Sunday 25 August 2019

Dan O'Brien: The UK: doing better than Remainers care to admit

'The broader picture on the UK economy since the referendum is that the vote to leave has had surprisingly limited effect.'
'The broader picture on the UK economy since the referendum is that the vote to leave has had surprisingly limited effect.'
Dan O'Brien

Dan O'Brien

How have all things related to Brexit affected the UK economy and how will that economy evolve in the run-up to Brexit in March 2019? These questions have fallen victim to the deepening partisanship that has taken hold across the water. Since the referendum to leave the EU in June of last year, many normally balanced individuals and organisations appear to have had their analytical capacities impaired by their feelings on the issue.

While the pro-Brexit side was never analytically strong in the first place, the change has been more marked among Remainers.

That was in evidence two weeks ago when the lastest UK economic growth figures were published. They showed that British GDP growth accelerated (slightly) in the third quarter of this year, growing by a very respectable 0.4pc compared to the previous three-month period.

If your only source of information was Remain-leaning analysts and outlets, you might well have missed this pretty decent news on the British economy. It was downplayed considerably.

The broader picture on the UK economy since the referendum is that the vote to leave has had surprisingly limited effect. In the second half of 2016 there was no discernible impact at all on GDP.

As the chart shows, it continued to grow strongly in both the third and fourth quarters.

The other big measure of economic activity is employment. Jobs growth slowed sharply in the quarter immediately after the referendum, but has since returned to strong growth.

As of August 2017, the most recent month for which figures are available, the UK jobless rate had reached a 42-year low of 4.3pc. Long-standing issues around the productivity of British workers aside, all the short term labour market indicators point to an economy doing pretty well.

Let's now return to more recent GDP figures. In the first three quarters of 2017, growth has been lower, if only modestly, than in recent years. What explains this slowdown and is it Brexit-related?

First off, given that most indicators of momentum in the British economy remain solid for the most part, a few quarters of slower GDP growth, after four years of strong growth, is not unusual.

Nor have the rates of growth recorded much below what economists believe to be in line with the UK's longer run growth potential.

That said, the softness does have an explanation, and it is Brexit-related.

The biggest spending component of GDP is household purchases of goods and services. The volume of household spending has slowed significantly since the referendum, dragging down overall GDP.

The most obvious explanation for this are developments in earnings, which turned negative early this year when adjusted for inflation. That, in turn, is a result of the Brexit-linked fall in the value of sterling vis a vis other major currencies. A weaker exchange rate causes prices of imported goods and services to rise. If wages don't rise to match inflation, then incomes are eroded. That is exactly what has been happening in the UK as a result of the depreciation of sterling between late 2015 and late 2016.

Since then, however, the pound has been broadly stable vis-a-vis the euro and dollar. And it is exactly this broad stability over the past year that is a major reason to be optimistic about the British economy's short-term prospects.

Because there has not been a further depreciation of the pound, the spike in imported inflation should start fading soon. If that happens, the inflation-eroding effect on incomes will ease. That would push real incomes back into growth territory.

If the tight labour market pushes pay up further, and a survey of employers by the Bank of England last week suggested it would, then it is plausible to believe that 2018 will be another decent year for the British economy.

It is also perfectly possible that a more negative dynamic will take hold. That may sound to readers like the stereotypical two-handed economist, but trying to do economic forecasting when something as unprecedented as Brexit is about to happen is even harder than in normal circumstances. The part of the economy that Brexit uncertainty was always likely to have the biggest impact on is investment in productive capacity.

Purchases of plant, equipment, premises and IT are done mostly by businesses, although the state and non-profits also contribute. When managers and executives sit down to consider their organisations' investment decisions they consider many factors. One factor that has a universally-dampening effect on investment spending is uncertainty.

Brexit is an uncertainty-generating dynamo, and it is becoming more so as the risk of a no-deal Brexit rises. The concern and frustration of the business community was well reflected last week by the Dubliner who heads of the Confederation of British Industry.

While hosting British prime minister Theresa May at his organisation's annual conference, Paul Drechsler likened her government's approach to Brexit talks to a weekly soap opera.

But if there is a lot of concern in the business community about how Brexit will play out, it has - quite remarkably - yet to have an impact on investment in productive capacity.

Since the referendum, the biggest economic surprise has been how well investment has held up. As of the second quarter of this year, the most recent figure available, spending on capital goods continued to grow solidly.

The biggest short-term risk to the UK outlook is if companies take fright and cancel investment decisions as Brexit uncertainty increases.

If, however, that uncertainty ends with an agreement on an extended transition period, in which the EU-UK relationship remains largely unchanged, then companies will breathe a sigh of relief.

Despite all the confusion around the Brussels-London negotiations, it must be more likely that whoever leads the UK over the next couple of years will decide against leaping off the Brexit cliff in March 2019.

None of this is to suggest that Brexit will be any thing but bad for the UK economy in the medium and long term.

Putting up barriers to commerce with your most important partner for trade and investment will exacerbate many of the long-term weaknesses in the British economy, including low productivity and a poor export record.

It may, however, take many years for that to become apparent.

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