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Brexit: The Weakest Link in the Production Chain?

Germany and the United Kingdom have forged close production networks, which are threatened by Brexit. A new study commissioned by the Bertelsmann Stiftung shows in which sectors particularly tight value chains exist and therefore the highest costs are to be expected due to Brexit.

For the UK, Germany is the second most important export market (after the USA), while the UK is the fourth most important export market for Germany. Germany buys goods and services worth 115 billion euros from Great Britain, whereas Great Britain still buys 70 billion goods and services from Germany. Brexit inevitably leads to an increase in trade costs. A new study examines to what extent value chains between the two countries are exposed to this increase.

Value-added is the additional value that an additional production step adds to an intermediate product. Import and export statistics show how much value-added was created along a production chain in each participating country. On this basis, this study examines how much British value-added is processed in German industries and, conversely, how much German and European value-added is processed in British industries. Since trade costs will rise as a result of Brexit, there is a need for adjustment in the German sectors which are particularly closely linked to Great Britain and vice versa – either by passing on the higher production prices or by shifting production steps away from Great Britain. For example, if a German car manufacturer is currently importing a part from the UK to be used in its cars worth 100 Euros, tariffs will increase that price to 110 Euros. That might make it worthwhile for the manufacturer to source that part elsewhere, say Poland, where there is a manufacturer that makes the same for 105 Euros. In this example, the British producer and the consumer loses as the part is no longer made in the cheapest available place.

For Germany, the study shows that there is a considerable need for adjustment in individual sectors, but this tends to be in sectors that account for a smaller share of the total value-added of the German economy (see graph).

For the UK, on the other hand, we can see that the need for adjustment is much greater and that there is also a more important need for adjustment in economically significant sectors.

In value-added chains, every step is performed by the best supplier of that task. If they are being artificially distorted by tariffs, this will impact price and quality, bitting producers and consumers. This is true for Germany, but even more so for the United Kingdom.

Christian Bluth, economist at the Bertelsmann Stiftung

Which German Sectors Are Most Strongly Affected?

For Germany, the main industries exporting value-added into the United Kingdom are business services (4.2 billion), wholesale trade (3.8 billion), pharmaceuticals (3.6 billion), automotive (3 billion) and chemicals (2.9 billion). The most important sectors importing British value-added into Germany are also the automotive industry (4.9 billion) and mechanical engineering (2.6 billion), but also construction (2.6 billion), the food industry (2.1 billion) and mining (1.9 billion). In relative terms, pharmaceuticals, metal work, coking, other vehicle construction and chemistry are the German sectors with the strongest dependency on the British economy.

Which British Sectors Are Most Strongly Affected?

For the United Kingdom, the most important export sectors of value-added into Germany are wholesale trade (2.9 billion), legal and tax consultancy (2.9 billion), business services (2.8 billion), mining (2.7 billion) and financial services (1.9 billion). The most important import sectors of value-added from Germany are healthcare (10.1 billion), automotive (5 billion), construction (4.7 billion) and public administration (3.8 billion). In relative terms, chemistry, metal work, mining and the automotive industry show the highest degree of dependency on the German economy.

For the United Kingdom Brexit will change trade relations not only with Germany but the entire EU. The level of value-added contributions from the EU in British products is much higher than the content of German value-added in British goods. Similarly, the demand for British value-added and final products from the EU is substantial. This implies a much higher need of adjustment. For the most important British sectors, it is highest in business services, wholesale, motor trade and legal and tax consultancy.

Background Information

This study was commissioned by Bertelsmann Stiftung from Prognos AG. The calculatations are based on the World Input Output Database (WIOD) for 2014 where values have been adjusted to the year 2017.

Value-added refers to the additional value created by a production step. The sum of the value-added of all production steps is equal to the final value of the product. The value created in a specific country as part of an international production chain can be measured. It is also possible to measure the value-added content in imports and exports of intermediates between different countries. These exports and imports are also referred to as trade in value-added or value-added trade. Intermediates trade merely captures the final value-added step and additionally assigns all value-added contributions of previous steps to the supplier of intermediates. In an international comparison, countries with a low value-added share in trade are typically countries where simple assembly of intermediate products is carried out.