Making social science accessible

22 Nov 2017


Britain will remain a full member of the EU for another 16 months. None of our legal obligations have yet changed. We take part in the same institutions and carry on trading with each other in the single market as we did before. Yet the very process of exiting the EU is having an observable – adverse – effect on our economy now.

At the National Institute of Economic and Social Research we’ve been looking at this issue. Our latest forecast highlighted that average growth in the advanced economies has picked up from an annual rate of 1.6% in the middle of 2016 to 2.4% in the middle of this year. The strengthening of growth since 2016 is particularly clear in Canada, the Euro Area, and Japan.

The UK was among the fastest growing advanced economies before the EU Referendum but now appears to be moving in the opposite direction, having grown just an estimated 1.5% in the year to the third quarter of 2017. Compared to the pre-Referendum years this represents a material loss of momentum from annual rates of GDP growth of around 2 to 3 per cent.

In the commentary introducing NIESR’s latest Economic Review I observed that the slowdown in UK growth has almost certainly been caused by the uncertainty surrounding Brexit . This is having an adverse effect on current levels of capital investment and other productivity-enhancing activities.

Businesses exporting heavily to the EU are probably delaying investment decisions until they have more clarity about what type of trade deal will be struck in the ongoing negotiations, which will determine the amount of access they will enjoy beyond 29 March 2019.

The Bank of England–Nottingham–Stanford Decision Maker Panel (DMP) – a poll of senior executives from UK businesses – offers some concrete evidence of the shift. Panel members come from a diverse range of non-financial businesses. They have been surveyed on a monthly basis since the referendum, providing their assessment of current business conditions, and have become less positive about expected investment over the course of the year.

More evidence comes from the recently published EEF/Santander Annual Investment Monitor covering the manufacturing sector, showing that a third of respondents were only investing to satisfy current plans and were waiting for clarity on any deal before investing further, while thirteen per cent were holding off investment altogether until there was further clarity on a Brexit deal.

It’s no wonder that leading UK business organisations wrote to David Davis, Secretary of State for Exiting the European Union, saying that ‘we need agreement of transitional arrangements as soon as possible, as without urgent agreement many companies have serious decisions about investment and contingency plans to take at the start of 2018’.

But lack of investment is not the only factor bearing down on real incomes. Another is the weakening of the pound, which has fallen by 17.5% since its mid-November 2015 peak, making imported goods and services more expensive.

Had sterling not depreciated and the economy continued to grow at its previous rate, made likely by the improving global backdrop, real household disposable income might have been more than 2% higher than now, worth over £600 per annum to the average household.

What about the future? The state of health of our economy is inevitably tied up to the outcome of the Brexit negotiations. Our central forecast for the years ahead is for the economy to grow at a rate of about 1½ per cent a year. This is assuming a relatively soft Brexit, with an ‘implementation period’ of around two years after March 2019 where the UK essentially remains a member of the EU single market, in line with the PM’s Florence speech.

We have assumed that beyond 2021 the UK will trade with the EU on a tariff-free basis by way of a negotiated free trade agreement.   Initially this would allow free trade in goods and services because UK and EU regulations would be aligned as they are now, but over time non-tariff barriers to trade would increase as regulations diverge.

A relatively ‘soft’ Brexit of this type is a reasonable assumption because it seems in the interest of both the EU and the UK. That said, we are not necessarily confident that reasonableness will prevail in the current climate. There are many possible alternatives, including a disorderly cliff-edge Brexit, with all the attendant repercussions on businesses and household incomes.

New estimates, published in the National Institute Economic Review, suggest that leaving the EU without a deal and moving to WTO rules which would lead to tariffs being imposed on EU imports, would push up annual households bills by an additional £930.

Some will no doubt take exception at these studies (and there will be many more as time goes by and the outlines of a deal or lack of it begin to emerge) and accuse experts of excessive gloom and pessimism. But whatever bright, or indeed brighter, future might lie ahead for Britain after Brexit, the toll imposed on our economy by the very process of exiting our current arrangements and transitioning to new ones cannot be denied and should not be underestimated.

By Dr Garry Young, Director of Macroeconomics and Forecasting at the National Institute of Economic and Social Research.


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