. For example, UK exporters would have to prove that their products adheres to the EU’s standards, while under the current system of Mutual Recognition, the UK’s standards are accepted across the EU. Even the extra paperwork and customs burden could lead to UK goods becoming less competitive.
 
Rules of Origin – whereby a certain percentage of a good’s value must be added within a country for it to count as produced in that country – will also now play a role and add further costs to producers. If an exporting firm’s product does not satisfy the specified Rules of Origin requirement then they may be forced to pay a higher tariff rate. Even if the goods satisfy the requirement, they must prove it. The biggest challenge will be to negotiate flexible rules of origin, that give UK businesses the ability to sell to the EU and other countries. But this is notoriously difficult in the textiles and clothing sector.  For example, the textiles industry has the second most stringent rules of origin in the North American Free Trade Agreement (NAFTA), just below the Chemicals industry which has obvious safety issues attached to it. Any future trade agreements covering the fashion industry will therefore need to grapple with the possibility of serious costs of doing business across borders.  
 
Beyond these border costs, Brexit will also have implications for the investment decisions of foreign multinationals; the UK will no longer be part of the EU Single Market and there is concern that foreign investors would shy away from using the UK as a platform to sell to the EU if new trade and investment barriers arise.  The uncertainty caused by the Brexit vote has dampened investment sentiment.  It has also made it harder for businesses to plan for the future.
 
During times of economic and policy uncertainty, small businesses suffer even more because they find it harder to raise resources than large firms. There are over 59,000 Small and Medium Enterprises (SMEs) in the UK fashion industry. It is well known that trade barriers are much more costly for SMEs, who lack the deep pockets needed to make the fixed investments for selling internationally. Small brands – which are common in fashion – may choose not to export given the rise in costs of entering markets. Or relocate.  Research suggests that UK firms are already entering fewer EU product markets and are exiting from exporting in the EU as a direct result of the uncertainty caused by the ongoing Brexit negotiations.
 
Fashion Roundtable has recommended that all fashion businesses – including EU firms wishing to export to the UK - attain Authorised Economic Operator (AEO) status to simplify customs procedures and speed up transit.
 
The greater burden on the UK Customs Authority could also lead to an increase in the number of counterfeit goods entering the UK. Northern Ireland is likely to be the target of these illicit imports due to the complexity of monitoring the border with the Republic of Ireland whilst simultaneously maintaining no borders with Britain. To date, there is still no clear viable solution to this issue agreed by both sides of the Brexit negotiation.
 
All the factors discussed so far, which have mainly focused on production, will have implications for consumers in the UK and, to a lesser extent, in the EU. Most importantly, UK consumers are likely to face higher prices. Currently, UK households spend an average of 4.5% of their disposable income on clothing and footwear. The effects of Brexit on prices can be seen already. In the 2 years since May 2016, the month before the referendum, the price of clothing and footwear in the UK has risen by 4.6%.This is driven by the sharp depreciation in the value of the pound that followed the referendum result, because as much as 90% of clothing and footwear is either directly or indirectly imported – higher than for any other group of products .
 
The depreciation of the pound was expected to bring benefits to UK exporters because UK goods are relatively cheap to foreign consumers.  But our new research at the Centre for Economic Performance finds that although export prices in sterling terms have risen, UK businesses have suffered much more from rising input costs. A weaker pound has meant higher costs of intermediate inputs from abroad. These increased production costs have reduced firm profits and even led to cuts in wages and training provided by businesses to workers in the UK. Real incomes of UK households have fallen already since the Brexit vote, and this is likely to put pressure on fashion businesses in the UK.
 
Brexit will also affect services associated with the fashion industry, many of which will be directly attached to goods. Services, and especially services trade, can often seem abstract. In fashion, services could include a British firm employing an Italian designer, or the organisation of the fashion weeks in London, Paris, and Milan, which draws together people and designers from across the globe.
 
For services trade after Brexit, the rules on movement of people will be crucial. It appears almost certain the UK will leave the EU Single Market, putting an end to freedom of movement, but it is not clear what deal, if any, the UK and EU will negotiate to replace it. The fashion industry depends on short-term travel visas and more long-term work visas; it would benefit hugely from an integrated deal with the EU post-Brexit.
 
Fashion students could also experience difficulties, including the 1,500 students from the EU currently studying in UK universities. Visas could again become an issue, both for UK students wishing to study in the EU and the reverse. Furthermore, the UK has some of the best fashion schools in the world, which currently benefit from EU funding.
 
The future of the UK fashion industry will be heavily affected by the arrangement agreed by the UK and EU. Minimising additional costs to both production and barriers to exporting for UK producers will be crucial, as well as maintaining free movement of people to carry out trade in services.
 
The fashion industry will also be influenced by the UK’s future industrial and international trade policies. The British Government is very keen to agree new trade agreements outside the EU; the nature of these could vary significantly for the fashion industry. For example, a trade agreement with the USA could be beneficial to trade in fashion services but currently looks unlikely due to the focus of US policy. Another possibility is that the UK agrees a comprehensive deal with India or China. This could benefit British designers who may gain access to cheaper textiles imports but could further hurt UK manufacturing due to the availability of cheaper labour and lower labour standards in these countries.
 
The effect that Brexit will have on the fashion industry - one of the largest industries in the UK by output and employment - is very sensitive to the final deal agreed with the EU, as well as future UK Government policy. A new trade deal that minimizes trade barriers between the UK and the EU would help in maintaining the high value addition generated by the industry.

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