Sunday 24 March 2019

Brendan Keenan: 'The economy could be in for a jolt even if Brexit is delayed or reversed'

UK Prime Minister Theresa May and EU European Commission President Jean-Claude Juncker met last night as the Brexit clock counts down with huge implications for Ireland. Photo: Bloomberg
UK Prime Minister Theresa May and EU European Commission President Jean-Claude Juncker met last night as the Brexit clock counts down with huge implications for Ireland. Photo: Bloomberg
Brendan Keenan

Brendan Keenan

There are sad stories going around about British banks which have moved headquarters to the EU-27 to be sure of 'passporting' rights, only to find that their customers are unsure whether to follow them.

Not that bank customers are the only ones who are uncertain. Everybody is, as tragedy descends into farce. Anything could happen at a day's notice. More likely, alas, is that nothing much will happen at all.

Companies, and governments, face an acute dilemma when it comes to taking firm decisions. All they can do is have contingency plans - and they may need more than one. There is a risk if their plans cover only a no-deal Brexit, or a very hard one with little or no transition arrangements.

As Edgar Morgenroth, economics professor at DCU Business School, put it last week, a 'soft' Brexit does not get rid of the Border problem entirely and would change the general economic relationship between Ireland and the UK, but also between Ireland and the EU.

Just to make things worse, there is the possibility that in the end there will be no Brexit at all, either through a second referendum or a newly-elected British government. It looks a remote possibility, but who wants to waste large sums of money getting ready for uncertain alternatives?

They are probably even less inclined to think about the implications of a soft exit, or no exit but perhaps they should. According to new analysis from ratings agency DBRS, government in particular should be braced for a quite different set of problems which good news may bring.

No wonder they call it the dismal science. It's like the bad, cop, good cop routine; but they're both cops. The bad one has received a lot of attention, and since he seems to be in charge right now, it is worth recalling again how nasty he can be.

Irish calculations about this are a bit more benign than some of the foreign ones. If there is a no-deal Brexit, the Department of Finance thinks the cost after five years will be a reduction of more than 3pc of GDP, as compared with the situation where none of this had happened.

That may not sound too much, except that most disruption will occur at the beginning; it will affect the most socially- and politically-important sector most, and this is GDP - so the loss in national income would be closer to 4pc.

Foreign analysts are even more gloomy. The Bank of England has drilled down a bit, estimating the effects of what it calls a disruptive Brexit and a disorderly Brexit. In the first, tariffs and other barriers to trade between the UK and EU are introduced suddenly and no new trade deals are implemented within the five-year period; in the second, in addition to this, the UK's border infrastructure is assumed to be unable to cope smoothly with customs requirements.

According to the bank, a disruptive break would see a cost in lost output of 6pc over the five years, rising to 8pc in a disorderly one. Everyone agrees that the losses will not be recovered in the longer term either.

The department calculates a 4pc GDP loss after 10 years, which is in line with other domestic forecasts. Copenhagen Economics puts it at 7pc, but the BoE thinks all the damage will have been done in the first five years - meaning those years will be worse than other forecasters think.

One cannot really be precise about such an uncertain future but there is disagreement even about the present. Brexiteers have made much of the apparent resilience of the UK economy; in particular Bank of England warnings after the referendum result which did not come to pass. In this age of soundbites, it has almost become conventional wisdom that nothing has happened, not just recession, leading to a certain acceptance of the pro-Brexit line that this will continue to be the case, even with a disruptive exit.

But the idea that there has been no effect at all on the UK economy is plain wrong and the truth gives no support to cheery optimism about Brexit. The evidence was clear in last week's official statistics which showed business investment down in the four consecutive quarters of last year.

Investment often leads the way and output actually fell 0.4pc in December - an annualised rate of almost 5pc, don't forget. So far, we have had the near-invisible effect of growth being slower than it would have been. This may be replaced by actual falls in the current three months, according to some forecasts, and perhaps recession in the first half of the year.

Whether there is an actual downturn or not, those invisible "would have been" losses are considerable. One UK analysis says they amount to 4pc of household purchasing power - €1,500 in the currently fashionable way of measuring.

Applying the same method to those Irish projections gives something like a €2,500 blow to household income gains. DBRS thinks the Brexit uncertainty is having some effect on the Irish economy already. The early signs it sees include a substantial slackening of consumer confidence and some easing of employment growth. Nothing serious as yet, but it highlights the unusual bit of this analysis - that a Brexit-induced slowdown might not be entirely a bad thing. That is based on a belief that the economy is operating at full capacity and the danger, Brexit aside, is overheating.

Such estimations are an inexact science, especially in a small open economy. One area where there can be little doubt, however, is construction. Price inflation is well into double figures, as we have seen from the children's hospital saga. The industry federation has identified serious shortage of skilled workers.

That is hardly surprising. The danger was foreseen some years back, given the need for more construction, not less, to deal with the housing shortage. Dealing with Brexit itself will require a lot of infrastructure investment, in ports, shipping and energy among others.

Even if the supply constraints can be overcome in some way, revenues would have to be diverted from current spending; exactly the opposite of what Irish governments like to do but necessary, perhaps, to avoid overheating and an inflationary spiral.

Like most observers, DBRS do not think this is a re-run of 2007. There is no credit bubble and, while the economy looks to be at or near full employment, the jobs appear to be of higher quality than during the easy money boom.

We are looking at something different, not seen since the 1990s, where the growth is solid genuine but eventually outstrips the country's resources, of labour in particular. Back then, governments were unwilling to try to slow things down. There is no evidence that today's are any different but Brexit might do the job for them.

The cruel paradox is that a Brexit solution - even one which did no more than install a transition period with no change for a few years - could give the economy a boost which it really does not need.

It is not just companies that are uncertain what to do. Financial markets - especially currency markets - are hedging against all possible outcomes. When we finally get one, there will be sharp adjustments, whether down or up.

A plunge in sterling and sudden disruption of trade will certainly remove the immediate overheating danger. There may be further assistance from the EU but cash, no matter how plentiful is just a palliative while the hard graft of finding new markets, new logistics and cost reductions goes on.

It is much less clear what the response could or should be to a happier Brexit outcome. The ratings agency thinks the 20pc sterling depreciation since 2016 would largely be reversed. Not as bad for exporters as the further falls which a hard Brexit is expected to bring, but it could fuel considerable price inflation in an already hot economy.

DBRS notes that wage growth of 3.2pc to the third quarter of last year was more than double the average rate from 2014 to 2017 and that, over the past 20 years, when the unemployment rate fell below 5pc wages rose 4-8pc.

One can easily imagine that trend accelerating in the relief and euphoria which would follow a Brexit deal. This would still be the better outcome but, even with the best will in the world, governments' ability to deal with overheating is limited when there is no national currency and interest rate.

There may not be the best will in the world. The different economic scenarios continue into politics. A Brexit crisis might see the Dáil run its full term but success would surely be followed by a 'victory election' in which cooling the economy will play no part.

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