It’s impossible to say where Brexit leaves us at the moment, and to an extent the experts don’t seem to know either – they seem to be reacting rather than being proactive, says Adam Bernstein.
LOOKING back at the span of time between the EU referendum and now, it’s fair to ask if Brexit made a difference and if there are other geopolitical influences affecting the country at present?
A false start
Before starting, it shouldn’t be forgotten that once the UK left the EU on 31 January 2020, Brexit and the EU-UK Trade and Cooperation Agreement (TCA) didn’t fully take effect until the expiry of an 11-month transitional period on 31 December of that year.
At the time, the then prime minister Boris Johnson hailed the agreement as his Christmas gift to the nation. However, it wasn’t long before there were calls to renegotiate the rules that applied to Northern Ireland, which, for trading purposes remained inside the EU. And the threat of political instability in the province has remained close to the surface as the Northern Ireland Protocol effectively created a trade border in the Irish Sea.
But let’s not forget the referendum led to sterling falling against the euro. Just before the vote in June 2016, sterling was worth around €1.26. By October 2016 it was close to €1.11. The devaluation was great for exporters but lousy for importers and those buying domestically.
In fact, the London School of Economics (LSE) has said that a year after the referendum, sterling settled at more than 12% below its previous level, and the higher price of imports led to higher inflation which has cost households around £870 per year.
Growing pains
Of course, the Covid-19 pandemic has made meaningful comparisons between the UK’s recent economic performance and economies in Europe hard to make precisely because of the disrupting nature of the pandemic.
However, Investment Monitor ran the numbers in January 2022 as best as it could – using data from the OECD that covered the period Q2 2016 to Q3 2021 – and made some interesting observations. It found that UK’s GDP growth of 14.3 percent over that time frame trailed that of various European states. In particular, Germany’s economy grew 32.2 percent, Spain’s by 25.6 percent, France’s by 23 percent while even moribund Italy grew by 16.3 percent.
That said, it’s important to remember that statistics can be used to prove anything and are invariably a function of their time. Consider that both Spain and Italy suffered following the 2008 financial crisis and so were growing from lower positions.
Italy’s GDP growth, for example, has – according to World Bank data – been on a declining path from a high point of 8.2 percent in 1961 to 1.7 percent in 2017. With a negative 9% in 2020 it rebounded to 6.6 percent in 2021. The UK, in comparison, saw growth in 1960 of 2.7%, and – barring odd peaks and troughs – growth of about 2%. Yes, like other economies it dropped – to negative 9.3% in 2020 following Covid-19, but it too recovered to 7.4%.
Now look at those percentages in dollar terms. According to the World Bank, Italy’s economy was worth $2.086tn in 2012 and the UK’s was worth $2.719tn. In 2015 the Italian economy stood at $1.836tn while the UK was at $2.956tn. And in 2021, Italy’s economy was valued at $2.099tn while the UK was worth $2.756tn. You get the point about percentages – it’s all relative.
That said, going forward government’s own Office for Budget Responsibility considers Brexit will be worse for the UK economy than Covid-19. It thinks Brexit will reduce the UK’s potential GDP by 4% with Covid-19 taking another 2% on top of that.
Changing trade patterns
Post-Brexit, government clearly wants UK export to target parts of the world other than the EU. However, while trade deals are being inked, it’s a slow process. Agreements have been signed with a number of major countries including Canada, Israel, Mexico, Singapore, South Korea, and Switzerland. The US eludes the list. But the rest, such as Lebanon, Albania, the Faroe Islands, and the Soloman Islands, are not global players and are of minimal impact to the UK. You can see the latest state of play at https://bit.ly/3T7Un2x.
Moreover, a recent report from the LSE stated that the UK has become a more closed economy as a result of Brexit. Interestingly, the LSE found the post-Brexit agreement with the EU didn’t lead to huge or persistent drops in trade with Europe when compared to trade with the rest of the world. Instead, it’s made the UK less competitive.
The LSE goes on to say that Brexit affected – for three years at least – UK business investment as firms were uncertain about their future trading terms; investment dropped by 0.1% per quarter compared to a rise of 1.7% per quarter. However, it also found that while some thought that exports would be more competitive following the devaluation of sterling, the reality is the UK’s exports to, and imports from, the EU changed little in the period immediately following the referendum.
However, significant change did take place after the TCA, but here we’re into the realms of disentangling trade data from Covid-19-related data. As traders well know, Covid-19 greatly interrupted manufacturing operations, halted distribution, and sent shipping costs through the roof as the world reopened – all because of rising fuel costs and containers being in the wrong locations. But again, put in context, data from the Bank of England found that in 2020, global trade fell by 8.9 percent, the steepest drop since the global financial crisis – and that was at a time when the TCA came into effect.
So, we’ve had the TCA for nearly two years and, although UK imports from the EU have now fallen relative to the rest of the world, the LSE sees no clear evidence of this occurring for UK exports to the EU.
Future of the UK economy
Thus, it looks like Brexit hasn’t transformed the UK economy. Instead, the LSE’s modelling believes that just 132,000 people will have had to make a change in employment as a result of Brexit, and this is partly because of the way the economy is structured. The UK will remain a services-dominated economy with a smaller manufacturing sector than France; the great manufacturing revival is unlikely to happen.
What Brexit is likely to do is make the UK less competitive and workers poorer as real pay declines. And this leads us to the next set of problems that the UK – and in fact, the world in general – is facing, that is, the changing nature of global trade, the rise of high inflation, and the weaponisation of food and energy.
Looking at the first, globalisation, it has been under threat for a while now. In recent times, former President Trump placed tariffs on goods that he felt were undermining the US economy. His tariffs – mainly on Chinese goods, but some from the EU – led to ‘tit for tat’ responses and little benefit to the US; American consumers lost out as they ended up paying more for food, drink, cars, and their iPhones.
It’s telling that world leaders meeting in Davos this year felt 30 years of globalisation could go into reverse as nations further protect their interests after being burned by the effects of the pandemic, the Russian invasion of Ukraine, and the disruption of supply chains. It’s possible that the reshoring – the bringing home of manufacturing – could reduce the risk of supply interruption and may even be a boon for domestic firms, assuming of course, they can get the raw materials and at a sensible price.
It’s probably worth noting at this point that according to the Centre for Economics and Business Research, long-haul shipping costs had almost tripled compared with pre-pandemic levels because of higher fuel and container costs, surging demand for goods and port disruption caused by the war in Ukraine. The problem isn’t unique to the UK. In the US, the Biden administration accused companies that control the Pacific shipping sector of raising prices by 1,000% and effectively stoking inflation.
On rising inflation, there’s a real risk that what was considered less than 12 months ago to be a transitory rise in inflation could become engrained for quite some time. The Bank of England has a target for inflation of 2%, but in August it was recorded as being 10.1%. That means prices now are 10.1% higher than a year ago. The bank expects the rate to slow down and settle around 2% in two years’ time. And to get inflation down it’s raising its base rate – it’s now 1.75% but some expect that it could end up about 6-7% next year, especially if Liz Truss wins the Conservative Party leadership and lowers taxes and as a result, further pushes up inflation.
For the UK there’s a distinct prospect of stagflation – a stagnant economy, high unemployment and inflation which perpetuates itself. Here measures to counter inflation actually force unemployment up in a vicious circle.
The problem with inflation is that prices rise but rarely fall. Demand-led commodities such as oil and gold are good examples of items that do drop, but unless a market making trader breaks ranks and lowers product prices that spurs a competitive race downwards, firms and consumers will be left coping with diminished purchasing power.
And of course, inflation hasn’t been helped by Russia’s actions; the UK gets just 5% of its gas from Russia, but the fuel is priced on the world market so no matter what government does, it cannot change the price charged. Similarly, wage price inflation has been exacerbated by what has been termed the ‘Big Quit’ where many, especially the over-50s, have left the world of employment following the impact of Covid-19 and a readjustment of their priorities. That’s left fewer employees changing a multitude of jobs and so having the whip hand when demanding pay – and pay rises.
In summary
So, where does this leave us? It’s impossible to say, and to an extent the experts don’t seem to know either – they seem to be reacting rather than being proactive.
Late last year the Bank of England and US Federal Reserve thought inflation was a temporary issue and so took no action. Clearly they were wrong. Then there’s the fiscal firepower of the central banks and the desire – ability – of governments to effectively print money and borrow to help individuals in need. That’s inflationary. And beyond that there are players such as Vladimir Putin whose crass actions in Ukraine have caused global mayhem and affected the poorest people in society and the poorest of nations. Yes, India and China have bought cheap oil, but the rest of the world is smarting and that’s not great for anyone.
But there’s one saving grace. There’s a phrase – ‘when the US sneezes the world catches a cold’. Well, thankfully it appears US employment rates are holding up and inflation over there is expected to peak soon.
