Executive Summary

This paper provides an illustration of the potential impact that a No Deal Brexit - leaving the EU on the 29 March 2019 without a transition period or agreement on any future trade deal and wider economic relationship - could have on the Scottish economy over the next 12 - 24 months.

A very wide range of outcomes fall under the heading of No Deal Brexit. The following analysis provides an indicative range of impacts based on two illustrative scenarios. Other scenarios are possible.

Scenario 1 is a short, sharp, supply disruption lasting a number of months - it is assumed that a No Deal Brexit with no transition agreement leads to an immediate economic shock from the second quarter of 2019. This shock is assumed to be primarily on the supply side, causing major disruption to the movement of goods and services.

is a short, sharp, supply disruption lasting a number of months - it is assumed that a No Deal Brexit with no transition agreement leads to an immediate economic shock from the second quarter of 2019. This shock is assumed to be primarily on the supply side, causing major disruption to the movement of goods and services. Scenario 2 assumes that the initial supply shock lasts longer, leading to a further fall in demand as a result of a sustained deterioration in consumer and business confidence. This in turn reduces activity right across the economy and magnifies the size of the shock.

There are a range of channels through which each scenario could impact on the wider economy. These are summarised in the diagram below. The headings in bold represent the additional channels assumed to occur under the second scenario.

Figure 1 - Transmission Channels for a No Deal Brexit

There is broad consensus that a No Deal Brexit would have a negative impact on the Scottish and UK economies. However, there is huge uncertainty about the duration, composition and scale of the shock. This is compounded by the fact that the response that such a shock would elicit from the UK government and EU is also unknown.

As such, the following analysis should not be considered a forecast. Instead it illustrates a number of potential outcomes, and in particular their relative economic impact in both aggregate terms and across different industries and geographies.

Drawing on the impact that previous economic shocks have had on the Scottish and UK economies, modelling by the Scottish Government and studies by other organisations suggest that a No Deal Brexit under the above Scenarios could result in the following impacts:

Trade Disruption: In the event of a disorderly No Deal Brexit, Scotland's trade with the EU would be significantly impaired. Trade with countries that the EU has negotiated Free Trade Deals with would also be impacted. Given the potential changes to market access and free movement of goods, it is possible that Scottish exports could fall by 10% - 20%. Imports from the EU would fall too, which may provide some opportunity for Scottish companies to refocus on domestic markets.

In the event of a disorderly No Deal Brexit, Scotland's trade with the would be significantly impaired. Trade with countries that the has negotiated Free Trade Deals with would also be impacted. Given the potential changes to market access and free movement of goods, it is possible that Scottish exports could fall by 10% - 20%. Imports from the would fall too, which may provide some opportunity for Scottish companies to refocus on domestic markets. Investment: Heightened economic uncertainty as a result of Brexit could reduce business investment in Scotland by £1 billion in 2019 [1] . Analysis by the Bank of England suggests that Foreign Direct Investment ( FDI ) into the UK would fall by around 20% over the coming years under a No Deal scenario. [2]

Heightened economic uncertainty as a result of Brexit could reduce business investment in Scotland by £1 billion in 2019 . Analysis by the Bank of England suggests that Foreign Direct Investment ( ) into the would fall by around 20% over the coming years under a No Deal scenario. Exchange Rate: A fall in exports and overseas investment, coupled with a broader reappraisal of the UK 's economic prospects, would reduce the demand for Sterling. Exchange rate movements in response to previous economic shocks suggests that a 10% - 30% depreciation could occur in the event of a No Deal Brexit.

A fall in exports and overseas investment, coupled with a broader reappraisal of the 's economic prospects, would reduce the demand for Sterling. Exchange rate movements in response to previous economic shocks suggests that a 10% - 30% depreciation could occur in the event of a No Deal Brexit. Inflation and Interest Rates: The Bank of England forecast that CPI would rise steadily in the event of a No Deal Brexit, peaking at 4.25% - 6.5% in 2020. They forecast that this would require interest rates to average 1.5% - 4% over the next three years. [3] However, the Bank's immediate response may be to reduce Bank Rate to support demand in the economy.

The Bank of England forecast that would rise steadily in the event of a No Deal Brexit, peaking at 4.25% - 6.5% in 2020. They forecast that this would require interest rates to average 1.5% - 4% over the next three years. However, the Bank's immediate response may be to reduce Bank Rate to support demand in the economy. Migration: International net migration into Scotland, currently +13,000 a year [4] , will fall and could even turn negative as a result of a depreciation in Sterling and wider economic slowdown.

International net migration into Scotland, currently +13,000 a year , will fall and could even turn negative as a result of a depreciation in Sterling and wider economic slowdown. Labour Market: An economic slowdown would be expected to result in the rate of unemployment increasing to between 5.5% - 8%, from its current rate of around 4%. If the unemployment rate were to increase in line with the top end of this range, the increase would be equivalent to the number of people unemployed rising by around 100,000.

An economic slowdown would be expected to result in the rate of unemployment increasing to between 5.5% - 8%, from its current rate of around 4%. If the unemployment rate were to increase in line with the top end of this range, the increase would be equivalent to the number of people unemployed rising by around 100,000. Overall Economic Implications: Collectively, the above pressures have the potential to push the Scottish economy into recession during 2019. Based on the response to the Scottish and UK economies to previous economic shocks, there is the potential for GDP to contract by between 2.5% - 7% by the end of 2019 depending on the way in which a No Deal Brexit outcome evolves.

Over time, the Scottish economy would be expected to return to growth, albeit at a lower level than would occur were the UK to remain in the EU . The speed with which the economy returns to growth would depend on the time taken to mitigate the disruption caused under a No Deal Brexit. The longer that the initial shock persists, the greater the risk that it develops into a wider economic slowdown from which it would take longer to recover.

Figure 2 - Projected GDP Index Path

Figure 3 - Projected Unemployment Rate

Source: Scottish Government analysis

Sectoral and Regional Implications

The impact of a No Deal Brexit economic shock will not be uniform across Scotland.

Agriculture and Fishing, Transport Equipment, Chemicals, Pharmaceuticals, Food and Construction are anticipated to see the greatest impact, however, all sectors would be negatively affected.

The local authorities with the highest concentration of workers in the above sectors is summarised in Figure 4. For agriculture and fishing, this is typically in more rural areas, reflecting the higher levels of employment in those sectors.

Figure 4 - Local Authorities: Proportion of Workforce in Sectors Most Exposed to a No Deal Brexit

<10% 10% - 14% 15% - 19% 20% - 24% 25%+ Dundee

Edinburgh Stirling

West Dunbartonshire

Aberdeen City

East Dunbartonshire

Inverclyde

Glasgow City Highland

South Lanarkshire

Argyll and Bute

West Lothian

Perth and Kinross

Midlothian

North Ayrshire

Fife

South Ayrshire

East Lothian

East Renfrewshire

Clackmannanshire

East Ayrshire North Lanarkshire

Na h-Eileanan Siar

Dumfries & Galloway

Renfrewshire

Scottish Borders Shetland

Moray

Orkney

Angus

Aberdeenshire

Falkirk

There are a range of other metrics which can be used to assess the areas of Scotland which could be most exposed to a No Deal Brexit. For example, the proportion of EU workers in a given locality. As a share of the workforce residing in an area, the areas with the highest levels of EU employment are Edinburgh (14% of all in employment in the area), Aberdeen (12%) and Aberdeenshire (7%). Additionally, in rural agricultural areas, there will be high level of exposure and reliance on short-term seasonal employment of EU nationals.

Longer Term Economic Implications of Brexit

It should be noted that the current Withdrawal Agreement only covers the terms of the UK 's departure from the EU .

The Political Declaration accompanying the Withdrawal Agreement does not set out in any detail the future economic relationship between the UK and EU . Further negotiations are still required to ensure a trade deal is in place at the end of the proposed transition period. It is therefore possible that even if the current Withdrawal Agreement and Political Declaration are approved by both the UK and European Parliaments before March 29, the risk of a disorderly No Deal outcome could re-emerge at a future date.

Previous analysis by the Scottish Government has considered the long term implications of Membership of the European Economic Area ( EEA ), a Free Trade Agreement: outside the Single Market and Customs Union, and a World Trade Organisation style relationship[5].

All three are estimated to result in a permanent decrease in GDP relative to continued full EU membership. The magnitude increases the looser the relationship with the EU becomes. The key results from the modelling are summarised in the table below.

Figure 5 - Headline Macroeconomic Indicators by 2030 relative to a baseline of Full EU Membership

GDP

(%) GDP Per Capita in 2016 Cash Prices

(£) Real Disposable Income

(%) Business Investment

(%) EEA -2.7% -£688 -1.4% -2.9% FTA -6.1% -£1,610 -7.4% -7.7% WTO -8.5% -£2,263 -9.6% -10.2%