A ‘No Deal’ Brexit will create an economic emergency
The rationale is set out below in terms of immediate disruption, business investment, macro-economic position, regional impacts, medium-term prospects and the longer term. It is considered likely that the impact of all of these factors will have a sufficiently detrimental effect – that any potential long-term upside (argued by some) will struggle to overcome the poor compound growth rate of a short-medium term slowdown. In other words, even the optimistic long-term view of hardliners will fail to address the short-term harm created for a generation.
This is not project fear and the IED is absolutely non-political. So why do I take this stance on ‘No Deal’? These are the facts, as I see them:
1. Immediate disruption
According to the Government’s own analysis, a ‘No Deal’ Brexit will result in additional paperwork, border delays, an immediate imposition of tariffs on large numbers of outbound goods and fewer tariffs to be charged by the UK.
This only creates economic ills. Additional paperwork takes time, inevitably impacting on profit margins. Border delays will result in lost export orders or the need to increase inventory to cope with additional days of stock sat in transit.
Tariff imposition will either make UK goods more expensive overseas (reducing sales) or will force exporters to cut their prices (reducing margin). The UK Government has set out its proposed tariff regime and also set out a light-touch approach. This means that for a large number of products, the cost of imports from outside the EU will fall – undermining UK suppliers. There is a view that food and fuel will be two product areas significantly affected – essential products where price rises have a disproportionate effect on lower income groups.
There is no upside in the immediate aftermath of a ‘No Deal’ Brexit. Some companies may benefit (from stockholding and subsequent higher charges to consumers, for example) but the overall impact on the whole economy is neutral.
There is an argument about scale, however it is clear that the immediate economic impact of a ‘No Deal’ Brexit is entirely negative.
2. Business investment
Analysis has shown that whilst the economy has avoided a recession since the EU referendum, business investment has declined. Cash hoarding on balance sheets is increasing and commercial borrowing is declining.
Negotiation of a favourable and known deal could release this pent up investment potential – but a ‘No Deal’ scenario continues uncertainty for a considerable period. Business impacted by increased export difficulties, or concerned about its competitiveness position in the face of suddenly reduced tariffs on imports, risks investment capital until the competitive environment is clearer.
There is no conceivable position where business investment increases in the short-term after a ‘No Deal’ Brexit – it may recover as a response to the new trading environment, but in the immediate term it will decline. Again, there is an argument to be made about scale, but it is clear that the immediate business investment impact of a ‘No Deal’ Brexit is entirely negative.
3. Macro-economic position
The macro-economic position of a ‘No Deal’ Brexit can be considered from a number of perspectives. In the short-term, from a narrow perspective, the evidence has shown that sterling has come under pressure amid uncertainty.
A ‘No Deal Brexit’ is likely to result in further deterioration in the value of the pound. This will lead to inflationary pressures as a result of the increase in the cost of imported goods – and this will be exacerbated by the tariff impact on some products. Inflationary pressures will immediately reduce consumer demand but they are also likely to increase pressure on the Bank of England to increase interest rates to meet their long-term inflation targets. This will further impact on consumer spending. It will also result in greater economic hardship for the elements of society most reliant on borrowings.
A responding Government stimulus effect through spending or fiscal measures is made difficult through the continued public sector deficit position. It is, therefore, difficult to envisage anything other than a negative macro policy position resulting from ‘No Deal’ in the short-term.
4. Regional impacts
The immediate downsides of a ‘No Deal Brexit’ set out above suggest that lower income groups will be disproportionately affected (high proportion of spend on food, fuel and interest charges) and businesses involved in import/export trade (manufacturing, wholesale, retail) will face disruption. In addition, any business focused on domestic discretionary spend is also likely to be affected by a general economic slowdown.
The result is that knowledge-driven, high-value added, flexible and fast-moving economies are likely to be least affected whilst those economies that are structurally more traditional will be less able to adapt. Generalisations in this area are dangerous but it is easy to foresee a scenario where the digital cluster of Liverpool Street, London (Silicon Roundabout) adapts and continues to grow compared to the automotive branch plant economies of Sunderland or Ellesmere Port.
Economic analysis has suggested that a ‘No Deal’ Brexit will worsen and hasten economic divides despite those economies being left behind in economic terms tending to favour Brexit.
Certainly, whilst the scale is debatable, there is no foreseeable prospect of poorer and more traditional economy dependent regions out-performing others in a ‘No Deal’ Brexit world.
5. Medium-term prospects
Short-term prospects after a ‘No Deal’ are regarded as definitely negative – and perhaps very negative. Medium prospects are more difficult to predict – but one area that the economic debate has somewhat overlooked is the impact of overseas ownership on the UK economy.
Globalisation has resulted in flows of capital that have resulted in large changes in the ownership and control of companies. The UK has been particularly laissez-faire in policy regarding change of ownership of influential businesses – European businesses typically allow business councils influence over such decisions.
Whether the influx of new foreign capital and influence into originally UK-owned businesses is a good idea is a matter for debate. Certainly, over a period of economic and legislative stability the outcomes would seem to have been relatively benign. In a period, however, of major economic disruption and uncertainty, there is a risk that remote UK subsidiaries bidding for Head Office investment against competing locations will now be disadvantaged.
Large-scale foreign ownership, built up over time, may now result in a gradual flight of capital from the UK economy – and this capital is more likely to have been sticky if business had remained UK-owned. Government statements and business reporting in this area suggests that the level of foreign influence in UK corporate activity is significantly under-estimated.
A further note on foreign ownership of the more dynamic businesses is that export policy is likely to be controlled from head office. The continued clamour for an increase in UK businesses to export is impacted by the ownership and control structure – German-owned businesses are likely to use their UK subsidiaries for the UK market, expansion to meet global needs is more likely to take place near head office – especially if UK exports face increased tariffs.
Medium-term, therefore, I do not recognise any credible arguments for an economic upside – but continue to see a rationale for pessimism in the event of a ‘No Deal’ Brexit.
6. Longer term
It is difficult to provide any certainty on a long-term position – and I would question any organisation that appears able to offer such a view.
One very well-evidenced economic model that does help predict future trade and investment with overseas markets is ‘Gravity Modelling’. Simply put, all other things being equal, economic links are most likely with the largest and closest markets. This predicts that shoppers in Reading, if they leave Reading, are more likely to shop in London than Bristol.
Extrapolating this view, even if the German market becomes difficult for UK exporters, it is unlikely that the volume lost in sales will manage to find markets in the Far East. Equally, any investment lost to the UK from EU neighbours is unlikely to be replaced by investment from strongly-performing Asian economies who continue to see huge opportunities on their own doorstep. All in all, therefore, the arguments for long-term upsides are fundamentally difficult to fully reconcile with long-term economic evidence.
In summary – in my opinion, a ‘No Deal’ Brexit is an act of economic self-harm. It is considered to be particularly pernicious because not only is it likely to damage the economy irrevocably, the expectation is that it will damage the regional economies and economic groups least able to adapt. On this basis it represents an economic emergency.
Nigel Wilcock is Executive Director of the Institute of Economic Development